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Financial Market
A broad term describing any marketplace where buyers and sellers participate in the trade of assets such as equities, bonds, currencies and derivatives. Some financial markets only allow participants that meet certain criteria, which can be based on factors like the amount of money held, the investor's geographical location, knowledge of the markets or the profession of the participant. Financial markets facilitate:
The raising of capital (in the capital markets) The transfer of risk (in the derivatives markets) Price discovery Global transactions with integration of financial markets The transfer of liquidity (in the money markets) International trade (in the currency markets)
A borrower issues a receipt to the lender promising to pay back the capital. In return for lending money to the borrower, the lender will expect some compensation in the form of interest or dividends. for long term finance, the Capital markets; for short term finance, the Money markets. Capital markets which consist of:
Stock markets, which provide financing through the issuance of shares or common stock, and enable the subsequent trading thereof. Bond markets, which provide financing through the issuance of bonds, and enable the subsequent trading thereof. Commodity markets, which facilitate the trading of commodities. Money markets, which provide short term debt financing and investment. Derivatives markets, which provide instruments for the management of financial risk. Futures markets, which provide standardized forward contracts for trading products at some future date; see also forward market. Insurance markets, which facilitate the redistribution of various risks. Foreign exchange markets, which facilitate the trading of foreign exchange.
Of this, the banking sectors and non-banking sectors are regulated by the central bank, State Bank of Pakistan. While rest of the market (lease, stock exchanges, modarba, mutual funds and insurance) is regulated by Securities and Exchange Commission of Pakistan.
Capital Market
The market in which corporate equity and longer-term debt securities are issued and traded. Include shares, and bonds. Capital markets, and especially the stock markets in Pakistan, have come a long way over the last decade.
Stock Exchange
Where bonds and stocks are exchanged is called stock exchange. basic function is to enable public companies, governments and local authorities to raise capital by selling securities to investors. In Pakistan there are three Stock Exchanges.
Karachi Stock Exchange (KSE) Lahore Stock Exchange (LSE) Islamabad Stock Exchange (ISE)
Money Market
segment of the financial market in which financial instruments with high liquidity and very short maturities are traded.
BANKS:
Organization that provides various financial services, for example keeping or lending money is known as bank. There are two types of bank
Central bank
Commercial bank
State Bank
A government monetary authority that issues currency and regulates the supply of credit and holds the reserves of other banks and sells new issues of securities for the government. Function of State Bank
Monopoly of note issue Bankers, Agent and Adviser to the Government Custodian of Cash Reserve of Commercial Bank Custodian of Nations Reserve of International Lender of the Last Resort Clearing House Function
Credit Control
Collection of Data
Commercial Banks
An institution which accepts deposits, makes business loans, and offers related services. Commercial banks also allow for a variety of deposit accounts, such as savings, current and fixed deposit account. While commercial banks offer services to individuals, they are primarily concerned with receiving deposits and lending to businesses. The primary functions of a commercial bank include:
Accepting deposits; and Granting loans and advances
Treasury bills make up the bulk of the money market instruments. Securities in the money market are relatively risk-free.
Money market funds are generally the safest and most secure of mutual fund investments.
The goal of a money-market fund is to preserve principal while yielding a modest return. Money market funds are of two types:
Institutional Money Market Mutual Funds. Retail Money Market Mutual Funds:
The retail market designates transactions made by smaller speculators and investors.
Hedge Funds - Hedge funds are private investment funds that speculate in various assets classes using leverage. Macro Hedge Funds pursue trading opportunities in the Forex Market. They design and execute trades after conducting a macroeconomic analysis that reviews the challenges affecting a country and its currency. Due to their large amounts of liquidity and their aggressive strategies, they are a major contributor to the dynamic of Forex Market. Corporations - They represent the companies that are engaged in import/export activities with foreign counterparts. Their primary business requires them to purchase and sell foreign currencies in exchange for goods, exposing them to currency risks. Through the Forex market, they convert currencies and hedge themselves against future fluctuations. Individuals - Individual traders or investors trade Forex on their own capital in order to profit from speculation on future exchange rates. They mainly operate through Forex platforms that offer tight spreads, immediate execution and highly leveraged margin accounts.
Eurocurrency Market
A Eurodollar is a U.S.-dollar denominated bank deposit held outside the U.S.
More generally, a Eurocurrency deposit is a domesticcurrency denominated bank deposit held outside the domestic geographical area. In other words, Eurocurrencies are typically time deposits denominated in currencies other than those of the countries in which they are located
In the late 1950s British-owned banks utilized foreign currency deposits (in the UK) as a lending medium in order to save the business that was at that time endangered by exchange controls (in the UK) on transactions in pounds sterling
The Soviet Union: provided impetus for the early growth of the market. As the cold war heated up, the Soviet Union began to worry about the U.S. Government freezing its deposits in New York. The Soviets needed to maintain dollar accounts for international trade and investment. The dollar was then virtually the only currency acceptable worldwide. The Soviet Union responded to this problem by placing its dollar-denominated deposits in banks outside the U.S. jurisdiction.
