MBA CF Session 2 PDF

FINANCIAL
MANAGEMENT
SESSION 2
FINANCIAL MARKETS AND INSTITUTIONS
By Prof. Biranchi Panigrahi

The Capital Allocation Process
▪ In a well-functioning economy, capital flows efficiently
from those who supply capital to those who demand it
▪ Suppliers of capital – individuals and institutions with

“excess funds.”
▪ These groups are saving money and looking for a rate of
return on their investment
▪ Demanders or users of capital – individuals and

institutions who need to raise funds to finance their
investment opportunities.
▪ These groups are willing to pay a rate of return on the
capital they borrow.
2-2
How is capital transferred between
savers and borrowers?
 Direct transfers
 Investment banking house
 Financial intermediaries 2-3
What is a market?
▪ A market is a venue where goods and

services are exchanged.
▪ A financial market is a place where individuals
and organizations wanting to borrow funds
are brought together with those having a
surplus of funds.
2-4
Types of Financial Markets
▪ Physical assets vs. Financial assets
▪ Physical asset market is for tangible products such as food
grains, real estate, machinery
▪ Financial asset market deals with stocks, bonds, notes and
mortgages, derivative securities
▪ Spot vs. Futures:
▪ Spot markets are markets in which assets are bought or sold
for ‘on-the-spot’ delivery (within few days)
▪ Future markets are markets in which participants agree
today to buy or sell an asset at some future date
2-5
Types of Financial Markets
▪ Money vs. Capital
▪ Money markets are the markets for short term , highly liquid
debt securities
▪ Capital markets are markets for intermediate and long term
debt and corporate stocks
▪ Primary vs. Secondary:
▪ Primary markets are markets where corporation raises new
capitals
▪ Secondary markets are markets in which existing, already
outstanding securities are traded among investors
2-6
The Importance of Financial Markets
▪ Well-functioning financial markets facilitate the

flow of capital from investors to the users of
capital.
▪ Markets provide savers with returns on their money
saved/invested, which provides them money in the
future.
▪ Markets provide users of capital with the necessary
funds to finance their investment projects.
▪ Well-functioning markets promote economic
growth.
▪ Economies with well-developed markets
perform better than economies with poorly-
functioning markets.
2-7
Financial Institutions (1/5)
▪ Commercial banks:
▪ A commercial bank is a type of bank that provides services such as
accepting deposits, making business loans, and offering basic
investment products
▪ Example: All the banks that you see around you (SBI, ICICI Bank,
Allahabad Bank)
▪ Investment banks:
▪ An investment bank is a financial institution that assists
individuals, corporations, and governments in
raising capital by underwriting or acting as the client's agent in the
issuance of securities (or both).
▪ An investment bank may also assist companies involved
in mergers and acquisitions and provide ancillary services such
as market making, trading of derivatives and equity securities, and
FICC services (fixed income instruments, currencies,
and commodities).
▪ Example: Nomura, Citibank, JP Morgan, SBI 2-8
▪ Non Banking Financial Company (NBFCs):
▪ These are financial institutions that provide banking services
without meeting the legal definition of a bank, i.e. one that does
not hold a banking license.
▪ These institutions typically are restricted from taking deposits from
the public depending on the jurisdiction.
▪ Example: Firms giving various types of loans such as auto loans,
housing loan. Mahindra & Mahindra Financial Services Ltd, Bajaj
Finance Ltd. ,L&T Finance
▪ Micro Finance Institutions (MFI)
▪ Microfinance institutions are a source of financial services for
entrepreneurs and small businesses lacking access to banking and
related services.
▪ Example: SKS Microfinance, Bandhan Microfinance
2-9
▪ Pension funds:
▪ A pension fund is any plan, fund, or scheme which provides
retirement income.
▪ These are generally funded by corporations and governments for
their employees.
▪ Pension funds primarily invest in bonds, stocks, mortgages and
real estate. They are especially important to the stock market
where large institutional investors dominate
▪ Example: SBI Pension Funds, ICICI Prudential pension
▪ Life insurance companies:
▪ Life insurance companies take savings in the form of annual
premiums, invest these funds in stocks and bonds and make
payment to the beneficiaries of the insured parties.
▪ Example: LIC, SBI Life, HDFC Life
2-10
▪ Mutual funds:
▪ A mutual fund is a type of professionally managed collective
investment scheme that pools money from many investors to
purchase securities
▪ They reduce risk by diversification and also achieve economies of
scale in analyzing securities, managing portfolios and buying and
selling securities.
▪ Example: Reliance Mutual Funds, Franklin Templeton
▪ Hedge funds
▪ A hedge fund is a pooled investment vehicle administered by a
professional management firm.
▪ These are similar to mutual funds; but the difference is the mutual
funds typically target small investors while hedge funds are
marketed primarily to institutions and individuals with high net
worths
▪ Example: Bridgewater Pure Alpha, Quantum Endowment Fund
2-11
▪ Private equity companies:
▪ A private equity fund is a collective investment scheme used for
making investments in various equity (and to a lesser extent debt)
securities
▪ These funds operate much like hedge funds, but rather than
buying some of the stock of a firm, private equity players buy and
then manage entire firms.
▪ Example: New Silk Route, ChrysCap, ICICI Venture
▪ Credit Rating Agencies:
▪ A credit rating agency is a company that assigns credit ratings —
rating of the debtor's ability to pay back the debt by making timely
interest payments and of the likelihood of default.
▪ Example: S&P, Moody’s, CRISIL and ICRA
2-12
Stock Markets
▪ A stock market or equity market is the aggregation of buyers and

