FDN-CM101-DB
Study Material for Introduction & Overviewof Securities Industry
Table of Contents
Introduction & Overview...3
Financial Markets...3
What are Financial Markets?...3
Objectives of Financial Markets...4
Participants in the Financial Markets...6 Investors...7 Issuers...10 Financial Intermediaries...12 Infrastructure Providers...25 Industry Bodies...34 Asset Classes...36 Equity...37
Fixed Income Securities...38 Currencies...39 Commodities...40 Derivatives...41
Types of Risks...42
Types of Markets...44
Primary Market and Secondary markets...44
Money and Capital Markets...45
Markets for Financial Instruments...47
Role of Regulators...51
Securities and Exchange Commission (SEC):...51
Financial Services Authority (FSA)...56
Recent Developments in Financial Services Industry...59 Dematerialization...59 Electronic Trading...59 Web Trading...60
Electronic Communications Networks...60
Financial Messaging...60
Shortening of Settlement Cycles...62
GLOSSARY...62
Introduction & OverviewFinancial Markets What are Financial Markets?
In any economy, entities such as individuals, organizations and governments may havesurplus funds or may need funds for a variety of purposes. Thus funds need to beexchanged between those who have surplus of them (
called savers/investors/lenders ) andthose who need them ( called issuers/borrowers
). Broadly speaking individuals are theprincipal savers while organizations and governments are principal borrowers or fundraisers. 1
This transfer of funds takes place through a mechanism of financial markets.
Indiviual Investors- Fund/Capital Raisers
Invest funds through –Financial markets-Funds are transferred to Organizations or Governments What are financial assets or securities?
When investors lend their surplus funds to organizations or governments, investors get anacknowledgement for the same from organizations or governments in the form of financialsecurities. Thus financial securities are issued by those who need capital
2
and represent thefact that such issuers have raised funds from investors. For the investors who have investedin such securities, such securities become financial assets. These financial assets represent aclaim on the issuer‟s earnings or resources. The issuers have certain obligations towards theinvestors, the most important among them being providing a return on their investments.
1
The classification of individuals as investors and organizations and governments as fund raisers is only abroad one. This is because individuals do borrow funds and organizations and governments do invest or lendfunds.
2
Capital is the amount of monetary resources required to run the business
Financial securities are primarily of two types i.e. equity shares or stocks and fixed incomesecurities. Equity share represents an ownership capital i.e. an investor buying equity sharesissued by a company, becomes a fractional owner of the company. Fixed income securities,on the other hand, is like a loan taken by the company from the holder of fixed incomesecurities. They are also called debt securities or debt instruments. Both these
financialsecurities are explained in detail in the section on “Asset Classes”.As we have already seen, financial markets facilitate transfer of funds between the twoparties. This transfer takes place by issuing financial securities to the investors. Theadvantage of these securities is that they are negotiable and thus can be traded. Forexample, Organization A issues securities to Investor B. Obviously, investor B has given /lent money to the organization A. Suppose investor B wants his money back after sometime, he can simply transfer the securities to any other investor, say Investor C by selling thesecurities to him. This is what is meant by negotiable instrument and transfer of securityfrom B to C is called trading in securities.
Objectives of Financial Markets
Bringing borrowers and lenders together - The most important objective of financialmarkets is to bring borrowers and lenders together so that excess funds can bechannelized from lenders to borrowers. Bringing borrowers and lenders togetherdoes not mean that they have to be brought together physically. We are living in atechnologically advanced world and with the help of technology borrowers andlenders in any part of the world can be brought together electronically.
Financial intermediation : The process of transfer of funds between issuers andinvestors is takes place through intermediaries who operate in financial markets.Thus one of the objectives of the financial markets is to perform the function offinancial intermediation as efficiently as possible.
Price Discovery : One of the objectives of financial markets is “price discovery”which means that when securities are continuously transferred between variousinvestors, it helps arrive at the correct price at which the security should trade.
Meeting needs of market participants : Investors and issuers have different needs.For example, Organization A wants to borrow funds for 1 year while Organization Bwants to borrow for 10 years. Investor A is very young and aggressive and hence isprepared to take higher risk while investing. On the other hand, Investor B, a retiredemployee wants to play very safe. Thus different investors and borrowers havediffering needs and a well developed financial market should provide a wide varietyof financial securities or instruments so that their requirements can be met.
