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FINANCIAL RISK MANAGEMENT

Submitted by:
Awan
Registration No.:
Class:
Submitted to:

Muzammal Shahzad
7468-FMS/MBA/F16
MBA-18(B)
Sir Sagheer Ahmed

Financial Markets:
The financial market is a broad term describing any marketplace where trading of securities
including equities, bonds, currencies and derivatives occurs. Although some financial
markets are very small with little activity, some financial markets including the New York
Stock Exchange (NYSE) and the forex markets trade trillions of dollars of securities daily.
Investors have access to a large number of financial markets and exchanges representing a
vast array of financial products. Some of these markets have always been open to private
investors; others remained the exclusive domain of major international banks and financial
professionals until the very end of the twentieth century.
Following are the major types of financial markets:
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Capital Markets
Money Market
Cash or Spot Market
Derivatives Markets
Foreign Exchange Market

6 Interbank Market

1 Capital Markets:
A capital market is one in which individuals and institutions trade financial securities.
Organizations and institutions in the public and private sectors also often sell securities on
the capital markets in order to raise funds. Thus, this type of market is composed of both the
primary and secondary markets. Primary markets are those in which stocks or bonds are
issued for the first time and in secondary markets existing securities are traded. Any
government or corporation requires capital (funds) to finance its operations and to engage in
its own long-term investments. To do this, a company raises money through the sale of
securities - stocks and bonds in the company's name. These are bought and sold in the capital
markets.
Stock Markets
Stock markets allow investors to buy and sell shares in publicly traded companies. They are
one of the most vital areas of a market economy as they provide companies with access to
capital and investors with a slice of ownership in the company and the potential of gains
based on the company's future performance.
Bond Markets
A bond is a debt investment in which an investor loans money to an entity (corporate or
governmental), which borrows the funds for a defined period of time at a fixed interest rate.
Bonds can be bought and sold by investors on credit markets around the world. This market
is alternatively referred to as the debt, credit or fixed-income market. It is much larger in
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nominal terms that the world's stock markets. The main categories of bonds are corporate
bonds, municipal bonds, and U.S. Treasury bonds, notes and bills.

2 Money Market:
The money market is a segment of the financial market in which financial instruments with
high liquidity and very short maturities are traded. The money market is used by participants
as a means for borrowing and lending in the short term, from several days to just under a
year. Money market securities consist of negotiable certificates of deposit (CDs), banker's
acceptances, U.S. Treasury bills, commercial paper, municipal notes, Eurodollars, federal
funds and repurchase agreements (repos). Money market investments are also called cash
investments because of their short maturities.

3 Cash or Spot Market:


Investing in the cash or "spot" market is highly sophisticated, with opportunities for both big
losses and big gains. In the cash market, goods are sold for cash and are delivered
immediately. By the same token, contracts bought and sold on the spot market are
immediately effective. Prices are settled in cash "on the spot" at current market prices. This is
notably different from other markets, in which trades are determined at forward prices.

4 Derivatives Markets:
The derivative is named so for a reason: its value is derived from its underlying asset or
assets. A derivative is a contract, but in this case the contract price is determined by the
market price of the core asset. If that sounds complicated, it's because it is. The derivatives
market adds yet another layer of complexity and is therefore not ideal for inexperienced
traders looking to speculate. However, it can be used quite effectively as part of a risk
management program. Examples of common derivatives are forwards, futures, options,
swaps and contracts-for-difference (CFDs).

5 Foreign Exchange Market:


The forex market is where currencies are traded. The forex market is the largest, most liquid
market in the world with an average traded value that exceeds $1.9 trillion per day and
includes all of the currencies in the world. The forex is the largest market in the world in
terms of the total cash value traded, and any person, firm or country may participate in this
market. There is no central marketplace for currency exchange; trade is conducted over the
counter. The forex market is open 24 hours a day, five days a week and currencies are traded
worldwide among the major financial centers of London, New York, Tokyo, Zrich,
Frankfurt, Hong Kong, Singapore, Paris and Sydney.

6 Interbank Market:
The interbank market is the financial system and trading of currencies among banks and
financial institutions, excluding retail investors and smaller trading parties. While some
interbank trading is performed by banks on behalf of large customers, most interbank trading
takes place from the banks' own accounts.

