Financial+Markets | Interest | Financial Markets

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Financial Markets
Financial Markets
John G. Kooti
John G. Kooti
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Financial Markets
Financial Markets

Real versus Financial Assets Markets
Real versus Financial Assets Markets

The Role of Financial Markets
The Role of Financial Markets

Classification of Financial Markets
Classification of Financial Markets

Primary versus Seconary Markets
Primary versus Seconary Markets

S!ot versus futures markets
S!ot versus futures markets

"orl# national# re$ional# an local markets
"orl# national# re$ional# an local markets
3
Real vs. Financial Asset Markets
Real vs. Financial Asset Markets

Real %Tan$i&le Asset' Market is the market
Real %Tan$i&le Asset' Market is the market
(here real assets are trae. These assets
(here real assets are trae. These assets
inclue such !roucts as (heat# auto# real
inclue such !roucts as (heat# auto# real
estate# com!uters# an Machinery.
estate# com!uters# an Machinery.

Financial Asset Markets eal (ith financial
Financial Asset Markets eal (ith financial
assets such as stocks# &ons# notes#
assets such as stocks# &ons# notes#
mort$a$es# an other claims on real
mort$a$es# an other claims on real
assets.
assets.
4
Ma)or Ty!es of Financial Markets
Ma)or Ty!es of Financial Markets

Money Markets
Money Markets

Ca!ital Markets
Ca!ital Markets

Mort$a$e Markets
Mort$a$e Markets

Consumer creit markets
Consumer creit markets
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Primary vs. Seconary Markets
Primary vs. Seconary Markets

Primary Markets***are the markets for
Primary Markets***are the markets for
!rimary securities %ne( issues of stocks
!rimary securities %ne( issues of stocks
an &ons'
an &ons'

Seconary Markets are the markets for
Seconary Markets are the markets for
e+istin$ securities. Generally# investors
e+istin$ securities. Generally# investors
other than the issuin$ firm &uy or sell
other than the issuin$ firm &uy or sell
financial instruments such as &ons#
financial instruments such as &ons#
stocks# o!tions or future.
stocks# o!tions or future.
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Financial Markets
Financial Markets

Money markets the market for short*term
Money markets the market for short*term
securities %maturity of one year or less'..
securities %maturity of one year or less'..
The ,e( -ork Commercial Pa!er an
The ,e( -ork Commercial Pa!er an
Treasury .ill markets are money markets.
Treasury .ill markets are money markets.

Ca!ital Market is the market for lon$*term
Ca!ital Market is the market for lon$*term
securities# such as notes# &ons# an
securities# such as notes# &ons# an
stocks.
stocks.
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Financial Markets
Financial Markets

Consumer Creit Markets are loans for
Consumer Creit Markets are loans for
!urchase of $oos an services such auto
!urchase of $oos an services such auto
loan# vacation loan# !ersonal loan# etc.
loan# vacation loan# !ersonal loan# etc.
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The Ca!ital Formation Process
The Ca!ital Formation Process

/irect Transfer
/irect Transfer

0nirect Transfers throu$h 0nvestment
0nirect Transfers throu$h 0nvestment
.ankers
.ankers

0nirect Transfers throu$h a Financial
0nirect Transfers throu$h a Financial
0ntermeiary
0ntermeiary
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Transfer of Funs
Transfer of Funs

/irect (hen securities are sol irectly to
/irect (hen securities are sol irectly to
savers &y the issuers.
savers &y the issuers.

0nirect Transfer throu$h investment
0nirect Transfer throu$h investment
&ankin$ is (hen the issuer sells the
&ankin$ is (hen the issuer sells the
securities to the investment &ank (ho in
securities to the investment &ank (ho in
turn sells them to investors.
turn sells them to investors.
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Transfer of Funs
Transfer of Funs

0nirect Transfer throu$h 0ntermeiaries**
0nirect Transfer throu$h 0ntermeiaries**
issuer sells the securities the
issuer sells the securities the
intermeiaries (ho in turn issue their o(n
intermeiaries (ho in turn issue their o(n
securities to savers.
securities to savers.
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0nvestment .anks
0nvestment .anks

Act as milemen &et(een savers an
Act as milemen &et(een savers an
&orro(ers %issuers of securities'. 1+am!le2
&orro(ers %issuers of securities'. 1+am!le2
Merrill 3ynch# Salomon .rothers# /ean
Merrill 3ynch# Salomon .rothers# /ean
"itter# an Golman Sach.
"itter# an Golman Sach.
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0ntermeiaries
0ntermeiaries

