Certificate in Alternative

Investment Industry

Equities Module

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This handbook is proprietary information of SS&C GlobeOp. This document is strictly to be used for academic purposes as part of the “Certificate in
Alternative Investment Industry” elective course. SS&C GlobeOp reserves the right for any kind of copying, duplicating, reproducing and distributing of
this information.
Equities Module

Table of Contents
1. Overview ...............................................................................................................................3
a. Global Capital Market ............................................................................................................................. 3
b. Market Participants ................................................................................................................................. 4
c. Hedge Fund ............................................................................................................................................. 6
d. Fund of Funds .......................................................................................................................................... 7
2. Trade life Cycle ......................................................................................................................8
a. Trade Origination / Order Origination .................................................................................................... 8
b. Trade Execution & Enrichment ............................................................................................................... 8
c. Confirmation of Trade ............................................................................................................................. 8
d. Settlement............................................................................................................................................. 10
e. Reconciliations ...................................................................................................................................... 11
3. Products .............................................................................................................................. 12
a. Equities .................................................................................................................................................. 12
i) Corporate Action’s ........................................................................................................................ 13
b. Fixed Income ......................................................................................................................................... 16
c. Futures, Options & CFD ......................................................................................................................... 20
d. Foreign Exchange Market ..................................................................................................................... 23

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1. Overview
a. Global Capital Market

Capital markets are financial markets for the buying and selling of long-term debt or equity-backed securities.
These markets channel the wealth of savers to those who can put it to long-term productive use, such as companies
or governments making long-term investments. Financial regulators, such as the UK's Bank of England (BoE) or the
U.S. Securities and Exchange Commission (SEC), oversee the capital markets in their jurisdictions to protect investors
against fraud, among other duties.
Modern capital markets are almost invariably hosted on computer-based electronic trading systems; most can be
accessed only by entities within the financial sector or the treasury departments of governments and corporations,
but some can be accessed directly by the public. There are many thousands of such systems, most serving only small
parts of the overall capital markets. Entities hosting the systems include stock exchanges, investment banks, and
government departments. Physically the systems are hosted all over the world, though they tend to be concentrated
in financial centres like London, New York, and Hong Kong. Capital markets are defined as markets in which money is
provided for periods longer than a year.
A key division within the capital markets is between the primary markets and secondary markets. In primary
markets, new stock or bond issues are sold to investors, often via a mechanism known as underwriting. The main
entities seeking to raise long-term funds on the primary capital markets are governments (which may be municipal,
local or national) and business enterprises (companies). Governments tend to issue only bonds, whereas companies
often issue either equity or bonds. The main entities purchasing the bonds or stock include pension funds, hedge
funds, sovereign wealth funds, and less commonly wealthy individuals and investment banks trading on their own
behalf. In the secondary markets, existing securities are sold and bought among investors or traders, usually on an
exchange, over-the-counter, or elsewhere. The existence of secondary markets increases the willingness of investors
in primary markets, as they know they are likely to be able to swiftly cash out their investments if the need arises.
A second important division falls between the stock markets (for equity securities, also known as shares, where
investors acquire ownership of companies) and the bond markets (where investors become creditors).

 Primary Market
The primary markets deal with the trading of newly issued securities. The corporations, governments and
companies issue securities like stocks and bonds when they need to raise capital. The investors can purchase
the stocks or bonds issued by the companies. Money thus earned from the selling of securities goes directly to
the issuing company. The primary markets are also called New Issue Market (NIM). Initial Public Offering is a
typical method of issuing security in the primary market. The functioning of the primary market is crucial for
both the capital market and economy as it is the place where the capital formation takes place.

 Secondary Market
The secondary market is that part of the capital market that deals with the securities that are already issued in
the primary market. The investors who purchase the newly issued securities in the primary market sell them in
the secondary market. The secondary market needs to be transparent and highly liquid in nature as it deals
with the already issued securities. In the secondary market, the value of a particular stock also varies from that

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of the face value. The resale value of the securities in the secondary market is dependent on the fluctuating
interest rates.

 Difference between money markets and capital markets

The money markets are used for the raising of short term finance, sometimes for loans that are expected to be
paid back as early as overnight. Whereas, the capital markets are used for the raising of long term finance, such
as the purchase of shares, or for loans that are not expected to be fully paid back for at least a year.
Funds borrowed from the money markets are typically used for general operating expenses, to cover brief
periods of illiquidity. For example a company may have inbound payments from customers that have not yet
cleared, but may wish to immediately pay out cash for its payroll. When a company borrows from the primary
capital markets, often the purpose is to invest in additional physical capital goods, which will be used to help
increase its income. It can take many months or years before the investment generates sufficient return to pay
back its cost, and hence the finance is long term.
Together, money markets and capital markets form the financial markets as the term is narrowly understood.
The capital market is concerned with long term finance. In the widest sense, it consist of a series of channels
through which the savings of the community are made available for industrial and commercial enterprises and
public authorities

b. Market Participants

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Stock Exchange: A stock exchange is an organized marketplace or facility that brings buyers and sellers
together and facilitates the sale and purchase of stocks.
Stock Exchange, it makes sure that trading transactions are done in an efficient, orderly, fair, and transparent
manner. It enforces rules and regulations that its publicly listed companies and trading participants must strictly
abide by. In this way, the Stock Exchange fulfills its function as the “guardian” of the stock market.

