Submitted to :

Dr. Harish Handa

Submitted By :
Chandan Kumar Das
(07-II-712)
Introduction
The field of finance refers to the concepts of time, money and risk and how they are
interrelated. Banks are the main facilitators of funding through the provision of credit,
although private equity, mutual funds, hedge funds, and other organizations have become
important. Financial assets, known as investments, are financially managed with careful
attention to financial risk management to control financial risk. Financial
instruments allow many forms of securitized assets to be traded on securities
exchanges such as stock exchanges, including debt such as bonds as well
as equity in publicly-traded corporations.

In economics, a financial market is a mechanism that allows people to easily buy and
sell (trade) financial securities (such as stocks and bonds), commodities (such as precious
metals or agricultural goods), and other fungible items of value at low transaction
costs and at prices that reflect the efficient-market hypothesis.
Financial markets have evolved significantly over several hundred years and are
undergoing constant innovation to improve liquidity.
Both general markets (where many commodities are traded) and specialized markets
(where only one commodity is traded) exist. Markets work by placing many interested
buyers and sellers in one "place", thus making it easier for them to find each other. An
economy which relies primarily on interactions between buyers and sellers to allocate
resources is known as a market economy in contrast either to a command economy or to
a non-market economy such as a gift economy.
In finance, financial markets facilitate –

 The raising of capital (in the capital markets);

 The transfer of risk (in the derivatives markets);
 International trade (in the currency markets)

– and are used to match those who want capital to those who have it.
Typically a borrower issues a receipt to the lender promising to pay back the capital.
These receipts are securities which may be freely bought or sold. In return for lending
money to the borrower, the lender will expect some compensation in the form
of interest or dividends.
Definition
In economics, typically, the term market means the aggregate of possible buyers and
sellers of a thing and the transactions between them.
The term "market" is sometimes used for what are more strictly exchanges, organizations
that facilitate the trade in financial securities, e.g., a stock exchange or commodity
exchange. This may be a physical location (like theNYSE) or an electronic system
(like NASDAQ). Much trading of stocks takes place on an exchange; still,corporate
actions (merger, spinoff) are outside an exchange, while any two companies or people,
for whatever reason, may agree to sell stock from the one to the other without using an
exchange.
Trading of currencies and bonds is largely on a bilateral basis, although some bonds trade
on a stock exchange, and people are building electronic systems for these as well, similar
to stock exchanges.
Financial markets can be domestic or they can be international.

Types of financial markets

The financial markets can be divided into different subtypes:

 Capital markets which consist of:

 Stock markets, which provide financing through the issuance of shares or common
stock, and enable the subsequent trading thereof.
 Bond markets, which provide financing through the issuance of bonds, and enable
the subsequent trading thereof.
 Commodity markets, which facilitate the trading of commodities.
 Money markets, which provide short term debt financing and investment.
 Derivatives markets, which provide instruments for the management of financial risk.
 Futures markets, which provide standardized forward contracts for trading
products at some future date; see also forward market.
 Insurance markets, which facilitate the redistribution of various risks.
 Foreign exchange markets, which facilitate the trading of foreign exchange.
The capital markets consist of primary markets and secondary markets. Newly formed
(issued) securities are bought or sold in primary markets. Secondary markets allow
investors to sell securities that they hold or buy existing securities.

Bond market
The bond market (also known as the debt, credit, or fixed income market) is
a financial market where participants buy and sell debt securities, usually in the form
of bonds. As of 2006, the size of the international bond market is an estimated $45
trillion, of which the size of the outstanding U.S. bond market debt was $25.2 trillion.
Nearly all of the $923 billion average daily trading volume (as of early 2007) in the U.S.
bond market takes place between broker-dealers and large institutions in a
decentralized, over-the-counter (OTC) market. However, a small number of bonds,
primarily corporate, are listed on exchanges.
References to the "bond market" usually refer to the government bond market, because of
its size, liquidity, lack of credit risk and, therefore, sensitivity to interest rates. Because of
the inverse relationship between bond valuation and interest rates, the bond market is
often used to indicate changes in interest rates or the shape of the yield curve.
Market structure

Bond markets in most countries remain decentralized and lack common exchanges
like stock, future andcommodity markets. This has occurred, in part, because no two bond
issues are exactly alike, and the number of different securities outstanding is far larger.
However, the New York Stock Exchange (NYSE) is the largest centralized bond market,
representing mostly corporate bonds. The NYSE migrated from the Automated Bond
System (ABS) to the NYSE Bonds trading system in April 2007 and expects the number
of traded issues to increase from 1000 to 6000.
Types of bond markets

The Securities Industry and Financial Markets Association classifies the broader bond
market into five specific bond markets.
 Corporate
 Government & agency
 Municipal
 Mortgage backed, asset backed, and collateralized debt obligation
 Funding

Fixed income
Fixed income refers to any type of investment that yields a regular (or fixed) return.
For example, if you lend money to a borrower and the borrower has to pay interest once a
month, you have been issued a fixed-income security. When a company does this, it is
often called a bond or corporate bank debt (although "preferred stock" is also sometimes
considered to be fixed income). Sometimes people misspeak when they talk about fixed
income. Bonds actually have higher risk, while notes and bills have less risk because
these are issued by government agencies.
The term fixed income is also applied to a person's income that does not vary with each
period. This can include income derived from fixed-income investments such as bonds
and preferred stocks or pensions that guarantee a fixed income. When pensioners or
retirees are dependent on their pension as their dominant source of income, the term
"fixed income" can also carry the implication that they have relatively
limited discretionary income or have little financial freedom to make large expenditures.
Fixed-income securities can be contrasted with variable return securities such as stocks.
To understand the difference between stocks and bonds, you have to understand a
company's motivation. A company wants to raise money, and it doesn't want to wait until
it has earned enough through ongoing operations (selling products or providing services).
In order for a company to grow as a business, it often must raise money; to finance an
acquisition, buy equipment or land or invest in new product development. Investors will
only give money to the company if they believe that they will be given something in
return commensurate with the risk profile of the company. The company can either
pledge a part of itself, by giving equity in the company (stock), or the company can give
a promise to pay regular interest and repay principal on the loan (bond or bank loan) or
(preferred stock).
While a bond is simply a promise to pay interest on borrowed money, there is some
important terminology used by the fixed-income industry:

 The issuer is the entity (company or govt.) who borrows an amount of money (issuing
the bond) and pays the interest.
 The principal (of a bond) is the amount that the issuer borrows.
 The coupon (of a bond) is the interest that the issuer must pay.
 The maturity is the end of the bond, the date that the issuer must return the principal.
 The issue is another term for the bond itself.
 The indenture is the contract that states all of the terms of the bond.

People who invest in fixed-income securities are typically looking for a constant and
secure return on their investment. For example, a retired person might like to receive a
regular dependable payment to live on, but not consume principal. This person can buy a
bond with their money, and use the coupon payment (the interest) as that regular
dependable payment. When the bond matures or is refinanced, the person will have their
money returned to them.
Interest rates change over time, based on a variety of factors, particularly rates set by
the Federal Reserve. For example, if a company wants to raise $1 million and not a lot of
people in the market have free cash to lend, the company will have to offer a high rate of
interest (coupon) to get people to buy their bond. If there are a lot of people in the market
trying to get a return on their money, the company can offer a lower coupon.
To complicate matters further, fixed income securities are actually traded on the open
market, just like stocks. To understand this, first realize that bonds are usually created in
round face values, for example $100,000. If the current yield (interest rate) of newly
issued similar bonds is 6% per year, and you are buying a bond with a coupon rate below
6%, then you can get the bond at a discount (below face value of $100,000), which brings
your rate of return on that bond to 6%. Similarly, if the coupon rate of the bond you are
buying is greater than 6% you will have to pay a premium for the bond to bring the rate
of return down to 6%.
There are also index-linked, fixed-income securities. The most common and an example
of the highest rated variety of this kind could includeTreasury Inflation Protected
Securities (TIPS). This type of fixed income is adjusted to the Consumer Price Index for
all urban consumers (CPI-U), and then a real yield is applied to the adjusted principal.
This means that the US Treasury issues fixed income that is backed by the full faith and
credit of the US government to outperform the CPI (e.g. to outperform the inflation rate).
This allows investors of all sizes to not lose the purchasing power of their money due to
inflation, which can be very uncertain at times. For example, assuming 3.88% inflation
over the course of 1 year (just about the 56 year average inflation rate, through most of
2006), and a real yield of 2.61% (the fixed US Treasury real yield on October 19, 2006,
for a 5 yr TIPS), the adjusted principal of the fixed income would rise from 100 to 103.88
and then the real yield would be applied to the adjusted principal, meaning 103.88 x
1.0261, which equals 106.5913; giving a total return of 6.5913%. TIPS moderately
outperform conventional US Treasuries, which yield just 5.05% for a 1 yr bill on October
19, 2006. By investing in such fixed income, index linked fixed income securities,
consumers can exceed the pace of inflation, and gain value in real terms.
All fixed income securities from any entity have risks including but not limited to:

 inflationary risk
 interest rate risk
 currency risk
 default risk
 repayment of principal risk
 reinvestment risk
 liquidity risk
 maturity risk
 streaming income payment risk
 duration risk
 convexity risk
 credit quality risk
 political risk
 tax adjustment risk
 market risk
 climate risk

Corporate bond
A Corporate Bond is a bond issued by a corporation. The term is usually applied to
longer-term debt instruments, generally with a maturity date falling at least a year after
their issue date. (The term "commercial paper" is sometimes used for instruments with a
shorter maturity.)
Sometimes, the term "corporate bonds" is used to include all bonds except those issued
by governments in their own currencies. Strictly speaking, however, it only applies to
those issued by corporations. The bonds of local authorities and supranational
organizations do not fit in either category.
Corporate bonds are often listed on major exchanges (bonds there are called "listed"
bonds) and ECNs like MarketAxess, and the coupon (i.e. interest payment) is
usually taxable. Sometimes this coupon can be zero with a high redemption value.
However, despite being listed on exchanges, the vast majority of trading volume in
corporate bonds in most developed markets takes place in decentralized, dealer-
based, over-the-counter markets.
Some corporate bonds have an embedded call option that allows the issuer to redeem the
debt before its maturity date. Other bonds, known as convertible bonds, allow investors to
convert the bond into equity.
One can obtain an unfunded synthetic exposure to corporate bonds via credit default
swaps.

