The Hindu Business Line : Tour of markets

Sample these lines picked from different stories in the day's news: Investment banks anticipate softening of yields. A retailer of mobile phones plans to raise Rs 100 crore through equity dilution. Zee has fixed the share-swap ratio after demerger. Bond prices increased due to comfortable liquidity in the system. The regulator has cut `open interest' positions on many commodities...

Difficult to understand? Marc Levinson offers help, in the third edition of Guide to Financial Markets, from Viva (www.vivagroupindia.com). "Financial markets have been around ever since mankind settled down to growing crops and trading them with others," he begins from the beginning, thus putting at ease the novice reader.

All financial markets, "whether highly organised, like the London Stock Exchange, or highly informal, like the money changers on the street corners of many African capitals," perform some basic functions, Levinson writes. These functions are: Price setting, asset valuation, arbitrage, raising capital, commercial transactions, investing, and risk management.

Key factors

Financial-market activity has increased manifold in recent years. Key factors, according to the author, are four. First, lower inflation. When inflation is high, "firms avoid raising long-term capital because investors require a high return on investment, knowing that price increases will render much of that return illusory." Second, pensions. Compared to the earlier `pay-as-you-go schemes,' countries are looking at "pre-funded individual plans, whereby each worker has an account in which money must be saved, and therefore invested, until retirement."

The third factor is stock and bond market performance. "The rapid increase in financial wealth feeds on itself: Investors whose portfolios have appreciated are willing to reinvest some of their profits in the financial markets." And fourth, risk management. "Innovation has generated many new financial products, such as derivatives and asset-backed securities whose basic purpose is to redistribute risk."

Bonds were a natural outgrowth of the loans that early bankers provided to finance wars starting in the Middle Ages, narrates the author in a chapter on bond markets. "As governments' financial appetites grew, bankers found it increasingly difficult to come up with as much money as their clients wanted to borrow." What happened then? "Bonds offered a way for governments to borrow from many individuals rather than just a handful of bankers, and they made it easier for lenders to reduce their risks by selling the bonds to others if they thought the borrower might not repay."

The earliest known bond funded a military expedition: `Issued by the Bank of Venice in 1157, to fund a war with Constantinople'. The first global bond, however, took a long time to come. It was a $1.5 billion issue by the World Bank in 1989, "sold simultaneously as a domestic security in the US and as an international security in the Euromarket".

Interestingly, the word `Euromarket', applied to `acceptance of offshore deposits', is traced to 1957, the height of the cold war, as the book chronicles. "Moscow Narodny Bank decided to transfer its dollar deposits out of the US to foreclose the possibility that the US government would confiscate Soviet assets." How was the operation carried out? "The Russians had their dollars transferred from New York to a French bank that had the cable address EUROBANK, and soon all dollars deposited in European banks took the name Eurodollars."

In a chapter on securitisation, read about how the Walt Disney Co `securitised the anticipated revenue from groups of films', and how `securities backed by anticipated ticket revenue have been used to build sports stadiums in several American cities.' Move on then to study `international fixed-income markets'.

The book also discusses equity markets, commodities and futures, and options and derivatives.

Engagingly educative.

The book discusses the most widely used financial instruments and also the way the markets for each of these instruments are organised. Begin with `the foreign-exchange markets', which `underpin all other financial markets'. In forex, the greatest risk arises from the fact that trading often occurs across many time zones, says the author. "This is known as Herstatt risk, after a German bank that failed in 1974 with $620 million of partially completed trades." One learns that bank regulators around the world try to reduce this risk by `speeding up settlement process'.

Next comes a chapter on money markets, the networks of `corporations, financial institutions, investors and governments, which deal with the flow of short-term capital'. Where do these markets exist? As `webs of borrowers and lenders, all linked by telephones and computers', in the arrays of treasurers `whose job is to invest any unneeded cash as safely and profitably as possible and, when necessary, to borrow at the lowest possible cost'.

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