Universidad Carlos III de Madrid 9/2/2010

Topic 1 Introduction to Financial Markets

Table of contents:

Topic 1 SESSION 1
Introduction to Financial 1.1 A brief introduction to Finance
1.2 The concept of Investment
Markets •Investment
•Types of Investments
Copyright of Spanish version from María Gutiérrez
Translation into English by Francisco Romero
•Link between Real and Financial Investments
1.3 Quick tour around the Financial Markets
Universidad Carlos III •Financial Assets
Financial Economics •Operations with Financial Assets
•Types of Financial Assets
•Who is who in the Financial Markets
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Topic 1 Introduction to Financial Markets 1.1 Introduction to Finance

Learning Objectives:
What is “Finance”?
It is an area of Economics that analyses investment and financing decisions and
the exchange of funds that these decisions generate.
1. Understand why Finance is important for wealth creation These are fundamental for the well-being and economic development of society:
in the economy.  Allow families to optimize their consumption, investment and savings decisions

 Allow companies to choose and fund their investments.

2. Analyse the concept of Investment and the types of Finance can be split into three main areas:
Investments available in the economy. Area DESCRIPTION COURSES AT UC3M
Asset Valuation Investment decisions in real Financial Economics
and financial assets.
3. Learn the different types of Financial Assets and the
Financial Institutions that enable the Financial System and
operations that can be performed with them.
Institutions flow of funds (markets, Banking
banks, legal system...).
4. Get a basic knowledge of how financial markets work
Financing and Financing Decisions of Financial Management
and the role of the different market participants. Corporate firms. and Corporate Finance
Governance
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1.1 Introduction to Finance 1.2 The concept of Investment

What are we going to study in this course? Investment: “technology” that transforms current wealth into
future wealth. It creates wealth.
Types of investments:
To determine asset prices and to optimize investment  Real Assets (companies and, predominantly, individuals): tangible and
decisions. intangible goods.
 Financial Assets (individuals and, predominantly, companies): contracts
that give the right to receive a future payment in exchange for a payment
We will focus on financial assets and markets because: today.
 Financial markets enable the agents to fund their Link between Financial and Real assets:
consumption and investment needs in real assets.  Each agent chooses its consumption and investment levels in real assets
 These are the most efficient and transparent markets. according to its wealth.
 If Wealth ≥ Consumption + Investment in Real Assets,
 Excess invested in the purchase of financial assets.

 Si Wealth < Consumption + Investment in Real Assets,

 Deficit financed via sale of financial assets.
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1.3 Financial markets: financial assets 1.3 Financial markets: operations

Debt product (loan, bond, bill, etc): Contract that entitles Buy: We invest in financial assets because:
the purchasing side the right to receive a future stream of  We wish to transfer current wealth into the future as we don’t want to
predetermined periodical payments. increase today’s consumption or investment in real assets any further.
 We expect the value of an asset to increase in the future (speculative
purposes).
Property rights (shares/stocks): Contract that entitles the
purchasing side the right to:
Sell: We sell financial assets because:
 Receive a share of the company profits (when applicable).
 We wish to transfer future wealth into the present in order to finance
 Control corporate decision making via voting rights.
today’s consumption or investment in real assets.
 We expect the value of an asset we own to drop in the future.
Derivative products: Rather than an asset, it is a bet on the
future value of the asset(s) they are linked to. Short selling: We borrow a financial asset in order to sell it;
 Put and Call options, swaps,…
the objective is to repurchase it later (to give it back to the
 Risk management and speculative purposes.
original owner/lender) at a lower price (hopefully).
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1.3 Financial markets: operations 1.3 Financial markets: types

Example (short selling): Three investors have €1,000 euros each and different amounts of Telefónica Financial Markets: Markets where financial assets are issued and exchanged.
shares (valued at 5 euros each). Classification:
 Carmen obtains beneficial terms from the bank for giving up her shares’ political rights. She • According to the type of financial asset negotiated:
keeps her share ownership in the long term.
 Ana believes the share price will go down and wants to sell.
• Public or private debt markets
 Pedro believes the share price will go up and wants to buy.
• Stock markets
• Derivatives markets
Ana Pedro Carmen • According to the level of regulation:
Initial balance Balance 1000 1000 1000 • Organized markets: regulated markets where operations are
Nº of shares 0 0 100 standardized and liquidity tends to be high.
Ana short sells 100 shares to Pedro for Balance 1500 500 1000 • Unregulated markets and OTC (over-the-counter): each operation
€5.00 Nº of shares -100 100 100 is unique.
Dividend payment of €0.10 per share Balance 1490 510 1010 • According to its function:
Nº of shares -100 100 100 • Primary markets: markets where financial assets are issued and
Ana buys 100 shares to Juan for €4.00 Balance 1090 510 1010 sellers obtain funds.
Nº of shares 0 100 100
• Secondary markets: already issued assets are exchanged, providing
liquidity to their owners.
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1.3 Financial markets: who is who? 1.3 Financial markets: who is who?
Investor: Person or institution that buys or sells financial assets. Company: Corporations are the main issuers of financial
assets.
Speculator: Person or institution that buys or sells financial  Other issuers are: public sector (public debt) and individuals (loans)
assets in order to profit from favorable fluctuations in prices. They are the major investors in real assets which they
fund issuing financial assets.
Regulator: Institution responsible for determining the laws and
 A company can be defined as a set of investment and financing
rules that govern what financial institutions can do. decisions.
Assets Liabilities
Commercial Bank: Institution whose main business is to (Investment) (Financing)
receive deposits and to give loans accordingly. Two types:
 Listed Company: bonds and shares are quoted and traded in
Investment Bank: Institution that enables corporate financing secondary markets.
processes (IPOs, debt issuance…).  Unlisted Company