The Role of Narrow Spreads: The desire of depositors to receive highest possible yields and of borrowers to pay lowest possible costs are met in the Eurocurrency market. Absence of regulation permits higher yields to depositors and lower costs to borrowers.
The Role of OPEC: OPEC countries use the Eurocurrency market to invest part of their petrodollars, so that the Eurocurrency market provides a medium for what is commonly called "Petrodollar Recycling.
Features of Eurocurrency
Low costs per transaction because of relatively large size of transactions. Costs of complying with regulations are low since there are no deposit insurance assessments. Borrowers' credit worthiness is well known so that the need for credit investigation is low. No taxes are withheld from interest payments to Eurocurrency depositors. Taxes and fees levied on euro-banking operations are generally lower than those applied to domestic banking.
Eurocurrency markets need not be located in Europe, though they originate in Europe. For example, in the U.S., domestic banks are (since 1981) permitted to open International Banking Facilities (IBF) which are computerized account records kept separate from U.S. banks' domestic accounts. They must be domiciled inside U.S. territory and focus on international commerce.
These "onshore/offshore" bank accounts are permitted in an effort to regain deposits lost to offshore banking operations.
IBF accounts are free from reserve requirements and assessment for deposit insurance; are also exempt from federal taxes, becoming taxable only when transferred to the banks' regular accounts.
Transactions are predominantly interbank, hence the market is frequently called "interbank market" In addition, large scale or "wholesale" transactions take place between banks and nonbank customers
Transactions are typically priced off the London Interbank Offer Rate (LIBOR) which is a floating rate commonly charged for loans between Eurobanks. LIBOR is the world's most widely used benchmark for short-term interest rates.
It is the rate at which the worlds most credit worthy borrowers are able to borrow money.
Loan rates float in accordance with movement of some market interest, such as the LIBOR
Eurobond market
Eurocurrency and Eurocredit loans help to accommodate short and medium term borrowers. The Eurobond was created to accommodate long-term borrowers. Partially the result of Interest Equalization Tax (IET) imposed in the U.S. in 1963 to discourage U.S. investors from investing in foreign securities. Foreign borrowers are thus forced to look elsewhere for funds and the Eurobond market fills the void. The Eurobond market facilitates the transfer of long-term funds from surplus spending units to deficit spending units around the world. This market helps to link investors with borrowers around the world, and thereby helps to integrate the world's financial system.
That means there is no physical location where traders get together to exchange currencies.
Traders located in the offices of major commercial banks around the world and communicate using the computer terminals, telephones, telexes, and other communication channels.
Most trading activities take place in a few currencies like the US dollar, The Euro, British Pounds, Yen, and Canadian Dollars. Foreign Exchange traders not only buy and sell currencies but, they create prices. Market Makers are those traders in major money-center banks around the world who are always ready to buy or sell by quoting the bid/ask prices. The difference between the two prices is called the spread." They create the market by setting bid/ask prices and dealing at those prices. Participants include importers, exporters, portfolio managers, central banks, brokers, commercial banks, arbitragers, speculators, tourists, governments, etc.
The Interbank Market: Major participants are foreign exchange traders employed by large banks. Also large Multinational Corporations often maintain trading departments that operate directly in this market.
Traders in the interbank market are called "Dealers." They make the market. Brokers: Bring buyers and sellers together for a small commission thereby helping to preserve the anonymity.
Arbitragers: Seek to earn riskless profit from price differences in different foreign exchange markets
Speculators: Buy and sell in the hope that a price change will result in a profit. Governments: Central Banks, Treasury Departments and other Government Agencies sometimes participate in the market in order to influence the exchange rate of a particular currency. For Example: FED buys dollars in the foreign exchange market to increase the value of the dollar. FED sells dollars in the foreign exchange market to reduce the value of the dollar. Coordinated efforts among central banks are often used. Example: The Federal Reserve Bank bought Mexican pesos to help prop up the value of the currency in 1995.
Traders: Use forward contracts to eliminate or cover the risk of loss on export or import orders that are denominated in foreign currencies. Hedgers: Hedgers, mostly Multinational corporations, enter into forward contracts to protect domestic currency value of foreign currency denominated asset and liabilities on their balance sheet. The increasing importance attached to exchange rates results from the globalization or internationalization of modern business, the continuing growth in world trade, the trend towards economic integration, and the rapid pace of change in the technology of money transfer
Provisions of credit: Movement of goods and services between countries takes time. This gives rise to financing of inventory in transit and sales inventory.
The foreign exchange market provides a means of transfer of credit. Specialized instruments like Bankers' Acceptances and Letters of Credit, are made possible through the foreign exchange market
Minimizing Foreign Exchange Risk: The foreign exchange market provides "risk transfer" facilities to third parties through Forward, Futures, Options, and Swaps markets. During the past decade the foreign exchange market has served as the invisible hand guiding the purchase and sale of goods, services, raw materials, and flow of investments in every corner of the globe. The market directly affects every countrys bonds, equities, private property, manufacturing, and all assets that are accessible to foreign investors. It plays a major role in determining who finances government deficits, who buys equity in companies, who owns real estates, who buys companies, and who hires and fires employees.