Off-exchange market, financial instruments
11th March 2009


Off-exchange market
nOff-exchange market is market where operations are not limited by exchange statue
nIts operations are also limited by directions or rules but there are more moderate then in
exchange market.
nOff-exchange market is a competitor of exchange market.

Off-exchange market
nExistence and function of off-exchange market is determined by several circumstance:
qStrict conditions for quotation of financial instruments in exchange market.
qFor instruments that do not fulfill quotation in exchange market is off-exchange market
alternative way for trading, liquidity and pricing of issued instruments.
q Trading in stock exchange is determined by schedule.
qAfter exchange hours is possible to trade only in off-exchange markets (some of them trading
24/7).
qOff-exchange market as a competition
qlower transactional payments, or
qfavorable trading conditions for particular investors (ARIEL, TRADEPOINT, etc. – trading system
for institutional investors with lower transactional costs).
qBecause Off-exchange markets are not bound by so strict rules as stock-exchanges they are able to
offer techniques of trading according to particular investors requirements.

NASDAQ
nOrganized off-exchange market in USA is supported by electronic system NASDAQ (National
Association of Security Dealers Automated Quotations) –quote driven system.
nNowadays in NASDAQ is traded with
qMore than 3000 stock issuances
qMore than 2000 debt issuances
nThere is more than 500.000 traders and about 500 market makers.

NASDAQ
nTrading system in NASDAQ works in several levels.
qLower level (the cheapest) – offers the flow of information through information agencies Reuters
or Quatron. There are no to disposal of information about quotation of market makers.
qUpper level – information about quotations of market makers. It is possible to trade with them.
qTop level (the most expensive and the largest) - traders operate as a market maker.

NASDAQ
nConditions for quotation in NASDAQ
qMinimal volume of emission – 4 millions USD
qMinimal number of public trade securities in emission:
n100.000 securities – segment of small companies
n500.000 securities

Specific market segments in NASDAQ
nNasdaq National Market
qMore strict condition for trading
qMore traded securities – blue chips
nSmallCap Market
qSegment for small, new starting companies
nSOES (Small Order Execution System)
qTrading with at most 1000 securities in one trading order
qGuarantee trading with the best price in the market
nNASDAQ International
qTrading in standard (London) time
nNASDAQ Canada, NASDAQ Japan, NASDAQ Europe.

Investment instruments and their characteristics
nInvestment instrument
qAsset that brings claim for future revenue
qRevenue is in the form of:
nDividends
nCoupon payments
nInterests
nExchange rate profits

Financial instruments
nStocks
qLong term security without maturity day.
qType of stocks
nCommon stocks
qmost widespread and most traded
nPrior stocks
qLimited voting rights, priority for dividends
qIn USA two types of prior stocks. Common and cumulative prior stocks.
qCommon prior stocks – dividends only if company gets profit.
qCumulative prior stocks – lower dividend payment but together with commutation of dividend payment
claims for years when company gets loss. Cumulated claims from bad years are paid out in good
years.

Financial instruments
nBonds
qDebtor security with
qowner right for redemption and
qissuer duty of settle a claim.
qMaturity day is fixed.
qShort-term bonds – several months
qLong-term bonds – till 30 years
qIssuer of bonds undertakes to
qredeem face-value of bond and
qpay coupon payments in regular intervals.
qCoupon payment has several forms:
nFix interest rate
nDifference between face value and emission price
nVariable interest rate derivates from different interest rates or revenues, foreign exchange
rates, etc.

Financial instruments
nTypes of bonds
qStraight Coupon Bonds
nThe oldest type o bond.
nIt is also known as a Vanilla Bond.
nPurchase of this bond investor gets right to fixed coupon payment and face value that are paid at
the same moment on maturity day.
nFor investor is this type of bond profitable in non-inflation environment and in time of interest
rate decrease.
nFor issuer is this type of bond profitable in inflation environment and in time of interest rate
increase.

Financial instruments
nFloating Rate Notes – FRN
qBonds with floating coupon payment.
qThe high of coupon payment is very often derived from particular referential value (PRIBOR, LIBOR,
BRIBOR, etc.).
qInterbank referential rate is only starting point for coupon payment. To this variable level is
very often crediting fixed premium (6M PRIBOR + 0,1%).
qCoupon payment imitates with delay the development of market interest rates. Investor participate
in the growth and decline in market interest rate (risk and chance).

Financial instruments
nIn same types of FRN there are strictly defined borders for movements of coupon payments.
qFloor FRN minimal border for decline of coupon payment.
qCap FRN maximal border for growth of coupon payment.
qMinimax FRN  maximal and minimal border
qDroplock FRN if interest rate decline under determine border FRA is converted into Straight Coupon
Bond.

