financial markets and institutions week 2 slide
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8/11/2019 Financial Markets and Institutions Week 2 Slide
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Week Two
The demand for financial assets.
Primary, secondary and tertiary (orderivative) markets.
Market organisation.
Factors influencing markets
Market analysis and forecasting The Assignment
– A discussion on ‘Endnote’
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Last Week We :
Described the role performed by the financialsystem
Explained the concept of a financial assetand identify the main types of financial assets
Discussed the functions of financial markets.
Explained how financial markets transferfunds
Defined intermediation vs. direct financing.
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The Market Mechanism
Objectives for this lecture
– Define the idea of a financial asset – The factors affecting demand for a financial asset
– Primary issue and secondary transfer markets
– How trading is organised
– Forecasting methods – Define Fundamental Analysis
– Identify Various forms of Technical Analysis
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What is a Financial Asset?
From last week’s lecture
– A claim to a real asset or to the cash flows thatreal asset will generate
Ongoing payments (dividend, coupon)
Residual value
– Characteristics
Risk
Return
Liquidity
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Financial Markets
1. Matching principle
2. Primary and secondary market transactions3. Direct and intermediated financial flow
markets
4. Wholesale and retail markets
5. Money markets
6. Capital markets
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1. Matching Principle
Short-term assets should be funded with
short-term (money market) liabilities, e.g. – Seasonal inventory needs funded by overdraft
Longer-term assets should be funded with
equity or longer-term (capital market)liabilities, e.g.
– Equipment funded by debentures
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2. Primary and Secondary market
transactions
Primary market transaction
– The issue of a new financial instrument to raisefunds to purchase goods, services or assets by
Businesses
– Company shares or debentures
Governments
– Treasury notes or bonds
Individuals
– Mortgage
– Funds are obtained by the issuer
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2. Primary and Secondary market
transactions (cont.)
Secondary market transaction
– The buying and selling of existing financialsecurities
No new funds raised and thus no direct impact on
original issuer of security
Transfer of ownership from one saver to another saver
Provides liquidity, which facilitates the restructuring ofportfolios of security owners
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3. Direct and Intermediated
Markets
Direct Markets
– Bond, Share markets especially – Predominantly (but not exclusively) wholesale
markets
Intermediated Markets
– Banks are main intermediaries – Predominantly (but not exclusively) retail markets
– Many derivatives can be intermediated
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4. Wholesale and retail markets
Wholesale markets
– Direct financial flow transactions betweeninstitutional investors and borrowers
Involves larger transactions
Retail markets
– Transactions conducted primarily with financialintermediaries by the household and small to
medium-sized business sectors
Involves smaller transactions
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5. Money markets
Wholesale markets in which short-term securities are
issued (primary market transaction) and traded
(secondary market transaction)
– Securities highly liquid
Term to maturity of one year or less
Highly standardised form
Deep secondary market
– No specific infrastructure or trading place
– Enable participants to manage liquidity
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5. Money markets (cont.)
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5. Money markets (cont.)
Money market submarkets exist for – Central bank: system liquidity and monetary
policy
– Inter-bank market
– Bills market – Commercial paper market
– Negotiable certificates of deposit (CDs) market
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6. Capital markets
Markets in which longer-term securities are issued
and traded with original term-to-maturity in excess of
one year
– Equity markets
– Corporate debt markets
– Government debt markets
Also incorporate use of foreign exchange markets and
derivatives markets
Participants include individuals, business, government
and overseas sectors
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Forecasting & Analysis
Price ultimately defined by supply anddemand
Several techniques used to forecast prices
Fundamental Analysis – Top down approach
– Bottom up approach Technical Analysis (Charting)
Psychological Factors and Sentiment
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Fundamental Analysis
Top down approach
A macro-economic viewpoint which attempts to
forecast the industry or country’s economic
environment in which the company operates
Bottom up approach
A micro-economic viewpoint which attempts to
forecast a company’s operational well-being by the
use of various accounting/investment ratios
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Fundamental Analysis
Top down approach
A macro-economic viewpoint looking at
– Industry Sectors – The impact of international economies
– The rate of economic growth
– The effect of exchange rates
– Interest rates, domestically and internationally – Balance of payments – current account
– Inflationary pressures and wages growth
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Fundamental Analysis
Bottom up approach
A micro-economic snapshot using various
accounting/investment ratios, for example: – Capital structure
Gearing, equity
– Liquidity and debt coverage
– Profitability – Management quality
– Current share price, prospects and risk
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Fundamental Analysis
Top down approach or a Bottom up approach
– You should consult Viney Chapter 7.1 to 7.2 and form your
own opinion. Conventional wisdom has it that acombination of both approaches works well
1. Identify industries and economies with good value
or growth prospects through a top down approach
2. Use a bottom up approach to identify the specificcompanies and their shares which are likely to
perform best
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Technical Analysis
Explains and forecasts share price
movements based on past price behaviour Assumes markets are dominated at certain
times by a mass psychology, from which
regular patterns emerge
Two main forecasting models – Moving averages (MA)
– Charting
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Moving Averages (MA) Models
Smooth out a series facilitating the
identification of trends in the series
Calculation of MA
– Assuming a five-day moving average, the MA is
calculated by taking the average of the priceseries for the preceding five days
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Moving Averages (MA) Models
(cont.)
