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Week Two
The demand for financial assets.
Primary, secondary and tertiary (or
derivative) markets.
Market organisation.
Factors influencing markets
Market analysis and forecasting
The Assignment
A discussion on Endnote
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Last Week We :
Described the role performed by the financial
system
Explained the concept of a financial asset
and identify the main types of financial assets
Discussed the functions of financial markets.
Explained how financial markets transfer
funds
Defined intermediation vs. direct financing.

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The Market Mechanism
Objectives for this lecture
Define the idea of a financial asset
The factors affecting demand for a financial asset
Primary issue and secondary transfer markets
How trading is organised
Forecasting methods
Define Fundamental Analysis
Identify Various forms of Technical Analysis
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What is a Financial Asset?
From last weeks lecture
A claim to a real asset or to the cash flows that
real asset will generate
Ongoing payments (dividend, coupon)
Residual value
Characteristics
Risk
Return
Liquidity
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Financial Markets
1. Matching principle
2. Primary and secondary market transactions
3. Direct and intermediated financial flow
markets
4. Wholesale and retail markets
5. Money markets
6. Capital markets
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1. Matching Principle
Short-term assets should be funded with
short-term (money market) liabilities, e.g.
Seasonal inventory needs funded by overdraft

Longer-term assets should be funded with
equity or longer-term (capital market)
liabilities, e.g.
Equipment funded by debentures
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2. Primary and Secondary market
transactions
Primary market transaction
The issue of a new financial instrument to raise
funds to purchase goods, services or assets by
Businesses
Company shares or debentures
Governments
Treasury notes or bonds
Individuals
Mortgage
Funds are obtained by the issuer
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2. Primary and Secondary market
transactions (cont.)
Secondary market transaction
The buying and selling of existing financial
securities
No new funds raised and thus no direct impact on
original issuer of security
Transfer of ownership from one saver to another saver
Provides liquidity, which facilitates the restructuring of
portfolios of security owners

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3. Direct and Intermediated
Markets
Direct Markets
Bond, Share markets especially
Predominantly (but not exclusively) wholesale
markets
Intermediated Markets
Banks are main intermediaries
Predominantly (but not exclusively) retail markets
Many derivatives can be intermediated
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4. Wholesale and retail markets
Wholesale markets
Direct financial flow transactions between
institutional investors and borrowers
Involves larger transactions
Retail markets
Transactions conducted primarily with financial
intermediaries by the household and small to
medium-sized business sectors
Involves smaller transactions
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5. Money markets
Wholesale markets in which short-term securities are
issued (primary market transaction) and traded
(secondary market transaction)
Securities highly liquid
Term to maturity of one year or less
Highly standardised form
Deep secondary market
No specific infrastructure or trading place
Enable participants to manage liquidity
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5. Money markets (cont.)
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5. Money markets (cont.)

Money market submarkets exist for
Central bank: system liquidity and monetary
policy
Inter-bank market
Bills market
Commercial paper market
Negotiable certificates of deposit (CDs) market
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6. Capital markets
Markets in which longer-term securities are issued
and traded with original term-to-maturity in excess of
one year
Equity markets
Corporate debt markets
Government debt markets
Also incorporate use of foreign exchange markets and
derivatives markets
Participants include individuals, business, government
and overseas sectors
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Forecasting & Analysis
Price ultimately defined by supply and
demand
Several techniques used to forecast prices
Fundamental Analysis
Top down approach
Bottom up approach
Technical Analysis (Charting)
Psychological Factors and Sentiment
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Fundamental Analysis
Top down approach
A macro-economic viewpoint which attempts to
forecast the industry or countrys economic
environment in which the company operates
Bottom up approach
A micro-economic viewpoint which attempts to
forecast a companys operational well-being by the
use of various accounting/investment ratios

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Fundamental Analysis
Top down approach
A macro-economic viewpoint looking at
Industry Sectors
The impact of international economies
The rate of economic growth
The effect of exchange rates
Interest rates, domestically and internationally
Balance of payments current account
Inflationary pressures and wages growth
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Fundamental Analysis
Bottom up approach
A micro-economic snapshot using various
accounting/investment ratios, for example:
Capital structure
Gearing, equity
Liquidity and debt coverage
Profitability
Management quality
Current share price, prospects and risk

