SUBJECT FACI LI TATOR :

DR. R. S. AURORA
MCOM, MFM, D. H. E. , PH. D. , UGC- NET,
AI STD, AI MCI , AAI MA
FACULTY I N FI NANCE, I BS- MUMBAI

Financial Markets
What are Financial Markets?
Financial markets are markets in which available funds are
transferred from people who have excess(for Investment) to
people who have a shortage(need money for Productive use).







Financial Markets is a mechanism that allows people to buy and
sell financial instruments such as (bond and stock) and
commodities (like precious metals and agricultural Products) and
provide much needed impetus for economic growth and
development.

The channelize funds for productive uses.

Functions of Financial Markets
Supply agents are those with "positive savings capacity
Demand agent for those in need of money for funds
Driving force in the economy
Forum to facilitate financial transactions through the
creation, sale and transfer of financial securities
Allow investors to invest in financial securities and earn a
reasonable rate of return
Balances Risk of investors
Balances time horizon of lenders and borrowers


Types of Financial Market
Capital
market
Money
Market
Commodity
Market
Derivatives
Market
Insurance
Market
Forex Market
Financial Markets
Flow of Funds in the Financial System
Financial
Intermediaries
Financial
Markets
Funds
Funds
Funds
Lenders - Savers
Household
Business Firms
Government
Foreigners
INDIRECT FINANCE
through borrowings
DIRECT FINANCE through
Sale of Securities
Lenders - Savers
Household
Business Firms
Government
Foreigners
F
u
n
d
s
F
u
n
d
s
Money Markets
It is a market where short term debt instruments are
traded.
Have maturity of less than one year.
Is more liquid than capital market
Price fluctuation is relatively less making
investments safe
Corporations and banks earn interest in money
market on funds available temporarily .
Capital Markets
It is a market where securities and bonds are traded
and exchanged.
Is a market where long-term debt instruments are
traded maturity of more than 1 year
Insurance companies and pension funds invest here
since there is uncertainty about amount they will have
in future
Fluctuations are more wild
Foreign exchange is the mechanism by which the currency of one
country gets converted into the currency of another country.
The conversion of currency is done by the banks who deal in foreign
exchange. These banks maintain stocks of one currencies in the
form of balances with banks It also refers to the stock of foreign
currencies and other foreign assets.
The Foreign Exchange Management Act 1999 defines
Foreign exchange means foreign currency and includes
(a) Deposits credits and balances payable in any foreign currency.
(b) Draft travelers cheques, letter or credit or bills of exchange
expressed or drawn in Indian currency but payable in any foreign
currency.
(c) Drafts travelers cheques, letter of credit or bills of exchange
drawn by banks, institution or persons outside India, but payable in
Indian currency

WHAT IS FOREIGN EXCHANGE
Volatile, affected by hedger, arbitrager, speculator.
Affected by demand and supply.
Affected by rate of interest.
Affected by balance of payment surplus and deficit.
Affected inflation rate.
Spot and forward rates are different.
Affected by the economic stability of the country.
Affected by the fiscal policy of the government.
Affected by the political condition of the country.
It can be quoted directly or indirectly
Nature of Foreign Exchange
Foreign exchange market operates either as:-
Spot Market: (Current Market)
Spot market for foreign exchange is that market which
handles only spot transaction or current transactions.

Principle characteristics
Spot Market is of daily nature. It does not trade in future
deliveries.
Spot rate of exchange is that rate which happens to
prevail at the time when transactions are
occurred.
Operation of Foreign Exchange Market
Types of Transactions
Forward Market:
Forward Market for foreign exchange is that market which handles
such transaction of foreign exchange as are meant for future
delivery.

Principles Characteristics
It only caters to forward transaction.
It determines forward exchange rate at which forward transaction
are to be honored.

Exchange Rates:
Fixed Exchange Rate System
Fixed rates provide greater certainty for
exporters and importers.
Flexible Exchange Rate System
Flexible exchange rate or floating exchange rates
change freely and are determined by trading in
the forex market.
Participants in Forex Market
Central banks participate in the foreign exchange market
to align currencies to their economic needs.
Commercial companies
Commercial companies often trade fairly small amounts
compared to those of banks or speculators, and their trades
often have little short term impact on market rate.
Commercial bank
Commercial Banks play an important role in the foreign
exchange markets. They try to control the money supply,
inflation, and/or interest rates and often have official or
unofficial target rates for their currencies. They work as per
the Central Banks instructions



What are Derivatives?
Derivative Contracts are wasting
assets, which derive their values
from an underlying asset. These
underlying can be :
Stocks (Equity)
Agri Commodities including
grains, coffee beans, etc.
Precious metals like gold
and silver.
Foreign exchange rate
Bonds
Short-term debt securities
such as T-bills
Why Derivatives Markets in India?
Increased
volatility in
Asset Prices
Integration of
National and
international
Markets
Low
transaction
cost of trading
Development of
Risk
Management
tools
Origin of Derivatives
Origin
First introduced in Chicago Board of
Trade in 1848 for forward contract in
Commodities
1.
Derivatives Introduced in Indian
Exchanges in June 2000
Stock
2.
3
Derivative terminology
TERM
MEANING
1. LOT SIZE
Minimum Quantity traded in a lot
decided by the Exchanges
2. EXPIRY DATE
Last Thursday of a month
3. CONTRACT SIZE
Next Three Month
4. SPOT PRICE
Price prevailing in delivery market
5. STRIKE PRICE
Price Prevailing in future Price market / price for
which call or put option exercise
6. INITIAL MARGIN
Minimum amount required to make position (Suppose
25% of contract size)= Option premium * lot Size
7. MARK TO MARKET MARGIN
Difference between trade Price & Closing Price (Daily
settled)= (trade Price Closing Price)* Lot Size
8. OPTION PREMIUM
Amount decided by the exchange on
the basis of strike Price & spot
9. CLOSING PRICE
Closing Price at the end of
day
TYPES OF DERIVATIVES
Forwards


