1. Global Financial Market

2. Private Financial Intermediaries (FIs)
Private FIs: profit-seeking firms whose assets are predominantly financial.
Financial Intermediaries (FIs) are the professionals that guide us through our risk shifting and cash flow timing transactions in financial markets.

3. Broker/Dealer Operations
FI that brings together buyers and sellers without acting as a principle in the transaction.
Dealer:
FI that makes a market in a financial security, thereby participating as a principal in the financial transaction.
Market Maker or Specialists:
Dealers that make a market in one or more number of securities and who maintain a “fair and orderly” market by dealing personally in the market.

4. Other Operations of Private FIs
Underwriting: the process whereby the FI brings to market a newly issued financial security.
Asset Transformation: the FI’s creation of new financial securities by selling financial securities that are different from the financial securities it buys.
Securitization: the packaging of non-traded financial securities into a newly created tradable financial security.

5. The Structure of Financial Markets
Two settings: 1. Formal Financial Exchanges
2. Over-the-counter (OTC) Markets
Financial Exchanges are formalized Trading Institutions. Only members have the right to trade in Fin. Exchanges. Each Financial Exchange has detailed and explicit rules governing the conduct of the trade of securities.
Examples:
NYSE: New York Stock Exchange
CBOT: Chicago Board of Trade
CME: Chicago Mercantile Exchange
LIFFE: London International Financial Futures Exchange
LSE: London Stock Exchange

6. The Structure of Financial Markets (cont.)
Over The Counter (OTC) covers all other financial market transactions. In an OTC trade buyer or seller are free to negotiate all contractual details. Modern OTC markets rely on telephone and computer screens to link buyers and sellers with market dealers. Dealers quote both bid and ask prices to prospective buyers and sellers.
Examples: NASDAQ, FX Market
NASDAQ: National Association of Securities Trader Automated Quotation
FX Market: Foreign Exchange Inter-bank Market

7. The Structure of Financial Markets (cont.)
Drivers of Liquidity: Manual vs. Automated trading systems
Example 1: Trade in German Govt. Bond futures moved from LIFFE derivatives market to Swiss- German derivatives exchange EUREX
Example 2: Flight from BBB to AA bonds in after Russian Default
Liquidity can also be created through the removal of credit (counterparty) risk. In the money market use of “Sale and Repurchase of Agreement’ or REPO is such an example.
Repo is a short-term contract when one party agrees to sell a security to another party (the lender) and then repurchase subsequently at a higher price.

8. Clearing & Settlement Service
Process: Each party (say A&B) keeps cash in a Bank Account, known as Clearing Bank) and keeps his/her own securities in “securities accounts”. To settle a trade, the securities are taking out of party A’s account and deposited into party B’s account, while the cash is taking out of party B’s account and deposited into party A’s account.
Oldest method – messengers sent for confirmation (up to 50’s).

9. Clearing & Settlement Service (cont.)
Depository Trust Company (DTC) in 60’s.
All parties have securities accounts with DTC and DTC keeps records of all transfers.
Other than the recording a trade, a trade confirmation is also required. In last 30 years, all clearing houses are consolidated as:
For equity trades: National Security Clearing Corporation (NSCC)
For all Fixed Income: Fixed Income Clearing Corporation (FICC)
Both NSCC and FICC, as well as DTC are subsidiaries of Depository Trust & Clearing Corporation (DTCC).
Today most trades are handled in an automated fashion from organization to settlement (called Straight through Processing, STP).

10. Clearing & Settlement Service (cont.)
Regulations:
There are two types of regulation in securities market, one by legislation (through US government) and the other is self governing. After Great Depression and 1929 market crash, the Security Act helped to create SEC or Security Exchange Commission and Commodity Futures Trading Commission (CFTC in 1972) which are government agencies.
Non-government agencies/ self regulatory organizations:
National Association of Security Dealers (NASC)
National Futures Association (NFA)
Bond Markets Association ( BMA)
Regulation and Compliance:
Whether self regulated or regulated by government, compliance is an important issue in every firm.

