Global Financial Markets - Essay Example

Global Financial Markets Global Financial Markets Financial markets can broadly be defined as an aggregate comprising of possiblebuyers and sellers of financial securities, commodities and other fungible items (Rejendran, 2012). This also includes all forms of transaction between them. The term financial market is exclusively employed when referring to general market that aims at raising finances. To be very specific, for long term finances, capital markets are always used. On the other hand, for short term finances, money markets are always used. Financial markets do exhibit a wide range of roles globally. In a stylistic sense, financial markets together with intermediaries have been rapidly evolving over the past few years. This is basically because of technological advancement that has seen the integration of financial markets and intermediaries globally (Rejendran, 2012). This ensures that as the financial system around the world changes, the markets also remained stable. The other primary function of any financial system is to facilitate the allocation and deployment of economic resources (Valdez & Molyneux, 2010). This is intended to happen both spatially and temporally. Financial market is also fundamentally vital when it comes to transferring of resources across time and space. This targets vast industries across geographical region. To illustrate this concept, loan helps in moving resources from the future to today (Rejendran, 2012). On the other hand saving products helps in accomplishing the opposite. Although the undelaying function of the two seems different, the general outcome is equally the same. Financial system also aid in shifting resources from one locality to the other. This can be illustrated when one uses financial systems sending money to his/her family members from a different location The other role of financial markets is that they provide means of managing uncertainty and control risks. This is attained through financial securities systems. Moreover, with private sectors and government intermediaries, financial systems do offer risk pooling and risk sharing opportunities (Rejendran, 2012). This structure of risk pooling aims at benefitting both household and big business firms. Clearing and settling payments is the other core function of financial markets (Rejendran, 2012). This is because, financial system have advanced payments systems that aid in exchange of goods and services. This acts as the most efficient way where traders can buy and pay for goods and services from one region to another without moving. For example, barter trade, use of credit cards, wire transfers checking accounts are some of the most effective means of buying and payment of goods and services. This also makes it easy to purchase goods from different region under zero risk. Finally, financial markets also serve as a platform where pooling of resources and subdividing of shares takes place (Rejendran, 2012). The pooling of funds is absolutely critical when it comes to funding large scale indivisible enterprise. Shareholding helps in raising huge capitals which also see each shareholder equally benefiting from the returns. The financial markets are classified under the following categories. Based on new issues, there are primary and secondary markets. Primary market is considered when financial securities are directly issued to the buyers (Saumo, 2013). In other words, primary market do offer securities to the public in form of IPO (Initial public offering), FPO (Follow-on public offer) among many other (Saumo, 2013). Contrary, when it comes to secondary markets, securities that are issued in primary markets are traded through an exchange over the counter (Saumo, 2013). This relatively offers an exit option to the holder of the security. The other financial market classification occurs on the basis of finance maturity period. Under this category we have money markets. This is a financial market involving short-term securities (Saumo, 2013). Money market precisely targets financial maturity of one year or less. On the other hand, we have capital market that offer financial market wit long-term securities (Saumo, 2013). This targets finances with more than one year maturity period. This creates more time for market where those securities could be traded. Finally we have financial market based on types of financial instruments. To supplement this, there is the stock market. Stock market is where shares are issued and traded (Bodie, Kane &Marcus, 2009). This is one of the most vital areas as far as market economy is concerned. This is simply because it gives investors access to capitals and investing companies ownership. Secondly, there is the bond market which primarily deals with issuing of loans (Saumo, 2013). The loan borrower will approach a subscribed lender and request for loan. This is granted after agreement met on repayment with interest over specified time. Foreign exchange or currency market is another class involving trading of worldwide currencies (Saumo, 2013). This includes huge participants like central banks and commercial banks. They act as anchor of global currency trade between different buyers and sellers (Saumo, 2013). Asset financing is a form of investment where the principal funding used to purchase the desired property originates from the bank. The bank can purchase the asset to the customer who will pay back the principal cost plus interest to the bank over specified period of time. This generally means that asset financing is a loan granted to purchase an asset which becomes part of the loans security. Ownership of the asset becomes personal upon completion of the loan repayment. Most asset financing managers do provide investment advisory and management services to clients as fiduciary agents (Saunders and Cornett, 2012). However, due to variety of clients expectation concerning asset financing most banks have developed variety of structures to run the business. The main focus of this structure is to permit flexibility and to also analyze the risks likely to be attached with the asset financing. In other words, the asset financing manager has to use an effective financing structure to protect the firm against loan default. When an asset financing manager offers a balanced portfolio where some percentage of the asset, bonds and cash payment are required as security; then the main agenda is to ensure 100% security for the loan. The manager has to ensure that there is established extensive security coverage for the loan granted. This would create room for development of a robust analytical and cash flow model. Alternatively, the proposed asset financing structure also assures the bank of 100% loan repayment compliance from customer. This also allows involvement of a third party to back up loan repayment incase of default. Moreover, the structure is very appropriate for liability driven investment (Saunders and Cornett, 2012). When the bank retain the 10% cash and 25% bond rendered as security, it is easy for them to still invest the money and generate more income. This could continue during the entire period the customer will take to fully repay the asset loan. In other words, incase of default, there will be no much loss in the bank (Saunders and Cornett, 2012). a) Consider a mutual fund P that invests 60% in the risk-free security and 40% in stock A, A has an expected return and standard deviation of 17% and 12% respectively. The risk free rate is 4.5%. (i) What is the expected return and standard deviation of the mutual fund P? Expected returns general formula (Investopedia, 2012). Written another way, the same formula is as follows: E(R) = w1R1 + w2Rq + ...+ wnRn Expected return= (0.6) (0.17) + (0.40) (0.12) ER= 0.102+0.048 ER=0.15 =15% returns. (ii) Suppose you wish to achieve an expected return of 25% by investing in the mutual fund and the risk-free asset. What proportion of your total investment will be in the mutual fund and what proportion in the risk-free asset to obtain this return? 25% = 0.25 returns 15% Returns = 60% (Mutual fund) + 40 %( risk Free asset)/3 5% Returns = 20% (Mutual fund) + 13.3 %( risk Free asset) 25% returns = 100% (Mutual fund) + 66.5 %( risk Free asset) (iii) What is the standard deviation associated with the portfolio which achieves the 25% return? 28 and 18 respectively. The banking sector is mainly split into two major categories. They include investment banking and commercial banking. In the recent regulatory perspective, such institutions that mix the two activities have been undergoing serious scrutiny. This is because, there have been allegation that such institutions are major contributor to the global economy meltdown of 2008 (Ingram & Media, 2011). To shed light on this, commercial banks mainly deal with managing deposit accounts. This includes checking and saving account that are opened by individuals or businesses. Commercial banks also issue loans to the public using the monies deposited by members. On the other hand, investment banking differs widely with the commercial banking. This is because, investment banking entirely deals with buying and selling of stoke, bonds and other investments (Ingram & Media, 2011). The regulatory federal authorities from February 2009 have been keen on making strict financial scrutiny on commercial banks. The regulatory authorities which involve federal deposit insurance corporation (FDIC) and the Federal Reserve have even ensured that the commercial banks are federry insured (Ingram & Media, 2011). This is to reduce risks and