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1.3 Financial markets: who is who? 1.3 Financial markets: who is who?
Rating agency: Entity that analyses the credit quality of debt issuers. The
The biggest non-financial Spanish debt issuers pay the rating agencies for getting a rating assigned to their debt.
companies (E.g: Standard & Poors, Moodys, Fitch)

(according to 2008 sales)

Moody’s S&P Interpretation Examples (December 2001)
Aaa AAA Maximum safety Pfizer, General Electric
Aa1 AA+
1 Telefónica 14 Dia Aa2 AA Very high safety Wal-Mart, Hewlett-Packard, Colgate-Palmolive
Aa3 AA-
2 Cepsa 15 Solred
A1 A+
Telefónica, Nabisco, Marks & Spencer, Viacom,
3 Repsol 16 Gas Natural A2 A High safety
Pepsi, Enersis
A3 A-
4 Ryttsa 17 Acciona
Baa1 BBB+ Marriott International, Motorola, Ford Motor,
5 Mercadona 18 Ferrovial Agroman Baa2 BBB Acceptable safety The Gap, Vivendi., Polo Ralph Lauren,
Baa3 BBB- Goodyear, Televisa, British Airways, Nissan
6 El Corte Inglés 19 Cofares
Ba1 BB+ Telefónica Argentina, Banco Santander Brasil,
7 Telefónica Móviles España 20 FCC Construcción Ba2 BB Low safety, speculative Apple, Playtex, Kia Motors, United Air Lines,
8 Carrefour 21 Alcampo Ba3 BB- Xerox, Lucent Technologies, Scott Paper
B1 B+ Jazztel, Samsonite, Amazon.com, Time Warner,
9 Endesa 22 Industria de Diseño Textil B2 B
Very low safety, highly Elizabeth Arden
speculative
10 Iberdrola 23 Logista B3 B-

11 Iberia 24 Acerinox CCC+ US Airways, Greyhound Lines

Substantial risk of
Caa CCC
12 Petronor 25 Sacyr default
CCC-
13 Dragados 26 Criteria CaixaCorp Ca
CC Enrond
C Imminent default
27 Eroski C
CI
D Default

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1.3 Financial markets: who is who? 1.3 Financial markets: who is who?
Analyst: individual who analyses asset characteristics with Trader individual who buys or sells financial assets
the objective of estimating asset values.  It could be an individual investor, and, more often, an investment
 The analyst scrutinizes the annual accounts and meets key people at bank employee who operates on behalf of the bank according to its
corporate and industry levels. own decisions.
 They can focus on a particular company, industry or geographical area. Broker Individual or company that intermediates a transaction
 They tend to work for investment funds, brokerage firm, or investment between a buyer and a seller.
banks, in order to support the decision making process of these
institutions or their customers’. Investment Fund Manager Individual or company that
 Analysts write reports with a buy, sell or hold recommendation. manages a group of investors’ funds, who receive in turn
 Two main types of analysis are prepared: proportional shares.
 Fundamental analysis main focus on financial reports and  The salary is linked to the how the value of the fund evolves.
“qualitative” parameters (management, competitive advantages,  Two main investment funds management techniques:
potential risks…)
 Active Management: select best investment opportunities based on prior
 Technical analysis main focus on market historical data (prices and analysis.
volumes); charts are widely used.  Passive Management: buy and hold a portfolio representing a specific
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1.3 Financial markets: who is who? Useful URLs

Bolsa de Madrid
Arbitrageur: individual who looks for arbitrage opportunities
 www.bolsamadrid.es/esp/portada.htm
and usually works for investment banks or investment funds NYSE New York Stock Exchange
 An arbitrage opportunity allows investors to obtain riskless profits at  www.nyse.com
no initial cost. CNMV Comisión Nacional del Mercado de Valores
 If an asset is quoted in two different markets at a different price there
 www.cnmv.es
SEC Securities & Exchange Comission
is an arbitrage opportunity since it is possible to buy in the cheap
 www.sec.gov
market via short-selling in the expensive one.
Standard & Poor’s
 If the market works correctly, the arbitrage opportunity gradually
 www.standardandpoors.com
disappear (by a supply-demand argument) Moody’s
 Example: let’s assume that the exchange rates (including market fees) in  www.moodys.com
Frankfurt are €10 = $13 =£5, while in London £5= $15= €12. MEFF Mercado Oficial de Futuros y Opciones Financieros en España
 http://www.meff.com/index2.html
LIFF London International Financial Futures
 http:// www.liffe-commodities.com
Chicago Mercantile Exchange
 http:// www.cmegroup.com/market-data/delayed-quotes/commodities.html

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Bibliography
1. Grinblatt , M. y S.Titman, “Mercados Financieros y
Estrategia Empresarial”, McGraw-Hill 2003.
 Chapter 1

2. Brealey, R., S. Myers y Allen, “Principios de

Finanzas Corporativas” 8ª edición, Mcgraw-Hill 2006
 Chapter 1

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