11. Clearing & Settlement Service (cont.)
Type of PFI
1. Buy-side companies:
Professional Asset Management Companies (invest client’s money): Blackrock, PIMCO, BGI, Deutsche Asset Mgmt
Mutual Fund Co.
2. Flagship Sell-side companies are:
Goldman Sachs
Morgan Stanley
Lehman Bros
Bear Sterns
3. Mutual Fund or Asset management companies.
Fidelity
Vanguard

12. Clearing & Settlement Service (cont.)
Commercial Bank and Investment Bank
1930’s Glass Steagal Act d separated the Commercial Banking activity and Investment Banking activity. In 1990’s it changed and
Citibank bought Salomon Brothers
Chase bought JP Morgan
UBS
HSBC
Deutsche Bank
Credit Swiss

13. Clearing & Settlement Service (cont.)
Money is made in Private Financial Intermediaries
Investment Banking fees
Asset Management fees
Brokerage fees
Market making revenues
Proprietary trading revenues
Hedge Funds make money from asset management and proprietary trading
Dealers make money from Market making revenues and Proprietary trading revenues
Brokers make money from Brokerage fees.

14. Global Financial Markets
1700’s: London, Amsterdam, Paris, Antwerp
Mid-1800’s: London, Amsterdam, Paris and New York
Mid-1900’s: mainly New York
1990: London is back with New York, Tokyo
1990’s: PIMCO, BAI – west coast
Florida, California
USA Europe Asia Australia
New York London Tokyo Sydney
Chicago Paris Singapore
Frankfort Hong Kong
+California Amsterdam Shanghai
+Florida Bombay

15. Global Financial Markets (cont.)
Investment Banking  Underwriting
 Bringing new securities to market
 Advising on Mergers & Acquisitions
Retail Brokerage – buy/sell securities for clients
Maintain accounts for individual investments
Prime Brokerage – buy & sell to other brokers/ dealers
Asset Management – buy side activity
Equities / Fixed Income / Securities – Trading

16. Global Financial Markets (cont.)
Trading groups are organized by type of customers.
Hedge Funds, Banks, Asset Managers, Corporations
Trading group include a Trader, Trading Assistants, Interns + some Quants And Technology people for support.
Trade Solicitation vs. Pricing securities vs. Closing Trade
Trading Books and manage p&L of the trading Desk
Bank Office or operations - reconciliation/clearing
- netting
- settling trades
Traders are supported by research group
1. Understand the existing Pricing Model
2. Develop programs that traders could run on their computers
All have Market Data Platforms (Bloomberg or Reuters)
Recent trend is Quantitative Risk Management

17. Global Financial Markets (cont.)
Other Market Players
1. Portfolio Managers  data mining task
2. Hedge Funds  Use models and take risks
(smaller operations) typically hires – quant traders
Quant traders need expertise in Excel modeling but knowledge of quantitative modeling and the knowledge of particular products are necessary.
Desk Quants  creates and maintains quantitative models that are used in day to day trading activity. Desk Quants are an intermediary between trader and technology units.
Sales and Market Research
They provide research support to the sales people. Broader analysis of economic / political / and issues driving market.

18. Global Financial Markets (cont.)
Positions of hiring:
Analysts vs. Associates
VP vs. Directors
Managing director

19. Sell Side Financial Intermediaries: Participants in Secondary Markets
Dealer
Inter
Broker
Dealer

20. Exchanges
NYSE
NASDAQ
FCN
Broker I N V E S T O R S

21. Organization Structure of a Sell Side Financial Intermediaries:
TOP MANAGEMENT
Legal / Compliance
Revenue / Producing
Technology
Risk Management
Investment Banking
Asset Management
Retail / Prime Brokarage
Equity
Fixed Income
Foreign Exchange
Rates
Credit
Risk Management
Mortgages
Treasuries
Int. Rate Derivatives
Munis
Swaps
Structured Products

22. Market Participants: Firms Government Agencies Other FIs
General Motors
US Treasury
FNMA
World Banks
Lehman Bros.
Goldman Sachs
Citi Group I N V E S T O R S

23. Global Financial Markets
Size of Different Global Financial Markets
(Source: RPM Handbook)

24. Table 1. Key Statistics for the Principle Global Equity Market
2002
Market Cap (End Yr) $ Trillion
Average Daily Turnover
$ Billion
Average Transaction Value
$ Thousand
NYSE
9.0
40.9 19
NASDAQ
2.0
28.8 12
London Stock Exchange
1.8
15.9
105
Euronext
1.5
7.8 31
Tokyo
2.1
6.4
n/a
Deutsche Borse
0.7
4.8 17
Other N. America
0.6
6.3
Other Europe
10.1
Emerging Markets
3.0
13.1
Total
22.8
134.0

