Summary Financial Markets and Institutions

Summary of Financial Markets and Institutions, all the lectures and additional comments made by Alexey.
Including a few interviews as well.

Preview samenvatting (3 van de 67 pagina's)

WEEK 1 – PART 1: BIRD’S EYE VIEW ON FINANCIAL MARKETS AND INSTITUTIONS .......................................... 3
Why do savers and borrowers need intermediaries? .................................................................................... 3
Primary and secondary financial markets ..................................................................................................... 4
Exchanges and over-the-counter markets: 2 different types how trading can be organized ........................ 6
WEEK 1 – PART 2 : INTEREST RATES, FIXED INCOME MARKETS, AND MONETARY POLICY ............................... 7
1. MARKET OVERVIEW ............................................................................................................................................. 7
2. YIELD CURVE AND FIXED INCOME INSTRUMENTS ....................................................................................................... 10
Annual y compounded interest rates ........................................................................................................... 10
Yield curve ................................................................................................................................................... 11
Risk-free rates beyond zero-coupon government bond yields ..................................................................... 12
Forward rate agreement (FRA) .................................................................................................................... 13
Short-term interest rate futures (a.k.a. money market futures) .................................................................. 13
Interest-rate swap (IRS) ............................................................................................................................... 13
Who needs interest-rate swaps? Used for two main purposes: .................................................................. 14
WEEK 2: INTEREST RATES, FIXED INCOME MARKETS, AND MONETARY POLICY ............................................. 16
3. THE GOAL OF MONETARY POLICY .......................................................................................................................... 16
Real and nominal interest rates .................................................................................................................. 16
Monetary policy rule – Taylor rule ............................................................................................................... 16
Unconventional policies ............................................................................................................................... 17
Estimates of QE effectiveness ...................................................................................................................... 18
4. LIBOR AND ITS STYLIZED SETTING PROCESS ............................................................................................................. 20
How could a better benchmark look like? ................................................................................................... 21
INTERVIEW SANDER WILLEMS (QUANT ANALYST AT NATWEST) ................................................................................ 23
WEEK 3 – PART 3: FX MARKETS: INSTRUMENTS, THEORETICAL PARITIES AND THEIR VIOLATION .................. 26
TEXTBOOK QUOTATION CONVENTION ........................................................................................................................ 26
Two types of swaps (one is very important) ................................................................................................ 27
Spot and forward FX rates ........................................................................................................................... 28
ARBITRAGE IS EITHER OF THE FOLLOWING: .................................................................................................................. 28
Interest rate differential: example ............................................................................................................... 29
Uncovered Interest Rate Parity (UIRP) ......................................................................................................... 30
VIOLATION OF CIRP .............................................................................................................................................. 31
FX basis ........................................................................................................................................................ 31
Why the basis opened up: 1. FX hedging demand ....................................................................................... 32
Why the basis opened up: 2. Central Bank-induced ‘mispricing’ of credit risk ............................................ 33
Why is the basis not closing? ....................................................................................................................... 34
WEEK 4 – PART 4: BANKING, REGULATION, MARKET LIQUIDITY ................................................................... 38
WHY BANKS EXIST ................................................................................................................................................. 38
Diamond and Dybvig (1983) simplified setup .............................................................................................. 38
Expected utility ............................................................................................................................................ 38
Policies which prevent a bank run ............................................................................................................... 39
FINANCIAL CRISES AND SYSTEMIC RISKS ...................................................................................................................... 39
Banks are connected through interbank networks: risk of contagion ......................................................... 40
Credit risk mitigation with CCP .................................................................................................................... 43
MACROPRUDENTIAL REGULATION – THE GOAL OF MACROPRUDENTIAL POLICY ................................................................... 43
Risk-weighted assets ................................................................................................................................... 44
(Some) risk weights under Basel III .............................................................................................................. 44
Capital-based ratios: ................................................................................................................................... 45
Leverage ratio: ............................................................................................................................................. 45
Liquidity ratios ............................................................................................................................................. 45
Stress-tests .................................................................................................................................................. 47
LIQUIDITY CRISES IN THE U.S. TREASURY MARKET AT THE WAKE OF COVID-19 ................................................................. 48
Criteria for a safe-haven asset: .................................................................................................................... 49
Dealers in the US Treasury market .............................................................................................................. 49
What happens when market-makers are not ready to make the market? ................................................. 50
Way out? How was the space on the balance sheets of banks created? .................................................... 50
INTERVIEW WITH JULIEN BLATT FROM UBS (STRESS-TESTING) .................................................................................... 51
WEEK 5 – PART 5: ASSET MANAGEMENT ..................................................................................................... 55
OVERVIEW ........................................................................................................................................................... 55
Global AUM by region ................................................................................................................................. 55
Types of products that asset managers offer .............................................................................................. 56
Active versus passive investing of the money .............................................................................................. 56
Asset management arithmetic .................................................................................................................... 57
Fees matter: chart of management fees: .................................................................................................... 57
Performance measurement active/passive portfolios ................................................................................. 59
EXCHANGE-TRADED FUNDS ..................................................................................................................................... 59
Mechanics of ETF shares creation ............................................................................................................... 60
Authorized Participants (APs) arbitrage out ‘mispricing’ of ETF shares on the secondary market .............. 60
Synthetic replication is getting more popular .............................................................................................. 62
MUTUAL FUNDS FEES AND SIZES IN LONG-TERM EQUILIBRIUM ........................................................................................ 63
Equilibrium net alpha .................................................................................................................................. 63
INTERVIEW DANIELE MELLANA – SALES SIDE OF ASSET MANAGEMENT BUSINESS ................................................................ 64

Week 1 – Part 1: Bird’s eye view on financial markets and institutions
Direct way: savers bring money into the financial markets, while the borrowers bring
securities. They meet at the security markets and exchange dol ars for securities.
Indirect way: instead of bringing dol ars to security markets, you bring them to banks, asset
managers, pension funds etc., and these guys take your dol ars and take them directly to the
security markets or they provide financing in another way, by loans, venture capital
financing etc. (why do we need banks ® Liquidity transformation and monitoring)

Why do savers and borrowers need intermediaries?
(also discussed on page 38)
1. Transaction costs: intermediaries take advantage of economies of scale. They also
reduce search costs (e.g. hire one lawyer for all the cases)
2. Risk sharing: intermediaries facilitate hedging against ‘bad’ states. Thus, they make
markets more complete
a. Al people are different and have different preferences. Intermediaries allow
for risk sharing among agents
b. It can happen that there is no one who is readily available to provide you with
a security that hedges you against ‘bad’ states ® go to investment banker to
ask to write such a security for you. You are better off because you are
hedged against some bad outcomes.
3. Information asymmetries: adverse selection (pre-contractual, used cars example)
and moral hazard (post-contractual). Information inefficiencies may lead to market
breakdown. Financial intermediaries, through pre-contractual research and post-
contractual monitoring, reduce adverse selection and moral hazard risks.
e.g. rating agencies

How are financial intermediaries doing?
Gross value added = Corporate
profits and wages paid to its
employees.

Right before ’08 it was at its peak,
at expense of non-financial
business. Now increasing again.