Investors: Investors, also referred to as stockholders or shareholders, are those who own shares of stock of a
publicly listed company. They are accorded certain privileges like the right to fair and equal treatment, the right to
vote and exercise related rights, and the right to receive dividends and other benefits due to stockholders. They are
classified as either retail or institutional, and local or foreign.

Stockbrokers: A stockbroker or trading participant is licensed by the Securities and Exchange Commission
(SEC) and is entitled to trade at the Exchange. They act as an agent between a buyer and seller of stocks in the
market. For their services as stockbrokers, they receive from their clients either a buying or a selling commission.
There are two (2) types of stockbrokers:
 Traditional – those who assign a licensed salesman to handle your account and to take your orders via a
written instruction or a phone call
 Online – those whose main interface is the internet where clients execute their orders and access market
information online

Listed Companies: A company is said to be “listed”, “quoted” or “have a listing” if its shares can be traded on a
stock exchange. To be more accurate, it is the securities that are listed, not the company. The phrase “listed
company” is widely used to mean a company that has listed ordinary shares.
It is possible (although not common) for a company to have listed debt securities but not listed shares.
Listing in more than one market is possible through secondary listings, or through the more complex approach of
dual listing.
A group of companies may also have separately listed subsidiaries, associates, and tracking stocks.

Clearing House: An agency or separate corporation of a futures exchange responsible for settling trading
accounts, clearing trades, collecting and maintaining margin monies, regulating delivery and reporting trading data.
Clearing houses act as third parties to all futures and options contracts - as a buyer to every clearing member seller
and a seller to every clearing member buyer.
Each futures exchange has its own clearing house. All members of an exchange are required to clear their trades
through the clearing house at the end of each trading session and to deposit with the clearing house a sum of money
(based on clearinghouse margin requirements) sufficient to cover the member's debit balance. For example, if a
member broker reports to the clearing house at the end of the day total purchase of 100,000 bushels of May wheat
and total sales of 50,000 bushels of May wheat, he would be net long 50,000 bushels of May wheat. Assuming that
this is the broker's only position in futures and that the clearing house margin is six cents per bushel, this would
mean the broker would be required to have $3,000 on deposit with the clearing house. Because all members are
required to clear their trades through the clearing house and must maintain sufficient funds to cover their debit
balances, the clearing house is responsible to all members for the fulfilment of the contracts.

Depository: On the simplest level, depository is used to refer to any place where something is deposited for
storage or security purposes. More specifically, it can refer to a company, bank or an institution that holds and
facilitates the exchange of securities. Or a depository can refer to a depository institution that is allowed to accept
monetary deposits from customers.
Central security depositories allow brokers and other financial companies to deposit securities where book entry
and other services can be performed, like clearance, settlement and securities borrowing and lending.

Settlement Banks: The settlement banks accept deposits of funds for payment of securities bought, confirm
payments of due clearing obligations to debit buyer’s cash account and credit seller’s cash account during
settlement, and receive and/or return cash collateral put up by clearing members to cover their daily trade negative
exposures.

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Transfer Agents: The stock transfer agent is considered the “official keeper” of the corporate shareholder
records. The stock transfer agents provide the issuer or the listed company with a list of holders of its securities.
They effect transfer of beneficial ownership and process corporate actions like stock or cash dividends, stock rights,
stock splits, and collation of proxy forms.

c. Hedge Fund

The Modern Hedge Fund

Following the dot-com crash of 2000 and the global economic crisis of 2008, regulators have clamped down on the
previously regulation-light world of hedge funds.
For instance, the U.S. Securities and Exchange Commission (SEC) implemented changes that require hedge fund
managers and sponsors to register as investment advisors in 2004. As a result, the number of requirements placed
on hedge funds has increased greatly, such as hiring compliance officers, creating a code of ethics, and being sure to
keep up-to-date performance records. Essentially this was all done with the intention of protecting investors.
Today, despite recent troubles, the hedge fund industry continues to flourish once more. Crucial to its success was
the development of the ‘fund of funds’, essentially a hedge fund with a diversified portfolio of numerous underlying
single-manager hedge funds.
The introduction of the fund of funds allowed for greater diversification, thereby taking some of the risk out of
hedge funding, but also allowed minimum investment requirements of as low as $25,000. This greatly opened up
the hedge fund investment option to a far greater number of average investors than ever before.

Hedge Funds Today

Today’s hedge funds look significantly different to their forerunners of the 1940s, and even the 1980s. A far greater
variety of strategies is used by today’s hedge funds, including many that do not involve traditional hedging
techniques at all.
The size of the industry is now absolutely vast. While Albert Jones started the first hedge fund with just $100, 000,
in 2013 the global hedge fund industry recorded a record high of US$2.4 trillion in assets under management.

Hedge Fund
A hedge fund is an alternative investment vehicle available only to sophisticated investors, such as institutions and
individuals with significant assets.
Like mutual funds, hedge funds are pools of underlying securities. Also like mutual funds, they can invest in many
types of securities—but there are a number of differences between these two investment vehicles.

 First, hedge funds are not currently regulated by the U.S. Securities and Exchange Commission (SEC), a financial
industry oversight entity, as mutual funds are. However, it appears that regulation for hedge funds may be
coming soon.