Trading rules
– Buy when the price series cuts the MA from below – Buy when the MA series is rising strongly and the
price series cuts or touches the MA from above
for only a few observations
– Sell when the MA flattens or declines and theprice series cuts MA from above
– Sell when the MA is in decline and the price
series cuts or touches the MA from below for only
a few observations
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Moving Averages (MA) Models
(cont.)
Typically for daily price series both 10-day
(short-term) and 30-day (medium-term)moving averages are calculated
Weighted MA
– The most recent information is given the greatest
weight
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Charting
Investigating patterns in price charts
Several techniques
– Trend lines
– Support and resistance lines
– Continuation patterns
– Reversal patterns
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Charting –
Trend Lines
Trends are regular movements in share prices
Two types of trends
– Uptrend line—connecting the lower points of rising price
series
– Downtrend line—connecting the higher points of falling price
series
Return line—line drawn parallel to a trend line to create atrend channel
Critical issue is to determine when the trend line is
going to change
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This chart has been taken from http://www.dailyfx.com/FinanceChart.html
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Charting- Support and Resistance lines
Support levels—where there is sufficient
demand to halt further price falls
Resistance levels—where there is sufficient
supply to halt further price increases
‘Strong’ levels—historical support and
resistance
‘Weak’ levels—support and resistance based
on more recent activity
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Charting - Continuation Patterns
Sideways share trading that does not
normally signal a change in a trend; 2 types
– Triangles—composed of a series of price
fluctuations, each smaller than its predecessor
Symmetrical triangle (no change in trend); ascending
triangle (uptrend); descending triangle (downtrend)
– Pennants and flags—formed during a sharp rise in
prices (‘the pole’); trading volume then reduces
and then increases suddenly to take prices
sharply higher
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Charting - Reversal patterns
Occur after a major market move
Result in a ‘head and shoulders’ pattern – Three successive rallies and reactions, the second
rally being stronger than the first and third rallies
Left shoulder —formed by volume-strong rally on uptrend,
followed by reduced-volume reaction
Head—second rally increases price before reaction
moves price back to previous low
Right shoulder —final rally marked by reduced volume
indicating price weakness
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Charting - Elliott Wave Theory
The existence of distinctive wave patterns
that characterise share-market cycles
Key proposition is that a bull market consists
of three major waves upwards, followed by
two major down-legs, resulting in a reversion
of share prices to about 60% of the peak Consult Viney Ch 7.3.2 for more on Charting
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Technical or Fundamental Analysis
Validity of technical analysis – Even where techniques have no apparent underlying
validity, if they are followed by enough participants they mayimpact share price behaviour at times
More likely to forecast successfully when shareprices move out of a range explained by economicand financial fundamentals
Technical Analysis can be very effective indetermining timing once fundamental reasons to buyhave been established
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Program Trading
Refers to buy and sell strategies generated
by computer programs
Programs range between
– Simple buy/sell orders based on moving averages
– Complex monitoring of both derivatives and share
markets for the purpose of hedging a shareportfolio
Program trading increases the speed at
which prices change
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Next Week - Week Three
Mathematics of Finance Revisited
Short, medium and long-term debt Structure of the money markets.
Interest bearing securities
Discount securities.
Securitisation
The Assignment