Section 1. Section 1. Lets first set the foundation for Banking Domain Knowledge by looking at some examples of financial markets
- Stock Markets
- Bond Markets
- Derivatives Markets
- Money Markets
- Forex Markets
Section 2. Section 2. Types of Financial Markets
1) 1) Primary Markets
Market where new financial instruments are issued for the first time. Primary market provides a standard institutionalized process to raise money. The public offerings are done through a prospectus – which is a document that gives detailed information about following
* Their prospective plans
* Potential risks associated with the business plans
* Financial instrument.
2) 2) Secondary Markets
primary market instruments, once issued, are bought and sold in Secondary Market. An investor may wish to invest or sell various financial instruments. They provide the investor with an easy way to buy or sell.
Section 3. Section 3. Categorizing banking and financial institutions
1) 1) Broker
A firm that facilitates trades between multiple clients for a fee or commission. Since it purely acts as a facilitator of the trade, it does not assume any risk in these transactions.
Broker firms are also known as Brokerage houses or brokerage firm.
2) 2) Dealer
A firm that buys or sells securities for their own firm.
3) 3) Broker-Dealer
Some firms act as broker ( i.e. facilitate trades between multiple clients) and also as Dealers ( i.e. buy securities for their own firm). These firms are known as broker-dealers.
4) 4) Investment Bank
Firms that help corporations and governments to raise capital by either underwriting or acting as client’s agent in the issuance of securities.
5) 5) Hedge Funds
Hedge funds invest in various speculative opportunities.
6) 6) Prime Broker
Prime brokers work with Hedge funds, money managers and professional investors who typically place large trades and need special attention from brokers.
Prime brokers provide following services
7) 7) Market Maker / Specialist
Market makers provide a fair amount of liquidity in the market by taking other side of the trade for customer orders.
8) 8) Merchant Bank
An investment bank that deals mostly in International finance is known as a Merchant Bank.
9) 9) Mutual Funds
A investment company that raises money from shareholders and invests in a group of assets
10) 10) Pension Funds
A fund established by an employer to facilitate and organize the investment of employees’ retirement funds
Section 4. Section 4. Financial markets for various instrument types
To have a better understanding of banking domain knowledge, lets also look at these financial markets based on the instrument type they deal with
1) 1) Stock markets
Stock exchanges provide a system that accepts orders from buyers and sellers for shares. Exchanges then follow a mechanism to match these orders based on various factors like price, time the order was placed, quantity and the order type.
2) 2) Bond markets
Financial market where bonds and other debt instruments are issued and traded. Government bonds constitute the major bulk of the bonds issued and traded in these markets.
Following instrument types are traded
- Treasury bonds
- Treasury bills and notes
- Municipal bonds
- Corporate bonds
3) 3) Derivatives Markets
Here, derivative instruments like futures and options and traded.
4) 4) Money Market
Market for short-term debt instruments such as
- Certificates of deposit
- Treasury bills
- Commercial paper
- Repos (repurchase agreements)
- Bankers acceptances
5) 5) Forex Market
Market for Foreign currency trading
Section 5. Section 5. Various instrument types trades in these markets
1) 1) Equity
This is equity as an ownership “share” in the revenue stream of a corporation’s income.
There are two types of equity:
• Common stock
• Preferred stock
2) 2) Fixed Income
These instrument offer a fixed amount of money for a specified period of time. Here are some of the attributes of Fixed Income Products
Principal Amount, Par Value, Face Amount
Three names for the same item, the amount that will be returned to the bondholder at maturity
–Percentage of the face value
–Fixed or Floating Rate
–The date the issuer will make a lump sum payment to return the principal to the bondholder, which eliminates the debt
–Call / Put /Sink
Credit Quality and Ratings
–The less the credit quality of the issuer is, the less you pay for the bond
– Rating agencies assign ratings to many bonds – Moody’s, S&P, Fitch
Price and Yield
Price is generally expressed in percentage of the face value
A bond priced at 100 is selling for 100% of its face value – Selling at par
Over 100% (over face value) – Selling at premium.
Below 100% – Selling at discount
Market Interest Rates
When interest rates rise on the market, bonds’ prices fall and when interests rates fall, bonds’ prices rise
Is return you get, based on the price you pay and the interest you receive
The price you pay reflects the present yield on the market compared to the interests paid by the the bond
2.1. 2.1. Types of Bonds
- Book Entry
3) 3) Derivatives
These are the products for which value is derived from the value of an underlying asset, index
or reference rate.
We will deep dive into these instrument types in our next post.