protect bank customer’s accounts. When comparing this with investment banking, the federal authorities have minimum scrutiny over the institution. The security and exchange commission (SEC) loosely engage in making follow-ups with investments banking institutions. This helps the institution in formulating independent decision on strategic development. The investment banking is said to by nature one of the banking that have a higher risk tolerance levels that the commercial banking (Frederic and Stanley, 2009). This is precisely because the bank does not serve as financial intermediaries. This permits them to only take cash deposit and lend them out to borrowers. In doing so, the investment bank is completely excluded from default risk. Investment banks also do receive fees and payments that serve as securities of loans. Commercial banks on the other hand are more exposed to financial risks. This is because; the banking allows deposit of cash. This cash is later used in making loans with the profits resulting in interest rate which is spread between deposit and loans (Romesh, 2010). The worst is the fact that commercial bank only receives profits when the borrower repays the loan. This means that if the borrower struggles in repayment, then the like hood of the commercial bank to recover the principal and interest is also very minimal. The other contrary operation disparity is that unlike commercial banks the investment banking is never involved with cash deposition. Over the years, there were proposals which aimed at separating investment banking from commercial banking. In the recent regulation, the separation was accelerated by the Gram-Leach-Bliley Act in the year 1999 (Frederic and Stanley, 2009). Moreover, in the year 2010 the Vocker Rule was passed to ensure that investment banking was separated from commercial banking. This regulatory acts and rules were mainly developed to minimize conflict of interest within the banking institutions (Frederic and Stanley, 2009). Additionally, the rules were also meant to limit and reduce chances of risks in the financial institutions (Frederic and Stanley, 2009). Table a: Consider the following set of orders Time Trader Order Side Size Price 15:03 ABC Sell 7 Market 15:04 DEF Buy 5 16 15:06 GHI Buy 4 18 15:08 JKL Buy 7 19 15:09 PQR Sell 8 Market 15:11 MNO Sell 5 17 15:16 STU Buy 4 16 15:17 VWX Buy 3 Market Basing on the price/time priority principal, the main consideration is directed to both the order and quote (Rutterford & Davison, 2007). When an order is first register onto an order book, there should be a timestamp assigned to it. This is precisely to enable prioritization of the orders in the book with special consideration on orders with same prize. Moreover, the order/bid that is first registered considering the price limits is always executed first (Rutterford & Davison, 2007). In addition to this, when a new order is registered at different time and with limits matching with an existing order it could be executable immediately. Time Unexecuted Trader Order side Unexecuted Size Unexecuted Price Executed Trader Executed price Executed Size 15.03 ABC Sell 7 Market 15.04 DEF Buy DEF 16 5 15.16 STU Buy STU 16 4 15.11 MNO Sell MNO 17 5 15.06 GHI Buy 4 18 15.08 JKL Buy 7 19 15.09 PQR Sell 8 Market 15.17 VWX Buy 3 Market Table b. Final order book with executed and unexecuted order References Bodie, Z., Kane, A., & Marcus, A. J., 2009. Investments edition. McGraw-Hill, 2.25-54. Frederic, S.M., and Stanley, G.E., 2009. Financial Markets and Institutions. Pearson Prentice Hall, 123. Ingram, D., & Media, D., 2011. Investment Bank Vs. Commercial Bank. Accessed on March 29, 2014, from http://smallbusiness.chron.com/investment-bank-vs-commercial-bank- 3450.html. Investopedia, 2012. Return, Risk And The Security Market Line - Expected Return, Variance And Standard Deviation Of A Portfolio. Accessed on March 29, 2014, from http://www.investopedia.com/walkthrough/corporate-finance/4/return-risk/expected- return.aspx. Rejendran, D., 2012. Functional Perspective of Financial Systems- an Introduction. Accessed on March 29, 2014, from http://www.ifmr.co.in/blog/2011/06/23/functional-perspective- offinancial-systems-%E2%80%93-an-introduction/. Romesh, V., 2010. The Financial Times guide to using the financial pages. Pearson Rutterford, J., & Davison, M., 2007. An Introduction to stock exchange investment. Palgrave Macmillan, 1. 23. Saumo, 2013. Classification of Financial Markets: A Guide to B-School Placements. Accessed on March 29, 2014, from http://www.careeranna.com/classification-of- financial-markets/. Saunders, A., and Cornett, M. M., 2012. Financial Markets and Institutions. McGraw-Hill. 5e. Valdez, S., & Molyneux, P., 2010. An Introduction to Global Financial Markets. Palgrave Macmillan, 2. 32. Read More