 Second, as a result of being relatively unregulated, hedge funds can invest in a wider range of securities than
mutual funds can. While many hedge funds do invest in traditional securities, such as stocks, bonds,
commodities and real estate, they are best known for using more sophisticated (and risky) investments and
techniques. Hedge funds typically use long-short strategies, which invest in some balance of long positions
(which means buying stocks) and short positions (which means selling stocks with borrowed money, then
buying them back later when their price has, ideally, fallen).
Additionally, many hedge funds invest in “derivatives,” which are contracts to buy or sell another security at a
specified price. You may have heard of futures and options; these are considered derivatives.
Many hedge funds also use an investment technique called leverage, which is essentially investing with
borrowed money—a strategy that could significantly increase return potential, but also creates greater risk of
loss. In fact, the name “hedge fund” is derived from the fact that hedge funds often seek to increase gains, and
offset losses, by hedging their investments using a variety of sophisticated methods, including leverage.

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 Third, hedge funds are typically not as liquid as mutual funds, meaning it is more difficult to sell your shares.
Mutual funds have a per-share price (called a net asset value) that is calculated each day, so you could sell your
shares at any time. Most hedge funds, in contrast, seek to generate returns over a specific period of time called a
“lockup period,” during which investors cannot sell their shares. (Private equity funds, which are similar to
hedge funds, are even more illiquid; they tend to invest in startup companies, so investors can be locked in for
years.)

 Finally, hedge fund managers are typically compensated differently from mutual fund managers. Mutual fund
managers are paid fees regardless of their funds’ performance. Hedge fund managers, in contrast, receive a
percentage of the returns they earn for investors, in addition to earning a “management fee”, typically in the
range of 1% to 4% of the net asset value of the fund. That is appealing to investors who are frustrated when
they have to pay fees to a poorly performing mutual fund manager. On the down side, this compensation
structure could lead hedge fund managers to invest aggressively to achieve higher returns—increasing investor
risk.

As a result of these factors, hedge funds are typically open only to a limited range of investors. Specifically, U.S. laws
require that hedge fund investors be “accredited,” which means they must earn a minimum annual income, have a
net worth of more than $1 million, and possess significant investment knowledge.

d. Fund of Funds

A fund of funds is a pooled investment, such as a mutual fund or a hedge fund, whose underlying investments are
other funds rather than individual securities.
Despite some major differences, what all funds of funds have in common is an emphasis on diversification for its
potential to reduce risk without significantly reducing return.
They're also designed to simplify the investment process by offering one-stop shopping.
Many mutual fund FOFs are asset allocation funds and typically include both stock and bond funds in a particular
combination that the FOF manager has chosen to meet a specific objective. A mutual fund FOF may select all its
funds from a single fund family or it may choose funds offered by different investment companies.
A hedge fund FOF, which owns stakes in other hedge funds, allows investors to commit substantially less money to
gain exposure to this investment category than it would cost to invest in even one fund.

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Equities Module

2. Trade life Cycle

From the Trade Origination to the Settlement

a. Trade Origination / Order Origination

 Orders are received from Clients
 Received by Sales Trader
o By Phone or
o Electronically
 New Orders are entered into Order Management System (Trading System)
 This step is referred as ‘Trade Capture’

b. Trade Execution & Enrichment

 When both the parties agree to the details of the trade and are willing to enter into the deal, the trade gets
executed
 Execution Confirmation Received by IM/Client
o By Phone or
o Electronically
 Both buyer and seller now enters in to contract which has legal obligation on all the parties involved in trade

c. Confirmation of Trade
The next process prior to clearing and settlement is confirmation. This is required because the clients need to know
what brokers have done on their behalf and also to bring out errors if any in trade execution

 Confirmation for retails clients:

Retail clients receive paper confirmations in the mail. They match this against the original order which they had
places and see if there are any mismatches which are immediately reported to the broker

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 Confirmation for institutional clients:

Institutional clients hold instruments such as equity shares with depository trust company. Hence they must
receive an electronic confirmation for the trades by broker on their behalf. For matching and verifying the trade
details, institutional clients often use automated matching mechanism.
o Basic economic trade details are confirmed with Counter Party
o Notional, Net Amount, Maturity, Rate, Price, Trade/Settlement Date
o The communication of confirmation can be through SWIFT, Telex, Fax, and Phone. , etc
o When the trade is done on the exchange, no further matching is required. This is because exchange
records and reports the event and trade details are automatically captured. Thus the trade is locked in
after completion by two counterparties. Hence no matching is required

Post-Trade Changes
 Amendment/Cancellation/Rebooks
 The trade can be amended by the consent of both the parties
 Can be on account discrepancy in any trade economics
 Erroneous Booking

Clearing and Settlement

 Clearing and settlement are final two processes in trade processing cycle. Before coming to clearing, all the
participants must have agreed to the trade details going through the above mentioned processes.
 This is a process of exchange of money and securities between brokers using a form of netting. The clearing
system nets all the trades done by all the brokers throughout the day. Thus the street side of a trade i.e. broker
to broker portion of a trade is netted out.
 There are two forms of netting.
o Bilateral netting – This means arriving at net obligations(i.e. netting) of securities and funds between two
brokers/parties
o Multilateral Netting: This means arriving at net obligations of securities and funds between all the
brokers. Thus at the end of the day, exchange arrive at a net position in securities or fund for each broker
 Broker also does netting between his different clients. In each stock the net position for the day is arrived at as
follows.