Government bond
A government bond is a bond issued by a national government denominated in the
country's own currency. Bonds issued by national governments in foreign currencies are
normally referred to as sovereign bonds. The first ever government bond was issued by
the British government in 1693 to raise money to fund a war against France. It was in the
form of a tontine.

Government bonds are usually referred to as risk-free bonds, because the government can
raise taxes or simply print more money to redeem the bond at maturity. Some counter
examples do exist where a government hasdefaulted on its domestic currency debt, such
as Russia in 1998 (the "ruble crisis"), though this is very rare.
As an example, in the US, Treasury securities are denominated in US dollars and are the
safest US dollar investments.[citation needed] In this instance, the term "risk-free" means free
of credit risk. However, other risks still exist, such as currency risk for foreign investors
(for example non-US investors of US Treasury securities would have received lower
returns in 2004 because the value of the US dollar declined against most other
currencies). Secondly, there is inflation risk, in that the principal repaid at maturity will
have less purchasing power than anticipated if the inflation outturn is higher than
expected. Many governments issue inflation-indexed bonds, which should protect
investors against inflation risk. The protection has been questioned by John Williams'
ShadowStats.com, which claims that government-calculated inflation is understated by as
much as 5 percent, making also inflation-indexed bonds yield a loss.
Municipal bond

n the United States, a municipal bond (or muni) is a bond issued by a city or other local
government, or their agencies. Potential issuers of municipal bonds include cities,
counties, redevelopment agencies, school districts, publicly owned airports and seaports,
and any other governmental entity (or group of governments) below the state level.
Municipal bonds may be general obligations of the issuer or secured by specified
revenues. Interest income received by holders of municipal bonds is often exempt from
the federal income tax and from the income tax of the state in which they are issued,
although municipal bonds issued for certain purposes may not be tax exempt.

Bond valuation
Bond valuation is the process of determining the fair price of a bond. As with any
security or capital investment, the fair value of a bond is the present value of the stream
of cash flows it is expected to generate. Hence, the price or value of a bond is determined
by discounting the bond's expected cash flows to the present using the
appropriate discount rate.

The present value relationship

The fair price of a straight bond (a bond with no embedded option; see Callable bond) is
determined by discounting the expected cash flows:

 Cash flows:
 the periodic coupon payments C, each of which is made n times (n is usually 2)
every year
  the par or face value F, which is payable at maturity of the bond after T years.(NB
final year payments will include the par value plus the coupon payments for the
year). In some of the bonds, their Maturity Redemption Price might be more than
par value, in this case the F is actually the Redemption Price.

 Discount rate: the required (annually compounded) yield or rate of return r

 r is the market interest rate for bonds with similar terms and risk ratings
 m is the number of coupons to be paid over the remaining lifetime of the bond,
ie n times T. (It is assumed that the previous coupon has just been paid.)
 u is (1+r)^(1/n) ie an interest accumulation factor over one coupon period

Bond Price =
Because the price is the present value of the cash flows, there is an inverse
relationship between price and discount rate: the higher the discount rate the lower
the value of the bond.
Coupon yield
The coupon yield is simply the coupon payment (C) as a percentage of the face value (F).
Coupon yield = C / F
Coupon yield is also called nominal yield.
Current yield
The current yield is simply the coupon payment (C) as a percentage of the bond price (P).
Current yield = C / P0.
Yield to Maturity

The yield to maturity (YTM) is the discount rate which returns the market price of the
bond. It is thus the internal rate of return of an investment in the bond made at the
observed price. YTM can also be used to price a bond, where it is used as the required
return on the bond.
In other words, it is identical to r in the above equation.
To achieve a return equal to YTM, the bond owner must:

 buy the bond at price P0,

 hold the bond until maturity, and
 redeem the bond at par.

The concept of current yield is closely related to other bond concepts, including yield to
maturity, and coupon yield. The relationship between yield to maturity and coupon rate is
as follows:

 When a bond sells at a discount, YTM > current yield > coupon yield.
 When a bond sells at a premium, coupon yield > current yield > YTM.
 When a bond sells at par, YTM = current yield = coupon yield amt

High-yield debt

n finance, a high yield bond (non-investment grade bond, speculative grade

bond or junk bond) is a bondthat is rated below investment grade at the time of
purchase. These bonds have a higher risk of default or other adverse credit events, but
typically pay higher yields than better quality bonds in order to make them attractive to
investors.

Global issuance of high yield bonds more than doubled in 2003 to nearly $146 billion in
securities issued from less than $63 billion in 2002, although this is still less than the
record of $150 billion in 1998. Issuance is disproportionately centered in the U.S.A.,
although issuers in Europe, Asia and South Africa have recently turned to high yield debt
in connection with refinancings and acquisitions. In 2006, European companies issued
over €31 billion of high yield bonds.

Risk

The holder of any debt is subject to interest rate risk and credit risk, inflationary risk,
currency risk, duration risk, convexity risk, repayment of principal risk, streaming
income risk, liquidity risk, default risk, maturity risk, reinvestment risk, market risk,
political risk, and taxation adjustment risk. Interest rate risk refers to the risk of the
market value of a bond changing in value due to changes in the structure or level of
interest rates or credit spreads or risk premiums. The credit risk of a high yield bond
refers to the probability and probable loss upon a credit event (i.e., the obligor defaults on
scheduled payments or files for bankruptcy, or the bond is restructured), or a credit
quality change is issued by a rating agency including Fitch, Moody's, or Standard &
Poors.
A credit rating agency attempts to describe the risk with a credit rating such as AAA.
In North America, the five major agencies are Standard and Poor's, Moody's, Fitch
Ratings, Dominion Bond Rating Service and A.M. Best. Bonds in other countries may be
rated by US rating agencies or by local credit rating agencies. Rating scales vary; the
most popular scale uses (in order of increasing risk) ratings of AAA, AA, A, BBB, BB, B,
CCC, CC, C, with the additional rating D for debt already in arrears. Government
bonds and bonds issued by government sponsored enterprises (GSE's) are often
considered to be in a zero-risk category above AAA; and categories like AA and A may
sometimes be split into finer subdivisions like "AA-" or "AA+".
Bonds rated BBB- and higher are called investment grade bonds. Bonds rated lower than
investment grade on their date of issue are called speculative grade bonds, derisively
referred to as "junk" bonds.
The lower-rated debt typically offers a higher yield, making speculative bonds attractive
investment vehicles for certain types of financial portfolios and strategies. Many pension
funds and other investors (banks, insurance companies), however, are prohibited in
their by-laws from investing in bonds which have ratings below a particular level. As a
result, the lower-rated securities have a different investor base than investment-grade
bonds.
The value of speculative bonds is affected to a higher degree than investment grade
bonds by the possibility of default. For example, in arecession interest rates may drop,
and the drop in interest rates tends to increase the value of investment grade bonds;
however, a recession tends to increase the possibility of default in speculative-grade
bonds.

Corporate debt
The original speculative grade bonds were bonds that once had been investment grade at
time of issue, but where the credit rating of the issuer had slipped and the possibility of
default increased significantly. These bonds are called "Fallen Angels".
The investment banker Michael Milken realized that fallen angels had regularly been
valued less than what they were worth. His time with speculative grade bonds started
with his investment in these. Only later did he and other investment bankers at Drexel
Burnham Lambert, followed by those of competing firms, begin organizing the issue of
bonds that were speculative grade from the start. Speculative grade bonds thus became
ubiquitous in the 1980s as a financing mechanism in mergers and acquisitions. In
a leveraged buyout (LBO) an acquirer would issue speculative grade bonds to help pay
for an acquisition and then use the target's cash flow to help pay the debt over time.
In 2005, over 80% of the principal amount of high yield debt issued by U.S. companies
went toward corporate purposes rather than acquisitions or buyouts.
Debt repackaging and subprime crisis
High-yield bonds can also be repackaged into collateralized debt obligations (CDO),
thereby raising the credit rating of the senior tranches above the rating of the original
debt. The senior tranches of high-yield CDOs can thus meet the minimum credit rating
requirements of pension funds and other institutional investors despite the significant risk
in the original high-yield debt.
When such CDOs are backed by assets of dubious value, such as subprime mortgage
loans, and lose market liquidity, the bonds and their derivatives are also referred to
as toxic debt. Holding such "toxic" assets has led to the demise of several investment
banks and other financial institutions during the subprime mortgage crisis of 2007-08 and
led the US Treasury to buy those assets in September 2008 to prevent a systemic crisis.