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Fundamental Analysis
Top down approach or a Bottom up approach
You should consult Viney Chapter 7.1 to 7.2 and form your
own opinion. Conventional wisdom has it that a
combination of both approaches works well
1. Identify industries and economies with good value
or growth prospects through a top down approach
2. Use a bottom up approach to identify the specific
companies and their shares which are likely to
perform best

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Technical Analysis
Explains and forecasts share price
movements based on past price behaviour
Assumes markets are dominated at certain
times by a mass psychology, from which
regular patterns emerge
Two main forecasting models
Moving averages (MA)
Charting

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Moving Averages (MA) Models
Smooth out a series facilitating the
identification of trends in the series

Calculation of MA
Assuming a five-day moving average, the MA is
calculated by taking the average of the price
series for the preceding five days
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Moving Averages (MA) Models
(cont.)
Trading rules
Buy when the price series cuts the MA from below
Buy when the MA series is rising strongly and the
price series cuts or touches the MA from above
for only a few observations
Sell when the MA flattens or declines and the
price series cuts MA from above
Sell when the MA is in decline and the price
series cuts or touches the MA from below for only
a few observations
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Moving Averages (MA) Models
(cont.)
Typically for daily price series both 10-day
(short-term) and 30-day (medium-term)
moving averages are calculated

Weighted MA
The most recent information is given the greatest
weight
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Charting
Investigating patterns in price charts

Several techniques
Trend lines
Support and resistance lines
Continuation patterns
Reversal patterns
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Charting Trend Lines
Trends are regular movements in share prices
Two types of trends
Uptrend lineconnecting the lower points of rising price
series
Downtrend lineconnecting the higher points of falling price
series
Return lineline drawn parallel to a trend line to create a
trend channel
Critical issue is to determine when the trend line is
going to change
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This chart has been taken from http://www.dailyfx.com/FinanceChart.html
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Charting- Support and Resistance lines
Support levelswhere there is sufficient
demand to halt further price falls
Resistance levelswhere there is sufficient
supply to halt further price increases
Strong levelshistorical support and
resistance
Weak levelssupport and resistance based
on more recent activity
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Charting - Continuation Patterns
Sideways share trading that does not
normally signal a change in a trend; 2 types
Trianglescomposed of a series of price
fluctuations, each smaller than its predecessor
Symmetrical triangle (no change in trend); ascending
triangle (uptrend); descending triangle (downtrend)
Pennants and flagsformed during a sharp rise in
prices (the pole); trading volume then reduces
and then increases suddenly to take prices
sharply higher
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Charting - Reversal patterns
Occur after a major market move
Result in a head and shoulders pattern
Three successive rallies and reactions, the second
rally being stronger than the first and third rallies
Left shoulderformed by volume-strong rally on uptrend,
followed by reduced-volume reaction
Headsecond rally increases price before reaction
moves price back to previous low
Right shoulderfinal rally marked by reduced volume
indicating price weakness
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Charting - Elliott Wave Theory
The existence of distinctive wave patterns
that characterise share-market cycles
Key proposition is that a bull market consists
of three major waves upwards, followed by
two major down-legs, resulting in a reversion
of share prices to about 60% of the peak
Consult Viney Ch 7.3.2 for more on Charting
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Technical or Fundamental Analysis
Validity of technical analysis
Even where techniques have no apparent underlying
validity, if they are followed by enough participants they may
impact share price behaviour at times
More likely to forecast successfully when share
prices move out of a range explained by economic
and financial fundamentals
Technical Analysis can be very effective in
determining timing once fundamental reasons to buy
have been established

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Program Trading
Refers to buy and sell strategies generated
by computer programs
Programs range between
Simple buy/sell orders based on moving averages
Complex monitoring of both derivatives and share
markets for the purpose of hedging a share
portfolio
Program trading increases the speed at
which prices change
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Next Week - Week Three
Mathematics of Finance Revisited
Short, medium and long-term debt
Structure of the money markets.
Interest bearing securities
Discount securities.
Securitisation
The Assignment