Broker A
Stock 1 Stock 2 Stock 3
Client 1 +400 ---- +300
Client 2 ---- +500 -300
Client 3 -200 -800 ----
Net Position +200 -300 0

+means purchases of securities and – means sale of securities by clients

Thus Broker A’s net position is + 200 in stock 1 ( he expects to receive 200 shares at time of settlement) and
-300 in stock 2 ( he should deliver 300 shares for settlement) and zero in case of stock 3
For every trade to be processed, there are two sides client side & street side .For a successful trade
processing. Both the sides have to settle simultaneously.
Client Side: the settlement of trade is through broker for retails clients & for institutional clients, the trades
generally settle through depository trust company

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d. Settlement
This is the last process in the life cycle of a trade. In settlement all the counterparties exchange securities and money
as per their obligations.

Order/Trade Flow in Automated Environment

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e. Reconciliations
Reconciliations are extremely important in trade processing. This is because in securities transactions there are a
number of participants involved, who need to keep records of balances of funds and securities. These records need
to tally with each others; otherwise it may lead to failure of trades i.e. trade will not settle
In Simple words, reconciliation involves comparing two different group of informationsThe kinds of reconciliation
required are
o Cash balances and cash transactions
o Security holdings and security transactions
o Accounting entries
o Special / Other reconciliation’s
If the records do not tally i.e. reconciliation break exist, then they should be immediately investigated and corrected.
The reconciliation are required between
Manager to Custodian: The securities records kept by investment managers should match with that of the custodian.
If records are not reconciled at regular intervals then it may lead to incorrect positions balance in the books of one
of them. It may give rise to a situation that investment manager may end up selling excess quantity of stocks
because the records as per his books show a higher balance of shares compared to the custodian records.
Other types of reconciliation done are
o Broker to Manager
o Broker to clearing agency
o Broker to an exchange
o Custodian to depository

A typical settlement cycle

US securities settle on T + 3 basis. This means that the settlement i.e. exchanges of securities and funds take place
within three days of the trade. For trades done on Monday, settlement has to be completed by Thursday. The actual
process follows the step as shown below.

Post – Trade processing

For a successful trade completion, a number of post trade functions are required to be performed. These functions
are generally performed by the participants in the securities such as banks,broker,investment managers and
specialized institutions like custodian and depositaries. These participants play an important role in post trade
processing, clearing and settlement which starts with preparation for clearing and settlement
The systems procedures for clearing and settlement have evolved over a number years as securities markets have
changed .Some factors that have changed drastically over the years as follows

o Automated processing of trade from manual processing

o Very high volume
o Changes in settlement cycles
o Increase in number and variety of securities
o Significant increase in cross border trades

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3. Products

a. Equities
Financial instrument representing a percentage of ownership in a corporation with a share in the ongoing success of
the enterprise.
Stock is a share in the ownership of a company. Stock represents a claim on the company’s assets and earnings. As
one acquires more stock, the person’s ownership stake in the company becomes greater. Share, equity or stock all
means the same thing. As an owner, the shareholder is entitled to the company’s earnings as well as any voting
rights attached to the stock. As the equity capital is not redeemed i.e. not returned back to the shareholders, it
becomes the permanent source of capital for the company.
Various types of equities include:
o Common Stock – most prevalent form of equity investment; shareholders have voting rights in the
management of the corporation
o Preferred Stock – equity security with many fixed income characteristics but shareholders are not
entitled to voting rights
o Cumulative Preferred Stock – stock dividends can be accumulated for later payment
o Convertible Preferred Stock –investor can convert the preferred stock to common
o Rewards associated with equity

 Dividends:
The importance of being a shareholder is that the shareholders are entitled to a portion of the company’s profit
and have a residual claim on assets.
Dividends are of following types
Cash Dividends: Dividends are generally paid out in cash. A part of profits are paid out in the form of cash
dividends
Stock Dividends: Dividends are given inform of shares. This means shareholders are given additional shares in
certain portion to their holdings, free of cost.

 Share repurchase:
This involves buying back equity shares from shareholders in certain portion. Thus instead of using cash to pay
dividends, cash is utilized by the company to repurchase the shares. The price at which shares are bought back
is generally higher than the current market price resulting in gain for shareholders.

 Capital Gains:
Capital gains refer to the increase in prices of shares of a company. In fact this is the reason why most of the
investors hold equity shares. In most of the cases, a large part of total return which a shareholder gets for
investing in equity comes from capital appreciation
Shareholders have the below rights as well
o Right to subscribe to new shares
o Right to Vote
o Right to information

 Share Capital
Funds raised by issuing shares in return for cash or other considerations. The amount of share capital a
company has can change over time because each time a business sells new shares to the public in exchange for
cash, the amount of share capital will increase. Share capital can be composed of both common and preferred
shares.
The amount of share capital a company reports on its balance sheet only accounts for the initial amount for
which the original shareholders purchased the shares from the issuing company. Any price differences arising
from price appreciation/depreciation as a result of transactions in the secondary market are not included.

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For example, suppose ABC Inc. raised $2 billion from its initial public offering. Over the next year, the total value
of its shares increases to $5 billion. In this case, the value of the share capital is still only $2 billion because ABC
Inc. had received only $2 billion from the sale of its securities to the investing public.