Stock market
A stock market, or equity market, is a private or public market for
the trading of company stock and derivatives of company stock at an agreed price; these
are securities listed on a stock exchange as well as those only traded privately.
The size of the world stock market is estimated at about $36.6 trillion US at the
beginning of October 2008 [1]. The world derivatives market has been estimated at about
$480 trillion face or nominal value, 12 times the size of the entire world economy. It must
be noted though that the value of the derivatives market, because it is stated in terms
of notional values, cannot be directly compared to a stock or a fixed income security,
which traditionally refers to an actual value. Many such relatively illiquid securities are
valued as marked to model, rather than an actual market price.
The stocks are listed and traded on stock exchanges which are entities a corporation or
mutual organization specialized in the business of bringing buyers and sellers of the
organizations to a listing of stocks and securities together. The stock market in the United
States includes the trading of all securities listed on the NYSE, theNASDAQ, the Amex,
as well as on the many regional exchanges, e.g. OTCBB and Pink Sheets. European
examples of stock exchanges include the London Stock Exchange, the Deutsche
Börse and the Paris Bourse, now part of Euronext.

Importance of stock market

Function and purpose
The stock market is one of the most important sources for companies to raise money.
This allows businesses to be publicly traded, or raise additional capital for expansion by
selling shares of ownership of the company in a public market. The liquidity that an
exchange provides affords investors the ability to quickly and easily sell securities. This
is an attractive feature of investing in stocks, compared to other less liquid investments
such as real estate.
History has shown that the price of shares and other assets is an important part of the
dynamics of economic activity, and can influence or be an indicator of social mood. An
economy where the stock market is on the rise is considered to be an up coming
economy. In fact, the stock market is often considered the primary indicator of a country's
economic strength and development. Rising share prices, for instance, tend to be
associated with increased business investment and vice versa. Share prices also affect the
wealth of households and their consumption. Therefore, central banks tend to keep an eye
on the control and behavior of the stock market and, in general, on the smooth operation
of financial systemfunctions. Financial stability is the raison d'être of central banks.
Exchanges also act as the clearinghouse for each transaction, meaning that they collect
and deliver the shares, and guarantee payment to the seller of a security. This eliminates
the risk to an individual buyer or seller that the counterparty could default on the
transaction.
The smooth functioning of all these activities facilitates economic growth in that lower
costs and enterprise risks promote the production of goods and services as well as
employment. In this way the financial system contributes to increased prosperity.
Relation of the stock market to the modern financial
system
The financial system in most western countries has undergone a remarkable
transformation. One feature of this development isdisintermediation. A portion of the
funds involved in saving and financing flows directly to the financial markets instead of
being routed via the traditional bank lending and deposit operations. The general public's
heightened interest in investing in the stock market, either directly or through mutual
funds, has been an important component of this process. Statistics show that in recent
decades shares have made up an increasingly large proportion of households' financial
assets in many countries. In the 1970s, in Sweden, deposit accounts and other very liquid
assets with little risk made up almost 60 percent of households' financial wealth,
compared to less than 20 percent in the 2000s. The major part of this adjustment
in financial portfolios has gone directly to shares but a good deal now takes the form of
various kinds of institutional investment for groups of individuals, e.g., pension funds,
mutual funds, hedge funds, insurance investment of premiums, etc. The trend towards
forms of saving with a higher risk has been accentuated by new rules for most funds and
insurance, permitting a higher proportion of shares to bonds. Similar tendencies are to be
found in other industrialized countries. In all developed economic systems, such as
the European Union, the United States, Japan and other developed nations, the trend has
been the same: saving has moved away from traditional (government insured) bank
deposits to more risky securities of one sort or another.

The stock market, individual investors, and financial risk

Riskier long-term saving requires that an individual possess the ability to manage the
associated increased risks. Stock prices fluctuate widely, in marked contrast to the
stability of (government insured) bank deposits or bonds. This is something that could
affect not only the individual investor or household, but also the economy on a large
scale. The following deals with some of the risks of the financial sector in general and the
stock market in particular. This is certainly more important now that so many newcomers
have entered the stock market, or have acquired other 'risky' investments (such as
'investment' property, i.e., real estate and collectables).
With each passing year, the noise level in the stock market rises. Television
commentators, financial writers, analysts, and market strategists are all overtaking each
other to get investors' attention. At the same time, individual investors, immersed in chat
rooms and message boards, are exchanging questionable and often misleading tips. Yet,
despite all this available information, investors find it increasingly difficult to profit.
Stock prices skyrocket with little reason, then plummet just as quickly, and people who
have turned to investing for their children's education and their own retirement become
frightened. Sometimes there appears to be no rhyme or reason to the market, only folly.
This is a quote from the preface to a published biography about the long-term value-
oriented stock investor Warren Buffett.[3] Buffett began his career with $100, and
$105,000 from seven limited partners consisting of Buffett's family and friends. Over the
years he has built himself a multi-billion-dollar fortune. The quote illustrates some of
what has been happening in the stock market during the end of the 20th century and the
beginning of the 21st.

The behavior of the stock market

From experience we know that investors may temporarily pull financial prices away from
their long term trend level. Over-reactions may occur—so that excessive optimism
(euphoria) may drive prices unduly high or excessive pessimism may drive prices unduly
low. New theoretical and empirical arguments have been put forward against the notion
that financial markets are efficient.
According to the efficient market hypothesis (EMH), only changes in fundamental
factors, such as profits or dividends, ought to affect share prices. (But this largely
theoretic academic viewpoint also predicts that little or no trading should take place—
contrary to fact—since prices are already at or near equilibrium, having priced in all
public knowledge.) But the efficient-market hypothesis is sorely tested by such events as
the stock market crash in 1987, when the Dow Jones indexplummeted 22.6 percent—the
largest-ever one-day fall in the United States. This event demonstrated that share prices
can fall dramatically even though, to this day, it is impossible to fix a definite cause: a
thorough search failed to detect any specific or unexpected development that might
account for the crash. It also seems to be the case more generally that many price
movements are not occasioned by new information; a study of the fifty largest one-day
share price movements in the United States in the post-war period confirms
this.[4] Moreover, while the EMH predicts that all price movement (in the absence of
change in fundamental information) is random (i.e., non-trending), many studies have
shown a marked tendency for the stock market to trend over time periods of weeks or
longer.
Various explanations for large price movements have been promulgated. For instance,
some research has shown that changes in estimated risk, and the use of certain strategies,
such as stop-loss limits and Value at Risk limits, theoretically could cause financial
markets to overreact.
Other research has shown that psychological factors may result in exaggerated stock price
movements. Psychological research has demonstrated that people are predisposed to
'seeing' patterns, and often will perceive a pattern in what is, in fact, just noise.
(Something like seeing familiar shapes in clouds or ink blots.) In the present context this
means that a succession of good news items about a company may lead investors to
overreact positively (unjustifiably driving the price up). A period of good returns also
boosts the investor's self-confidence, reducing his (psychological) risk threshold.
Another phenomenon—also from psychology—that works against an objective
assessment is group thinking. As social animals, it is not easy to stick to an opinion that
differs markedly from that of a majority of the group. An example with which one may be
familiar is the reluctance to enter a restaurant that is empty; people generally prefer to
have their opinion validated by those of others in the group.
In one paper the authors draw an analogy with gambling. In normal times the market
behaves like a game of roulette; the probabilities are known and largely independent of
the investment decisions of the different players. In times of market stress, however, the
game becomes more like poker (herding behavior takes over). The players now must give
heavy weight to the psychology of other investors and how they are likely to react
psychologically.
The stock market, as any other business, is quite unforgiving of amateurs. Inexperienced
investors rarely get the assistance and support they need. In the period running up to the
recent Nasdaq crash, less than 1 percent of the analyst's recommendations had been to
sell (and even during the 2000 - 2002 crash, the average did not rise above 5%). The
media amplified the general euphoria, with reports of rapidly rising share prices and the
notion that large sums of money could be quickly earned in the so-called new
economy stock market. (And later amplified the gloom which descended during the 2000
- 2002 crash, so that by summer of 2002, predictions of a DOW average below 5000 were
quite common.)

Irrational behavior
Sometimes the market tends to react irrationally to economic news, even if that news has
no real effect on the technical value of securities itself. Therefore, the stock market can be
swayed tremendously in either direction by press releases, rumors, euphoria and mass
panic.
Over the short-term, stocks and other securities can be battered or buoyed by any number
of fast market-changing events, making the stock market difficult to predict. Emotions
can drive prices up and down. People may not be as rational as they think. Behaviorists
argue that investors often behave irrationally when making investment decisions thereby
incorrectly pricing securities, which causes market inefficiencies, which, in turn, are
opportunities to make money.