Participants in the Financial Markets
Participants and Vendors in financial markets include • Investors Institutional Individual • Issuers Organizations / Corporations
Governments
Government Sponsored Agencies • Financial Intermediaries Banks
Investment Managers / Asset Managers
Broker / Dealers
Managed Investment Companies Investment Banks Insurance Companies • Infrastructure Providers
Stock Exchanges, Over the counter markets
Settlement Service Providers
Market Data Vendors •
Industry Bodies •
Support Service Providers
Data Vendors
All the participants have important roles to play. Their roles are described in detail in thesections that follow
Investors
Two types of investors
participate in the
Institutional and
Individualinvestors. The
features and
characteristics of the
two types of investors
are discussed below.
Institutional Investors
These are the investors
who exist as
Corporations. As they
are corporations, they
poolmoney from a
invest through financial
markets. Examples of
theseinclude banks,
mutual funds and
insurance companies.
o
Banks
are depository
institutions i.e. they
collect deposits from
individual investorsand
business corporations.
borrowers or invested
infinancial securities of
issuers.
o
Managed Investment
Companies
collect money
from individual
investors,
businesscorporations and
other institutional
them mutual fundunits
which are again
financial securities. On
behalf of investors from
whom moneyhas been
collected, mutual fund
managers / asset
managers invest these
fundsthrough financial
markets in various
securities.
o
Insurance companies
collect insurance
premiums for a variety
of purposes fromthose
who insure their lives or
assets. These funds are
in turn invested in
variousfinancial
instruments.Let us look
at some of the
characteristics of these
investors.
o
An institutional investor
has a pool of funds. This
pool of funds can be
invested in avariety of
assets.
o
Since they collect a pool
of funds from investors,
the resources available
to them arehuge
compared to individual
investors. Hence their
investments are in
largeamounts.
o
They employ one or
several investment
managers who take
investment
decisions.These
investment managers
are well trained, market
professionals and hence
these institutions are
considered to have
superior market
knowledge and access to
information
Since transactions are
on large scale, they get
preferential
(competitive) rates
frombrokers
3
who execute the
transactions on their
behalf.
Individual Investors
Individual investors are
also called as
„retail investors
‟. Retail investors
participate infinancial
markets either directly
or indirectly. Direct
participation means
investors
makeinvestment
decisions on their own
and invest money in
various securities
directly. Else, theycan
park their funds with
mutual funds who in
turn invest in financial
instruments. In thiscase,
investors do not
participate in investment
decision making process
and thus
participateindirectly..
Retail investors are an
important part of any
financial market.
As against the
institutional investors,
retail investors have the
following
characteristics.
Retail
investors have limited
resources since they use
their own funds to
invest.
o
If they participate
directly, investment
decision making may not
be professional.
o
Small sizes of
investments.
o
Since investment sizes
are small, no
preferential rates are
offered by brokers
toexecute the
transactions.
Brokers actually execute
transactions for investors.
Detailed information about
brokers in mentioned in
thesection of “Infrastructure
Providers”.
Types of Individual/
Retail InvestorsIt is
generally observed that
different types of
different
investmentapproaches
supported by a
multiplicity of factors
together with their
propensity for risk
4.Mutual Fund Investors
Professional Investors Day Traders
Stock Pickers
The different types of individuals are as follows:
Professional Investors:
This refers to all those individuals who have substantialinvestment resources so that they can acquire professional money managementservices for their investment portfolio.
Stock Pickers:
Stock Pickers are those individuals who are of the opinion that they canchoose individual stocks 5
for long-term investment on their own. They do their ownresearch and pick the stocks accordingly.
Mutual Fund Investors :
A majority of the investors do not have adequate resources toacquire individual professional money management services or adequate time orpenchant to invest on their own. It is these kind of individuals who normally selectMutual Funds to invest in Securities
Day Traders :
Yet another category of individual investors is a day trader. A daytrader typically buys or sells securities during the day and does the reverse to closepositions by the end of the day. For example if a day trader purchases /(sells) a
Risk refers to the uncertainty of investment return
---Stocks or equity shares are explained in the section on “Asset Classes” security of a particular issuer, then he will sell / (buy) the same before the tradingcloses for the day. Thus he does not keep his position open overnight i.e. till the nextday. Hence such traders are called day traders. The day trader bets on a very shortterm movement in prices of securities, and hence it is considered to be a riskyactivity because security prices may not move in desired direction in such a shortperiod of time.