Commercial &anks
Commercial &anks

Savin$s an loan associations
Savin$s an loan associations

Mutual savin$ &anks
Mutual savin$ &anks

Creit unions
Creit unions

3ife 0nsurance Com!anies
3ife 0nsurance Com!anies

Mutual funs
Mutual funs

Pension Funs
Pension Funs
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Stock Markets
Stock Markets

,e( -ork Stock 1+chan$e %,-S1'
,e( -ork Stock 1+chan$e %,-S1'

American Stock 1+chan$e %AM14'
American Stock 1+chan$e %AM14'

5ver*the*counter %5TC' markets
5ver*the*counter %5TC' markets

Smaller re$ional markets
Smaller re$ional markets
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5r$ani6e 1+chan$es
5r$ani6e 1+chan$es

The or$ani6e security e+chan$es are
The or$ani6e security e+chan$es are
formal or$ani6ations havin$ tan$i&le#
formal or$ani6ations havin$ tan$i&le#
!hysical locations an train$ in
!hysical locations an train$ in
esi$nate securities. There are
esi$nate securities. There are
e+chan$es of stocks# &ons# commoities#
e+chan$es of stocks# &ons# commoities#
future# an o!tions. T(o (ell kno(n
future# an o!tions. T(o (ell kno(n
markets are ,-S1 an American Stock
markets are ,-S1 an American Stock
1+chan$e %AM14'
1+chan$e %AM14'
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Train$ at the ,-S1
Train$ at the ,-S1

The ,-S1 is a continuous# seconary
The ,-S1 is a continuous# seconary
security market (ith a centrali6e
security market (ith a centrali6e
e+chan$e2
e+chan$e2

Train$ can occurany time (hen the market is
Train$ can occurany time (hen the market is
o!en %at this !oint &et(een 7289 a.m. an :299
o!en %at this !oint &et(een 7289 a.m. an :299
!.m.'
!.m.'

Train$ is in shares issue !reviously &y a firm
Train$ is in shares issue !reviously &y a firm

All train$ occurs on the ,-S1 floor
All train$ occurs on the ,-S1 floor
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Train$ at the ,-S1
Train$ at the ,-S1

Su!!ose you (ish to sell shares of a ,-S1*
Su!!ose you (ish to sell shares of a ,-S1*
liste firm such as GM. ;o( (oul you o
liste firm such as GM. ;o( (oul you o
it<
it<

-ou nee to locate a &roker to assist you
-ou nee to locate a &roker to assist you
an instruct her or him on ho( you (ant to
an instruct her or him on ho( you (ant to
e+ecute the trae.
e+ecute the trae.
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Train$ at the ,-S1
Train$ at the ,-S1

The &roker (ill !ass your orer to a traer
The &roker (ill !ass your orer to a traer
%market maker' (ho has a !ermission to
%market maker' (ho has a !ermission to
trae at the ,-S1# such as floor &roker# or a
trae at the ,-S1# such as floor &roker# or a
com!etitive ealer.
com!etitive ealer.

The floor &roker (ill either trae irectly on
The floor &roker (ill either trae irectly on
the floor (ith another &roker %(ho (ishes to
the floor (ith another &roker %(ho (ishes to
&uy GM shares' or trae (ith an iniviual
&uy GM shares' or trae (ith an iniviual
calle the s!ecialist associate (ith GM.
calle the s!ecialist associate (ith GM.
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"ho is the S!ecialist<
"ho is the S!ecialist<

1ach stock on the ,-S1 has a s!ecialist
1ach stock on the ,-S1 has a s!ecialist
associate to it (ho mana$es its !urchases
associate to it (ho mana$es its !urchases
an sales an kee!s an inventory of the
an sales an kee!s an inventory of the
stock.
stock.

0f you (ish to sell GM stocks# the s!ecialist is
0f you (ish to sell GM stocks# the s!ecialist is
o&li$ate to &uy all GM stocks. The
o&li$ate to &uy all GM stocks. The
s!ecialist sets the !rice.
s!ecialist sets the !rice.

5f course# !rice can not &e set ar&itrarily.
5f course# !rice can not &e set ar&itrarily.
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;o( oes the S!ecialist
;o( oes the S!ecialist
Com!ensate<
Com!ensate<

The s!ecialist su!!lies li=uiity to the
The s!ecialist su!!lies li=uiity to the
market &y &uyin$ (hen you (ant to sell an
market &y &uyin$ (hen you (ant to sell an
sellin$ (hen you (ant to &uy.
sellin$ (hen you (ant to &uy.