Stock
In business and finance, a share (also referred to as equity share) of stock means a share
of ownership in acorporation (company). In the plural, stocks is often used as a synonym
for shares especially in the United States, but it is less commonly used that way outside
of North America.
In the United Kingdom, South Africa, and Australia, stock can also refer to completely
different financial instruments such as government bonds or, less commonly, to all kinds
of marketable securities.
Types of stock
Stock typically takes the form of shares of either common stock or preferred stock. As a
unit of ownership, common stock typically carries voting rights that can be exercised in
corporate decisions. Preferred stock differs from common stock in that it typically does
not carry voting rights but is legally entitled to receive a certain level
of dividend payments before any dividends can be issued to other
shareholders.[1][2] Convertible preferred stock is preferred stock that includes an option for
the holder to convert the preferred shares into a fixed number of common shares, usually
anytime after a predetermined date. Shares of such stock are called "convertible preferred
shares" (or "convertible preference shares" in the UK)
Although there is a great deal of commonality between the stocks of different companies,
each new equity issue can have legal clauses attached to it that make it dynamically
different from the more general cases. Some shares of common stock may be issued
without the typical voting rights being included, for instance, or some shares may have
special rights unique to them and issued only to certain parties. Note that not all equity
shares are the same.
Stock derivatives
stock derivative is any financial instrument which has a value that is dependent on the
price of the underlying stock. Futures and options are the main types of derivatives on
stocks. The underlying security may be a stock index or an individual firm's stock,
e.g. single-stock futures.
Stock futures are contracts where the buyer is long, i.e., takes on the obligation to buy on
the contract maturity date, and the seller is short, i.e., takes on the obligation to sell. Stock
index futures are generally not delivered in the usual manner, but by cash settlement.
A stock option is a class of option. Specifically, a call option is the right (not obligation)
to buy stock in the future at a fixed price and a put option is the right (not obligation) to
sell stock in the future at a fixed price. Thus, the value of a stock option changes in
reaction to the underlying stock of which it is a derivative. The most popular method of
valuing stock options is the Black Scholes model. Apart from call options granted to
employees, most stock options are transferable.
Shareholder
A shareholder (or stockholder) is an individual or company (including a corporation)
that legally owns one or more shares of stock in a joint stock company. Companies listed
at the stock market are expected to strive to enhance shareholder value.
Shareholders are granted special privileges depending on the class of stock, including the
right to vote (usually one vote per share owned) on matters such as elections to the board
of directors, the right to share in distributions of the company's income, the right to
purchase new shares issued by the company, and the right to a company's assets during
a liquidation of the company. However, shareholder's rights to a company's assets are
subordinate to the rights of the company's creditors.
Shareholders are considered by some to be a partial subset of stakeholders, which may
include anyone who has a direct or indirect equity interest in the business entity or
someone with even a non-pecuniary interest in a non-profit organization. Thus it might be
common to callvolunteer contributors to an association stakeholders, even though they
are not shareholders.
Although directors and officers of a company are bound by fiduciary duties to act in the
best interest of the shareholders, the shareholders themselves normally do not have such
duties towards each other.
However, in a few unusual cases, some courts have been willing to imply such a duty
between shareholders. For example, in California, USA, majority shareholders of closely
held corporations have a duty to not destroy the value of the shares held by minority
shareholders.
The largest shareholders (in terms of percentages of companies owned) are often mutual
funds, and especially passively managed exchange-traded funds.
Trading
A stock exchange is an organization that provides a marketplace for either physical
or virtual trading shares, bonds and warrants and other financial products where investors
(represented by stock brokers) may buy and sell shares of a wide range of companies. A
company will usually list its shares by meeting and maintaining the listing
requirements of a particular stock exchange. In the United States, through the inter-
market quotation system, stocks listed on one exchange can also be bought or sold on
several other exchanges, including relatively new so-called ECNs (Electronic
Communication Networks like Archipelago or Instinet).
In the USA stocks used to be broadly grouped into NYSE-listed and NASDAQ-listed
stocks. Until a few years ago there was a law that NYSE listed stocks were not allowed to
be listed on the NASDAQ or vice versa.
Many large non-U.S companies choose to list on a U.S. exchange as well as an exchange
in their home country in order to broaden their investor base. These companies have then
to ship a certain number of shares to a bank in the US (a certain percentage of their
principal) and put it in the safe of the bank. Then the bank where they deposited the
shares can issue a certain number of so-called American Depositary Shares, short ADS
(singular). If someone buys now a certain number of ADSs the bank where the shares are
deposited issues an American Depository Receipt (ADR) for the buyer of the ADSs.
Likewise, many large U.S. companies list themselves at foreign exchanges to raise capital
abroad.

Arbitrage trading
Although it makes sense for some companies to raise capital by offering stock on more
than one exchange, a keen investor with access to information about such discrepancies
could invest in expectation of their eventual convergence, known as an arbitrage trade. In
today's era ofelectronic trading, these discrepancies, if they exist, are both shorter-lived
and more quickly acted upon. As such, arbitrage opportunities disappear quickly due to
the efficient nature of the market.
Buying
There are various methods of buying and financing stocks. The most common means is
through a stock broker. Whether they are a full serviceor discount broker, they arrange
the transfer of stock from a seller to a buyer. Most trades are actually done through
brokers listed with a stock exchange, such as the New York Stock Exchange.
There are many different stock brokers from which to choose, such as full service brokers
or discount brokers. The full service brokers usually charge more per trade, but give
investment advice or more personal service; the discount brokers offer little or no
investment advice but charge less for trades. Another type of broker would be
a bank or credit union that may have a deal set up with either a full service or discount
broker.
There are other ways of buying stock besides through a broker. One way is directly from
the company itself. If at least one share is owned, most companies will allow the
purchase of shares directly from the company through their investor
relations departments. However, the initial share of stock in the company will have to be
obtained through a regular stock broker. Another way to buy stock in companies is
through Direct Public Offerings which are usually sold by the company itself. A direct
public offering is an initial public offering in which the stock is purchased directly from
the company, usually without the aid of brokers.
When it comes to financing a purchase of stocks there are two ways: purchasing stock
with money that is currently in the buyer's ownership, or by buying stock on margin.
Buying stock on margin means buying stock with money borrowed against the stocks in
the same account. These stocks, or collateral, guarantee that the buyer can repay the loan;
otherwise, the stockbroker has the right to sell the stock (collateral) to repay the borrowed
money. He can sell if the share price drops below the margin requirement, at least 50% of
the value of the stocks in the account. Buying on margin works the same way as
borrowing money to buy a car or a house, using the car or house as collateral. Moreover,
borrowing is not free; the broker usually charges 8-10% interest.
Selling
Selling stock is procedurally similar to buying stock. Generally, the investor wants to buy
low and sell high, if not in that order (short selling); although a number of reasons may
induce an investor to sell at a loss, e.g., to avoid further loss.
As with buying a stock, there is a transaction fee for the broker's efforts in arranging the
transfer of stock from a seller to a buyer. This fee can be high or low depending on which
type of brokerage, full service or discount, handles the transaction.
After the transaction has been made, the seller is then entitled to all of the money. An
important part of selling is keeping track of the earnings. Importantly, on selling the
stock, in jurisdictions that have them, capital gains taxes will have to be paid on the
additional proceeds, if any, that are in excess of the cost basis.
Stock price fluctuations
The price of a stock fluctuates fundamentally due to the theory of supply and demand.
Like all commodities in the market, the price of a stock is directly proportional to the
demand. However, there are many factors on the basis of which the demand for a
particular stock may increase or decrease. These factors are studied using methods
of fundamental analysis and technical analysis to predict the changes in the stock price. A
recent study shows that customer satisfaction, as measured by the American Customer
Satisfaction Index (ACSI), is significantly correlated to the stock market value. Stock
price is also changed based on the forecast for the company and whether their profits are
expected to increase or decrease.
Preferred stock
Preferred stock, also called preferred shares or preference shares, is typically a higher
ranking stock thanvoting shares, and its terms are negotiated between the corporation and
the investor.
Preferred stock usually carry no voting rights, but may carry superior priority
over common stock in the payment of dividends and upon liquidation. Preferred stock
may carry a dividend that is paid out prior to any dividends to common stock holders.
Preferred stock may have a convertibility feature into common stock. Preferred
stockholders will be paid out in assets before common stockholders and after debt holders
in bankruptcy. Terms of the preferred stock are stated in a "Certificate of Designation".
Unlike common stock, preferred stock usually has several rights attached to it:

 The core right is that of preference in the payment of dividends and upon liquidation
of the company. Before a dividend can be declared on the common shares, any
dividend obligation to the preferred shares must be satisfied.
 The dividend rights are often cumulative, such that if the dividend is not paid it
accumulates from year to year.
 Preferred stock may or may not have a fixed liquidation value, or par value,
associated with it. This represents the amount of capital that was contributed to the
corporation when the shares were first issued.
 Preferred stock has a claim on liquidation proceeds of a stock corporation, equivalent
to its par or liquidation value unless otherwise negotiated. This claim is senior to that
of common stock, which has only a residual claim.
 Almost all preferred shares have a negotiated fixed dividend amount. The dividend is
usually specified as a percentage of the par value or as a fixed amount. For example
Pacific Gas & Electric 6% Series A preferred. Sometimes, dividends on preferred
shares may be negotiated as floating i.e. may change according to a benchmark
interest rate index such as LIBOR.
 Some preferred shares have special voting rights to approve certain extraordinary
events (such as the issuance of new shares or the approval of the acquisition of the
company) or to elect directors, but most preferred shares provide no voting rights
associated with them. Some preferred shares only gain voting rights when the
preferred dividends are in arrears for a substantial time.
 Usually preferred shares contain protective provisions which prevent the issuance of
new preferred shares with a senior claim. Individual series of preferred shares may
have a senior, pari-passu or junior relationship with other series issued by the
same corporation.
 Occasionally companies use preferred shares as means of preventing hostile
takeovers, creating preferred shares with a poison pill or forced exchange/conversion
features that exercise upon a change in control.
The above list, although including several customary rights, is far from comprehensive.
Preferred shares, like other legal arrangements, may specify nearly any right conceivable.
Preferred shares in the U.S. normally carry a call provision, enabling the issuing
corporation to repurchase the share at its (usually limited) discretion.
Some corporations contain provisions in their charters authorizing the issuance of
preferred stock whose terms and conditions may be determined by the board of directors
when issued. These "blank check" preferred shares are often used as takeover defense
(see also poison pill). These shares may be assigned very high liquidation value that must
be redeemed in the event of a change of control or may have enormous super voting
powers.