Issuers
Issuers include government, government sponsored agencies and corporations that desire toraise funds. They need to raise funds for a variety of purposes.
Issuers - Governments
Government requires funds for expenditures on infrastructure, health, education etc. as wellas to meet the shortfall in government revenue. Governments issue different forms of fixedincome securities
6
to meet their needs. Government includes following categories: o
US Federal Government (or Central government of any country) o
US Government Agencies and Quasi-government Agencies – These are governmentformed or sponsored agencies. o
State Governments o
Local Governments such as Counties and Municipalities
Issuers – Government Sponsored Agencies
The government sponsored agencies get privileges so that they can lend to desired sectors.For example in the US, a number of special purpose agencies with varying degrees offederal government sponsorship raise finance so that they can lend to designated sectors ofthe economy i.e. agriculture and housing. The principal agencies are as follows.
o
Farm Credit System (FCS) - The Farm Credit System (System) is a network ofborrower-owned lending institutions and related service organizations in the US.These institutions specialize in providing credit and related services to farmers,
6
Fixed Income Securities are explained in detail in the section on Asset Classes
ranchers, and producers or harvesters of aquatic products. Loans may also be madeto finance the processing and marketing activities of these borrowers.
o
Federal Home Loan Mortgage Corporation (FHLMC) - The Federal Home LoanMortgage Corporation ("Freddie Mac") is a government sponsored enterprise. It is astockholder-owned and a publicly-traded company chartered by the United Statesfederal government to purchase mortgages
7
and related securities. These securitiesare then issued in financial markets backed by those mortgages. o
Federal National Mortgage Association (FNMA) – It is a competitor to FHMLC. It isalso a government-backed corporation which purchases mortgages from lenders andresells them to investors. It is financed by the issue of fixed income securities.
o
Student Loan Marketing Association (SLMA) – It is a government-sponsored privatecorporation created to increase the flow of funds into student loans by facilitating thepurchase of student loans in the secondary market.These agencies issue fixed income securities.
Issuers – Corporations
Corporations need funds for carrying out new projects, expansion projects or to financetheir day to day needs. The securities issued by corporates are of various types and includeboth fixed income and equity shares.
8 7
A mortgage is a loan that is secured by the underlying real estate. For example when a loan is taken by a homebuyer, the house property is mortgaged with the lender.
8
Equity shares are explained in detail in the section on Asset Classes. Financial Intermediaries
A number of institutions, agencies play an important role in bringing issuers and investorstogether. These are as follows.
Banks
Investment Managers / Asset Managers
Broker / Dealers
Managed Investment Companies
Insurance CompaniesThese are called financial intermediaries and perform a vital function of transfer of capitalfrom one party to another. Let us now look at important financial intermediaries.
Banks
All of us as individuals and even business houses and governments consider banks as a safeplace to deposit money. A number of accounts can be opened with banks which havedifferent features and allow us to deposit money with them. They are financialintermediaries because these deposits are in turn lent to those who need them or are used toinvest in financial instruments issued by issuers.The services offered by Banks for individuals and institutions include:Services for deposit holders
o
Checking accounts also called as demand deposits – These accounts do not earn anyinterest for keeping deposits but the deposit holder can withdraw deposit any timehe wants. That is why they are called demand deposits.
o
Savings accounts – These accounts pay a low rate of interest. These accounts aregenerally very popular amongst individuals who park their surplus funds andwithdraw whenever they want subject to certain restrictions.
o
Time deposits that includes Certificates of Deposit – These pay a higher rate ofinterest compared to savings deposits. In this case funds have to be parked for a
specific time period, say a six months‟ time deposit. Funds can not be withdrawnbefore six months.Services for borrowers o
Secured lending – As mentioned above, banks lend the deposits collected, toorganizations or other entities that need them. By secured lending we mean that theloan given is secured against any asset that borrower has. For example, a corporationmay obtain a loan from a bank by securing it against the machinery that it has. In theevent that the company is unable to pay off the loan, the bank can sell off themachinery to recover its dues.
o
Unsecured lending – These types of lending are not secured against any asset. Hencein the event of default i.e. corporate not paying back the loan, the bank can not takecharge of any asset and recover its dues.Other important services
o
Transfer of funds from one bank to another – This service is provided so thatpayments can be made by one party to another. Thus when party A issues a chequein favor of party B, and when latter deposits it with his bank, funds get transferredfrom party A‟s account to party B‟s account in the same or a different bank.
o
Distribution of investment products - Making available a number of investmentproducts including the mutual funds o
Foreign exchange – When party A which is based in US wants to purchase or sellany foreign currency say British Pounds or Euros, he can do so through the banks.
