Brokers Awareness program

1
Brokers Awareness program

• Dr. Mounther Barakat
• Securities and Commodities Authority

2
?????? ????? ???????

• ?. ???? ????? ??????
• ???? ??????? ??????? ??????

3
Introduction?????

• It has been noticed that traders and entry level
  brokers may be
• 1- from backgrounds other than finance, or
• 2- little finance background, or
• 3- of finance background that needs to be
  refreshed
• If you are none of the above, this is not for you

4
What is this program about????? ???? ??????
????? ????????

• Introduction to the field of finance
• Financial risk and return
• Demand on financial assets
• Structure of interest rates
• Financial markets efficiency
• Economic policies and the role of the central
  bank
• Capital, money, commodity, derivatives, mortgage,
  foreign exchange markets
• Organization of markets and its operations
• Introduction to financial analysis
• Conflict of interest and financial crises
• Financial institutions Investment companies,
  securities firms, banks, insurance companies,
  finance companies, pensions, ...

5
What is Finance?????? ????? ???? ???????

• Finance deals with efficient allocation of
  resources by using pricing systems that are based
  on the riskness of assets.
• Three areas of finance
• Financial markets and Institutions
  Intermediation
• Corporate finance
• Investments

6
Definitions from Finance perspective??????? ????

• Asset
• Real asset Vs. Financial asset
• Primary asset Vs. Secondary asset
• Intermediary Vs. broker Vs. dealer
• Market
• Financial market
• Balance sheet
• Income statement
• Statement of cash flow
• Cash Vs. profit
• Surplus Vs. Deficit Units

7
The financial System?????? ??????

• Types of financial Systems
• Religious
• Socialism
• Capitalism
• Mixed
• The financial system in the UAE is the free
  market system with considerations specific to the
  UAE (e.g. Islamic and Arab culture, )

8
The financial system?????? ?????? ??????

• Participants
• Governments
• Businesses
• Individuals
• Foreigners
• The financial sector
• Financial markets
• Financial institutions
• Money and Interest rates

9
The Financial System?????? ??????
Financial System
I/M
Fin. Sec.
Participants
- Interest rates - Money Supply
- Government. - Businesses - Individuals -
Foreigners
- Financial Markets - Financial Institutions
10
The Financial Sector?????? ??????
Financial Sector
Financial Markets
Financial Institutions
Long Term Equity Debt
Short Term Money FOREX
Non-depositories Investment Companies Securities
firms Contractual financing
Depositories Banks Credits Unions
11
Interest Rates and Money Supply????? ???????
??????? ???????

• Interest is the rent of money
• Equal to the real growth rate of GDP plus the
  expected inflation rate plus a premium to
  compensate for the riskness of the company being
  analyzed.
• Money supply is the amount of liquidity that is
  being allowed by the UAE central bank. The
  company being analyzed benefits if the amount of
  liquidity is near the healthy level.
• Both interest rates and money supply have a great
  effect on the performance and value of the
  company and need to be taken into consideration
  in any financial analysis.

12
Function of Financial Markets and
Institutions????? ??????? ????????? ???????

• Allows transfers of funds from person or business
  without investment opportunities (i.e.,
  Lender-Savers) to one who has them (i.e.,
  Borrower-Spenders)
• ????? ??????? ??? ???????? ??? ?? ?????????
• Improves economic efficiency
• ????? ???????? ??????????

13
Segments of Financial Markets

• Direct Finance
• Borrowers borrow directly from lenders in
  financial markets by selling financial
  instruments which are claims on the borrowers
  future income or assets
• ??????? ???????
• Indirect Finance
• Borrowers borrow indirectly from lenders via
  financial intermediaries (established to source
  both loanable funds and loan opportunities) by
  issuing financial instruments which are claims on
  the borrowers future income or assets
• ??????? ??? ???????

14
Importance of Financial Markets ?????
??????? ???????

• Financial markets are critical for producing an
  efficient allocation of capital, which
  contributes to higher production and efficiency
  for the overall economy, as well as economic
  security for the citizenry as a whole
• ????? ??????? ??????? ???????? ????? ?????
• Financial markets also improve the lot of
  individual participants by providing investment
  returns to lender-savers and profit and/or use
  opportunities to borrower-spenders
• ????? ???? ?????? ???????? ??????

15
Function of Financial Markets ??? ?????? ?????
?????? ???????
Flow of Funds Through the Financial System
16
Classifications of Financial Markets?????
??????? ??? ???????