Common stock
Common stock is a form of corporation equity ownership represented in the securities
(the stock). It is risky in comparison to preferred shares and some other investment
options, in that in the event of bankruptcy, common stock investors receive their funds
after preferred stockholders, bondholders, creditors, etc. On the other hand, common
shares on average perform better than preferred shares or bonds over time.

Holders of common stock are able to influence the corporation through votes on
establishing corporate objectives and policy, stock splits, and electing the company's
board of directors. Some holders of common stock also receive preemptive rights, which
enable them to retain their proportional ownership in a company should it issue another
stock offering.

Stock exchange
A stock exchange, securities exchange or (in Europe) bourse is a corporation or mutual
organization which provides "trading" facilities for stock brokers and traders, to
trade stocks and other securities. Stock exchanges also provide facilities for the issue and
redemption of securities as well as other financial instruments and capital events
including the payment of income and dividends. The securities traded on a stock
exchange include: shares issued by companies, unit trusts and other pooled investment
products and bonds. To be able to trade a security on a certain stock exchange, it has to
be listed there. Usually there is a central location at least for recordkeeping, but trade is
less and less linked to such a physical place, as modern markets are electronic networks,
which gives them advantages of speed and cost of transactions. Trade on an exchange is
by members only. The initial offering of stocks and bonds to investors is by definition
done in the primary market and subsequent trading is done in the secondary market. A
stock exchange is often the most important component of a stock market. Supply and
demand in stock markets is driven by various factors which, as in all free markets, affect
the price of stocks (see stock valuation).
There is usually no compulsion to issue stock via the stock exchange itself, nor must
stock be subsequently traded on the exchange. Such trading is said to be off
exchange or over-the-counter. This is the usual way that bonds are traded. Increasingly,
stock exchanges are part of a global market for securities.

Foreign exchange market

The foreign exchange (currency, forex or FX) market is where currency trading takes
place. FX transactions typically involve one party purchasing a quantity of one currency
in exchange for paying a quantity of another. The FX market is one of the largest and
most liquid financial markets in the world, and includes trading between large
banks, central banks, currency speculators, corporations, governments, and other
institutions. The average daily volume in the global forex and related markets is
continuously growing. Traditional turnover was reported to be over US$ 3.2 trillion in
April 2007 by the Bank for International Settlement. Since then, the market has
continued to grow. According to Euromoney's annual FX Poll, volumes grew a further
41% between 2007 and 2008.

Market participants
Unlike a stock market, where all participants have access to the same prices, the forex
market is divided into levels of access. At the top is the inter-bank market, which is made
up of the largest investment banking firms. Within the inter-bank market, spreads, which
are the difference between the bid and ask prices, are razor sharp and usually unavailable,
and not known to players outside the inner circle. The difference between the bid and ask
prices widens (from 0-1 pip to 1-2 pips for some currencies such as the EUR). This is due
to volume. If a trader can guarantee large numbers of transactions for large amounts, they
can demand a smaller difference between the bid and ask price, which is referred to as a
better spread. The levels of access that make up the forex market are determined by the
size of the “line” (the amount of money with which they are trading). The top-tier inter-
bank market accounts for 53% of all transactions. After that there are usually smaller
investment banks, followed by large multi-national corporations (which need to hedge
risk and pay employees in different countries), large hedge funds, and even some of the
retail forex-metal market makers. According to Galati and Melvin, “Pension funds,
insurance companies, mutual funds, and other institutional investors have played an
increasingly important role in financial markets in general, and in FX markets in
particular, since the early 2000s.” (2004) In addition, he notes, “Hedge funds have grown
markedly over the 2001–2004 period in terms of both number and overall size” Central
banks also participate in the forex market to align currencies to their economic needs.

Banks

The interbank market caters for both the majority of commercial turnover and large
amounts of speculative trading every day. A large bank may trade billions of dollars daily.
Some of this trading is undertaken on behalf of customers, but much is conducted by
proprietary desks, trading for the bank's own account.
Until recently, foreign exchange brokers did large amounts of business, facilitating
interbank trading and matching anonymous counterparts for small fees. Today, however,
much of this business has moved on to more efficient electronic systems. The broker
squawk box lets traders listen in on ongoing interbank trading and is heard in
most trading rooms, but turnover is noticeably smaller than just a few years ago.
Commercial companies

An important part of this market comes from the financial activities of companies seeking
foreign exchange to pay for goods or services. Commercial companies often trade fairly
small amounts compared to those of banks or speculators, and their trades often have
little short term impact on market rates. Nevertheless, trade flows are an important factor
in the long-term direction of a currency's exchange rate. Some multinational companies
can have an unpredictable impact when very large positions are covered due to exposures
that are not widely known by other market participants.

Central banks

National central banks play an important role in the foreign exchange markets. They try
to control the money supply, inflation, and/or interest rates and often have official or
unofficial target rates for their currencies. They can use their often substantial foreign
exchange reserves to stabilize the market. Milton Friedman argued that the best
stabilization strategy would be for central banks to buy when the exchange rate is too
low, and to sell when the rate is too high — that is, to trade for a profit based on their
more precise information. Nevertheless, the effectiveness of central bank "stabilizing
speculation" is doubtful because central banks do not go bankrupt if they make large
losses, like other traders would, and there is no convincing evidence that they do make a
profit trading.
The mere expectation or rumor of central bank intervention might be enough to stabilize
a currency, but aggressive intervention might be used several times each year in countries
with a dirty float currency regime. Central banks do not always achieve their objectives.
The combined resources of the market can easily overwhelm any central bank. Several
scenarios of this nature were seen in the 1992–93 ERM collapse, and in more recent
times in Southeast Asia.
Hedge funds

Hedge funds have gained a reputation for aggressive currency speculation since 1996.
They control billions of dollars of equity and may borrow billions more, and thus may
overwhelm intervention by central banks to support almost any currency, if the economic
fundamentals are in the hedge funds' favor.

Investment management firms

Investment management firms (who typically manage large accounts on behalf of

customers such as pension funds and endowments) use the foreign exchange market to
facilitate transactions in foreign securities. For example, an investment manager bearing
an international equity portfolio needs to purchase and sell several pairs of foreign
currencies to pay for foreign securities purchases.
Some investment management firms also have more speculative specialist currency
overlay operations, which manage clients' currency exposures with the aim of generating
profits as well as limiting risk. Whilst the number of this type of specialist firms is quite
small, many have a large value of assets under management (AUM), and hence can
generate large trades.
Retail forex brokers

There are two types of retail brokers offering the opportunity for speculative
trading: retail forex brokers and market makers. Retail traders(individuals) are a small
fraction of this market and may only participate indirectly through brokers or banks.
Retail forex brokers, while largely controlled and regulated by the CFTC and NFA might
be subject to forex scams. At present, the NFA and CFTC are imposing stricter
requirements, particularly in relation to the amount of Net Capitalization required of its
members. As a result many of the smaller, and perhaps questionable brokers are now
gone. It is not widely understood that retail brokers and market makers typically trade
against their clients and frequently take the other side of their trades. This can often
create a potential conflict of interest and give rise to some of the unpleasant experiences
some traders have had. A move toward NDD (No Dealing Desk) and STP (Straight
Through Processing) has helped to resolve some of these concerns and restore trader
confidence, but caution is still advised in ensuring that all is as it is presented.