Categories of Banks:
Various categories of banks are as follows. o
Retail Banks:
As the name suggests, these banks basically satisfy the needs ofretailers i.e. individuals. They offer services such as
Secured and Unsecured
Loans:
These loans are provided to the retailers for avariety of purposes.
Checking and savings accounts
Electronic funds transfers
Bank investment products such as Certificates of Deposit o
Commercial Banks:
Commercial Banks do not restrict their operations toindividuals; in fact their main clients are business enterprises. These banks offerdifferent kinds of services, such as:
Loans to business enterprises that may be both; secured or unsecured
Loans to brokerage firms for the brokers to finance their purchase ofsecurities
Categories of Banks:
Various categories of banks are as follows Banks: Retails Banks Commercial Banks Custodian Banks Trust Banks Retail Banks:
As the name suggests, these banks basically satisfy the needs ofretailers i.e. individuals. They offer services such as
Secured and Unsecured
Loans:
These loans are provided to the retailers for avariety of purposes.
Checking and savings accounts
Purchase and sale of mutual funds and securities through specific purposesubsidiaries
Electronic funds transfers
Bank investment products such as Certificates of Deposit
Commercial Banks: Commercial Banks do not restrict their operations toindividuals; in fact their main clients are business enterprises. These banks offerdifferent kinds of services, such as:
Loans to business enterprises that may be both; secured or unsecured
Loans to brokerage firms for the brokers to finance their purchase ofsecurities
Underwriting services9 with the help of bank‟s corporate financedepartments
Securities custody services10
Clearing of US government securities – Whenever investors buy securitiesissued by US government, they need to be transferred from seller of securitiesto the buyer. Similarly funds have to be transferred from buyer of securitiesto seller of securities. This means that these trades need to be cleared andsettled. Clearing of US government securities is done by banks. Clearing andsettlement of various securities are explained in detail in subsequentmodules.
Recent trends in commercial banking
The commercial banking business has undergone lot of changes over the years. Some trendsin the financial services industry have resulted in the decline in the banking business formany years. These trends are as follows:
There is growing disintermediation in financial securities industry. Thissimply means that issuers and investors come together without anyintermediary and transfer funds amongst themselves. As a result the bank‟srole as an intermediary gets reduced.
Traditionally retail investors have preferred to keep their surplus funds inbanks. However, with the availability of new investment opportunities suchas investing in mutual funds, retail investors have shifted to such productsfor getting better returns. Hence banks face considerable competition incollecting deposits.
9
Underwriting Services mean whenever issuers issue securities underwriters ensure that any unsubscribedportion is subscribed to by the underwriters. This ensures that the issuer raises the amount which is required byhim. For example, if issuer A wants to issue securities and raise $ 10 million. If the investors‟ response is notgood, the issuer may not be able to raise the required amount. Underwriters ensure that he gets the full amount.The function of underwriting is explained detail in Equity Module.
10
Custody function is explained in the next section on Custodian Banks Custodian Banks :
We have already seen earlier that institutional investors have vastresources at their disposal and hence their investments are large. The securities inwhich they invest need to be kept safely and administered in the sense the record ofbuying and selling and the stock of securities need to be updated on a continuousbasis. This service is called custody service which is provided by Custodian banks.Not only securities are administered but cash is also managed by custodian banks. Acustodian may resort to perform its services for institutions and also for thoseindividuals who are very wealthy private clients, known as High Net WorthIndividuals (HNIs). Banks generally form separate legal entities or departments tooffer these services. o
Trust Banks
: The custodialservices mentioned above can be provided by the banksdirectly or by forming trusts. Such banks are called Trust Banks. For example, aninstitutional trust may be formed to take care of employee benefit programs such asretirement plans for the employees that invest a certain amount regularly for thebenefit of the employees. The proceeds from such investments are payable to theemployees when they retire.
