country is built on a certain economy; controlling, managing,
sustaining is the main major role of an economy; Economy means the
largest set of inter-related economic production and consumption
activities which aid in determining how scarce resources are allocated.
economy must encompass every single detail that is related to the
production and consumption of goods and services in a certain allocated
area, trying to sustain it in a way that might help to prosper and
develop certain sectors.
In each economy there are two different types of policies; fiscal and monetary policy:
The fiscal policy:
is a policy stimulated by the policy makers, it is divided into
taxation law and government spending; the government can adjust these
laws in order to modify the amount of non-refundable income available
to its tax payers, for example a government could ask more taxes from
individual which makes them have less amount of money used in spending
on goods and services, then the government could use those money to
inject it back again into certain companies and markets by something
called Government Spending. The higher the government spending means
that they are going to demand more taxes from individuals in the
economy; but the major disadvantage of this policy is that it might
take time in order to achieve all that.
The Monetary Policy:
is the second type of polices used in managing a certain economy, this
type of policy is mainly controlled by central banks, meaning that they
control the supply of money into the economy, by putting cost on the
borrowing of these money with some thing called Interest Rates.
Interest rates are defined as the percentage amount of money charged on
borrowed or lent money, as it could be variable or fixed.
classification to an economy is, open and closed economy; an open
economy means that it has bilateral trade with other economies all
around the world for example the United States. A closed economy has a
limited regulated trade with other world economies like china.
each economy there is a Financial System; Financial System is "found to
organize the settlement of payments, to raise and allocate finance and
to manage the risks associated with financing and exchange; developed
to secure efficient payment system, security markets and financial
intermediaries that arrange financing and derivative markets and
financial institutions that provide access to risk management
are two major roles of a financial system; the first one is to organize
surplus funds from people and organizations, and to reallocate them
into deficit facing organizations or people; as those mobilized funds
are used to generate returns for the surplus entities, by enabling
deficit entities to augment their productive and purchasing capacities.
financial system contains something called financial markets; a
financial market is a mechanism that allows people to easily buy and
sell financial securities, commodities, and other fungible items of value at low transaction costs and at prices that reflect efficient market hypothesis.
Securities: "essentially a contract that can be assigned a value and traded”.
" a tangible good, or product that are subject of sale or barter, such
as grains, metals, and foods traded on commodities exchange or on spot
"it is a specified type of commodities; it is defined with a certain
type of good that must be given without any changes in the contract”.
cost: "cost incurred when buying or selling securities, which includes
commission and spreads (the difference between the prices the dealer
paid for a security and the prices at which it can sold)”.
Efficient Market hypothesis: "means that each share price in a market must reflect all relevant information".
is a person who invests in any different type of markets, for example
equities, commodities derivatives, currencies, real estate; as this
term is connected with the individual who is looking for profit from a
certain investment. Types of investors' can be classified on certain
criterion which is known by risk (the possibility of suffering damage
Risk is calculated by dividing the standard deviation over the historical average returns.
Risk = Standard Deviation /Average Returns
type of investors' who take higher than average risks, seeking for
abnormal profits, as they are mainly concerned about speculating which
might be the futuristic prices of a certain asset e.g. currency or a
commodity; mainly they are involved in buying and selling future and
option contracts in the short term, as they represent almost 70% if
investors'; which might be known by "Risk Seekers".
types of investors' who tries to avoid or cancel any risks that can be
accompanied with certain investment, they try to take positions that
might prevent them from any potential losses, these types of investors'
are widely found in markets that are full of uncertainties and high
volatility. There are many types of hedging positions like natural
hedges, hedging credit risk, hedging currency risk, hedging equity and
equity futures. Which are also known by "Risk Neutrals".
types of investors' who buy securities in one market then immediately
resell it in another market in order to profit from prices divergence,
as this type of dealing is only suggested only for well experienced
investors' as any delay in transactions could result of huge losses;
the effect of these transaction would result in adjusting price
differences between markets.
There are three types of markets
Factor market: it is the types of markets that include all features of production for example land, labor, capital.
Product market: is the market that includes all distributing products like food, goods and services.
Types of financial markets
Primary market: type of market that only sells the newly issued securities.
Secondary market: it’s a market where buyers buy from the seller rather than getting it from issuing company.
Over the counter market (OTC):
it’s a type of market that trades occur via phone or a network instead
of a physical trading. Those types of markets are found for companies
that do not meet the exchange listing requirements. Inside the OTC
market there are:
makers: it’s a type of firm that takes in a certain type and number of
shares in order to ease the trading in this security, each market maker
displays buy and sell quotations for a certain number of shares, when
the order is set the market maker instantly sells from his inventory,
as this transaction takes only a small amount of time; for example
NASDAQ is considered to be a market maker. The market maker profits
from the spread, which is the difference between the prices for buying
and the prices at which they are willing to sell at.
