Financial Investments

 Financial system

A payments system for the exchange of goods and services.

A mechanism for the polling of funds to undertake large-scale non-fungible, or indivisible,
enterprise.
A way to transfer economic resources through time and across geographical regions and
industries.

 4 players on financial field:

- Households; (supply)
- Businesses; (demand)
- Government; (demand)
- Foreigners. (supply & demand)

We need households to save money.

With taxes, government takes money from the population to finance public goods.
Free-rider is to use a good or service for free without paying for it when someone else paid
for it.

 SEC: Security and Exchange Commission.

They’re making sure that everybody is playing correctly.

 Supply and demand:

Households are responsible for supplying.

Businesses, governments and foreigners are responsible for demand for money.

 Examples of financial intermediary:

1° Commercial banks
2° Saving banks
3° Mutual funds
4° Insurance companies
5° Pension funds
6° Hedge funds
7° Endowment funds
8° Credit union
  What is a brokerage firm?

Broker is someone who know both parties and is the intermediary because he’s brokering
the deal.

 Assets classes:

o Fixed Incomes  Money markets

Money market is where people have money to give but they need it back
under one year (short-term).

 Short term
 Liquid (easy to get money back)
 Low risk
 Often have large denominations.

Examples of money market instruments:

Treasury bills
 Treasury bills under 1 year, treasury notes between 1 & 10, treasury bonds
over 10 years.

Certificate of deposit
When we deposit money to the bank they give us a certificate of deposit
saying the amount of money and when they’re going to give us the money
back.

Commercial paper
 It’s only for companies.

Bankers’ acceptance
 It’s a proof of payment, a guarantee of payment like a letter of credit.

Eurodollars
 These are American dollars in banks outside the United States.

Repos and reserves

 It helps banks to borrow money temporarily in order to satisfy their
customers. Repurchase agreement (repos) between dealer’s institutions
(group with big money) highly collateral light borrowing between dealers.
Sum-up:

Capital Market:

1- Fixed income:
a. Government bonds
b. Corporate bonds
c. Mortgage-backed securities
2- Equities:
a. Preferred
b. Common
3- Derivatives

Corporate bonds:

Coupons bonds are coupons, each year they give you interest on your investment and at the
end they give you your money back. It’s fixed. Because there are interest every year the
price is higher.

Zero coupon bonds are the same but they only pay you at the end, no interest during the
time. It’s fixed. Because they don’t give you something during the period, the price is
cheaper because the price of the coupons is deducted from the offering price.

Floating coupons are coupons that every year brings you interest but which is not fixed,
which is based on an index (usually it’s LIBOR London Interbank Offered rate).

Debenture is a corporate bond that is not secured by a collateral.

Federal funds are the funds banks should have in their account at the FED. The reason is that
this exist in case if they go bankrupt or for insurance.

Mortgage is an “emprunt bancaire”. If I buy a house it’s the bank that really own it. For the
bank, this is an asset. Usually in the US it’s for 30 years. When the person cannot pay it
anymore it becomes a bad loan and the bank have then to save more money on their FED
account. If they want to get rid of it, they can sell it in a pool of mortgage so they won’t have
to increase their FED account but they will lose money during the sell, but at least they don’t
have the risk anymore. Pools of mortgages are owned by Fannie Mae. Pools are classified
depending on their insurance (AAA, BBB, CCC).

Equities:

- Preferred:
You cannot vote. In this case you are guaranty to receive your dividends. They can
skip it some years if they’re not profitable but when they become it they have to pay
you all the years unpaid. It’s called cumulative.
 Common:
They have different classes than means that even if you can vote your vote as a
certain value depending on the investment.

Derivatives:

1- Forward contracts
2- Futures Both are part of the same family.
3- Swaps

4- Options This one is more different.

We can combine them like swaptions, futures options.

Securities:

When a company decide to go public they go to the primary market. Example: first time for
Facebook if you were not part of the initial ownership then you go to the primary market.
IPO: Initial Public Offer. When it’s the first time you go to the primary market otherwise you
go to the secondary market, if you want to buy shares later.

Primary market:
- Market for newly-issued securities.

Secondary market:
- Trades in existing securities take place in the secondary market.

Privately Held Firms

- Up to 499 shareholders.
o Middlemen have formed partnerships to buy shares and get around the 499-
investors restrictions.
- Raise funds through private placement.
- Lower liquidity of shares.
- Have fewer obligations to release financial statements and other information.
When you’re private you cannot go to Wall Street and raise money. You have to go public to
do it. When you’re private you have to go to an insurance and ask for private placement.

Publicly Traded Companies

- Raise capital from a wider range of investors through initial public offering, IPO
o Seasoned equity offering: the sale of additional shares in firms that already
are publicly traded.
- Public offerings are marketed by investment bankers or underwriters.
- Registration must be filed with the SEC.
SEC (Security and Exchange Commission) will engage detectives for every executive
of the company in order to know every detail about the company. They are in charge
of the control and regulation of the financial markets.
Underwriter syndicate is a temporary group of investment banks and broker-dealers who
come together to sell new offerings of equity or debt securities to investors. They are several
because it’s in order to divide the risk.

Shelf registration:
- SEC Rules 415  Allows firms to register securities and gradually sell them to the
public for two years.
o Shares can be sold on short notice and in small amounts without incurring
high floatation costs.

Types of Markets (this is direct finance):

- Direct search
o Buyers and sellers seek each other.
- Brokered markets
o Brokers search out buyers and sellers. (ex: Goldman Sachs)
- Dealer markets
o Dealers have inventories of assets from which they buy and sell.
- Auction markets
o Traders converge at one place to trade.

Difference between brokers and dealers are that brokers only find the two parties but
dealers can take some actions into it.

Mutual Funds and other Investments Companies

Unit investments
trusts

Managed
Investment
Investment
companies
companies
Other
investment
companies
Hedge funds are like mutual funds are the same but they have no regulation. Since the crisis
it has changed but just a little.