Types of share capital

o Authorized share capital is also referred to, at times, as registered capital. It is the total of the share
capital which a limited company is allowed (authorized) to issue. It presents the upper boundary for the
actually issued share capital.
Shares authorized = Shares issued + Shares unissued
o Issued share capital is the total of the share capital issued (allocated) to shareholders. This may be less
or equal to the authorized capital.
o Shares outstanding are those issued shares which are not treasury shares. These are all the shares held
by the investors in the company.
o Issued capital can be subdivided in another way, examining whether it has been paid for by investors:
o Subscribed capital is the portion of the issued capital, which has been subscribed by all the investors
including the public. This may be less than the issued share capital as there may be capital for which no
applications have been received yet ("unsubscribed capital").
o Called up share capital is the total amount of issued capital for which the shareholders are required to
pay. This may be less than the subscribed capital as the company may ask shareholders to pay by
installments.
o Paid up share capital is the amount of share capital paid by the shareholders. This may be less than the
called up capital as payments may be in installments ("calls-in-arrears").

i) Corporate Action’s
A corporate action is an event initiated by a public company that affects the securities (equity or debt) issued by
the company.
This has a direct or indirect financial impact on the shareholders.
Direct Impact: Cash Dividend
Indirect Impact: Stock Split

 Purpose of Corporate Action

o Return Profits to Shareholders:
Cash dividends and Bonus are classic example where a public company declares dividend or Bonus to be
paid on each outstanding share.
o Influence the Share Price:
If the price of a stock is too high or too low, the liquidity of the stock suffers.
o Corporate Restructuring:
Corporate re-structure in order to increase their profitability. Spinoffs are an example of a corporate
action where a company breaks itself up in order to focus on its core competencies.

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 Dividend
o Distribution of portion of company's earnings to its Shareholders, decided by the board of directors.
o Types of Dividend:
 Cash Dividend
 Stock Dividend
 Optional Dividend
 Rights Offer
o Rights Issues are Shares issued by a company only to its existing shareholders
o Investor Exercise the Right.
o Investor does not Exercise the Right.

 Stock Split & Reverse Stock Split

o Increase / Decrease in the number of outstanding shares of a company’s stock, such that proportionate
equity of each shareholder remains the same

Effects of Split
o Number of share increases/decreases to the extent of Terms (ratio).
o Cost of stock decreases/increases to the extent of Terms (ratio).
o Overall value remains the same.

Example Stock Split Reverse Stock Split

Original Face Value 10 5

Original Shares 100 100

Ratio 2:1 1:2

New Face Value 5 10

New Shares 200 50

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 Spin Off
o The separation of a subsidiary or division of a corporation from its parent company.
o Issuing shares in a new corporate entity.
o A large company may require separating a line of business or creating a separate entity.

 Merger / Acquisition
o Acquisition: - An acquisition is the purchase of one company by another company. An acquisition may be
private or public, depending on whether the acquire or merging company is or isn't listed in public
markets. An acquisition may be friendly or hostile.
o Merger: - Two companies merge together to form one single entity.
The shareholders of the company becoming non-existent would receive stock in the merged entity or
cash for their holdings as per agreed terms.

 Bonus
o Very popular way of rewarding the shareholders as well as increasing the share capital.
o It’s done by capitalizing the reserves created out of profits.
o Shareholders receive additional free shares in proportion to their holding.
- 1:1 bonus means-One new bonus share for every one share held

 Change of Name / Identifier

Change in the Company’s Name, Identifier and Ticker from original to new Name, Identifier and Ticker.
This has No Effect on:
o Cash or Price
o Position
o Par Value & Market Value

Types Receive / Receive / Pay Stock Receive / Pay Receive Stock for
Pay Cash Stock & Cash Cash Payment
Bonus √
Dividend √ √ √
Identifier Changes √
Merger / Acquisition √ √ √
Reverse Stock Split √ √ √
Right offer
Spin Off √ √
Stock Split √ √

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b. Fixed Income
Fixed income refers to any type of investment under which the borrower/issuer is obliged to make payments of a
fixed amount on a fixed schedule: for example, if the borrower has to pay interest at a fixed rate once a year, and to
repay the principal amount on maturity.
Fixed-income securities can be contrasted with equity securities, often referred to as stocks and shares that create no
obligation to pay dividends or any other form of income. In order for a company to grow its business, it often must
raise money: to finance an acquisition, buy equipment or land or invest in new product development. The terms on
which investors will finance the company will depend on the risk profile of the company. The company can give up
equity by issuing stock, or can promise to pay regular interest and repay the principal on the loan (bond, bank loan,
or preferred stock). Fixed-income securities also trade differently than equities. Whereas equities, such as common
stock, trade on exchanges or other established trading venues, many fixed-income securities trade over-the-counter
on a principal basis.

Types of borrowers
Governments issue government bonds in their own currency and sovereign bonds in foreign currencies. Local
governments issue municipal bonds to finance themselves. Debt issued by government-backed agencies is called an
agency bond. Companies can issue a corporate bond or obtain money from a bank through a corporate loan.

Some of the terminology used in connection with these investments is:

o The issuer is the entity (company or government) who borrows the money by issuing the bond, and is
due to pay interest and repay capital in due course.
o The principal of a bond – also known as maturity value, face value, par value – is the amount that the
issuer borrows which must be repaid to the lender.
o The coupon (of a bond) is the annual interest that the issuer must pay, expressed as a percentage of the
principal.
o The maturity is the end of the bond, the date that the issuer must return the principal.
o The issue is another term for the bond itself.
o The indenture, in some cases, is the contract that states all of the terms of the bond.