• Primary Market ????? ???????
• New security issues sold to initial buyers
• Secondary Market ????? ????????
• Securities previously issued are bought and sold

17
Classifications of Financial Markets?????
??????? ??? ???????

• Exchanges ??????? ??????? (????????)
• Trades conducted in central locations (e.g.,
  ADSM, DFM, .)
• Over-the-Counter Markets ??????? ????? ?????
• Dealers at different locations buy and sell

18
Classifications of Financial Markets?????
??????? ??? ?????????

• Long term (Capital Markets)
• Debt
• Equity
• Short term (Money Markets)
• Foreign Exchange
• Money markets

19
Classifications of Financial Markets ?????
??????? ??????? ??? ????? ??????

• Debt Markets ????? ?????
• Short-Term (maturity lt 1 year) Money Market
• Long-Term (maturity gt 1 year) Capital Market
• Equity Markets ????? ???????
• Common Stock

20
Characteristics of Debt Markets Instruments?????
?????

• Debt instruments ???? ????? ?????
• Buyers of debt instruments are suppliers (of
  capital) to the firm, not owners of the firm
• Debt instruments have a finite life or maturity
  date
• Advantage is that the debt instrument is a
  contractual promise to pay with legal rights to
  enforce repayment
• Disadvantage is that return/profit is fixed or
  limited

21
Characteristics of Equity Markets
Instruments????? ???????

• Equity instruments (common stock is most
  prevalent equity instrument) ???? ????? ???????
• Buyers of common stock are owners of the firm
• Common stock has no finite life or maturity date
• Advantage of common stock is potential high
  income since return is not fixed or limited
• Disadvantage is that debt payments must be made
  before equity payments can be made

22
Characteristics of Financial Markets????? ?????

• Debt Markets ???? ????? ?????
• Although less well-known by the average person,
  debt markets are much larger in total dollars
  than equity markets, due to greater number of
  participant classes (households, businesses,
  government, and foreigners) and size of
  individual participants (businesses, and
  government)
• This is not the case in the UAE debt market is
  mostly bank loans and informal or off balance
  sheet lending.

23
Characteristics of Financial Markets????? ???????

• Equity Markets ???? ????? ???????
• Although newly founded and lacks the needed
  environment to function properly, it proved to
  have played its role in establishing the elements
  of the sovereignty of the country and in
  promoting economic development.
• To the contrary of most economies including that
  of the US the equity market in UAE is larger than
  the debt market, due to the fact that the bond
  markets are small and illiquid.

24
Function of Financial Intermediaries??? ???????
???????

• Financial Intermediaries ??????? ????????
• Engage in process of indirect finance
• More important source of finance than securities
  markets
• Needed because of transactions costs and
  asymmetric information

25
Function of Financial Intermediaries??? ???????
???????

• Transactions Costs ?????? ?????????
• Financial intermediaries make profits by reducing
  transactions costs
• Reduce transactions costs by developing expertise
  and taking advantage of economies of scale and
  scope.

26
Function of Financial Intermediaries??? ???????
???????

• A financial intermediarys low transaction costs
  mean that it can provide its customers with
  liquidity services, services that make it easier
  for customers to conduct transactions ?????
  ??????? ??? ?????? ??? ????? ??????? ????????
• Banks provide depositors with checking accounts
  that enable them to pay their bills easily
• Depositors can earn interest on checking and
  savings accounts and yet still convert them into
  goods and services whenever necessary without
  having to discontinue and liquidate investments

27
Function of Financial Intermediaries??? ???????
???????

• Another benefit made possible by the FIs low
  transaction costs is that they can help reduce
  the exposure of investors to risk, through a
  process known as risk sharing
• ????? ???????
• FIs create and sell assets with lesser risk to
  one party in order to buy assets with greater
  risk from another party (e.g. banks)
• This process is referred to as asset
  transformation, because in a sense risky assets
  are turned into safer assets for investors

28
Function of Financial Intermediaries??? ???????
???????

• Adverse Selection ???????? ?? ?????????
• Before transaction occurs
• Potential borrowers most likely to produce
  adverse outcome are ones most likely to seek loan
  and be selected brokers and financial analysts
  can prevent that by studying the credit
  worthiness of the borrowers

29
Function of Financial Intermediaries??? ???????
???????

• Moral Hazard ???????? ?????? ?????
• After transaction occurs
• Hazard that borrower has incentives to engage in
  undesirable (immoral) activities making it more
  likely that won't pay loan back

30
Function of Financial Intermediaries??? ???????
???????

• Financial intermediaries reduce adverse selection
  and moral hazard problems, enabling them to make
  profits. How they do this is covered in many of
  the topics to come.
• ???????? ??????? ???? ?? ??? ???????