As a su!!lier of li=uiity# the s!ecialist
As a su!!lier of li=uiity# the s!ecialist
seeks a com!ensation.
seeks a com!ensation.

As a emaner of li=uiity# you must !ay for
As a emaner of li=uiity# you must !ay for
the service
the service
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The S!ecialist Com!ensation
The S!ecialist Com!ensation

The ask is the sellin$ !rice of the security &y
The ask is the sellin$ !rice of the security &y
ealers
ealers

The &i is the &uyin$ !rice of the security &y
The &i is the &uyin$ !rice of the security &y
ealers
ealers

S!rea is the ifference &et(een the ask an
S!rea is the ifference &et(een the ask an
the &i
the &i

The S!ecialist receives the s!rea &et(een
The S!ecialist receives the s!rea &et(een
the &i an the ask
the &i an the ask
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3i=uiity Su!!ly an /eman
3i=uiity Su!!ly an /eman

-ou may eman li=uiity &y !lacin$ a
-ou may eman li=uiity &y !lacin$ a
market orer.
market orer.

0mmeiately sell >99 shares of GM shares at
0mmeiately sell >99 shares of GM shares at
the &est !rice you can $et.
the &est !rice you can $et.

-ou may su!!ly li=uiity &y !lacin$ a limit
-ou may su!!ly li=uiity &y !lacin$ a limit
orer to sell GM shares
orer to sell GM shares

Sell >99 shares of GM at a !rice of ?@: or &etter
Sell >99 shares of GM at a !rice of ?@: or &etter
as soon as !ossi&le.
as soon as !ossi&le.
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5ver*the*Counter Market
5ver*the*Counter Market

Mae of hunres of &rokers an ealers
Mae of hunres of &rokers an ealers
aroun the country (ho are connecte
aroun the country (ho are connecte
electronically &y tele!hones an
electronically &y tele!hones an
com!uters.
com!uters.
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.on Markets
.on Markets

5ver*the*counter %5TC' markets
5ver*the*counter %5TC' markets

,e( -ork Stock 1+chan$e %,-S1'
,e( -ork Stock 1+chan$e %,-S1'
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Sources of Funs
Sources of Funs
AAB
:B
C:B
common stock
!referre stock
&ons an notes
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0nterest Rates
0nterest Rates

0nterest Rate is the !rice !ai for &orro(e
0nterest Rate is the !rice !ai for &orro(e
money
money

Funamental Factors influencin$ 0nterest
Funamental Factors influencin$ 0nterest
Rates
Rates

Prouction 5!!ortunities
Prouction 5!!ortunities

Time Preference for consum!tion
Time Preference for consum!tion

Risk
Risk

1+!ecte inflation
1+!ecte inflation
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Prouction 5!!ortunities
Prouction 5!!ortunities

Refers to the returns that are availa&le
Refers to the returns that are availa&le
from investment in !rouctive assets.
from investment in !rouctive assets.

The more !rouctive the asset# the more
The more !rouctive the asset# the more
(illin$ to !ay ac=uire the ca!ital neee
(illin$ to !ay ac=uire the ca!ital neee
for investment.
for investment.
27
Time Preference of Consumers
Time Preference of Consumers

Consumer !reference for current
Consumer !reference for current
consum!tion versus future consum!tion
consum!tion versus future consum!tion
also affects interest rate. Thrift mine
also affects interest rate. Thrift mine
!eo!le are (illin$ to acce!t lo(er rate to
!eo!le are (illin$ to acce!t lo(er rate to
invest.
invest.
28
0nflation
0nflation

Refers to the tenency for !rices to rise.
Refers to the tenency for !rices to rise.

The hi$her the e+!ecte rate of inflation#
The hi$her the e+!ecte rate of inflation#
the hi$her the rate of return re=uire.
the hi$her the rate of return re=uire.
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Risk
Risk

/efault Risk * the chance that the issuer (ill
/efault Risk * the chance that the issuer (ill
efault on a loan
efault on a loan

Maturity Risk is relate to the len$th of the
Maturity Risk is relate to the len$th of the
term. 0t reflects the interest rate risk. 3on$er
term. 0t reflects the interest rate risk. 3on$er
term securities &ear hi$her risk.
term securities &ear hi$her risk.