Investors:
Investors in fixed-income securities are typically looking for a constant and secure return on their investment. For
example, a retired person might like to receive a regular dependable payment to live on, but not consume principal.
This person can buy a bond with their money, and use the coupon payment (the interest) as that regular dependable
payment. When the bond matures or is refinanced, the person will have their money returned to them. The major
investors in fixed-income securities are institutional investors, such as pension plans, mutual funds, insurance
companies and others

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 Bonds:
Bond is a debt security, in which the authorized issuer owes the holders a debt and is obliged to repay the
principal and interest (coupon) at a later date, termed maturity.
A bond is simply a loan, but in the form of a security,
o The issuer = the borrower,
o the bond holder = lender,
o The coupon = interest.

Bonds are generally issued for a fixed term (the maturity). For example 10 years.

Bonds and stocks are both securities, but the major difference between the two is that (capital) stockholders
have an equity stake in the company (i.e. they are investors), whereas bondholders have a creditor stake in the
company (i.e. they are lenders). Being a creditor, bondholders have absolute priority and will be repaid before
stockholders (who are owners) in the event of bankruptcy. Another difference is that bonds usually have a
defined term, or maturity, after which the bond is redeemed, whereas stocks are typically outstanding
indefinitely. An exception is an irredeemable bond, such as Consoles, which is perpetuity, i.e. a bond with no
maturity

Debt versus Equity

Bonds are debt, whereas stocks are equity. This is the important distinction between the two securities. By
purchasing equity (stock) an investor becomes an owner in a corporation. Ownership comes with voting rights and
the right to share in any future profits. By purchasing debt (bonds) an investor becomes a creditor to the corporation
(or government). The primary advantage of being a creditor is that you have a higher claim on assets than
shareholders do: that is, in the case of bankruptcy, a bondholder will get paid before a shareholder. However, the
bondholder does not share in the profits if a company does well - he or she is entitled only to the principal plus
interest.

Measuring Return with Yield

Yield is a figure that shows the return you get on a bond. The simplest version of yield is calculated using the
following formula: yield = coupon amount/price. When you buy a bond at par, yield is equal to the interest rate.
When the price changes, so does the yield.
Let's demonstrate this with an example. If you buy a bond with a 10% coupon at its $1,000 par value, the yield is
10% ($100/$1,000). Pretty simple stuff. But if the price goes down to $800, then the yield goes up to 12.5%. This
happens because you are getting the same guaranteed $100 on an asset that is worth $800 ($100/$800). Conversely,
if the bond goes up in price to $1,200, the yield shrinks to 8.33% ($100/$1,200).

Features of Bond
o Issue Price: - the price at which investors buy the bonds when they are first issued.
o Maturity date: - the date on which the issuer has to repay the nominal amount.
o Coupon: - the interest rate % that the issuer pays to the bond holders.
o Coupon dates: - the dates on which the issuer pays the coupon to the bond holders, e.g. quarterly, semi-
annually, annually.
o Par Amount/Face Value
o Clean Price: Current traded price.
o (Price is always calculated on a percent basis)
o Accrued Interest: Coupon rate % * No of days from the Prev coupon paid / Day Count Denominator
o Dirty Price: Clean price + Accrued Interest
- (Price is always calculated on a percent basis)
o Total Cash: Nominal * Dirty price

Bond Basics: Conclusion

o Bonds are just like IOUs. Buying a bond means you are lending out your money.
o Bonds are also called fixed-income securities because the cash flow from them is fixed.

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o Stocks are equity; bonds are debt.

o The key reason to purchase bonds is to diversify your portfolio.
o The issuers of bonds are governments and corporations.
o A bond is characterized by its face value, coupon rate, maturity and issuer.
o Yield is the rate of return you get on a bond.
o When price goes up, yield goes down, and vice versa.
o Bills, notes and bonds are all fixed-income securities classified by maturity.
o Government bonds are the safest bonds, followed by municipal bonds, and then corporate bonds.
o Bonds are not risk free. It's always possible - especially in the case of corporate bonds - for the borrower
to default on the debt payments.

 Repurchase Agreement - Repo

A form of short-term borrowing for dealers in government securities. The dealer sells the government
securities to investors, usually on an overnight basis, and buys them back the following day.
For the party selling the security (and agreeing to repurchase it in the future) it is a repo; for the party on the
other end of the transaction, (buying the security and agreeing to sell in the future) it is a reverse repurchase
agreement.
Repos are classified as a money-market instrument. They are usually used to raise short-term capital.
Repo is a money market instrument involving 2 parties. One party “sells” bonds to the other while
simultaneously agreeing to repurchase them or receive them back at a specified future date.
On maturity date seller receives the Bonds and pays cash to the buyer (includes sale price + interest)
If a security pays a coupon during the term of the repo, the coupon belongs to the seller of the security.

 Reverse Repo
Reverse Repo is the same repurchase agreement from the buyer’s viewpoint.
On maturity date buyer delivers the Bonds to the seller and in turn receives cash (includes sale price - interest)
Diagram 1 – start
Trade details:
Principal: $10,000,000
Bond price: 100%
Repo principal: $10,000,000
Repo rate: 5.00% Actual/360
Term: 7 days

Diagram 2 - maturity
Trade details:
Principal: $10,000,000
Bond price: 100%
Repo principal: $10,000,000
Repo rate: 5.00% Actual/360
Repo interest: $9,722.22

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Haircuts
Haircuts are the repo market's way of imposing a margin on the collateral seller. Here is a simple example. Suppose a
haircut of 2% is applied to a repo trade where the market value of the collateral is $10m. The seller only receives
$9.8m from the buyer and the repo interest is calculated on $9.8m.
Why do haircuts exist? Because some bonds are more risky than others. The buyer will look to the collateral for
repayment should the seller default. If the collateral has a volatile price history the buyer is at risk. The collateral
may fall in price at the very time it is being relied on. To reduce this risk a haircut is imposed.