25. Table 2. Stock of International and Domestic Market Debt, Sept
Table 2. Stock of International and Domestic Market Debt, Sept (US$ Trillion)
All Maturities
Remaining Maturities < 12M
Domestic
Internat’l
Total
Government
18.1
1.1
19.2
4.1
0.1
4.2
Financial Institutions
15.5
7.8
23.2
4.0
1.4
5.4
Corporate Sector
4.9
6.3
0.6
0.2
0.8
38.5
10.2
48.7
8.7
1.7
10.4

26. Table 3. Market Capitalization of Bonds Listed on Principal Exchanges (US $ Trillion)
Luxembourg
London
Osaka
NYSE
Italy
Domestic Public Sector
0.0
3.6
1.1
Domestic Private Sector
0.1
0.2
Foreign
4.8
0.6
Total
4.9
0.7
3.7
1.4
1.2

27. Table 4. Daily Foreign Exchange Turnover April 2001 (US$ Billion)
Different Foreign Exchange Markets
Turnover Volume (US$ Billion)
Spot
387
Forward
131
Foreign Exchange Swap
656
Total
1173

28. Table 5. Major OTC Derivatives June 2003
Notional Amounts
(US$ Trillion)
Gross Market Values
(US$ Billion)
Interest Rate Swaps
94.6
1126
Interest Rate Options
16.9
434
Forward Rate Agreements
10.3 20
Currency Forwards and
Currency Swaps
12.3
476
5.2
419
Currency Options
4.6
101
Equity Derivatives
2.8
260
Commodity Derivatives
1.0
110
Other Including Credit
Derivatives
22.0
1083
Total
169.7
4029

29. Table 6. Principal Exchanges for Equity Derivatives
Millions of Contracts Traded 2002
Individual Stock
Equity Index
Options
Futures
AMEX
150.7
32.7
BOVESPA (Sao Paolo Stock Exchange)
89.7
1.1
Chicago Board Options Exchange
173.2
94.4
Chicago Mercantile Exchange
5.4
212.2
International Securities Exchange
152.3
EUREX
143.3
0.1
90.3
120.4
Euronext
323.6
7.6
108.3
51.9
Pacific SE
72.7
12.7
Philadelphia SE/BOT
84.9
3.6
World-Wide
1300.0
57.1
420.2
531.3
Notes: EUREX was formed joining DTB and SOFEX Euornext is a combination of Dutch and Paris exchanges
DTB: Deutsche TerminBorse
SOFEX: Swiss Options and Financial Futures Exchanges

30. Table 7. Principal Exchanges for Fixed Income Derivatives
Millions of Contracts Traded 2002
Government Debt
Interest Rate
Options
Futures
Chicago Board Options Exchange (CBOT)
54.7
205.6
7.7
Chicago Mercantile Exchange (CME)
105.6
202.5
EUREX
31.6
415.0
Euronext
8.1
42.7
149.2
Korean Futures Exchange
12.8
Sydney Futures Exchange
1.6
21.7
Singapore Exchange
BM & P
2.5
48.6
World-Wide
89.1
677.5
151.2
532.5

31. Table 8. Principal Exchanges for Currency and Commodity Derivatives
Millions of Contracts Traded 2002
Currency
Commodity
Options
Futures
Chicago Board Options Exchange (CBOT)
12.6
54.1
Chicago Mercantile Exchange (CME)
2.2
22.1
0.8
6.8
New York Mercantile Exchange
26.4
107.3
London Metal Exchange
2.3
56.3
Zhenzhou Commodity Exchange
14.6
Tel Aviv SE
12.0
BM & P
2.0
16.1
World-Wide
16.7
41.1
47.8
265.2

32. Brokers Dealers Banks Insurance comp Underwriters Investment bankers
Figure 2.1 Private Financial Intermediaries (FIs)
Brokers
Financial
Securities
Financial
Securities
Dealers
Financial
Securities
Financial
Securities
Transparent FIs
Underwriters
Investment bankers
Financial
Securities
Financial
Securities
Funds Deficit
Units
Funds Surplus
Units
Financial
Securities
Shares
Mutual funds
Pension funds
Opaque FIs
Loans
Deposits
Banks
Financial
Securities
Policies
Insurance comp
Non-intermediated
Transactions
(direct financing)
IOUs
IOUs