31
Financial Institutions????? ???????? ???????

• Depository Institutions (Banks) ????????
  ?????????
• Commercial banks
• Savings Loan Associations (SLs)
• Mutual Savings Banks
• Credit Unions
• Contractual Savings Institutions ????????
  ?????????
• Life insurance companies
• Property casualty insurance companies
• Pension funds

32
Financial Institutions ????? ???????? ???????

• Investment Intermediaries ???????? ???????????
• Finance companies
• Mutual funds
• Money market mutual funds

33
Financial Institutions ????? ???????? ???????

• Commercial banks ?????? ????????
• Raise funds primarily by issuing checkable,
  savings, and time deposits which are used to make
  commercial, consumer and mortgage loans
• Collectively, these banks comprise the largest
  financial intermediary and have the most
  diversified asset portfolios
• Around 1 trillion DHS in total assets in the UAE

34
Financial Institutions ????? ???????? ???????

• SLs, Mutual Savings Banks and Credit Unions
• ???????? ????????? ??????? ??????? ????? ?????
• Raise funds primarily by issuing savings, time,
  and checkable deposits which are most often used
  to make mortgage and consumer loans, with
  commercial loans also becoming more prevalent at
  SLs and Mutual Savings Banks
• Mutual savings banks and credit unions issue
  deposits as shares and are owned collectively by
  their depositors, most of which at credit unions
  belong to a particular group, e.g., a companys
  workers

35
Financial Institutions ????? ???????? ???????

• All CSIs acquire funds from clients at periodic
  intervals on a contractual basis and have fairly
  predictable future payout requirements.
• Life Insurance Companies ????? ????? ??????
• receive funds from policy premiums, can invest
  in less liquid corporate securities and
  mortgages, since actual benefit pay outs are
  close to those predicted by actuarial analysis
• Fire and Casualty Insurance Companies ????? ?????
  ??????? receive funds from policy premiums, must
  invest most in liquid government and corporate
  securities, since loss events are harder to
  predict

36
Financial Institutions ????? ???????? ???????

• All CSIs acquire funds from clients at periodic
  intervals on a contractual basis and have fairly
  predictable future payout requirements.
• Pension and Government Retirement Funds
• ?????? ???????
• hosted by corporations and state and local
  governments acquire funds through employee and
  employer payroll contributions, invest in
  corporate securities, and provide retirement
  income via annuities

37
Financial Institutions ????? ???????? ???????

• Finance Companies ????? ???????
• sell commercial paper (a short-term debt
  instrument) and issue bonds and stocks to raise
  funds to lend to consumers to buy durable goods,
  and to small businesses for operations
• Mutual Funds ?????? ?????????
• acquire funds by selling shares to individual
  investors and use the proceeds to purchase large,
  diversified portfolios of stocks and bonds we
  will have a training course on these some time
  this summer

38
Financial Institutions ????? ???????? ???????

• Money Market Mutual Funds
• ?????? ????????? ???????? ????? ?????
• acquire funds by selling checkable deposit-like
  shares to individual investors and use the
  proceeds to purchase highly liquid and safe
  short-term money market instruments
• Hedge Funds, ETFs and others

39
Regulation of Financial Markets

• Reasons for Regulation ????? ??????? ??????
• Increase Information to Investors
• Protect investors and their investments
• Ensure the Soundness of Financial Intermediaries
• Improve Monetary Control

40
Regulation Reason Increase Investor
Information????? ???? ?????????

• Asymmetric information in financial markets means
  that investors may be subject to adverse
  selection and moral hazard problems that may
  hinder the efficient operation of financial
  markets and may also keep investors away from
  financial markets
• The Securities and Commodities Authority (SCA)
  requires corporations issuing securities to
  disclose certain information about their sales,
  assets, and earnings to the public and restricts
  trading by the largest stockholders (known as
  insiders) in the corporation.

41
Regulation Reason Increase Investor
Information????? ???? ?????????

• Such government regulation can reduce adverse
  selection and moral hazard problems in financial
  markets and increase their efficiency by
  increasing the amount of information available to
  investors

42
Regulation Reason Ensure Soundness of Financial
Intermediaries ????? ???????

• Because providers of funds to financial
  intermediaries may not be able to assess whether
  the institutions holding their funds are sound or
  not, if they have doubts about the overall health
  of financial intermediaries, they may want to
  pull their funds out of both sound and unsound
  institutions, with the possible outcome of a
  financial panic that produces large losses for
  the public and causes serious damage to the
  economy

43
Regulation Reason Ensure Soundness of Financial
Intermediaries ????? ???????

• To protect the public and the economy from
  financial panics, six types of regulations are
  needed
• Restrictions on Entry - soundness
• Disclosure transparency
• Restrictions on Assets and Activities no
  dummies
• Deposit Insurance peace of mind
• Limits on Competition no price wars
• Restrictions on Interest Rates no usury

44
Regulation Restriction on Entry ????? ??????

• Restrictions on Entry
• Very tight regulations as to who is allowed to
  set up a financial intermediary
• Individuals or groups that want to establish a
  financial intermediary, such as a bank or an
  insurance company, must obtain a charter from the
  government
• Only if they are upstanding citizens with
  impeccable credentials and a large amount of
  initial funds will they be given a charter.