 MBS
What Is a Mortgage?
A mortgage represents a loan on a property/house that has to be paid over a specified period of time.

What is securitization?
Securitization is the process by which assets are pooled together into one security. Securitization allows firms to
convert small, illiquid assets, primarily loans, into a large security that can be easily sold into the capital markets.
Types of Mortgages
o MBS( Mortgage Backed Security)
o ABS(Asset Backed Security

Mortgage Backed Securities

Mortgage backed securities are created when mortgage loans are packaged, or “pooled,” by issuers or servicers for
sale to investors. As the underlying mortgage loans are paid off by the homeowners, the investors receive payments
of interest and principal.
Mortgage securities represent an ownership interest in mortgage loans made by financial institutions (savings and
loans, commercial banks or mortgage companies) to finance the borrower’s purchase of a home or other real estate.

Asset-backed Security - ABS

A financial security backed by a loan, lease or receivables against assets other than real estate and mortgage-backed
securities. For investors, asset-backed securities are an alternative to investing in corporate debt
An ABS is essentially the same thing as a mortgage-backed security, except that the securities it backs are assets such
as loans, leases, credit card debt and so on, and not mortgage-based securities.

How They Are Formed

MBS are debt obligations purchased from banks, mortgage companies, credit unions and other financial institutions
and then assembled into pools by a governmental, quasi-governmental, or private entity. These entities then sell the
securities to investors. This process is illustrated below:
Real estate buyers borrow from financial institutions.
ßßßß
Financial institutions sell mortgages to MBS entities.
ßßßß
MBS entities form mortgage pools.
ßßßß
Individuals invest in mortgage pools.

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c. Futures, Options & CFD

A futures contract is a type of derivative instrument, or financial contract, in which two parties agree to transact a set
of financial instruments or physical commodities for future delivery at a particular price. If you buy a futures
contract, you are basically agreeing to buy something that a seller has not yet produced for a set price. But
participating in the futures market does not necessarily mean that you will be responsible for receiving or delivering
large inventories of physical commodities - remember, buyers and sellers in the futures market primarily enter into
futures contracts to hedge risk or speculate rather than to exchange physical goods (which is the primary activity of
the cash/spot market). That is why futures are used as financial instruments by not only producers and consumers
but also speculators.
In the futures market, margin has a definition distinct from its definition in the stock market, where margin is the use
of borrowed money to purchase securities. In the futures market, margin refers to the initial deposit of "good faith"
made into an account in order to enter into a futures contract. This margin is referred to as good faith because it is
this money that is used to debit any day-to-day losses.
When you open a futures contract, the futures exchange will state a minimum amount of money that you must
deposit into your account. This original deposit of money is called the initial margin. When your contract is
liquidated, you will be refunded the initial margin plus or minus any gains or losses that occur over the span of the
futures contract. In other words, the amount in your margin account changes daily as the market fluctuates in
relation to your futures contract. The minimum-level margin is determined by the futures exchange and is usually
5% to 10% of the futures contract. These predetermined initial margin amounts are continuously under review: at
times of high market volatility, initial margin requirements can be raised.
The initial margin is the minimum amount required to enter into a new futures contract, but the maintenance margin
is the lowest amount an account can reach before needing to be replenished. For example, if your margin account
drops to a certain level because of a series of daily losses, brokers are required to make a margin call and request
that you make an additional deposit into your account to bring the margin back up to the initial amount.
Let's say that you had to deposit an initial margin of $1,000 on a contract and the maintenance margin level is $500.
A series of losses dropped the value of your account to $400. This would then prompt the broker to make a margin
call to you, requesting a deposit of at least an additional $600 to bring the account back up to the initial margin level
of $1,000.

 Futures Fundamentals: The Players

o Hedgers
Farmers, manufacturers, importers and exporters can all be hedgers. A hedger buys or sells in the futures
market to secure the future price of a commodity intended to be sold at a later date in the cash market.
This helps protect against price risks.
The holders of the long position in futures contracts (the buyers of the commodity), are trying to secure
as low a price as possible. The short holders of the contract (the sellers of the commodity) will want to
secure as high a price as possible. The futures contract, however, provides a definite price certainty for
both parties, which reduces the risks associated with price volatility. Hedging by means of futures
contracts can also be used as a means to lock in an acceptable price margin between the cost of the raw
material and the retail cost of the final product sold.

o Speculators
Other market participants, however, do not aim to minimize risk but rather to benefit from the inherently
risky nature of the futures market. These are the speculators, and they aim to profit from the very price
change that hedgers are protecting themselves against. Hedgers want to minimize their risk no matter
what they're investing in, while speculators want to increase their risk and therefore maximize their
profits.
In the futures market, a speculator buying a contract low in order to sell high in the future would most
likely be buying that contract from a hedger selling a contract low in anticipation of declining prices in
the future.
Unlike the hedger, the speculator does not actually seek to own the commodity in question. Rather, he or
she will enter the market seeking profits by offsetting rising and declining prices through the buying and
selling of contracts.

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 Options
An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a
specific price on or before a certain date. An option, just like a stock or bond, is a security. It is also a binding
contract with strictly defined terms and properties.
Still confused? The idea behind an option is present in many everyday situations. Say, for example, that you
discover a house that you'd love to purchase. Unfortunately, you won't have the cash to buy it for another three
months. You talk to the owner and negotiate a deal that gives you an option to buy the house in three months for
a price of $200,000. The owner agrees, but for this option, you pay a price of $3,000.

