FINANCIAL MANAGEMENT Local & Intnl Financial Markets Insight

FINANCIAL MANAGEMENTLocal & Intnl Financial Markets InsightByADEEL AHMED KHAN (001) ; MUHAMMAD KASHIF (008)MAAZ BIN ABDUL QUDDUS (023) ; UMAR FAROOQ (033)1Financial MarketA 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 ofcapital(in thecapital markets)The transfer ofrisk(in thederivatives markets)Price discoveryGlobal transactions with integration of financial marketsThe transfer ofliquidity(in themoney markets)International trade(in thecurrency markets)2A borrower issues areceiptto 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 ofinterestordividends.for long term finance, theCapital markets; for short term finance, theMoney markets. Capital marketswhich consist of:Stock markets, which provide financing through the issuance of shares orcommon stock, and enable the subsequent trading thereof.Bond markets, which provide financing through the issuance ofbonds, 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 offinancialrisk.Futures markets, which provide standardizedforward contractsfor trading products at some future date; see alsoforward market.Insurance markets, which facilitate the redistribution of various risks.Foreign exchange markets, which facilitate the trading offoreign exchange.

FINANCIAL MARKET OF PAKISTANPakistan Financial market comprise of Money Market, Forex Market (foreign exchange), Capital Market.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 MarketThe 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.

Securities and Exchange Commission of PakistanThefinancial regulatory agencyin Pakistan Objective is to develop a modern and efficientcorporatesector and acapital marketbased on sound regulatory principles, in order to encourage investment and foster economic growthand prosperity in Pakistan. Functions include:Regulating the issue of securities;Regulating the business in Stock Exchanges and any other securities markets;Supervising and monitoring the activities of any central depository and Stock Exchange clearing house;Registering and regulating the working of stock brokers, sub-brokers, share transfer agents, bankers to an issue, trustees of trust deeds, registrars to an issue, underwriters, portfolio managers, investment advisers and such other intermediaries who may be associated with the securities markets in any manner;

Stock ExchangeWhere 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 Marketsegment of the financialmarket 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 bankCentral bankCommercial bank

State BankA 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 BankMonopoly of note issue Bankers, Agent and Adviser to the GovernmentCustodian of Cash Reserve of Commercial BankCustodian of Nations Reserve of InternationalLender of the Last ResortClearing House FunctionCredit ControlCollection of DataCommercial BanksAn 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; andGranting loans and advancesSecondary Functions include:Issuing letters of credit, travellers' cheques, circular notes etc.Undertaking safe custody of valuables, important documents, and securities by providing safe deposit vaults or lockers.Providing customers with facilities of foreign exchange.Transferring money from one place to another; and from one branch to another branch of the bank.Standing guarantee on behalf of its customers, for making payments for purchase of goods, machinery, vehicles etc.Collecting and supplying business information.Issuing demand drafts and pay orders.

Money Markets Mutual FundsInvests solely in money market instruments. Forms of debt that mature in less than one year and are very liquid. 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:

Foreign Exchange MarketThe market in which currencies are traded; people trade one country's money for another's. Though there is no physical existence of this market, the foreign exchange market is the largest financial market in the world, with its average daily traded amount reaching to US $2-2.5 trillion. The main players in the forex market are large banks, governments, central banks, multinational corporations, and currency speculators.

The Interbank MarketThe interbank market designates Forex transactions that occur between central banks, commercial banks and financial institutions.Central Banks- National central banks (such as the SBP, US Fed and the ECB) play an important role in the Forex market. As principal monetary authority, their role consists in achieving price stability and economic growth. To do so, they regulate the entire money supply in the economy by setting interest rates and reserve requirements. They also manage the country's foreign exchange reserves that they can use in order to influence market conditions and exchange rates.Commercial Banks- Commercial provide liquidity to the Forex market due to the trading volume they handle every day. Some of this trading represents foreign currency conversions on behalf of customers' needs while some is carried out by the banks' proprietary trading desk for speculative purpose.Financial Institutions- Financial institutions such as money managers, investment funds, pension funds and brokerage companies trade foreign currencies as part of their obligations to seek the best investment opportunities for their clients. For example, a manager of an international equity portfolio will have to engage in currency trading in order to buy and sell foreign stocks.The Retail MarketThe 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.

International financial MarketsThe International Financial Market is the place where financial wealth is traded between individuals (and between countries). It can be seen as a wide set of rules and institutions where assets are traded between agents in surplus and agents in deficit and where institutions lay down the rules.Two components of international MarketsEurocurrency, euro credit and euro bond marketThe foreign Exchange Market

Eurocurrency Market

A Eurodollar is a U.S.-dollar denominated bank deposit held outside the U.S.

More generally, a Eurocurrency deposit is a domestic-currency 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 locatedEvolution of Eurocurrency market

The development and expansion of the Eurocurrency markets have their roots in overt and covert events.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. British banks were the primary recipients of these deposits.

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. They accept foreign currency denominated depositsThese "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.

Participants in Eurocurrency marketThe primary participants in the Eurocurrency Market are large banks called Eurobanks.

Transactions are predominantly interbank, hence the market is frequently called "interbank market" In addition, large scale or "wholesale" transactions take place between banks and non-bank 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'smost 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.

Euro credit marketLoans of 1 year or longer extended by Eurobanks are called Eurocredit Loans. (Medium term) These loans are popular with corporations and government agencies.Since Eurobanks accept short-term deposits, there exists the problem of maturity mismatch between deposits and loans. To avoid the risk Eurobanks commonly use Floating Rate Eurocredit Loans. Loan rates float in accordance with movement of some market interest, such as the LIBOREurobond 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.

Foreign exchange MarketThe Foreign Exchange Market is the world's largest financial market. The Bank for International Settlements estimates daily trading volume is about $4 trillion (WSJ 09-01-10)

The Foreign Exchange Market is an over-the-counter market. 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 Foreign Exchange Market can be subdivided into:

The Retail Market: Permits the firms and individuals to obtain foreign exchange for business or personal use.

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 marketsSpeculators: 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 Functions of Foreign Exchange MarketsTransfer of Purchasing Power: International trade and capital transaction usually involve parties with different functional currencies. Trade and capital transactions can be invoiced in any convenient currency. Therefore, one or more of the parties must transfer purchasing power to or from own national currency. The Foreign exchange market facilitates this transfer of purchasing power.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 marketMinimizing 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.