Role of Financial Markets in Financial Economic System:


Financial markets play an important role in the mobilization of financial resources for long
term investment through financial intermediation. The existence of money markets facilitate
trading in short-term debt instruments to meet short-term needs of large users of funds such
as governments, banks and similar institutions. Government treasury bills and similar
securities, as well as company commercial bills, are examples of instruments traded in the
money market. A wide range of financial institutions, including merchant banks, commercial
banks, the central bank and other dealers operate in the money market. Public as well as
private sector operators make use of various financial instruments to raise and invest short
term funds which, if need be, can be quickly liquidated to satisfy short-term needs. Unlike
the money market, the capital market mobilizes long-term debt and equity finance for
investments in long-term assets. Capital markets also help to strengthen corporate financial
structure and improve the general solvency of the financial system.
Public as well as private sector operators make use of various financial instruments to raise
and invest short term funds which, if need be, can be quickly liquidated to satisfy short-term
needs. The Central Government, for instance, can borrow money from the general public to
finance long-term investment projects by issuing treasury notes or bonds. The proceeds from
the bonds issue can be used to build public hospitals, construct roads, provide public
transports, build airports, construct dams, or build other social infrastructures. This entails
national wealth creation for economic growth. The Government of Sierra Leone can mobilize
a huge amount of financial resources from the Capital Market to finance long term
development projects.
Investors make money in the Capital Market through buying and selling of financial
securities. When investors buy debt instruments like government bonds, municipal bonds or
corporate bonds, they receive an interest payment from the issuer of the debt security plus the
principal amount at the end of the loan period. The amount of interest payable to an investor
holding a debt security depends on the interest rate agreed by the loan contract. The higher
the interest rate on a debt security, the higher the expected interest payment. Thus, investors
create wealth in the capital market by investing in debt securities.
Suppose an individual invests in equities (i.e. common and preference shares). The investor
in this case becomes a shareholder or part owner of the company that issues the shares. As a
shareholder, the investor is entitled to receive a share of the Companys annual profit which
is distributed in the form of dividend. The amount of dividend received by an investor
depends on the number of shares he/she holds as well as the dividend policy of the company.
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Sometimes the company may decide not to pay dividend in cash but rather by issuing
additional shares to the existing shareholders. An investor may also decide to sell his/her
shares to make a capital gain. The receipt of dividend, bonus shares and capital gains from
selling shares all amount to wealth creation by the investor.
Large financial markets with lots of trading activity provide more liquidity for market
participants than thinner markets with few available securities and participants and thus
limited trading opportunities. The U.S. financial system is generally considered to be the
most, well developed in the world. Daily transactions in the financial markets, both the
money (short term, a year or less) and capital (over a year) markets, are huge. Many financial
assets are liquid; some may have secondary markets to facilitate the transfer of existing
financial assets at a low cost.
Financial markets play a critical role in the accumulation of capital and the production of
goods and services. The price of credit and returns on investment provide signals to
producers and consumers, financial market participants. Those signals help direct funds
(from savers, mainly households and businesses) to the consumers, businesses, governments,
and investors that would like to borrow money by connecting those who value the funds
most highly (i.e., are willing to pay a higher price, or interest rate), to willing lenders. In a
similar way, the existence of robust financial markets and institutions also facilitates the
international flow of funds between countries.
In addition, efficient financial markets and institutions tend to lower search and transactions
costs in the economy. By providing a large array of financial products, with varying risk and
pricing structures as well as maturity, a well-developed financial system offers products to
participants that provide borrowers and lenders with a close match for their needs.
Individuals, businesses, and governments in need of funds can easily discover which
financial institutions or which financial markets may provide funding and what the cost will
be for the borrower. This allows investors to compare the cost of financing to their expected
return on investment, thus making the investment choice that best suits their needs. In this
way, financial markets direct the allocation of credit throughout the economy and facilitate
the production of goods and services.
In many developing nations, limited financial markets, instruments, and financial
institutions, as well as poorly defined legal systems, may make it more costly to raise capital
and may lower the return on savings or investments. Limited information or lack of financial
transparency mean that information is not as readily available to market participants and
risks may be higher than in economies with more fully-developed financial systems. In
addition, it is more difficult to hold a diversified portfolio in small markets with only a
limited selection of financial assets or savings and investment products. In such thin financial
markets with little trading activity and few alternatives, it may be more difficult and costly to
find the right product, maturity, or risk profile to satisfy the needs of borrowers and lenders.

1 http://www.investopedia.com/walkthrough/corporate-finance/1/financial-markets.aspx
2 http://www.frbsf.org/education/publications/doctor-econ/2005/january/financial-marketseconomic-performance/
3 http://www.waifemcbp.org/v2/dloads/THE%20ROLE%20OF%20FINNCIAL
%20MARKET.pdf