45
Regulation Disclosure ???????

• Disclosure Requirements
• There are stringent reporting requirements for
  financial intermediaries
• Their bookkeeping must follow certain strict
  principles,
• Their books are subject to periodic inspection,
• They must make certain information available to
  the public.

46
Regulation Restriction on Assets and Activities
????? ????????

• There are restrictions on what financial
  intermediaries are allowed to do and what assets
  they can hold
• Before you put your funds into a bank or some
  other such institution, you would want to know
  that your funds are safe and that the bank or
  other financial intermediary will be able to meet
  its obligations to you

47
Regulation Restriction on Assets and Activities
????? ????????

• One way of doing this is to restrict the
  financial intermediary from engaging in certain
  risky activities
• Another way is to restrict financial
  intermediaries from holding certain risky assets,
  or at least from holding a greater quantity of
  these risky assets than is prudent

48
Regulation Deposit Insurance???????

• The government can insure people providing funds
  to a financial intermediary from any financial
  loss if the financial intermediary should fail

49
Regulation Past Limits on Competition ????
???????

• Although the evidence that unbridled competition
  among financial intermediaries promotes failures
  that will harm the public is extremely weak, the
  government needs to impose many restrictive
  regulations
• The purpose is to prevent financial
  intermediaries from competing to the point where
  the integrity of the financial system is
  compromised.

50
Regulation Past Restrictions on Interest Rates
???? ?????? ???????

• Competition must also be inhibited by regulations
  that impose restrictions on interest rates that
  can be paid on deposits
• These regulations need to be instituted because
  of the widespread belief that unrestricted
  interest-rate competition help encourage bank
  failures

51
Regulation Reason Improve Monetary Control
?????? ??????? ???????

• Because banks play a very important role in
  determining the supply of money (which in turn
  affects many aspects of the economy), much
  regulation of these financial intermediaries is
  intended to improve control over the money supply
• One such regulation is reserve requirements,
  which make it obligatory for all depository
  institutions to keep a certain fraction of their
  deposits in accounts with the central bank
• Reserve requirements help the central bank
  exercise more precise control over the money
  supply well, much can be detailed about the UAE
  monetary policy.

52
The cost of money????? ??? ?????

• The price, or cost, of debt capital is the
  interest rate.
• The price, or cost, of equity capital is the
  required return. The required return investors
  expect is composed of compensation in the form of
  dividends and capital gains.

53
What four factors affect the cost of
money???????? ???? ???? ?? ????? ??? ?????

• Time preferences for consumption (sacrifice)
• Expected inflation (loss in purchasing power)
• Risk (worry)

54
Nominal vs. Real rates?????? ?????? ????????

• k represents any nominal rate
• k represents the real risk-free rate of
  interest, if there was no inflation. Typically
  ranges from 1 to 4 per year.
• kRF represents the rate of interest on Treasury
  securities.

55
Determinants of interest rates?????? ??? ???????
(??????)

• k k IP DRP LP MRP
• k required return on a debt security
• k real risk-free rate of interest
• IP inflation premium
• DRP default risk premium
• LP liquidity premium
• MRP maturity risk premium

56
Premiums added to k for different types of
debt?????? ?????? ??????? ????????
57
Yield curve and the term structure of interest
rates????? ?????? ?????? ??????? ??????????

• Term structure relationship between interest
  rates (or yields) and maturities.
• The yield curve is a graph of the term structure.

58
Hypothetical yield curve????? ???? ???????

• An upward sloping yield curve.
• Upward slope due to an increase in expected
  inflation and increasing maturity risk premium.

59
The Yield Curve????? ??????

• Corporate yield curves are higher than that of
  Treasury securities, though not necessarily
  parallel to the Treasury curve.
• The spread between corporate and Treasury yield
  curves widens as the corporate bond rating
  decreases.

60
The Yield Curve????? ??????
Interest Rate ()
15
10
Treasury Yield Curve
6.0
5.9
5
5.2
Years to Maturity
0
0
1
5
10
15
20