3i=uiity Risk is the risk relate to the
3i=uiity Risk is the risk relate to the
marketa&ility of the security. ;i$her risk is
marketa&ility of the security. ;i$her risk is
associate (ith less marketa&le securities.
associate (ith less marketa&le securities.
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5ther Factors 0nfluencin$
5ther Factors 0nfluencin$
0nterest Rates
0nterest Rates

Feeral Reserve .oar Policy
Feeral Reserve .oar Policy

.alance of Payments
.alance of Payments

Ta+esD feeral eficit
Ta+esD feeral eficit
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Com!onents of 0nterest Rate
Com!onents of 0nterest Rate

The real risk*free rate of interest %kE'
The real risk*free rate of interest %kE'

The inflation !remium %0P'
The inflation !remium %0P'

The nominal risk*free rate %K
The nominal risk*free rate %K
rf rf
F KE G 0P
F KE G 0P

The efault risk !remium %/RP'
The efault risk !remium %/RP'

The li=uiity !remium %3P'
The li=uiity !remium %3P'

The maturity risk !remium
The maturity risk !remium

K F K
K F K
rf rf
G /RP G 3P G MRP
G /RP G 3P G MRP
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Risk Free Rate of Return
Risk Free Rate of Return

Risk free rate of return is the real risk*free
Risk free rate of return is the real risk*free
rate !lus e+!ecte rate of inflation. The
rate !lus e+!ecte rate of inflation. The
Treasury &ill is the closest security to risk
Treasury &ill is the closest security to risk
free security.
free security.

The T*&ill is use as a !ro+y for lon$*term
The T*&ill is use as a !ro+y for lon$*term
risk free rate. 3on$*term &ons have
risk free rate. 3on$*term &ons have
interest rate risk# (hile T*&ill oes not.
interest rate risk# (hile T*&ill oes not.
33
Risk Premium
Risk Premium

/efault risk is the !remium &ase on the
/efault risk is the !remium &ase on the
!ro&a&ility that the issuer (ill efault on
!ro&a&ility that the issuer (ill efault on
the loan. 0t is measure &y the ifference
the loan. 0t is measure &y the ifference
&et(een the interest rate on HS Treasury
&et(een the interest rate on HS Treasury
.ons an a cor!orate &on of e=ual
.ons an a cor!orate &on of e=ual
maturity an marketa&ility.
maturity an marketa&ility.
34
Risk Premium
Risk Premium

3i=uiity Risk Premium is ae to the rate
3i=uiity Risk Premium is ae to the rate
of return on securities that are not li=ui.
of return on securities that are not li=ui.

The maturity Risk Premium %MRP' is a
The maturity Risk Premium %MRP' is a
!remium (hich reflects interest rate risk.
!remium (hich reflects interest rate risk.
3on$er term securities have more interest
3on$er term securities have more interest
rate risk than o shorter term securities.
rate risk than o shorter term securities.
35
Risk
Risk

Shorter term treasury securities inclue only
Shorter term treasury securities inclue only
inflation !remium.
inflation !remium.

3on$*term Treasury securities contain
3on$*term Treasury securities contain
inflation an MRP
inflation an MRP

The rate of short*term cor!orate securities is
The rate of short*term cor!orate securities is
e=ual to the real risk free rate !lus inflation G
e=ual to the real risk free rate !lus inflation G
/RP G 3P
/RP G 3P

3on$*term Cor!. .on has MRP in aition to
3on$*term Cor!. .on has MRP in aition to
the a&ove.
the a&ove.
36
Risk Premium
Risk Premium
Sec. Ratin$ K 0P /RP 3P MRP
T*.ill RF @.CC -es ,o ,o ,o
89*yr T*. RF C.I> -es ,o ,o -es
Cor! . AAA J.AI -es ,o ,o -es
Cor! . AA J.87 -es Small -es -es
Cor! . A J.:J -es K AA -es -es
Cor! . ... J.J@ -es K A -es -es
37
Term Structure of 0nterest Rate
Term Structure of 0nterest Rate

0s the relationshi! &et(een interest rates#
0s the relationshi! &et(een interest rates#
or yiels# an the maturities of securities.
or yiels# an the maturities of securities.

The -iel Curve is a $ra!h sho(in$ the
The -iel Curve is a $ra!h sho(in$ the
relationshi! &et(een interest rate an the
relationshi! &et(een interest rate an the
maturities.
maturities.