Investment Managers / Asset Managers
We have already seen that mutual funds provide an opportunity for retail investors andother investors to invest their funds in instruments or units of mutual funds. Who managethese funds? The answer is investment managers or asset managers. The investmentmanagers or asset managers actually take the decisions to deploy these funds in variousinvestment products / securities. Since they are principally buyers of securities they arenormally considered to be the buy-side of the industry. Investment managers or assetmanagers can be structured as sole proprietorships, partnerships and corporations. TheSecurities Exchange Commission (SEC) under the Investment Advisors Act of 1940 regulateall these structures.
The main function of these investment managers is to manage money for pension funds,high net worth individuals or any other institutions and mutual funds. The functions can besummarized as below.
o
Investment Research and Portfolio Management – They have to identify the rightkind of investment instruments and manage the total portfolio of securities. o
Offering investment advice – In this case, they simply offer investment advice, noactual portfolio management is done by them.
Broker / Dealers :
Brokers are the intermediaries who provide broking services tothe investors. That means whenever the investors want to buy or sell securities theydo so through brokers. Brokers use the mechanisms established in the financialmarkets to make sales or purchases for investors. Thus they act as agents for theirclients and charge a commission for services rendered. Unlike brokers who dosecurities‟ transactions for their clients, dealers act on their own accounts asprincipals. That means they buy or sell securities for themselves. How do dealersmake money? They make money by buying the securities at a lower prices andselling them at higher prices. The terms Brokers and Dealers are used togetherbecause the same firms may act as brokers or dealers at different times. Hence theseterms are used together at many places throughout the text.The services offered by brokerage firms can be summarized as follows :
Supporting clients in buying and selling securities
Providing research on securities which help the clients make investmentdecisions
Offering a custody service for the securities
Making available statements of the assets in the account periodicallyWe saw earlier that investment managers are considered buy side of securities industry.Brokers are considered sell side because they sell their research on securities and offerbroking services.
With the changes in securities industry, broking business has also undergone lot of changes.The recent trends in broking businesses are as follows.
o
Increasing competition – Broking business has become fiercely competitive witha large number of firms offering these services. This increased competition hasbrought down brokerage rates. Dealers also face narrowing spreads between theprices at which they buy and prices at which they sell. Obviously this causesreduction in their profits. Thus broking business witnesses increased competitionand pressure on profit margins.
o
Need for continuous upgradation of technology – The securities industry isundergoing constant changes due to technological advancements. To give asimple example, across all the markets there is a trend that the trades be settledin lesser time. In fact one would like to settle trades on the same day when theyare entered into. This requires significant investment on part of the brokers.
o
Changes in the methods of Trading :
The trading practice has shown noteworthychanges during the last few AlternativeTrading years. This is basically due to the new Systems (ATS) and Electronic Communication Networks (ECN)
11
provided by a large number of vendors. Similarly internet trading has changedthe way retail investors may trade. All this affects broking firms directly.
o
Stringent Regulations :
Broker / Dealers are regulated entities and their activitiesare closely monitored by the regulators in various markets. The reportingrequirements of brokers are increasing. This requires them to incur some costsand may restrict their activities in some ways affecting their profitability
Categories of Brokers/Dealers
The following are the three major types of brokerage firms: o
Full Service Firms :
As the name itself suggests, these broking firms offer a fullrange of services. They have large research departments which offer client adviceand research on securities. They also provide additional services such as financialplanning, wealth management etc. The commissions charged by them are highercompared to discount brokers.
o
Discount Firms:
These firms have not traditionally offered investmentrecommendations along with their implementation and transaction processingservices. They just execute the deals for their clients charging lower commissions.It should be noted the differences between them are getting blurred as fullservice firms may charge lower commissions through their online accounts,while discount firms have started offering research to their clients. o
Online firms
: These may be either virtual firms with no physical existence. Orthey can be online services offered by the full service or discount firms.However, there is no personal contact or advice in case of online trading.
Managed Investment Companies
: These are formed so that the investments can bepooled together from a number of investors and invested in various securities.Managed investment companies create a mutual fund and manage the same byhiring professional portfolio managers. There are generally more than one mutualfunds created by these companies and each fund has different objectives. Thus itbecomes easier for investors to select the fund that meets their objectives Mutual Funds
A mutual fund is a fund collected by Managed Investment Companies that is invested in adiversified portfolio of securities. The individuals who buy shares or units of a mutual fundare known as its shareholders or owners. Their investments offer the money for a mutualfund to buy shares, namely, stocks and bonds.
