Capital Markets
Introduction
Chapter 1
Lecture 1
Chapter 1
Introduction
Learning Objectives
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What a Financial Asset is
The distinction between Debt & an Equity
instrument
The general purpose for determining the price
of an Asset
Properties of Financial Assets
Principle Economic Functions of Financial
Assets
What a Financial Market is & its principle
Economic Functions
Different ways to classify Financial Markets
What is meant by Derivative Instruments
Globalization of financial Markets
Financial Assets
Financial Assets
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An Asset is any possession that has value in
exchange.
Assets can be classified as tangibles or
intangibles.
Tangible Assets is one whose value depends on
particular physical properties.
Intangible Asset represents legal claim to
some future benefit.
For Financial Instruments, the typical Future
benefit is a claim to future cash.
Issuer Vs Investor
Debt Vs Equity Claims
Debt Vs Equity Claims
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In case of Debt instruments, the claim that the
holder has is a fixed dollar amount.
An Equity claim (Residual Claim) obligates the
issuer of the Financial Asset to pay the holder
an amount based on earnings, if any, after
holders of debt instruments have been paid.
Hybrid Financial Assets
The Value of a Financial
Asset
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Valuation is the process of determining the fair
value or price of Financial Asset
The fundamental Principle of valuation is that
the value of any financial Asset is the Present
Value of the cash flow expected
The type of financial Asset, weather debt
instrument or an equity instrument, and the
characteristics of the issuer determines the
degree of certainty of cash flows expected.
Inflation Effect
The appropriate interest rate for discounting
the cash flows
Summary of the process for
valuing a financial Asset
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Estimate The Cash flow
(Cash flow = interest, principle, dividends, expected
sale price of stock)
Determine the appropriate interest rate for discounting
Minimum interest rate on U.S Treasury Securities
Plus Premium required for perceived risk
Value of Financial Asset = Present Value of Expected
Cash flows
The role of Financial
Assets
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The first is to transfer funds from those who
have surplus funds to those who need funds to
invest in tangible Assets.
The second function is transferring funds in
such a way as to redistribute the unavoidable
risk associated with the cash flow generated
by tangible Assets among those seeking &
those providing for funds
Properties of Financial
Assets
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Moneyness
Divisibility
Reversibility
Term to maturity
Liquidity
Convertibility
Currency
Cash flow & return predictability
Complexity
Tax status
Properties of Financial
Assets
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Moneyness
Some financial Assets are used as medium of exchange
or in settlement of transactions
Divisibility
Relates to the minimum size at which at which a
financial Asset can be liquidated and exchanged for
money
Reversibility
(round-trip cost) Depends on Price volatility & liquidity
Term to maturity
The term to maturity is the length of the interval until
the date when the instrument is scheduled to make its
final payment.
Liquidity
Liquidity depends not only on the financial asset but
also on the quantity one wishes to buy & sell.
Properties of Financial
Assets
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Convertibility
An important property of some financial Assets is that
they are convertible into other financial Assets
Currency
Most financial Assets are denominated in one currency
but there are dual-currency securities as well.
Cash flow & return predictability
The return that an investor will realize by holding a
financial asset depends on a cash flow that is expected
to be received.
Complexity
(Convertible Bonds, callable Bonds, Putable Bonds)
Tax Status
Governmental codes for taxing the income form the
ownership or sale of financial Assets vary widely.
Financial Markets
Financial Markets
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A financial Market is a market where Financial
Assets are exchanged.
Role of Financial Markets
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Price Discovery Process
Liquidity
Reduction of search & information costs
Role of Financial Markets
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Price Discovery Process
Interaction of buyers & sellers in a financial Market
determines the price of the traded asset
Liquidity
Financial Markets provide a mechanism for an investor
to sell financial Asset
Reduction of search & information costs
Search Costs include explicit (advertisement costs) &
implicit costs (opportunity costs).
Information Costs are those entailed with assesing the
amount & the likelihood of the cash flow expected to be
generated
Classification of Financial
Markets
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Type of Claim
Maturity of Claim
New or Seasoned Issue
Classification of Financial
Markets
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Type of Claim
(Debt market, Stock Market)
Maturity of Claim
(Money Market, Capital Market)
New or Seasoned Issue
(Primary Market, Secondary Market)
Derivative Instruments
Derivative Instruments
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Some Contracts give the contract holder either
the obligation or the choice to buy or sell a
financial asset.
Such contracts derive their value from the
price of the underlying financial asset.
Consequently, these contracts are called
Derivative Instruments.
The array of Derivative Instruments include
Options Contracts, Future Contracts & Forward
Contracts.
Globalization of Financial
Markets
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Globalization means the integration of
Financial Markets throughout the world into an
international Financial Market.
Thank you for your Time &
Patience 