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Investment Analysis

Lecture 1
Introduction:
Financial System, Institutions &
Instruments

Nadir Khan Mengal

5/4/2010

Investment Analysis

Financial Markets
A market is a venue where goods and
services are exchanged.
A financial market is a place where
individuals and organizations needing
funds are brought together with those
having surplus of funds.
Nadir Khan Mengal

5/4/2010

Investment Analysis

Types of Markets
Physical Assets Market
Physical markets deal with real assets such as wheat, automobiles, computers,
etc.

Financial Assets Market


Financial markets deal with stocks, bonds, derivative securities, etc.

Money Market
Money markets are for short-term, highly liquid debt securities.

Capital Market
Capital markets are for intermediate, long-term debt etc.

Primary Market
Primary markets are markets where corporations raise new capital.

Secondary Market
Secondary markets are where existing shares are traded among investors.
Nadir Khan Mengal

5/4/2010

Investment Analysis

Types of Markets (Cont )


Spot Markets
Spot markets are markets where assets are bought or sold
for on the spot delivery.

Futures Markets
Futures markets are markets in which participants agree to
buy or sell an asset at some future date.

Private Markets
Private markets are markets where transaction occurs
between two parties.

Public Markets
Public markets are markets where standardized contracts are
traded on organized exchange.
Nadir Khan Mengal

5/4/2010

Investment Analysis

How is Capital Transferred?


1.Direct Transfers
2.Indirect Transfers
a) Investment Banking House
b) Financial Intermediaries
Nadir Khan Mengal

5/4/2010

Investment Analysis

Direct Finance
Borrowers borrow funds directly from lenders in financial markets by selling
them securities (also called financial instruments) which are claims on
borrowers future income or assets.
Securities are assets for the person who buys them but liabilities for the
individual or firm that sells them.
For example, if Toyota Indus needs to borrow funds to pay for a new factory to
manufacture electric cars, it might borrow funds from savers by selling them
bonds, debt securities that promise to make payments periodically for a
specified period of time.

Indirect Finance
Borrowers borrow funds from a financial institution (commercial bank etc)
where the savings are deposited, i.e. they borrow through financial
intermediaries and these borrowings are backed by their portfolio of assets
which are claims on the borrowers.
Or hire a financial advisor (investment bank) to arrange capital for them.
Nadir Khan Mengal

5/4/2010

Investment Analysis
INDIRECT
FINANCE

FUND
S

Financial
Intermediaries

FUND
S

FUND
S

Lenders-Savers
1.Households
2.Business Firms
3.Government
4.Foreigners

FUND
S

Financial
Markets

FUND
S

BorrowersSpenders
1.Business Firms
2.Government
3.Households
4.Foreigners

DIRECT
FINANCE
Nadir Khan Mengal

5/4/2010

Investment Analysis

Financial Institutions (FIs)


A financial institution acts as an agent that
provides financial services to its clients or
members.
FIs perform the essential function of arranging
funds from those with surplus funds to those
with shortage of funds.
FIs generally fall under financial regulation
from a government.
Nadir Khan Mengal

5/4/2010

Investment Analysis

Types of FIs
I. International Financial Institutions

International Monetary Fund


World Bank
European Investment Bank

II. Government Institutions

Export Credit Agencies


Export Insurance Agencies

Public
Financial
Institutions

III.Depository Institutions

Commercial Banks
Mutual Savings Banks
Credit Unions

IV. Non-Depository Institutions

Investment Banks
Insurance Companies
Pension Funds
Stock Market Brokers and Dealers

Nadir Khan Mengal

Private
Financial
Institutions

5/4/2010

Investment Analysis

Financial System
The financial system of a country consists of institutions
and regulators that act on a national or regional level.
The main players are the (1) financial institutions, such as,
commercial banks, (2) financial intermediaries, such as,
brokers/investment banks, (3) financial markets, such as,
exchanges, (4) national agencies and government
departments, such as, central bank and finance ministries
etc.
Financial system hence , is the channel through which
savings become investments and through which money
and financial claims are transferred and settled. The
participants in a financial system work together for the
health and stability of a nations economy.
Nadir Khan Mengal

5/4/2010

Investment Analysis

Why Regulators are needed?


FIs provide vital services to all sectors of the
economy; therefore, their regulation is in public
interest.
In an attempt to prevent the failure of FIs and
the failure of financial markets overall and hence
the whole economy.
Regulatory authorities are necessary for
maintenance and financial stability of the
economy and building confidence of all stake
holders in the system.
Nadir Khan Mengal

5/4/2010

Investment Analysis

Financial Instruments
Financial instruments are cash, evidence of ownership
interest in an entity or a contractual right to receive or
deliver cash or another financial instrument.
An instrument having monetary value or recording a
monetary transaction.
In general, any financial security such as a bond, stock,
check, etc. Money market securities (such as Treasury
Bills, Commercial Papers) and Capital market securities
(such as Certificate of Deposit, long-term bonds) are
also referred to as instruments.
Nadir Khan Mengal

5/4/2010

Investment Analysis

Types of Financial Instruments


Categorized by Asset Class
1.Equity Based: representing ownership
of the asset.
2.Debt Based: reflecting a loan the
investor has made to the issuing entity.
Nadir Khan Mengal

5/4/2010

Investment Analysis

Types of Financial Instruments


Categorized by Maturity
1. Money Market:

Short-term (less than 1 year)


Less price fluctuation
Hence less risky investments

2. Capital Market:

Debt and equity instruments with maturities greater


than 1 year
Wider price fluctuation
Fairly risky investments
Nadir Khan Mengal

5/4/2010

Investment Analysis

1. Money Market Instruments

Treasury Bills
Certificate of Deposits (CDs)
Commercial Paper
Repurchase Agreements (Repos)

Nadir Khan Mengal

5/4/2010

Investment Analysis

2. Capital Market Instruments

Stocks
Corporate Bonds
Government Securities
Sukuks

Nadir Khan Mengal

5/4/2010

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