Need for Investing in Mutual Funds
Mutual funds help in create savings, are simple, accessible and also within an individuals‟reach. The major benefits of mutual funds are: Diversification
: It is said that
it is better not to put all the eggs in one basket. This applies toinvestments also.
The successful investors are aware that diversification of their investmenthelps in decreasing the adverse effect of a single investment. Mutual funds bring indiversification to an investor‟s investment portfolio automatically by holding a large varietyof securities. In addition, since the investor pools his assets with those of the other investors,a mutual fund enables an investor to acquire a more diversified portfolio than one wouldperhaps be in a position to comfortably manage on his own and also at a fraction of cost. Inbrief, mutual funds give the opportunity to the investors to invest in many markets andsectors / industries.
: In spite of best market conditions, it takes a judicious,knowledgeable investor to choose investments properly, and a further commitment of timeto constantly supervise those investments. As far as the mutual funds are concerned,experienced professionals manage a portfolio of securities to buy and also sell based onwide research. An individual or a team choosing investments that best match the fund‟sobjectives normally manage a fund. Along with the changes in economic conditions, themanagers, frequently adjust the combination of the fund‟s investments to make sure itcontinues to meet the fund‟s objectives
Convenience:
The investor can sell or purchase fund shares directly from a fund or through abroker, insurance or bank agent, financial planner, by mail or over the telephone and alsothrough the computer. The arrangement can also be made for automatic reinvestment of thedividends
12
paid by the fund. Funds can also offer a large variety of other services, whichinclude monthly or quarterly account statements, tax information, computer accessibility tothe fund and account information and 24-hour phone service.
Low Costs:
Mutual funds normally hold dozens or even hundreds of securities like stocksand bonds. The basic method through which an investor pays for this service is through afee that is based on the total value of an individual‟s account. Since the fund industry ischaracterized by the possession of hundreds of competing firms and thousands of funds, theexact level of fees changes. But, in the case of many investors, mutual funds provideprofessional management and diversification at a fraction of the cost of making such kind ofinvestments independently by the investors on their own.
Liquidity:
This refers to the ability to voluntarily access investor‟s money in an investment.Mutual fund shares are considered as liquid investments as they can be sold on anybusiness day. The price per share at which an investor can redeem shares is referred to asthe fund‟s net asset value (NAV). NAV is the current market value of all the fund‟s assets,minus liabilities, divided by the total number of outstanding shares.
Protecting the Investors:
The mutual funds are not only subjected to rigorous internalstandards, they are also highly regulated by the federal government through the USSecurities and Exchange Commission (SEC). As part of this government regulation, all thefunds are required to meet particular operating standards, should observe strict anti-fraudrules, and reveal total information to existing and prospective investors. These laws arestringently imposed and intended to protect investors from fraud and abuse. However,these laws cannot help the investor in picking up a fund that is appropriate for the investor or prevent a fund from losing the money. The individual can still lose money by investing in a mutual fund
---
Dividends are a part of profits that any company / investment institution pays out to the shareholders Types of Funds
Basically, there are three types of mutual funds based on asset class :i.
Stock or Equity: Stock mutual funds invest basically in shares of stock issued byforeign companies or US.ii.
Bonds: These mutual funds invest mostly in bonds.iii.
Money Market: They invest basically in short-term securities issued by the USgovernment and its agencies, US corporations and state and local governments.
Stock Funds
These funds invest primarily in stocks. A share of stock fund signifies a unit of ownership ina company. If a company is successful, then, the shareholders earn profits in the followingtwo ways:The stock increases in valueThe company can pass its profits to shareholders which take the form of dividends
Bond Funds
These funds invest basically in securities known as bonds. A bond is referred to as a type ofsecurity that resembles a loan. Whenever a bond is purchased, money is lent to thecompany, municipality or government agency that issued the bond. In exchange for use ofthis money, the issuer promises to repay the amount loaned, in other words, the principal,also known as the face value of the bond, on a specific maturity date. Apart from this, theissuer characteristically assures to make periodic interest payments over the entire period of
the loan
Money Market Funds
This fund invests in a pool of short-term, interest-bearing securities. A money marketinstrument is a short-term debt instruments issued by the US government, US corporations,and state and local governments. These instruments have a maturity period of less than oneyear.The short-term character of money market investments makes money market funds lessvolatile than any other type of fund.
