Primary Versus Secondary Markets

Primary Versus Secondary markets(Ch 2)

The comparison between primary and secondary market lies in the process in which funds are raised from the capital market. Primary markets refers to the market where securities are created, while the secondary market is one in which they are traded among investors. Primary markets are where the firms sell (float) new stocks and bonds to the public for the first time. Underwriting new securities, means investment banks buy the new issue from the issuing corporation at a guaranteed price and then sell these to the public. Firms get funds only when the stocks/bonds are issued first. The important thing to understand about the primary market is that securities are purchased directly from an issuing company.

A secondary market is a financial market in which previously issued stocks and bonds are traded(is that investors trade amongst themselves). That is, in the secondary market, investors trade previously-issued securities without the involvement of the issuing companies. For example, if you go to buy Microsoft stock, you are dealing only with another investor who owns shares in Microsoft. Microsoft (the company) is in no way involved with the transaction. Secondary markets, however, serve an important function of making financial markets more liquid by providing a marketplace in which a security is converted to cash. These markets include various types of formal organized exchanges, less formal Over the Counter (OTC) markets, like informal telephone dealer markets, electronic trading through computer screens. In secondary markets, brokers are agents of investors who match buyers with sellers of securities. Security dealers, on the other hand, act as the buyer and seller by continuously quoting a price at which they are ready to buy a security (the bid price) and the price at which they will sell the security (the ask price).

Monetary Policy of the Bank of Canada(Ch 17), Including Credit Easing and Quantitative Easing Policies(See module 13 and article given in assignment 2 package)

Monetary policy is concerned with how much money circulates in the economy and what that money is worth. In Canada, monetary policy is conducted by adjusting very short-term interest rates to achieve a rate of monetary expansion consistent with maintaining a low and relatively stable rate of inflation. By keeping inflation low, stable and predictable, the Bank contributes to solid economic performance and rising living standards for Canadians .

Quantitative easing

The central bank buying longer maturity government securities will help when the underlying problem is too high a value of risk-free long-term interest rates. That, however, is not the problem. If anything, long-term risk-free rates continue to be surprisingly and damagingly low. So outright purchases of government securities by the central bank do nothing to alleviate liquidity pressures on banks, let alone the banks' capital shortage. They are no more than a sop to the ministry of finance and its deficit financing preoccupations. At best, such monetisation of the public debt will, if it not expected to be reversed, have a 'fiscal' effect - helicopter money. But if households are saving their windfalls, even this will fail to boost the economy.

Credit easing

The central bank purchasing private securities outright will help if there are liquidity problems in the markets for these securities, making for excessive spreads over corresponding maturity risk-free rates. Apart from that, such outright purchases help only if the central bank pays over the odds for the securities and thus helps recapitalise the banks. No doubt the massive past liquidity injections by the central banks of Japan, the US, the Euro Area, the UK and elsewhere in Europe have taken the liquidity spreads out of the corporate bond yields. Corporate borrowing through issuance in the markets is running at a high level, even in the Euro Area. Much of this substitutes for bank finance that is no longer available. If the authorities believe that the spreads of corporates over Treasuries are still in excess of what is warranted by differences in default risk, they should by all means buy more corporate debt. If they believe, as I do, that these spreads are likely to be a fair reflection of credit risk differentials, then even credit easing is a waste of time.

Islamic Finance(see Module 13)

Islamic Finance is banking activity that is consistent with the principles of Islamic law (Sharia) and its practical application through the development of Islamic economics. Sharia prohibits the payment or acceptance of specific interest or fees (known as Riba or usury) for loans of money. Investing in businesses that provide goods or services considered contrary to Islamic principles is also Haraam (forbidden). Islamic finance is the fastest growing area of global financial services, it increases about 15-20 per year. The growth outlook for Islamic banks is very positive, with Muslims comprising one-fifth of the world's population, and due to the increasing oil revenue in the Middle East. The products that Islamic banks offer may appear to parallel those of conventional banking, but are designed to exclude the receipt or payment of interest. For example, a person wishing to buy a property will approach the bank for a mortgage loan. The bank will buy the property on that individual's behalf, add a certain amount of bank profit to the value of the property and then allow the individual to make a set of equal payments until the full amount is paid back to the bank. No interest enters the transaction. However, to remain competitive in businesses, the bank profit is calculated to be similar to that of a conventional bank using an interest based mortgage transaction.

Securitization and mortgage-backed Securities (Ch 9 3rd edition or Ch 11 4th edition or and article given in assignment 2 package )

The Securitization Process

The homeowner raises a loan from her bank (the originator of the loan). The bank sells the loan to a third party. The third party can be a government sponsored entity such as Ginnie Mae, Fannie Mae or Freddie Mac or a private sector financial institution, such as Countrywide Financial, Lehman Brothers or Well Fargo). The third party then often packages the mortgage with others into mortgage-backed securities and sells the payment rights to other investors.

As an example, assume that an issuer has collected 1,000 mortgages, each worth $100,000 with a 30-year maturity and a fixed interest rate of 6.50%. This $100 million pool of mortgages can be used to back 10,000