OVERVIEW OF MODERN FINANCIAL
MARKETS & TRADING
A. Markets & Instruments
Reference Readings
 For Topic 2:
 Teall [chapter 2]: Financial Markets Trading,
Processes and Instruments
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The Basics
 A security is a tradable claim on assets. Security types
include:
 Debt securities, which denote creditorship and involve fixed
payments
 Equity securities (stock): Denote ownership in a business or
corporation.
 Derivative securities, which have payoff functions derived
from the values of other securities, rates or indices. Options
include:
 Call: A contract granting its owner the right to purchase a given asset
 Put: A contract granting its owner the right to sell a given asset
 Futures Contracts, which oblige their participants to either
purchase or sell a given asset at a specified price
 Swaps: Provide for the exchange of cash flows associated with
one asset, rate or index for the cash flows associated with
another asset, rate or index.
 Commodities: Contracts, including futures and options on
physical commodities such as oil, metals, corn, etc.
 Currencies (FX)
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Major Classes of Assets and Trading
Instruments
 Equity
 Stocks
 equity-like instruments such as ETFs (exchange traded
funds), called delta one product
 Debt
 Fixed income instrument - as bills, notes, bonds,
government and corporate
 Short Term Money Markets - CD, repos
 Currency
 FX - spot, forward, non-deliverable forwards (NDF), swaps,
cross currencies
 Rates
 interest rate swaps (IRS), interest rate options (IRO), basis
swaps, forward rate agreements (FRAs). 4
 Participants take position in the trading
instrument:
 Long - An investor has a "long" position in that
asset or currency that he will accept at the later
date.
 Short - An investor has a "short" position in that
asset or currency that he must deliver in the
exchange.
 Square or Cover one’s position
 Counterparty = opponent
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Long and Short Positions
TOPIC 2
OVERVIEW OF MODERN FINANCIAL
MARKETS & TRADING
B. Trading Major Markets
Securities Trading
 Trading occurs in securities markets, physical or
virtual, where traders communicate with one
another and execute transactions.
 The basic function of a market is to bring
together buyers and sellers.
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Four Components of a Trade
1. Acquisition of information and quotes.
▪ Quality information and transparency are
crucial to price discovery.
▪ Transparent markets quickly disseminate
high-quality information.
▪ Opaque markets are those that lack
transparency.
2. Routing of the trade order.
▪ Selecting the broker(s) to handle the
trade(s),
▪ Deciding which market(s) will execute the
trade(s) and transmitting the trade(s) to the
market(s).
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Four Components of a Trade
3. Execution. Buys are matched and executed
against sells according to the rules of that market.
4. Confirmation, clearance and settlement.
▪ Clearance is the recording and comparison of
the trade records
▪ Settlement involves the actual delivery of
the security and its payment.
▪ Might include trade allocation
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Types of Markets
 Cash market and Derivative market
 Exchange-traded and OTC
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Cash Market
 Also called the spot market
 Cash market instruments convey ownership of
something
 In the cash market, securities are sold for cash
and immediate delivery (value date is usually
T+2).
 Stocks, FX and bonds
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Derivative Market
 In the derivative market, contracts that are
traded oblige the parties involved to take certain
actions depending on the terms of the agreement
they make.
 Derivative instruments derive their value from
the value of another instrument (an underlying
securities in the cash market) and usually settled
in the future.
 Futures, forwards, swap and options are
examples of derivative instruments
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Exchange-Traded Market
 An exchange is an organised trading centre
facilitating the trades between buyers and sellers
(in price discovery and central clearing
mechanism)
 Highly regulated
 Stock exchange, futures exchange, commodity
exchange
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Over-the-Counter Market (OTC)
 A decentralised trading place where buyers and
sellers make transactions through the use of
various communication systems.
 Highly tailor-made and less regulated
 Most FX and bonds and derivatives are traded
OTC.