The -iel curve is normally u!(ar.
The -iel curve is normally u!(ar.

term structure
term structure
38
Theories to 1+!lain the -iel
Theories to 1+!lain the -iel
Curve
Curve

Market Se$ment Theory
Market Se$ment Theory

3i=uiity Preference Theory
3i=uiity Preference Theory

1+!ectation Theory
1+!ectation Theory
39
Se$mente Theory
Se$mente Theory

The Market Se$mente Theory**states that
The Market Se$mente Theory**states that
each &orro(er an lener has a !referre
each &orro(er an lener has a !referre
maturity# an that the slo!e of the yiel
maturity# an that the slo!e of the yiel
curve e!ens on the su!!ly an eman
curve e!ens on the su!!ly an eman
for short*term an lon$*term securities.
for short*term an lon$*term securities.
40
The 3i=uiity Theory
The 3i=uiity Theory

States that investors $enerally !refer
States that investors $enerally !refer
short*term securities t (hile &orro(ers
short*term securities t (hile &orro(ers
$enerally !refer to &orro( lon$*term.
$enerally !refer to &orro( lon$*term.

3on$*term rate is $enerally hi$her than
3on$*term rate is $enerally hi$her than
short*term rate.
short*term rate.
41
1+!ectation Theory
1+!ectation Theory

States that the yiel curve e!ens on
States that the yiel curve e!ens on
investorsL e+!ectations a&out future
investorsL e+!ectations a&out future
interest rates. 0f inflation is e+!ecte to
interest rates. 0f inflation is e+!ecte to
rise# the yiel curve (ill &e u!(ar*slo!in$
rise# the yiel curve (ill &e u!(ar*slo!in$

Conclusion is that all these theories have
Conclusion is that all these theories have
merit# an each of the a&ove factors
merit# an each of the a&ove factors
influences the sha!e of the curve.
influences the sha!e of the curve.
42
Cor!orate 0ncome Ta+
Cor!orate 0ncome Ta+
43
/euctions from 0ncomes
/euctions from 0ncomes

/e!reciation
/e!reciation

Strai$ht line
Strai$ht line

Accelerate Cost Recovery
Accelerate Cost Recovery

0nterest e+!enses
0nterest e+!enses

/ivien income
/ivien income

5!eratin$
5!eratin$
losses
losses
44
Cor!orate 0ncome Ta+
Cor!orate 0ncome Ta+

The
The
Ta+ Scheule
Ta+ Scheule

The
The
mar$inal ta+ rate
mar$inal ta+ rate
is that rate !ai on the ne+t
is that rate !ai on the ne+t
ollar of cor!orate income.
ollar of cor!orate income.

The
The
avera$e ta+ rate
avera$e ta+ rate
is that rate !ai on all cor!orate
is that rate !ai on all cor!orate
income.
income.

"hen are &oth
"hen are &oth
e=ual
e=ual
to 8:B<
to 8:B<

Tax Problems Tax Problems

Ca!ital
Ca!ital
loss
loss
• Ca!ital
Ca!ital
$ain
$ain
45
Ta+ Scheule
Ta+ Scheule
Tax Rate Income
.15 0-50,000
.25 50,000-75,000
.34 75,000-100,000
.39 100,000-335,000
.34 335,000-
46
Calculation of Ta+a&le 0ncome
Calculation of Ta+a&le 0ncome
Salary ?:@#999
/iviens 8#999
Personal
1+em!tions
%A#:@9'
/euctions %:#I@9'
Ta+a&le 0ncome ?:9#799
47
Ta+ 3ia&ility
Ta+ 3ia&ility

Ta+ 3ia&ility F ?8#:>8 G .AJ%:9#799 * AA#C@9'
Ta+ 3ia&ility F ?8#:>8 G .AJ%:9#799 * AA#C@9'
F J#:7@
F J#:7@
48
Calculation of Mar$inal Ta+es
Calculation of Mar$inal Ta+es

Avera$e Ta+ Rates F Ta+ 3ia&ility M Ta+a&le
Avera$e Ta+ Rates F Ta+ 3ia&ility M Ta+a&le
0ncome
0ncome

Mar$inal Ta+ Rate F Chan$e in Ta+
Mar$inal Ta+ Rate F Chan$e in Ta+
3ia&ilityMChan$e in Ta+a&le 0ncome
3ia&ilityMChan$e in Ta+a&le 0ncome
49
After Ta+ -iels
After Ta+ -iels

A sin$le iniviual in the AJB mar$inal ta+
A sin$le iniviual in the AJB mar$inal ta+
&racket has t(o investment o!!ortunities
&racket has t(o investment o!!ortunities
(ith the follo(in$ yiels2
(ith the follo(in$ yiels2

CB state of California munici!al &ons
CB state of California munici!al &ons

>9B 0.M cor!orate &ons
>9B 0.M cor!orate &ons

"hich alternative is the &est<
"hich alternative is the &est<

After ta+ yiel F .T- *Ta+es F .T- %>*T'
After ta+ yiel F .T- *Ta+es F .T- %>*T'

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