Other

Non-bank foreign exchange companies offer currency exchange and international

payments to private individuals and companies. These are also known as Foreign
Exchange Brokers but are distinct from Forex Brokers as they do not offer speculative
trading but currency exchange with payments. i.e. there is usually a physical delivery of
currency to a bank account.
It is estimated that in the UK, 14% of currency transfers/payments are made via Foreign
Exchange Companies. These companies' selling point is usually that they will offer better
exchange rates or cheaper payments than the customer's bank. These companies differ
from Money Transfer/Remittance Companies in that they generally offer higher-value
services.
Money Transfer/Remittance Companies perform high-volume low-value transfers
generally by economic migrants back to their home country. In 2007, the Aite Group
estimated that there were $369 billion of remittances (an increase of 8% on the previous
year). The four largest markets (India, China, Mexico and the Philippines) receive $95
billion. The largest and best known provider is Western Union with 345,000 agents
globally.
Trading characteristics

There is no unified or centrally cleared market for the majority of FX trades, and there is
very little cross-border regulation. Due to the over-the-counter (OTC) nature of currency
markets, there are rather a number of interconnected marketplaces, where different
currencies instruments are traded. This implies that there is not a single exchange rate but
rather a number of different rates (prices), depending on what bank or market maker is
trading, and where it is. In practice the rates are often very close, otherwise they could be
exploited by arbitrageursinstantaneously. Due to London's dominance in the market, a
particular currency's quoted price is usually the London market price. A joint venture of
the Chicago Mercantile Exchange and Reuters, called FxMarketSpace opened in 2007
and aspires to the role of a central market clearing mechanism.
The main trading center is London, but New York, Tokyo, Hong Kong andSingapore are
all important centers as well. Banks throughout the world participate. Currency trading
happens continuously throughout the day; as the Asian trading session ends, the European
session begins, followed by the North American session and then back to the Asian
session, excluding weekends.
Exchange rate fluctuations are usually caused by actual monetary flows as well as by
expectations of changes in monetary flows caused by changes in GDPgrowth, inflation,
interest rates, budget and trade deficits or surpluses, large cross-border M&A deals and
other macroeconomic conditions. Major news is released publicly, often on scheduled
dates, so many people have access to the same news at the same time. However, the large
banks have an important advantage; they can see their customers' order flow.
Currencies are traded against one another. Each pair of currencies thus constitutes an
individual product and is traditionally noted XXX/YYY, where YYY is the ISO 4217
international three-letter code of the currency into which the price of one unit of XXX is
expressed (called base currency). For instance, EUR/USD is the price of
the euro expressed in US dollars, as in 1 euro = 1.5465 dollar. Out of convention, the first
currency in the pair, the base currency, was the stronger currency at the creation of the
pair. The second currency, counter currency, was the weaker currency at the creation of
the pair.
The factors affecting XXX will affect both XXX/YYY and XXX/ZZZ. This causes
positive currency correlation between XXX/YYY and XXX/ZZZ.
On the spot market, according to the BIS study, the most heavily traded products were:

 EUR/USD: 27 %
 USD/JPY: 13 %
 GBP/USD (also called sterling or cable): 12 %

and the US currency was involved in 86.3% of transactions, followed by the euro
(37.0%), the yen (16.5%), and sterling (15.0%) (see table). Note that volume
percentages should add up to 200%: 100% for all the sellers and 100% for all the
buyers.
 Trading in the euro has grown considerably since the currency's creation in January
1999, and how long the foreign exchange market will remain dollar-centered is open
to debate. Until recently, trading the euro versus a non-European currency ZZZ
would have usually involved two trades: EUR/USD and USD/ZZZ. The exception to
this is EUR/JPY, which is an established traded currency pair in the interbank spot
market. As the dollar's value has eroded during 2008, interest in using the euro as
reference currency for prices in commodities (such as oil), as well as a larger
component of foreign reserves by banks, has increased dramatically. Transactions in
the currencies of commodity-producing countries, such as AUD, NZD, CAD, have
also increased.

Factors affecting currency trading

Although exchange rates are affected by many factors, in the end, currency prices are a
result of supply and demand forces. The world's currency markets can be viewed as a
huge melting pot: in a large and ever-changing mix of current
events, supply and demand factors are constantly shifting, and the price of one currency
in relation to another shifts accordingly. No other market encompasses (and distills) as
much of what is going on in the world at any given time as foreign exchange.
Supply and demand for any given currency, and thus its value, are not influenced by any
single element, but rather by several. These elements generally fall into three
categories: economic factors, political conditions and market psychology.
Economic factors
These include economic policy, disseminated by government agencies and central banks,
economic conditions, generally revealed through economic reports, and other economic
indicators.
Economic policy comprises government fiscal policy (budget/spending practices)
and monetary policy (the means by which a government's central bank influences the
supply and "cost" of money, which is reflected by the level of interest rates).
Economic conditions include:
Government budget deficits or surpluses: The market usually reacts negatively to
widening government budget deficits, and positively to narrowing budget deficits. The
impact is reflected in the value of a country's currency.
Balance of trade levels and trends: The trade flow between countries illustrates the
demand for goods and services, which in turn indicates demand for a country's currency
to conduct trade. Surpluses and deficits in trade of goods and services reflect the
competitiveness of a nation's economy. For example, trade deficits may have a negative
impact on a nation's currency.
Inflation levels and trends: Typically, a currency will lose value if there is a high level
of inflation in the country or if inflation levels are perceived to be rising. This is because
inflation erodes purchasing power, thus demand, for that particular currency. However, a
currency may sometimes strengthen when inflation rises because of expectations that the
central bank will raise short-term interest rates to combat rising inflation.
Economic growth and health: Reports such as gross domestic product
(GDP), employment levels, retail sales, capacity utilization and others, detail the levels of
a country's economic growth and health. Generally, the more healthy and robust a
country's economy, the better its currency will perform, and the more demand for it there
will be.
Political conditions
Internal, regional, and international political conditions and events can have a profound
effect on currency markets.
For instance, political upheaval and instability can have a negative impact on a nation's
economy. The rise of a political faction that is perceived to be fiscally responsible can
have the opposite effect. Also, events in one country in a region may spur positive or
negative interest in a neighboring country and, in the process, affect its currency.
Market psychology
Market psychology and trader perceptions influence the foreign exchange market in a
variety of ways:
Flights to quality: Unsettling international events can lead to a "flight to quality," with
investors seeking a "safe haven". There will be a greater demand, thus a higher price, for
currencies perceived as stronger over their relatively weaker counterparts. The Swiss
franc has been a traditional safe haven during times of political or economic uncertainty.
Long-term trends: Currency markets often move in visible long-term trends. Although
currencies do not have an annual growing season like physical commodities, business
cycles do make themselves felt. Cycle analysis looks at longer-term price trends that may
rise from economic or political trends.
"Buy the rumor, sell the fact:" This market truism can apply to many currency
situations. It is the tendency for the price of a currency to reflect the impact of a particular
action before it occurs and, when the anticipated event comes to pass, react in exactly the
opposite direction. This may also be referred to as a market being "oversold" or
"overbought". To buy the rumor or sell the fact can also be an example of thecognitive
bias known as anchoring, when investors focus too much on the relevance of outside
events to currency prices.
Economic numbers: While economic numbers can certainly reflect economic policy,
some reports and numbers take on a talisman-like effect: the number itself becomes
important to market psychology and may have an immediate impact on short-term market
moves. "What to watch" can change over time. In recent years, for example, money
supply, employment, trade balance figures and inflation numbers have all taken turns in
the spotlight.
Technical trading considerations: As in other markets, the accumulated price
movements in a currency pair such as EUR/USD can form apparent patterns that traders
may attempt to use. Many traders study price charts in order to identify such patterns.
Financial instruments

Spot
A spot transaction is a two-day delivery transaction (except in the case of the Canadian
dollar, which settles the next day), as opposed to thefutures contracts, which are usually
three months. This trade represents a “direct exchange” between two currencies, has the
shortest time frame, involves cash rather than a contract; and interest is not included in
the agreed-upon transaction. The data for this study come from thespot market. Spot has
the largest share by volume in FX transactions among all instruments.
Forward

One way to deal with the Forex risk is to engage in a forward transaction. In this
transaction, money does not actually change hands until some agreed upon future date. A
buyer and seller agree on an exchange rate for any date in the future, and the transaction
occurs on that date, regardless of what the market rates are then. The duration of the trade
can be a few days, months or years.

Future
Foreign currency futures are forward transactions with standard contract sizes and
maturity dates — for example, 500,000 British pounds for next November at an agreed
rate. Futures are standardized and are usually traded on an exchange created for this
purpose. The average contract length is roughly 3 months. Futures contracts are usually
inclusive of any interest amounts.

Swap

The most common type of forward transaction is the currency swap. In a swap, two
parties exchange currencies for a certain length of time and agree to reverse the
transaction at a later date. These are not standardized contracts and are not traded through
an exchange.

Option

A foreign exchange option (commonly shortened to just FX option) is a derivative where

the owner has the right but not the obligation to exchange money denominated in one
currency into another currency at a pre-agreed exchange rate on a specified date. The FX
options market is the deepest, largest and most liquid market for options of any kind in
the world.

Exchange Traded Fund

Exchange-traded funds (or ETFs) are Open Ended investment companies that can be
traded at any time throughout the course of the day. Typically, ETFs try to replicate
a stock market index such as the S&P 500 (e.g. SPY), but recently they are now
replicating investments in the currency markets with the ETF increasing in value when
the US Dollar weakens versus a specific currency, such as the Euro. Certain of these
funds track the price movements of world currencies versus the US Dollar, and increase
in value directly counter to the US Dollar, allowing for speculation in the US Dollar for
US and US Dollar denominated investors and speculators.