Now, consider two theoretical situations that might arise:

1. It’s discovered that the house is actually the true birthplace of Elvis! As a result, the market value of the
house skyrockets to $1 million. Because the owner sold you the option, he is obligated to sell you the
house for $200,000. In the end, you stand to make a profit of $797,000 ($1 million - $200,000 - $3,000).
2. While touring the house, you discover not only that the walls are chock-full of asbestos, but also that the
ghost of Henry VII haunts the master bedroom; furthermore, a family of super-intelligent rats have built a
fortress in the basement. Though you originally thought you had found the house of your dreams, you now
consider it worthless. On the upside, because you bought an option, you are under no obligation to go
through with the sale. Of course, you still lose the $3,000 price of the option.
This example demonstrates two very important points. First, when you buy an option, you have a right but not
an obligation to do something. You can always let the expiration date go by, at which point the option becomes
worthless. If this happens, you lose 100% of your investment, which is the money you used to pay for the option.
Second, an option is merely a contract that deals with an underlying asset. For this reason, options are called
derivatives, which mean an option derives its value from something else. In our example, the house is the
underlying asset. Most of the time, the underlying asset is a stock or an index.

Calls and Puts

The two types of options are calls and puts:
1. A call gives the holder the right to buy an asset at a certain price within a specific period of time. Calls are
similar to having a long position on a stock. Buyers of calls hope that the stock will increase substantially
before the option expires.

2. A put gives the holder the right to sell an asset at a certain price within a specific period of time. Puts are
very similar to having a short position on a stock. Buyers of puts hope that the price of the stock will fall
before the option expires.

Participants in the Options Market

There are four types of participants in options markets depending on the position they take:
1. Buyers of calls
2. Sellers of calls
3. Buyers of puts
4. Sellers of puts
People who buy options are called holders and those who sell options are called writers; furthermore, buyers are
said to have long positions, and sellers are said to have short positions.

Contract for Differences

In finance, a contract for difference (CFD) is a contract between two parties, typically described as "buyer" and
"seller", stipulating that the seller will pay to the buyer the difference between the current value of an asset and
its value at contract time (If the difference is negative, then the buyer pays instead to the seller). In effect CFDs
are financial derivatives, that allow traders to take advantage of prices moving up (long positions) or prices
moving down (short positions) on underlying financial instruments and are often used to speculate on those
markets.
For example, when applied to equities, such a contract is an equity derivative that allows traders to speculate on
share price movements, without the need for ownership of the underlying shares.

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Charges
The contracts are subject to a daily financing charge, usually applied at a previously agreed rate linked to LIBOR
or some other interest rate benchmark e.g. Reserve Bank rate in Australia. The parties to a CFD pay to finance
long positions and may receive funding on short positions in lieu of deferring sale proceeds. The contracts are
settled for the cash differential between the price of the opening and closing trades.
Traditionally, equity based CFDs are subject to a commission that is a percentage of the size of the position for
each trade. Alternatively, a trader can opt to trade with a market maker, foregoing commissions at the expense of
a larger bid/offer spread on the instrument.

Margin
Traders in CFDs are required to maintain a certain amount of margin as defined by the brokerage or market
maker (usually ranging from 0.5% to 30%). One advantage to traders of not having to put up as collateral the full
notional amount of the CFD is that a given quantity of capital can control a larger position, amplifying the
potential for profit or loss. On the other hand, a leveraged position in a volatile CFD can expose the buyer to a
margin call in a downturn, which often leads to losing a substantial part of the assets.

Futures v/s Options v/s CFD’s

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d. Foreign Exchange Market

The foreign exchange market (forex, FX, or currency market) is a global decentralized market for the trading of
currencies. In terms of volume of trading, it is by far the largest market in the world. The main participants in this
market are the larger international banks. Financial centers around the world function as anchors of trading
between a wide range of multiple types of buyers and sellers around the clock, with the exception of weekends. The
foreign exchange market determines the relative values of different currencies.
The market in which 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 foreign exchange market assists international trade and investments by enabling currency conversion. For
example, it permits a business in the United States to import goods from the European Union member states,
especially Eurozone members, and pay Euros, even though its income is in United States dollars. It also supports
direct speculation and evaluation relative to the value of currencies, and the carry trade, speculation based on the
interest rate differential between two currencies.

 Financial instruments

o Spot
A spot transaction is a two-day delivery transaction. This trade represents a “direct exchange” between
two currencies, has the shortest time frame, involves cash rather than a contract, and interest is not
included in the agreed-upon transaction. Spot trading is one of the most common types of Forex Trading

o Forward
One way to deal with the foreign exchange risk is to engage in a forward transaction. In this transaction,
money does not actually change hands until some agreed upon future date. A buyer and seller agree on an
exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the
market rates are then. The duration of the trade can be one day, a few days, months or years. Usually the
date is decided by both parties. Then the forward contract is negotiated and agreed upon by both parties.

o FX Swap
A foreign exchange swap, forex swap, or FX swap is a simultaneous purchase and sale of identical
amounts of one currency for another with two different value dates.
A foreign exchange swap consists of two legs:
a spot foreign exchange transaction, and
a forward foreign exchange transaction.
These two legs are executed simultaneously for the same quantity, and therefore offset each other.

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