Investment Banks:
Investment banks offer a number of services including brokingservices and underwriting of new securities. Their different businesses may beconsidered as buy side or sell side businesses in securities industry. The role ofinvestment banks and the functions they perform are extremely vital for thesecurities industry. The services provided by investment banks are as follows.
o
Investment research – In this case, investment banks provide research onindustries, companies to their clients so that the clients can take investmentdecisions.
o
Portfolio management – The investment portfolios of clients need to be monitored,altered on a regular basis in response to the developments in financial markets. Thisservice is provided by the investment banks.
o
Trading for the clients – Investment banks act as brokers and trade on behalf of theirclients. o
o
Wealth management – This is a service provided to High Net worth Individualswhere their wealth is managed as per their objectives by the investment banks.
o
Mergers & acquisitions (M&A) – In the corporate world, developments such asmerger of two companies, acquisition of one company by another company takeplace continuously. Investment banks play a vital role in identifying opportunities for M & A, valuing companies in case of M & A, meeting the necessary regulatoryrequirements etc. for their clients.
A point that needs to be remembered is that the operations of investment banks need to beseparated from each other by a Chinese wall. This is because there is chance of conflict ofinterest between the operations of different departments of investment banks. For example,a research analyst in research department should provide an independent opinion aboutany company, whether that company is the client of an investment bank or not.
Insurance Companies:
These companies are active in the securities marketthrough their treasury functions 13
and also in the course of their investmentmanagement activities. This means that the premiums collected from the buyers ofinsurance need to be invested in various securities so that the insurance companiescan meet their payment obligations smoothly. Their treasury departments watchcash inflows and outflows carefully and invest surplus funds from the short termperspective. On the other hand, investment mangers invest these funds from longterm perspective.
---
In simple terms treasury function involves managing short term cash surpluses and deficits. Infrastructure Providers
Stock Exchanges
Stock exchanges are the institutions which provide trading facilities to all interested partieswho trade through individuals or firms which are the trading members of stock exchanges.Once the issuers issue securities, these securities are listed on stock exchanges. Listing is amechanism through which securities are allowed to be traded by the stock exchanges. Oncethe securities are listed, they are traded by the investors through trading members. The mostimportant objective of getting securities listed is that participants can trade in the securities.Let us see how this process works
Issuer
Gets securities listed on stock exchanges
Thus the most important function of stock exchanges is that they provide trading a platformfor securities issued. Suppose Investor A has purchased a few securities issued by Issuer B.The investor is in need of money and wants to sell the securities. This is greatly facilitatedby the stock exchanges since all the market participants who want to trade in particulartypes of securities, do so through stock exchanges where the securities are listed. Withoutstock exchanges, trading would have been difficult.In most of the countries there may be a number of stock exchanges but a few usuallydominate in terms of volumes of securities traded. There may be National level stockexchanges or regional stock exchanges. The stock exchanges operate under the supervision of market regulators and form their own rules and regulations regarding listing ofsecurities, allowing membership to market participants etc.
Stock Exchanges in US are:
New York Stock Exchange
American Stock Exchange
Philadelphia Stock Exchange
Pacific Stock Exchange
Boston Stock Exchange
Chicago Stock Exchange
Cincinnati Stock ExchangeThe stock exchanges may require the members to assemble at a place to trade in shares(called an open outcry system) or may allow trading through computer networks (called ascreen based trading).
Over-the-Counter Market
Unlike the stock exchanges, an Over-the-Counter (OTC) Market for stocks consists of dealers who buy or sell stocks by negotiating through telephones and computer systems.OTC market trading in US is done through network of computer systems called NationalAssociation of Securities Dealers Automated Quotations (NASDAQ) System. It was put intooperation by the National Association of Securities Dealers (NASD). This nationwidecommunication system allows brokers to know instantly the terms currently offered by allmajor dealers in securities covered by the system. The dealers buy stocks for their own account and sell them to investors at prices higher than their buying prices. A number of companies are listed on NASDAQ.