Speculation

Controversy about currency speculators and their effect on currency devaluations and
national economies recurs regularly. Nevertheless, economists including Milton
Friedman have argued that speculators ultimately are a stabilizing influence on the
market and perform the important function of providing a market for hedgers and
transferring risk from those people who don't wish to bear it, to those who do. Other
economists such as Joseph Stiglitz consider this argument to be based more on politics
and a free market philosophy than on economics.
Large hedge funds and other well capitalized "position traders" are the main professional
speculators.
Currency speculation is considered a highly suspect activity in many countries. While
investment in traditional financial instruments like bonds or stocks often is considered to
contribute positively to economic growth by providing capital, currency speculation does
not; according to this view, it is simply gambling that often interferes with economic
policy. For example, in 1992, currency speculation forced the Central Bank of Sweden to
raise interest rates for a few days to 500% per annum, and later to devalue the krona.
Former Malaysian Prime Minister Mahathir Mohamad is one well known proponent of
this view. He blamed the devaluation of the Malaysian ringgit in 1997 on George
Soros and other speculators.
Gregory Millman reports on an opposing view, comparing speculators to "vigilantes"
who simply help "enforce" international agreements and anticipate the effects of basic
economic "laws" in order to profit.
In this view, countries may develop unsustainable financial bubbles or otherwise
mishandle their national economies, and forex speculators allegedly made the inevitable
collapse happen sooner. A relatively quick collapse might even be preferable to continued
economic mishandling. Mahathir Mohamad and other critics of speculation are viewed as
trying to deflect the blame from themselves for having caused the unsustainable
economic conditions. Given that Malaysia recovered quickly after imposing currency
controls directly against IMF advice, this view is open to doubt.

Derivatives market
The derivatives markets are the financial markets for derivatives. The market can be
divided into two, that forexchange traded derivatives and that for over-the-counter
derivatives. The legal nature of these products is very different as well as the way they
are traded, though many market participants are active in both.
Futures markets
Futures exchanges, such as Euronext.liffe and the Chicago Mercantile Exchange, trade in
standardized derivative contracts. These are options contracts and futures contracts on a
whole range of underlying products. The members of the exchange hold positions in
these contracts with the exchange, who acts as central counterparty. When one party
goes long (buys) a futures contract, another goes short (sells). When a new contract is
introduced, the total position in the contract is zero. Therefore, the sum of all the long
positions must be equal to the sum of all the short positions. In other words, risk is
transferred from one party to another. The total notional amount of all the outstanding
positions at the end of June 2004 stood at $53 trillion.

Over-the-counter markets
Tailor-made derivatives traded on a futures exchange, are traded on over-the-counter
markets, also known as the OTC market. These consist of investment banks who have
traders who make markets in these derivatives, and clients such as hedge
funds, commercial banks, government sponsored enterprises, etc. Products that are
always traded over-the-counter are swaps, forward rate agreements, forward
contracts, credit derivatives, etc. The total notional amount of all the outstanding
positions at the end of June 2004 stood at $220 trillion.
Netting
Global: OTC Derivatives Markets The notional outstanding value of OTC derivatives
contracts rose by 40% from $298 trillion at end-2005 to $415 trillion at end-2006.
Average daily global turnover rose by two thirds from $1,508bn to $2,544bn between
April 2004 and April 2007. The UK remains the leading derivatives centres worldwide
with its share of turnover stable at 43% in 2007. The US is the only other major location
with 24% of trading (Chart 2). Interest rate instruments remain the key driver of trading,
accounting for 88% of UK turnover and 70% of global notional value (Chart 3 & Table
2). Derivatives based on foreign exchange contracts account for a further 10% of notional
value, with credit, equity-linked and commodity contracts also important. Energy, metal
and freight derivatives have grown rapidly in recent years. The euro’s share of interest
rate derivatives turnover worldwide has risen to 39% while the US dollar has fallen to
32%: pound sterling and yen also increased their market share over the past three years.
Trading is becoming more concentrated amongst the largest banks, while other financial
institutions such as hedge funds, mutual funds, insurance companies and smaller banks
have become much bigger users of derivatives.
Money market
In finance, the money market is the global financial market for short-term borrowing
and lending. It provides short-term liquidity funding for the global financial system. The
money market is where short-term obligations such asTreasury bills, commercial
paper and bankers' acceptances are bought and sold.
The money market consists of financial institutions and dealers in money or credit who
wish to either borrow or lend. Participants borrow and lend for short periods of time,
typically up to thirteen months. Money market trades in short-term financial
instruments commonly called "paper." This contrasts with the capital market for longer-
term funding, which is supplied by bonds and equity.
The core of the money market consists of banks borrowing and lending to each other,
using commercial paper,repurchase agreements and similar instruments. These
instruments are often benchmarked (i.e. priced over and above) to the London Interbank
Offered Rate (LIBOR).
Finance companies, such as GMAC, typically fund themselves by issuing large amounts
of asset-backedcommercial paper (ABCP) which is secured by the pledge of eligible
assets into an ABCP conduit. Examples of eligible assets include auto loans, credit card
receivables, residential/commercial mortgage loans, mortgage-backed securities and
similar financial assets. Certain large corporations with strong credit ratings, such
asGeneral Electric, issue commercial paper on their own credit. Other large corporations
arrange for banks to issue commercial paper on their behalf via commercial paper lines.
In the United States, federal, state and local governments all issue paper to meet funding
needs. States and local governments issue municipal paper, while the US
Treasury issues Treasury bills to fund the US public debt.

 Trading companies often purchase bankers' acceptances to be tendered for payment to

overseas suppliers.
 Retail and institutional money market funds
 Banks
 Central banks
 Cash management programs
 Arbitrage ABCP conduits, which seek to buy higher yielding paper, while themselves
selling cheaper paper.
Common money market instruments

 Bankers' acceptance - A draft issued by a bank that will be accepted for payment,
effectively the same as acashier's check.
 Certificate of deposit - A time deposit at a bank with a specific maturity date; large-
denomination certificates of deposits can be sold before maturity.
 Repurchase agreements - Short-term loans—normally for less than two weeks and
frequently for one day—arranged by selling securities to an investor with an
agreement to repurchase them at a fixed price on a fixed date.
 Commercial paper - Unsecured promissory notes with a fixed maturity of one to 270
days; usually sold at a discount from face value.
 Eurodollar deposit - Deposits made in U.S. dollars at a bank or bank branch located
outside the United States.
 Federal Agency Short-Term Securities - (in the U.S.). Short-term securities issued
by government sponsored enterprises such as the Farm Credit System, the Federal
Home Loan Banks and the Federal National Mortgage Association.
 Federal funds - (in the U.S.). Interest-bearing deposits held by banks and other
depository institutions at theFederal Reserve; these are immediately available funds
that institutions borrow or lend, usually on an overnight basis. They are lent for
thefederal funds rate.
 Municipal notes - (in the U.S.). Short-term notes issued by municipalities in
anticipation of tax receipts or other revenues.
 Treasury bills - Short-term debt obligations of a national government that are issued to
mature in three to twelve months. For the U.S., see Treasury bills.
 Money market mutual funds - Pooled short maturity, high quality investments which
buy money market securities on behalf of retail or institutional investors.
 Foreign Exchange Swaps - Exchanging a set of currencies in spot date and the
reversal of the exchange of currencies at a predetermined time in the future.

Primary market
he primary is that part of the capital markets that deals with the issuance of
new securities. Companies, governments or public sector institutions can
obtain funding through the sale of a new stock or bond issue. This is typically done
through a syndicate of securities dealers. The process of selling new issues to investors is
called underwriting. In the case of a new stock issue, this sale is an initial public
offering(IPO). Dealers earn a commission that is built into the price of the security
offering, though it can be found in the prospectus.
Features of primary markets are:

 This is the market for new long term capital. The primary market is the market where
the securities are sold for the first time. Therefore it is also called New Issue Market
(NIM).
 In a primary issue, the securities are issued by the company directly to investors.
 The company receives the money and issues new security certificates to the investors.
 Primary issues are used by companies for the purpose of setting up new business or
for expanding or modernizing the existing business.
 The primary market performs the crucial function of facilitating capital formation in
the economy.
 The new issue market does not include certain other sources of new long term
external finance, such as loans from financial institutions. Borrowers in the new issue
market may be raising capital for converting private capital into public capital; this is
known as ‘going public’.

Methods of issuing securities in the primary market are:

 Initial public offering,

 Rights issue (for existing companies), and
 Preferential issue.

Initial public offering

Initial public offering (IPO), also referred to simply as a "public offering", is when a
company issues common stock or shares to the public for the first time. They are often
issued by smaller, younger companies seeking capital to expand, but can also be done by
large privately-owned companies looking to become publicly traded.
In an IPO, the issuer may obtain the assistance of an underwriting firm, which helps it
determine what type of security to issue (common orpreferred), best offering price and
time to bring it to market.
IPOs can be a risky investment. For the individual investor, it is tough to predict what the
stock or shares will do on its initial day of trading and in the near future since there is
often little historical data with which to analyze the company. Also, most IPOs are of
companies going through a transitory growth period, and they are therefore subject to
additional uncertainty regarding their future value.