Financial instruments
nZero Coupon Bonds
qBonds without coupon payment.
qThis type of bond is issued with discount it means that issue price is lower than face value.
qIn the maturity day is paid back face value.
qThe profit for investor is difference between issue price and face value.
nIndex-Linked Bonds
qCoupon payment is determined by development of some index - wages, prices, oil or some market
index.
nWith real indexing
qDevelopment of index-linked bonds is determined by changes in real asst prices.
qDuring growth of inflation the price of most real assets is growing
qThis bonds retain value in high inflation environment because the value of real asset is rising.
nWith financial indexing
qDevelopment of index-linked bonds is determined by changes in financial instruments prices e.g.
stock index.

Financial instruments
nMortgages bonds
nMunicipal bonds
nConvertible bonds
qThis bond links classical bonds rights with right to convert this bond into another
nBond or
nstock of the same issuing company
qInvestor into this convertible bond must decide in particular day if
nconverts bond into another instrument or
nretains bond till maturity when takes face value and regular coupon payments.

Financial instruments
nThe coupon payments of this bond are lower than in case of standard bonds.
nSuitable for situation when investors assume that stocks of issuing company are underestimate and
expects future growth in their price.

Financial instruments
nSubordinated bonds special type of bonds
nin case of liquidation or bankrupt the claims of owner of subordinated bonds will be settled after
settlement of all other claims.
nThe best know subordinated bonds are follows:
qJunk Bonds
nBonds of poor quality
nRating in level of speculative (Ba, BB, B)
nIssued by
qcompanies where occur decline in financial situation – Fallen Angels or
qyoung, starting companies with high risk profile
nJunk Bonds
qHigh risk but also above-average revenue
qThe value of Junk Bonds reacts to sensitive in economy cycle

Financial instruments
qCallable Bond
nAccording to predefined conditions can be withdraw by issuers or investors.
qPerpetuity Bond
nWithout maturity
nCoupon payments for unlimited period
nIssued usually by government

Rating
nRevenue that is expected from particular bond is derived from level of risk related with
particular bond.
nFor appreciation of credit risk is used rating.
nCredit risk – depends on issuers and possibility to settle their obligations.
nRating offer information how is particular subject able to fulfill engagements in time and in full
extent.

Rating
nFirst rating is related with debenture bonds of railway companies in USA. Made in 1909 by John
Moody.
nIn 1914 first rating company Moody’s Investor Service.
nIn 1916 rating company Standard & Poor’s.
nThe development of rating from the 1960’s-70’s in USA and 1970’s – 1980’s in Europe.
nThe first activities was related with rating of debenture bonds and bill of exchange.
nNowadays rating companies carry out rating of
qBonds, mortgages, derivatives or instruments as a result of securitization.
qCompanies, cities, countries, etc.

List of Ratings
Ratings


Financial instruments
nOptions
 Options are financial instrument which give the holder the right, but not the obligation, to buy
(call) or to sell (put) an underlying asset at a predetermined price (exercise price or strike
price) on or up to a certain date (European or American exercise style).

Financial instruments
nUnderlying assets
qThe option derives its price from the value of an underlying asset. This can be a
qstock,
qindex,
qbasket or any other financial asset.
nA basket is a group of two or more assets, such as shares or indices.
nUsually baskets have an investment theme, commonly a region or a sector (such as shares of banking
or telecommunications companies).

Financial instruments
nEuropean and American style
qOptions can be classified as a European or American style according to time period when holder may
use its right to receive payment.
q European style holder can use its right only in particular predetermined  maturity day.
qAmerican style  holder can use its right on any business day till particular predetermined
maturity day.
n

Financial instruments
nFirst option exchange was established in 1973 in Chicago.
qChicago Board Options Exchange
qAbout 60 % of all option trades is in North America
qAbout 30 % in Europe and the rest is Asia
nAccording to embodied right
qCall Option – right to buy underlying
qPut Option – right to sell underlying
qPremium
qThe price of option

Financial instruments
n Motions to use options
qSpeculation
nbear or bull market trend
qHedging, especially
nInterest rate risk
nExchange rate risk

Financial instruments
nCall option
qA call option is an financial instrument which gives the holder the right, but not the obligation,
to buy an underlying asset at a predetermined price (exercise price or strike price) on or up to a
specified date (European or American style).
qA call option gives the holder the possibility to benefit from an increase in the value of the
underlying asset, while limiting potential losses to the premium paid.

Financial instruments
nA put option is a financial instrument which gives the holder the right, but not the obligation,
to sell an underlying asset at a predetermined price (exercise price or strike price) on or up to a
specified date (European or American style).
nA put option gives the holder the possibility to benefit from a decrease in the value of the
underlying asset, while limiting potential losses to the premium paid.

Financial instruments
nIn case of put or call options there are different expectations between buyer and seller.
nAccording to character of trade:
qExchange trading options
qOff-exchange trading options
nExchange trading options are traded together with financial futures in derivative exchanges from
the 1970's. All options parameters are standardized:
qUnderlying, exercise price, maturity day
nOff-exchange trading options are designed according to investor requirements, esp. to hedge
against risks.
q
n

Financial instruments
nWarrants
���A call warrant is a tradable security which gives the holder the right, but not the obligation, to
buy an underlying asset at a predetermined price (exercise price or strike price) .
nA put warrant is a tradable security which gives the holder the right, but not the obligation, to
sell an underlying asset at a predetermined price (exercise price or strike price).