Ask prices: is the price the seller is willing to take for a certain
type of security and besides the ask prices their will be the amount of
securities the market maker is willing to sell; which are also known by
Bid prices: the prices the buyer is willing to take, which is the
opposite of the ask prices, the bulls in the markets are known by the
is a type of market instruments that mature in less than one year as
they are very liquid, the instruments involved in this market have
fixed income and low risk for example treasury bills and commercial
it’s a market of trading more risky instruments with a longer maturity
date, as this market consists of the primary and the secondary markets.
"the place were the issuance and the trading of the debt securities
occur", as most bond market instruments are traded in the OTC market.
Stock market: is
the market in which shares are traded through exchange floor or
over-the-counter, which is known by another name equity market, this
market helps investors' to have a partial ownership in a certain
company, and some gains or dividends based on the company's
stock is defined as share of ownership in a certain company, and the
more stocks you obtain the bigger your share in the company, which is
confirmed by a certain piece of paper called a certificate. The
managers of a company are supposed to increase the value of those
investments to increase the confidence of investors' in the company to
raise its share price.
are two types of stocks, preferred and common stocks. A common stock
are type of shares that are released to public were any body can
acquire; a preferred stocks are another type of stocks that are sold to
certain people, not publicly available. The difference between both
types of stocks is that preferred stocks have the priority in taking
distributed dividends and in the liquidation of the company.
Functions of Financial markets
and lending: financial markets provides money to investors', by giving
out certain amount of money but with certain interests which is known
by cost of borrowing.
Price determination: sets or defines fixed or volatile prices for each type of instrument in the market.
collection and analysis: provides information for market participants
to value or estimate prices of a certain instrument.
Risk sharing: financial markets eliminate a type of risk known by systematic risk, by diversifying investments.
markets provide sufficient amount of buyers and sellers helping any
investors' to directly convert instruments into cash
Efficiency: markets reflecting all the publicly available information on a certain instrument.
Major market participant
· Broker: a broker's job is to locate a buyer to the seller, as they involve in assets transformation.
· Dealer: smoothes the process of matching the buyer with the seller.
· Investment banks: contributes in selling the newly issued securities.
· Financial intermediaries: They are foundations that act as mediator between investors and firms.
type of securities that their value is abstracted from other financial
instruments; these types of derivates are used as a hedging bargain to
stop any losses from any reversal movement in the market, so the main
use is to "Control Risk"; it is mainly used with currency and interest
The derivative is used by the three types of investors:
the Hedger uses the derivates in order to minimize the losses by taking
a position opposite to the transaction that he/she is having, so if the
market reverse no major losses will occur.
Speculators: the speculator will get in market just looking for abnormal profits, with accepting higher risk, by taking an open position.
Arbitragers: the arbitrager try's to look for low risk profit, by taking advantage of difference in prices.
A derivative includes different types of instruments:
Contracts: are negotiated between two parties, to buy a long position
and sell a short position of a specified amount of a commodity, as the
buyer hold the right to undertake the action but not obligated, and
setting the price (known by the spot price) of the commodity at a
Contracts: are standardized contracts that are traded on a regulated
floors, obligating the delivery of the agreed amount of commodity or a
currency or an instrument for example treasury bonds, foreign currency.
These types of contracts are considered to have low risk.
There are two types of option contracts:
- Call option: gives the buyer the right to buy (but not the obligation) a specified amount of securities at a certain price at a set date.
option: gives the buyer the right to sell (but not the obligation) to
the writer of the option by a certain prices and a specified date.
"is a flexible, private, forward-based contract or agreement, which is
used to hedge against exchange risk from mismatched currencies on
assets and liabilities.
There are different types risk associated with derivatives:
Basis risk: it is the price of the hedged asset subtracted from it the price of the derivative contract.
Credit risk: it's the risk of the chance of one party offsetting the financial obligation under the contract.
risk: it's the loss due to changes in the value of the derivative,
including different types of risks control, accounting and legal risks.
depth is defined as the capability of the market to generate enough or
extra orders without having an affect on the price of a security, as it
can be defined in another way, it is measured also with the liquidity,
the more liquid the markets are the more depth it has; moving security
prices in large markets is really hard, because of the depth of the
markets large orders must be taken in order to change prices slightly.
There are certain factors which affect market depth:
there is a very big role that takes place in the markets that we can't
ignore, which is known by investors' rationality, or market psychology.
in general are really built on speculations, forecasts and fears; if
certain gossip spreads in markets average investors' would really panic
which at the end leads them to take irrational acts, that could really
affect the trend that is going into markets, but let's not forget the
bigger influential which is known by attitude toward risk. We all know
a rational investor won't really take into consideration any spread of
rumors into markets they will concentrate more risk; but the enigma
starts when the amount of average investors' in markets gets bigger
which would eventually affect the overall movement, obligating rational
investors' to take different actions to wipe away any extra risk that
can be added on them.