Reasons for listing

When a company lists its shares on a public exchange, it will almost invariably look to
issue additional new shares in order to raise extra capital at the same time. The money
paid by investors for the newly-issued shares goes directly to the company (in contrast to
a later trade of shares on the exchange, where the money passes between investors). An
IPO, therefore, allows a company to tap a wide pool of stock market investors to provide
it with large volumes of capital for future growth. The company is never required to
repay the capital, but instead the new shareholders have a right to future profits
distributed by the company and the right to a capital distribution in case of a dissolution.
The existing shareholders will see their shareholdings diluted as a proportion of the
company's shares. However, they hope that the capital investment will make their
shareholdings more valuable in absolute terms.
In addition, once a company is listed, it will be able to issue further shares via a rights
issue, thereby again providing itself with capital for expansion without incurring any
debt. This regular ability to raise large amounts of capital from the general market, rather
than having to seek and negotiate with individual investors, is a key incentive for many
companies seeking to list.
Procedure
IPOs generally involve one or more investment banks as "underwriters." The company
offering its shares, called the "issuer," enters a contract with a lead underwriter to sell its
shares to the public. The underwriter then approaches investors with offers to sell these
shares.
The sale (that is, the allocation and pricing) of shares in an IPO may take several forms.
Common methods include:

 Best efforts
 Bought deal
 Dutch auction
 Firm commitment
 Self Distribution of Stock

A large IPO is usually underwritten by a "syndicate" of investment banks led by one or

more major investment banks (lead underwriter). Upon selling the shares, the
underwriters keep a commission based on a percentage of the value of the shares sold.
Usually, the lead underwriters, i.e. the underwriters selling the largest proportions of the
IPO, take the highest commissions—up to 8% in some cases.
Multinational IPOs may have as many as three syndicates to deal with differing legal
requirements in both the issuer's domestic market and other regions. For example, an
issuer based in the E.U. may be represented by the main selling syndicate in its domestic
market, Europe, in addition to separate syndicates or selling groups for US/Canada and
for Asia. Usually, the lead underwriter in the main selling group is also the lead bank in
the other selling groups.
Because of the wide array of legal requirements, IPOs typically involve one or more law
firms with major practices in securities law, such as theMagic Circle firms of London and
the white shoe firms of New York City.
Usually, the offering will include the issuance of new shares, intended to raise new
capital, as well the secondary sale of existing shares. However, certain regulatory
restrictions and restrictions imposed by the lead underwriter are often placed on the sale
of existing shares.
Public offerings are primarily sold to institutional investors, but some shares are also
allocated to the underwriters' retail investors. A broker selling shares of a public offering
to his clients is paid through a sales credit instead of a commission. The client pays no
commission to purchase the shares of a public offering; the purchase price simply
includes the built-in sales credit.
The issuer usually allows the underwriters an option to increase the size of the offering by
up to 15% under certain circumstance known as thegreenshoe or overallotment option.
Secondary market
The secondary market is the financial market for trading of securities that have already
been issued in an initial private or public offering.[1] Alternatively, secondary market can
refer to the market for any kind of used goods. The market that exists in a new security
just after the new issue, is often referred to as the aftermarket. Once a newly
issued stock is listed on a stock exchange, investors and speculators can easily trade on
the exchange, as market makers provide bids and offers in the new stock.

Function
In the secondary market, securities are sold by and transferred from
one investor or speculator to another. It is therefore important that the secondary market
be highly liquid (originally, the only way to create this liquidity was for investors and
speculators to meet at a fixed place regularly; this is how stock exchanges originated,
seeHistory of the Stock Exchange).
Secondary marketing is vital to an efficient and modern capital market.[citation
needed]
Fundamentally, secondary markets mesh the investor's preference for liquidity (i.e.,
the investor's desire not to tie up his or her money for a long period of time, in case the
investor needs it to deal with unforeseen circumstances) with the capital user's preference
to be able to use the capital for an extended period of time. For example, a
traditional loan allows the borrower to pay back the loan, with interest, over a certain
period. For the length of that period of time, the bulk of the lender's investment is
inaccessible to the lender, even in cases of emergencies. Likewise, in an emergency, a
partner in a traditional partnership is only able to access his or her original investment if
he or she finds another investor willing to buy out his or her interest in the partnership.
With a securitized loan or equity interest (such asbonds) or tradable stocks, the investor
can sell, relatively easily, his or her interest in the investment, particularly if the loan or
ownership equity has been broken into relatively small parts. This selling and buying of
small parts of a larger loan or ownership interest in a venture is called secondary market
trading.
Under traditional lending and partnership arrangements, investors may be less likely to
put their money into long-term investments, and more likely to charge a higher interest
rate (or demand a greater share of the profits) if they do. With secondary markets,
however, investors know that they can recoup some of their investment quickly, if their
own circumstances change.
Private Secondary Markets
Partially as a result of the increased compliance and reporting obligations hoisted on
U.S.-listed public companies by the Sarbanes-Oxley Actof 2002, private secondary
markets began to emerge. These markets are generally only available to institutional or
accredited investors and allow trading of unregistered and private company securities.
Goldman Sachs' GS TRuE, Nasdaq's PORTAL, and SecondMarket are all examples of
these private secondary markets.
In private equity, the secondary market (also often called private equity
secondaries or secondaries) refers to the buying and selling of pre-existing investor
commitments to private equity funds. Sellers of private equity investments sell not only
the investments in the fund but also their remaining unfunded commitments to the funds.

Financial market participants

There are two basic financial market
participant categories, Investor vs. Speculator andInstitutional vs. Retail. Action in
financial market by Central banks is usually regarded as intervention rather than
participation.
Supply Side vs. Demand Side
A market participant may either be coming from the Supply Side, hence supplying excess
money (in the form of investments) in favor of the demand side; or coming from the
Demand Side, hence demanding excess money (in the form of borrowed equity) in favor
of the Demand Side. This equation originated from Keynesian Advocates. The theory
explains that a given market may have excess cash; hence the supplier of funds may lend
it; and those in need of cash may borrow the funds as supplied. Hence, the equation:
aggregate savings equals aggregate investments.
The demand side consists of: those in need of cash flows (daily operational needs); those
in need of interim financing (bridge financing); those in need of long-term funds for
special projects (capital funds for venture financing).
The supply side consists of: those who have aggregate savings (retirement funds, pension
funds, insurance funds) that can be used in favor of demand side. The origin of the
savings (funds) can be local savings or foreign savings. So much pensions or savings can
be invested for school buildings; orphanages; (but not earning) or for road network (toll
ways) or port development (capable of earnings).
The earnings goes to owner (Savers or Lenders) and the margin goes to the banks. When
the principal and interest are added up, it will reflect the amount paid for the user
(borrower) of the funds. Thus, an interest percentage for the cost of using the funds.
Investor vs. Speculator
Investor
An investor is any party that makes an Investment.
However, the term has taken on a specific meaning in finance to describe the particular
types of people and companies that regularly purchaseequity or debt securities for
financial gain in exchange for funding an expanding company. Less frequently the term is
applied to parties who purchase real estate, currency, commodity derivatives, personal
property, or other assets.
Speculation
Speculation, in the narrow sense of financial speculation, involves the buying, holding,
selling, and short-selling of stocks, bonds,commodities, currencies, collectibles, real
estate, derivatives or any valuable financial instrument to profit from fluctuations in its
price as opposed to buying it for use or for income via methods such
as dividends or interest. Speculation or agiotage represents one of three marketroles in
western financial markets, distinct from hedging, long term investing and arbitrage.
Speculators in an asset have no intention to have long term exposure all the best asset.
Institutional vs. Retail
Institutional investor
An institutional investor is an investor, such as a bank, insurance company, retirement
fund, hedge fund, or mutual fund, that is financially sophisticated and makes large
investments, often held in very large portfolios of investments. Because of their
sophistication, institutional investors may often participate in private placements of
securities, in which certain aspects of the securities laws may be inapplicable.
Retail investor
A retail investor is an individual investor possessing shares of a given security. Retail
investors can be further divided into two categories of share ownership.
1. A Beneficial Shareholder is a retail investor who holds shares of their securities in the
account of a bank or broker, also known as “in Street Name.” The broker is in possession
of the securities on behalf of the underlying shareholder.
2. A Registered Shareholder is a retail investor who holds shares of their securities
directly through the issuer or its transfer agent. Many registered shareholders have
physical copies of their stock certificates.

Conclusion
The capital market deals with capital. Capital Market is generally understood as a
market for long term funds and investments in long term instruments available in this
market. However now this market also includes short-term funds. Capital markets mean
the market for all the financial instruments, short term and long term as so commercial
industrial and government paper.

The capital market is a market where borrowing and lending of long term funds
takes place. Capital market deals in both, debt and equity. In these markets productive
capital is raised and made available to the corporate. The governments both central and
state raise money in the capital market through the issue of government securities. Capital
market refers to all the institutes and mechanisms of raising medium and long-term funds,
through various instruments available like shares, debentures, bonds etc.

Thus the capital market plays a very important role in promoting economic growth
through the mobilization of long-term savings and the savings get invested in the
economy for productive purpose. The capital market in India is a well integrated structure
and its components include stock exchanges, developed banks investment trusts,
insurance corporations and provident fund organization. It caters to the varied needs for
capital of agriculture, industrial and trading sectors of the economy. There are two
important operations carried on in these markets. The raising the new capital and Trading
in the securities already issued by the companies.

With the pace of economic reforms followed in India, the importance of capital
markets has grown in the last ten years. Corporate both in the private sector as well as in
the public sector raise thousands of crores of rupees in these markets. The governments,
through Reserve Bank of India, as well as financial institutes also raise a lot of money