Financial instruments
nWarrants are in some characteristics similar to options but there are also differences:
qWarrant is security issued by one issuer
qOption is not security and it is issued by more persons.
qWarrants are traded in spot markets, are not under strong standardization and offer several types
of underlying.
qOptions are traded in future exchanges, are under strong regulations and types of underlying   are
limited.
qWarrants has duration several years
qOption has duration several mounts
qNumber of issued warrants is fixed determined
qNumber of options is daily changeable.
qAccording to right dominates call warrants
qNumber of call and put options are almost similar
q

Financial instruments
nWarrants has been traded since 1850's.
nThe interest of investors has increase since the 1980's.
nMotivations to use warrants
qHedging of current low price of financial instrument for future buy.
qHedging of current high price of financial instrument for future sell.
qSpeculation for future bull or bear market – leverage effect.
nLeverage effect
qInvestor profit from warrant investment can rise in some conditions quicker than profit in
particular rising underlying.
qThe reason is that investor invest less money in warrant then is direct investment in underlying.
qBut leverage effect works in both ways in decline of underlying the decline in warrant price is
higher.

Financial futures
nFinancial futures contract is a standardized contract, traded on a futures exchange, to buy or
sell a certain underlying instrument at a certain date in the future, at a specified price. The
future date is called the delivery date or final settlement date. The pre-set price is called the
futures price. The price of the underlying asset on the delivery date is called the settlement
price.
nA futures contract gives the holder the obligation to buy or sell .
nFinancial futures contracts are not issued but it is necessary to meet buyer and sell of contract.
This process is called as a matching.
n

Financial instruments
nReal assets
qFinancial instruments in physical, material form.
nAdvantages of investment in real assets
qHedging again inflation
qDiversification in portfolio
qHedging against political uncertainty
qRevenues
nDisadvantages
qHigh transactional costs
nSpread between bid and offer about 20-25%
n financial assets spread about 0,5-2 %.
qNon-existence of liquid and effective market
qVolatility of revenues in short time period

Financial instruments
nPrecious metals, especially
qGold, platinum, palladium
qThe revenues from precious metals are volatile and investment in precious metal is related with
higher risk.
n Investments in gold instruments
qNowadays in the world there is about 150 000 tunes of gold, yearly is mined about 1600-2000 tunes.
qInvestment n gold instruments are in form of
nDirect investment - goldbrick, ingot
nIndirect investment - “paper gold” - stocks of mining companies, gold bonds, etc.

Financial instruments
nDirect investment
qCenters: London, Zurich, NY, Hong-Kong, etc.
qSpot or future trades
qSpot trades
nPhysical buy of goldbrick, ingots with delivery till 2 days
nInvestor can gold takes physically  or deposit in bank -> gets certificate about proprietorship.
nWith spot trading of gold are related storage and insurance costs about 2-3% per year.
nStandard goldbrick weights 400 troy ounce (12,44 kg) and it is called bar.
nFor retail investors are created tola bars or Ten tola bars with weight about several grams.

Financial instruments
nFuture trades in form of
nGold swaps, gold loans and gold forward sales
nTraded in OTC markets
nMain traders: gold producers, central banks and gold dealers.
n

Financial instruments
nGold loans
nFinancing of gold mining, used since 1982.
nBefore gold mining a company borrows gold that sells and moneys uses for gold mining financing.
nMined out gold is used as a payment for first gold  loan.

Financial instruments
nForward sales are used by mining companies to sell gold that will be mined in several years.
qMain purpose is a hedging against decline in gold price.
qForward sales are mediated by banks called bullion banks.
qThis bank borrows (usually from central bank) gold in volume that is expected to be mined and
sells the gold in spot market.
qMoney from this transaction are deposited in money market.
qSeveral mounts later mining company returns mined gold together with interest payment to central
bank.
qMining company gets back money from money market together with interest payments minus interest
payments paid central bank and provision for bullion bank.
n

Financial instruments
qInvesting in stocks of gold mining companies
nThe value of gold mining companies is determined by development of price of gold.
nMovements of these stocks are under leverage effect it means that 1% change in price of gold
effect several percentage change in price of gold mining companies stocks.
nBeside price of gold these stocks are determined by
qMining costs, political and economical situation in the country, labour costs, etc.
qGold bonds
nIndex bonds their price is related with price of gold.
nThe best know – France government issue – Pinay and Giscard.

Financial instruments
nDiamonds
qThe most of diamond supply is under control of South African company DeBeers Consolidate Mines
Limited that
nkeeps 1/3 of all diamond mine.
ncontrols about 75 % of world trade with not-cutted diamonds.
nReal Estate
n  Arts

Thank you for your attention