Futures


Option
Distinguish between
Features Forward Futures
Operational Mechanism Not traded on exchange Traded on exchange.
Contract Specifications Differs from trade to
trade.
Contracts are
standardized contracts.
Counterparty Risk Exists. Exists, but assumed by
Clearing Corporation/
house
Liquidation Poor Liquidity as
contracts are tailor made
contracts
Very high Liquidity as
contracts are
standardized contracts.
Profile Price Discovery Poor; as markets are
fragmented.
Better; as fragmented
markets are brought to
the common platform.
Derivatives Trading on Exchanges
Index
Futures
Index
Options
Stock
Futures
Stock
Options
4
Business Growth in FO Segment in India
Classification of Option
According to exercise of option

- European option : Index : NIFTY, CNXIT
- American option : Stocks : TATA MOTORS, ONGC


According to type of option

- Call Option
- Put Option

Option Jargons
Infosy
s
(2800)
In-the-Money
(ITM)
At-the-
Money
(ATM)
Out -the-
Money
(OTM)
CALL S > K
2800 > 2700
S = K
2800 = 2800
S < K
2800 < 2900
PUT S < K
2800 < 2900
S = K
2800 = 2800
S > K
2800 > 2700
S = Spot price
K = Strike price



Types of Market
of
Spot Market
Derivative
Market
Spot Market
Immediate
Delivery
Immediate
Payment
Assets Class Delivery
Equity Shares
Commodity Physical
Currency Physical
Derivative Market - Transactions Types

Forward Segment

Future Segment

Options Segment
Forward Contracts
Transaction
at Expiry
Date
Two Private
Parties
Contact
Physical
Cash
/
(Forward
Price)
Settlement
Participants in Forward Contract
Money
Delivery of Asset
Buyer
(Who takes a
long position)
Seller
(Who takes a
short position )
Participants in Forward Contract
Money
Delivery of Asset
Buyer
(Who takes a
long position)
Seller
(Who takes a
short position )
10 Professional Training Academy
Future
Contract Between Two Parties
Traded in Recognized Stock
Exchange
Future Date
Price Agreed Upon Today
Contact Specification
S. no Terminology Remark Index Future
(Nifty)
Index Option
(Nifty)
7 Initial Margin Minimum amount
required to make position
(Suppose 25% of contract
Size)
Rs 69,375
(25% of
2,77,500)
Option Premium * Lot
Size
Rs 5,000
(100*50)
8 Closing Price Closing Price at the end of
day
5500
9 Mark to Market
Margin
Difference between Trade
price & closing Price
(Daily Settled )
MTM=(Trade price
closing price)* Lot Size
Pay Rs 2,500 No MTM as we
pay whole
amount (5550-5500)*50
Our Expectation is that index
Professional Training Academy
rise
22
Participants
in
Futures Contract
Payment Sell Contract
Buy Contract
Payment
Clearing
Corporation
Future Seller
Future Buyer
Positions in
a Futures Contract
When a person
futures contract
buy a
Long
When a person
futures contract
sell a
Short
Difference Between Future & Forward
Forward Future
Nature of Contracts Customized Standardized
Counterparty Any Party Clearing Corporation
Credit Risk Exist No Risk
Liquidity Very Low Very High
Margins Not Required
Received / Paid on

Daily Basis
Valuation Not Done Daily Basis
Physical / Cash No Delivery
Options
A contract between two parties
Where Buyer of the option has
the right and not obligation to
Seller is under obligation to
fulfill the Contract
fulfill the contract

Types
of
Options
Call Option
Options
Put Option
Call
Options
to
Right to Buy
Put Options
Right to sell
Factors impacting Option Prices
Expiration

Volatility

Risk Free Rate

Underlying
Price

Strike Price

Time to
Participant
Insuring an investment
against risk.
Hedgers
Who bets on derivatives
markets
Speculators
Attempt to profit from
pricing inefficiencies
Arbitrageurs


Slide 21-41

Copyright
2003 Pearson
Education, Inc.
Meaning
International capital market
The group of closed interconnected markets in which
residents of different countries trade assets such as
currencies, stocks and bonds
This chapter focus on three main questions:
How has the international capital market enhanced countries
gains from trade?
What caused the rapid growth in international financial activity
that has occurred since the early 1960s?
How can policymakers minimize problems raised by a
worldwide capital market without sharply reducing the benefits
it provides?


Slide 21-42

Copyright
2003 Pearson
Education, Inc.
Three Types of Gain From Trade
Trades of goods or services for goods or services
Trades of goods or services for assets
Trades of assets for assets
Risk Aversion
Portfolio Diversification as a Motive for International Asset
Trade
The Menu of International Assets: Debt Versus Equity
Debt instruments
Equity instruments


The International Capital Market
and the Gains From Trade
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