International Financial Tools 4 Folder of Exercises and Case Studies
EXERCISES
Exercise 1. Financial markets and their participants
With globalization, financial markets have multiplied and become more complex. Overview of
the main participants.
"The markets think the crisis is over", "The markets have decided not to buy any more Greek
public debt", These are the phrases that have been heard or read recently in the media. But who
are these financial markets with such formidable intelligence and power? The answer is both
simple and complicated. Simple, because markets basically co
espond to the actors who trade
on them. But the answer is actually more complicated because there are several types of
financial markets, organised in different ways.
In particular, the role of the authorities and the mode of regulation differ significantly from one
market to another and from one country to another.
The Stock Exchange, an organized market: Basic intermediaries,
okerage firms, often
subsidiaries of banking institutions, are responsible for trading and listing securities. But the
eal protagonists of these exchanges are three: the issuers that offer the new securities on the
primary market, institutional investors and banks, which ca
y out the bulk of the transactions
in the securities (purchases and sales). Two other categories of actors play an essential role in
the evaluation and control of stock exchanges. First and foremost, financial analysts, who
monitor developments in corporate and government finances, and especially the rating
agencies, which are responsible for assessing and rating the ability of issuers of securities to
epay, and whose influence on market equili
ium has become considerable. Secondly, there
are the market authorities, which are of two types: on the one hand, the private authorities,
which run the stock exchanges through public limited companies. Thus, Euronext is a public
limited company under Dutch law with a supervisory board and a management board that
defines the operating rules of this pan-European market. Above the private authorities are the
public authorities, present at the national level - in France, the Autorité des marchés financiers
- and at the European level (the European Securities Market Authority (ESMA). The role of
these public authorities is to set market rules and monitor their application; they have the power
to impose sanctions.
Over-the-counter markets: Alongside exchanges such as Euronext, which are "organised"
markets controlled by the authorities, over-the-counter markets have developed on which
transactions are ca
ied out between operators who define the terms of their exchange directly
etween themselves. These markets are totally opaque and are therefore very different from
stock exchanges. They have grown considerably since the early 2000s and are present in
different segments of the financial industry. They now capture the bulk of securities
transactions. They are known as "dark pools", markets where transactions are ca
ied out "in
the shadows", thus escaping the scrutiny of public authorities. These markets are reserved for
large investors, not least because the packages of shares traded amount to millions or even
illions of euros. Dark pools constitute a real "black hole" in the cu
ent system of stock market
egulation. The public authorities have a share of responsibility in this wo
ying situation: dark
pools developed following a 2007 European directive (Markets in Financial Instruments
Directive, MiFID) that sought to
eak the monopoly of stock exchanges by promoting these
"alternative" forms of trading, encouraging financial players to create their own exchanges
outside organised markets. Over-the-counter markets also account for more than 90% of
transactions in derivatives, sophisticated financial products that are used both to hedge against
International Financial Tools 5 Folder of Exercises and Case Studies
unexpected changes in financial assets (exchange rates, equities, commodities, etc.) and to
speculate on these changes.
The foreign exchange market, a global market: In addition to the securities markets discussed
above, the foreign exchange markets are the place where cu
encies are exchanged, leading to
the determination of exchange rates. This global cu
ency market is by far the largest of all
markets: according to the recent triennial survey of the Bank for International Settlements
(BIS), daily trading in this market will amount to $4 trillion in 2010, which is ten times that of
equities and four times that of bonds. This market is highly concentrated: 85% of transactions
are in dollars; more than 50% of transactions are ca
ied out in two financial centres, the United
Kingdom (36.7%) and the United States (17.9%). Another feature is that most transactions are
again over-the-counter, most often using automated electronic systems that can handle
thousands of orders per minute.
The latest BIS survey reveals an important change: inte
ank transactions have been overtaken
for the first time by non-bank financial institutions, such as institutional investors, but especially
hedge funds and central banks. This change co
esponds to a twofold evolution. The speculative
dimension of the foreign exchange market has become predominant, as shown by the growing
ole of hedge funds. In other words, whereas foreign exchange market transactions were directly
linked to trade in the early 1970s, they are now linked to international financial transactions,
most of which are purely financial transactions of a speculative nature.
H. Lopin, Alternatives Economiques, 01/01/2011
Question 1: Explain the difference between an OTC market and an organised market and show,
ased on the text, the growing importance of the former for market participants.
Question 2: Explain the relationships between the main players in the financial markets:
issuers, institutional investors, banks, financial analysts and rating agencies.
Question 3. What are the differences between private and public regulators?
International Financial Tools 6 Folder of Exercises and Case Studies
Exercise 2. Which stock market index should you trust?
Criticized, the major traditional indices are competing with newcomers.
The CAC 40 regularly finds itself criticized. Like all indices, it measures the weight of the
stocks that make up the index according to their market capitalization. Because the more
fashionable a stock is, the higher its price, the more its capitalization increases... and the more
its weight in the index increases. Most major stock market indices, built on this model, therefore
have the unfortunate reputation of passing on all bu
les. Or to overemphasize the star stocks
of the moment, like Total, which represented up to 15% of the CAC 40. Some indices, such as
the Dow Jones in the United States or the Nikkei in Japan, escape this shortcoming because
they give equal weight to the selected stocks. But professionals criticize them for not being
epresentative of the market, and for exhibiting greater volatility and turnover than traditional
indices. This debate is not new. But today's savers are more concerned about this. For them,
indices have become investment vehicles (listed index funds) and no longer just market
indicators. "It's paradoxical. Investors who rely on indices often think they are limiting risk,
whereas, by construction, indices can be quite risky," notes David Gagnozzi, Managing
Director of Fidelity Gestion. So some people are looking for the parade. "There is now a demand
for alternative indices and other ways of weighting stocks," observes Lars Hamich, CEO of
Stoxx Ltd. This index provider first introduced indices that weight values based on dividends
paid over the past five years. Others had the same idea: to compose indices where values would
e weighted by fundamental criteria. These relate to the significance of cash flows, sales, profits
and book values over the past year or the past five years. Will these newcomers perform better?
Less volatile, they should be less sensitive to bu
les than their elders, their promoter promises.
But already some criticisms have been made. "These clues aren't really clues. No economic
theory justifies the choice of these fundamental criteria. This amounts to making a systematic
ut active selection of securities," says Noël Amenc, professor of finance at Edhec. The main
virtue of these newcomers will therefore perhaps be to make investors aware that, in one zone,
choosing one index over another is a real management choice. "There are no good clues.
Everyone has a bias. It is likely that in time we will find that these new clues have one too. And
that the most important thing for the investor is to know which bias and which risks he is
prepared to take," emphasises Jean-Pie
e Grimaud, Investment Director at Swiss Life.
A. Bodescot, Le Figaro, 3 March 2007
Question 1: Explain any reservations about the relevance of stock market indices.
Can you
ing counterarguments to these same reservations?
Question 2. What is the use of stock market indices and for whom are they useful?
Question 3. Justify, with example, the existence of several stock market indices for the same
stock market.