Global Financial System (BFIB233)

Unit I Environment of Global Financial System 6 Hours

Introduction – Global Financial System vs Domestic Financial System, Rise of
Multinational Corporation- Internationalization of Business and Finance-
Participants - Technological Advances and Other Developments

Unit II The Economic Environment 10 Hours

Introduction - Factors Determining Economic Activity- The Economic Cycle and
Economic Policy - Balance of Payments (BoP) and Exchange Rates Country Risk
Analysis Measuring Political
Risk- economic and political factors underlying country risk-Key Indicators of
Country Risk and Economic Health-Country Risk Analysis in International lending

Unit III Global Financial Securities- I 8 Hours

Equities/Stocks- Company Formation and Features and Benefits of Shares- The
Risks of Owning Shares- Corporate Actions- Bonds – Introduction- Characteristics
of Bonds- Types of Bonds- Asset-Backed Securities (ABSs)- International Bonds-
Yields- Other Financial Assets- Cash Deposit
Unit IV Global Financial Securities -II 8 Hours
Investment Funds-: Open-Ended Funds, Closed-Ended Investment Companies,
Exchange-Traded Funds (ETFs), Alternative Investment Funds (AIFs)- Derivatives

Unit V Global Financial Markets 10 Hours

Primary and Secondary Markets- Depositary Receipts- World Stock Markets-
Stock Market Indices- Settlement Systems. Money Markets- Property- Foreign
Exchange (FX)

Unit VI Global Financial Services 10 Hours

Financial Advice- Budgeting- Borrowing- Protection- Critical Illness Insurance
Cover- Investment and Saving- Legal Concepts in Financial Advice- The Financial
Advice Process- Other Financial Service: Wealth Management- Portfolio
Management- Brokerage Services-Credit Rating- Investment Banking- Factoring-
Depositories
Unit VII Regulation and Ethics 8 Hours
Need- Regulatory Principles- Financial Crime- Insider Trading and Market
Abuse- Integrity and Ethics in Professional Practice

Essential Reading:
• Shapiro Alan. C.(2012), Multinational Financial Management(9ed), Prentice
Hall, New Delhi.