sellers of stocks (shares); these are securities listed on a stock
exchange as well as those only traded privately.
▪ Physical Location
Exchanges vs. Over-
the-Counter Markets
▪ NYSE vs. Nasdaq
▪ Differences are
narrowing
2-13
Stock markets in India (1/2)
▪ Bombay Stock
Exchange:
▪ Bombay Stock
Exchange (BSE) is a stock
exchange located on Dalal
Street, Mumbai, Maharashtra
, India.
▪ It is the 11th largest stock
exchange in the world
by market capitalization as
on 31 December 2012
▪ Historically an open outcry
floor trading exchange, the
Bombay Stock Exchange
switched to an electronic
trading system in 1995.
1-14
Stock markets in India (2/2)
▪ National Stock
Exchange:
▪ The National Stock
Exchange (NSE) is stock
exchange located
in Mumbai, India.
▪ It is India's largest
exchange
1-15
Stock Market Indices
▪ A stock index or stock market index is a method of
measuring the value of a section of the stock market.
▪ It is computed from the prices of selected stocks(typically
a weighted average).
▪ It is a tool used by investors and financial managers to
describe the market, and to compare the return on specific
investments.
▪ Example: Sensex, Nifty 50, Nasdaq 100, S&P Global 100
1-16
Stock Market Indices in India
▪ BSE Sensex (Current Value – 27,506)
▪ The S&P BSE SENSEX, also-called the SENSEX, is a stock market
index of 30 well-established and financially sound companies listed
on Bombay Stock Exchange
▪ The base value of the S&P BSE SENSEX is taken as 100 on 1 April
1979, and its base year as 1978–79
▪ CNX NIFTY 50 (Current Value – 6,218)
▪ The CNX Nifty, also called the Nifty 50, is National Stock Exchange
of India's benchmark index for Indian equity market.
▪ It consists of 50 company from 22 sectors of the Indian econcomy
▪ The base period for the CNX Nifty index is November 3, 1995
▪ The base value of the index has been set at 1000
1-17
Stock Market Transactions
▪ Infosys decides to issue additional stock with

the assistance of its investment banker. An
investor purchases some of the newly issued
shares. Is this a primary market transaction
or a secondary market transaction?
▪ Since new shares of stock are being issued,
this is a primary market transaction.
▪ What if instead an investor buys existing
shares of Infosys stock in the open market –
is this a primary or secondary market
transaction?
▪ Since no new shares are created, this is a
secondary market transaction. 2-18
What is an IPO?
▪ An initial public offering (IPO) is where a

company issues stock in the public market for
the first time.
▪ “Going public” enables a company’s owners to
raise capital from a wide variety of outside
investors.
▪ Once issued, the stock trades in the
secondary market.
▪ Public companies are subject to additional
regulations and reporting requirements.
2-19

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FINANCIAL

FINANCIAL MARKETS AND INSTITUTIONS

By Prof. Biranchi Panigrahi

▪ Suppliers of capital – individuals and institutions with

▪ Demanders or users of capital – individuals and

▪ A market is a venue where goods and

▪ Well-functioning financial markets facilitate the

▪ A stock market or equity market is the aggregation of buyers and

▪ Infosys decides to issue additional stock with

▪ An initial public offering (IPO) is where a

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