Recommended Reading
1. Apte P.G (2011) , International Financial Management(6 ed), Tata McGraw Hill,
New Delhi.
2. Jeevanandam. C. Foreign Exchange and Risk Management. New Delhi: Sultan
Chand & sons.
3. Vij, M (2010). International Financial Management (3 ed). New Delhi: Excel
Books
 Investment Funds
• When investors decide to invest in a particular asset class, such
as equities, there are two ways they can do it: direct
investment or indirect investment.
• Direct investment is when an individual personally buys shares
in a company, such as buying shares in Apple, the technology
giant.
• Indirect investment is when an individual buys a stake in an
investment fund, such as a mutual fund that invests in the
shares of a range of different types of companies, perhaps
including Apple.
 Open-ended fund
• An open-ended fund is an investment fund that can issue and redeem
shares at any time.
• If investors wish to invest in an open-ended fund, they approach the fund
directly and provide the money they wish to invest. The fund can create
new shares in response to this demand, issuing new shares or units to the
investor at a price based on the value of the underlying portfolio. If
investors decide to sell, they again approach the fund, which will redeem
the shares and pay the investor the value of their shares, again based on the
value of the underlying portfolio.
 US Open-Ended Funds
Some of their key distinguishing characteristics include:
• The mutual fund can create and sell new shares to accommodate new
investors.
• Investors buy mutual fund shares directly from the fund itself, rather than
from other investors on a secondary market such as the New York Stock
Exchange (NYSE) or National Association of Securities Dealers
Automated Quotations (NASDAQ).
• The price that investors pay for mutual fund shares is based on the fund’s
net asset value (the NAV, which is the value of the underlying investment
portfolio) plus any charges made by the fund.
• The investment portfolios of mutual funds are typically managed by
separate entities known as investment advisers, who are registered with
the Securities Exchange Commission (SEC), the US regulator.
 European Open-Ended Funds
• UCITS or 'undertakings for the collective investment in
transferable securities' are investment funds regulated at
European Union level.
• The directives have been issued with the intention of creating a
framework for cross-border sales of investment funds. They
allow an investment fund to be sold throughout the EU,
subject to regulation by its home country regulator.
• UCITS – Undertakings for the Collective Investment in
Transferable Securities.
 Unit Trusts
• A unit trust is an investment fund that is established as a trust, in which the
trustee is the legal owner of the underlying assets and the unit holders
are the beneficial owners.
• As with other types of open-ended funds, the trust can grow as more
investors buy into the fund, or shrink as investors sell units back to the
fund and they are cancelled. As with SICAVs, investors deal directly with
the fund when they wish to buy and sell.
 Open-Ended Investment Companies (OEICs)
• The term ‘OEIC’ is used mostly in the UK, while in Ireland they are
known as a variable capital company (VCC). They have similar structures
to unit trusts, investors deal directly with the fund when they wish to buy
and sell.
The key characteristics of OEICs are the parties that are involved and how
they are priced.
• When an OEIC is set up, it is a requirement that an authorised corporate
director (ACD) and a depository are appointed. The ACD is responsible
for the day-to-day management of the fund, including managing the
investments, valuing and pricing the fund and dealing with investors. It
may undertake these activities itself or delegate them to specialist third
parties.
• The fund’s investments are held by an independent depositary, responsible
for looking after the investments on behalf of the fund’s shareholders
and overseeing the activities of the ACD. The depository plays a similar
role to that of the trustee of a unit trust. The depository is the legal owner of
the fund investments and the OEIC itself is the beneficial owner, not the
shareholders.
 Closed-Ended Investment Companies
• A closed-ended investment company is another form of investment fund.
When they are first established, a set number of shares is issued to the
investing public, and these are then subsequently traded on a stock market.
Investors wanting to subsequently buy shares do so on the stock market
from investors who are willing to sell.
• The capital of the fund is, therefore, fixed and does not expand or
contract in the way that an open-ended fund’s capital does. For this
reason, they are referred to as closed-ended funds in order to differentiate
them from mutual funds, SICAVs, unit trusts and OEICs.
 Characteristics of Closed-Ended
Investment Companies
In US:
Come in many varieties and can have different investment objectives,
strategies and investment portfolios. They also can be subject to
different risks, volatility and charges. They are permitted to invest
in a greater amount of illiquid securities than are mutual funds. (An
illiquid security generally is considered to be a security that cannot
be sold within seven days at the approximate price used by the fund
in determining NAV.) Due to this feature, funds that seek to invest in
markets where the securities tend to be more illiquid are typically
organised as closed-end funds.
In Europe:
• In Europe, closed-ended funds are usually known as
investment trusts and more recently as investment companies.
• An investment trust is actually a company, not a trust. As a
company it has directors and shareholders. However, like a
unit trust, an investment trust will invest in a range of
investments, allowing its shareholders to diversify and lessen
their risk.
 Share Classes
• Some investment trust companies might issue both ordinary
and preference shares. A split-capital investment trust, which
has a limited life, will issue other classes of shares.
• Preference shares can be issued on different terms, such as
convertible preference shares that are convertible into ordinary
shares or as zero dividend preference (ZDP) shares.
 Pricing, Discounts and Premiums
• The price of a share is what someone is prepared to pay for it.
The price of a share in a closed-ended investment company
is no different. The share prices for closed-ended investment
companies are, therefore, arrived at in a very different way
from an open-ended fund.
 Real Estate Investment Trusts (REITs)
• Established in countries such as the US, UK, Australia, Canada
and France. Globally, the market is worth more than US$400
billion.
• They are normal investment companies that pool investors’
funds to invest in commercial and possibly residential
property.
 Review questions…….
• The increasing role of investment funds in
global financial system
• Do investment fund drive macro-financial
spill-overs after the global financial crisis?
• Implications for financial stability.
 Exchange-Traded Funds (ETFs)
• An exchange-traded fund (ETF) is an investment fund,
usually designed to track a particular index.
• ETFs use passive investment management which is a method
of managing an investment portfolio that seeks to match the
performance of a broad-based market index. Its investment
style is described as passive because portfolio managers do
not make decisions about which securities to buy and sell;
instead, they invest in the same securities that make up an
index. It, therefore, seeks to hold a portfolio that mirrors the
index it is tracking and undertakes trading only to ensure that
the portfolio’s performance is in line with the index.
It employs one of three established tracking methods:

1. Full replication – this method requires each constituent of the

index being tracked to be held in accordance with its index
weighting. Although full replication is accurate, it is also the most
expensive of the three methods and so is only really suitable for
large portfolios.
2. Stratified sampling – this method requires a representative
sample of securities from each sector of the index to be held.
Although this method is less expensive, the lack of statistical
analysis renders it subjective and potentially encourages biases
towards those stocks with the best perceived prospects
3. Optimisation – this method costs less than fully replicating the
index tracked, but is statistically more complex. Optimisation uses a
sophisticated computer modelling technique to find a
representative sample of those securities which mimic the broad
characteristics of the index tracked
 Alternative Investment Funds (AIFs)
Hedge Funds
• Hedge funds are reputed to be high risk. They sought to
eliminate or reduce market risk.
• The most obvious market risk is the risk that is faced by an
investor in shares – as the broad market moves down, the
investor’s shares also fall in value.
• A hedge fund is a limited partnership of private investors
whose money is managed by professional fund managers who
use a wide range of strategies, including leveraging or trading
of non-traditional assets, to earn above-average investment
returns.
The common aspects of hedge funds are the following:
• Structure – most hedge funds are established as unauthorised and therefore
unregulated, meaning that they cannot be generally marketed to private individuals
because they are considered too risky for the less financially sophisticated investor.
• High investment entry levels – most hedge funds require minimum investments in
excess of US$500,000 some exceed US$1 million.
• Investment flexibility – because of the lack of regulation, hedge funds are able to
invest in whatever assets they wish (subject to compliance with the restrictions in
their constitutional documents and prospectus).
• Gearing – many hedge funds can borrow funds and use derivatives to potentially
enhance returns.
• Liquidity – to maximise the hedge fund manager’s investment freedom, hedge funds
usually impose an initial ‘lock-in’ period of between one and three months before
investors can sell their investments on.
• Cost – hedge funds typically levy performance-related fees which the investor pays if
certain performance levels are achieved, otherwise paying a fee comparable to that
charged by other growth funds.
 Derivatives
• Derivatives are financial contracts, set between two or more
parties, that derive their value from an underlying asset, group
of assets, or benchmark. A derivative can trade on an exchange
or over-the-counter. Prices for derivatives derive from
fluctuations in the underlying asset.
• A futures contract, or simply futures, is an agreement between
two parties for the purchase and delivery of an asset at an
agreed-upon price at a future date. Futures are standardized
contracts that trade on an exchange.
• Forward contracts, or forwards, are similar to futures, but they
do not trade on an exchange. These contracts only trade over-
the-counter. When a forward contract is created, the buyer and
seller may customize the terms, size, and settlement process.
As OTC products, forward contracts carry a greater degree of
counterparty risk for both parties.
• Swaps are another common type of derivative, often used to
exchange one kind of cash flow with another. For example, a
trader might use an interest rate swap to switch from a variable
interest rate loan to a fixed interest rate loan, or vice versa.
• An options contract is similar to a futures contract in that it is
an agreement between two parties to buy or sell an asset at a
predetermined future date for a specific price. The key
difference between options and futures is that with an option,
the buyer is not obliged to exercise their agreement to buy or
sell. It is an opportunity only, not an obligation, as futures are.
As with futures, options may be used to hedge or speculate on
the price of the underlying asset.
• A call option is the right to buy a stock at a specific price by an
expiration date, and a put option is the right to sell a stock at a
specific price by an expiration date.
 Derivatives
• Derivatives based on these underlying elements are available
on both the exchange-traded market and the OTC market. An
OTC market is where trading takes place directly between
parties rather than on an exchange and the trading of
derivatives is increasingly moving from OTC to trading on
exchange. The largest of the exchange-traded derivatives
markets is the Chicago Mercantile Exchange (CME), while
Europe dominates trading in the OTC derivatives markets
worldwide. Based on the value of the notional amounts
outstanding, the OTC derivatives markets worldwide are
about four times the size of stock quoted on stock
exchanges.