Pooled Investment. Close-Open end, Hedge, mutual fund, Asset-backed-securities

.     Pooled Investment

·         Are Mutual funds, Depositories, Trusts and Hedge Funds.

·         Shared ownership in the assets that these entities hold.

Pooled Investment	Created securities called by
Mutual funds	Share
Depositories	Depository receipt
Trusts	Units
Hedge Funds	Limited partnership interest

·         Benefit opportunity from pooled investment are not readily available on an individual basis.

·         May be open or close end fund

o   Open end fund: issue new share and redeem existing share on daily basis (usually). The price at which a fund redeem and sell the funds based on net asset value of fund’s portfolio which is difference between fund’s asset and liability. Normal choice of investees with mutual funds.

o   Close end fund: issued in primary market and not for sell back to the fund by demanding redemption but can trade in secondary market. Close end generally trade at discount or premium to net asset value. These discounts and premiums on closed end measures market sentiments.

o   Exchange traded funds (ETFs) and exchange traded notes (ETNs) are open ended funds tradable in secondary market. Authorized participants (Aps) has the option of trading directly with ETFs. Rare difference in between ETFs and net asset value.

o   ETFs permits only in-kind deposits and redemption. Buyers who buy directly from such a funds pay for their share with portfolio of securities rather than with cash and sellers receive portfolio securities. Generally similar or identical transactions are done. ETFs are depositories because of issuing depository receipt for the portfolio to traders then they use same receipt to trade in secondary market.

·         Asset backed securities: whose values and income payment are derived from pool assets (mortgage bonds, credit card debt, and car loan). These securities typically pass interest and principal payment received from pool asset through to their holders on monthly basis.

·         Hedge funds: generally organized in limited partnership. The hedge managers are partners. The limited partner are qualified and wealthy enough to bear losses. The requirement to participate in hedge funds and the regulatory restriction are vary jurisdiction. Most hedge fund follow single investment strategy but no single strategy characterized as a group. Hedge funds strategies are ranging from long-short arbitrage in the stock market to direct investment into exotic alternative asset.

Hedge funds are distinguished by their management compensation scheme. All funds pay their managers annual fee that is proportional to their asset and their performance fee that depend on wealth that generate for shareholders and second one is many hedge funds use leverage to increase risk exposure and to hopefully increase return.

·         Mutual Funds

o   Investment in portfolio of securities

o   Legally organized as investment trust and corporate investment companies

Finance Brokers, dealers, exchanges

Brokers:
·         Fill order for clients
·         Do not trade, but search for traders who are willing to take the other side of their client’s order
·         Can be individual or from a large brokerage firm or from a bank or at exchanges
·         Identifies potential trade for clients which reduces the cost the costs of finding counterparts for their traders
·         Block traders: provide brokerage service to large clients. Large trade is difficult to get. A large buy Trading goes at a premium to the current market price and large sell trading goes at a discount to the current market price. Price concession enhances large, trading, revealing such large trade makes trader reluctant which handled by block traders.

Exchanges:
·         Provides a place where traders can meet to arrange trades, e.g. NYSE-Euronext, Eurex, Tokyo stock exchange, etc.  Exchange floor is where a broker and dealer negotiate. Exchanges arrange trades for traders based on orders that broker and dealer submit to them. Such exchanges essentially act as broker. Most use an electronic order matching system to arrange the trades.
·         Regulates operation separates exchanges to broker. Most of exchanges regulate their member’s behavior when trading on or off an exchange.
·         Regulate the issuers that list their security of the exchanges. These regulations require timely financial disclosure which is the information to value the securities in the market.
·         Derive their regulatory authority from their national or regional government, or through the voluntary agreement of their member and issuers to subject themselves to the exchange regulation. In most country government regulators oversee the exchange rule and regulatory operation. Most counties also impose financial disclosure standards on public issuers.
·         Alternative trading system ATSs functions same as exchange, but do not exercise regulatory authority over subscriber, except with respect to the conduct trading in their trading system, any electronics. Other operating innovative trading system based information on the customer and their preference. Many ATSs known as dark pools because they do not display that their clients send to them.

Dealers:
·         Fill their clients’ orders from trading with them. If clients are willing to sell or buy then dealer will be a buyer or seller respectively.
·         Liquidity is ability to buy or sell with low transaction costs, which is provided by the dealer at trading time to the client.
·         In over-the-counter market client ask the dealer to trade, but in exchange it is open.
·         Dealers operation:  proprietary trading house, investment banks, hedge funds, sole proprietorship. Large dealing companies: RBC capital market, Nomura timber hill knight securities, IG group etc.

·         Primary dealer: deal with the central bank when conducting monetary policy. They buy bonds, notes, bills when CB wants to reduce money supply. Dealers sell them to their clients. When CB wants to increase money supply, they get back all these instruments.

Exchanges and Securitizer

Exchanges:

Provides a place where traders can meet to arrange trades, e.g. NYSE-Euronext, Eurex, Tokyo stock exchange etc.  Exchange floor is where a broker and dealer negotiate. Exchanges arrange trades for traders based on orders that broker and dealer submit to them. Such exchanges essentially act as broker. Most use an electronic order matching system to arrange the trades.

Regulates operation separates exchanges to broker. Most of exchanges regulate their member’s behavior when trading on or off an exchange.

·         Regulate the issuers that list their security of the exchanges. These regulations require timely financial disclosure which is the information to value the securities in the market.

·         Derive their regulatory authority from their national or regional government, or through the voluntary agreement of their member and issuers to subject themselves to the exchange regulation. In most country government regulators oversee the exchange rule and regulatory operation. Most counties also impose financial disclosure standards on public issuers.

·         Alternative trading system ATSs functions same as exchange, but do not exercise regulatory authority over subscriber, except with respect to the conduct trading in their trading system, any electronics. Other operating innovative trading system based information on the customer and their preference. Many ATSs known as dark pools because they do not display that their clients send to them.

Securities:

·         Once the financial product which improves liquidity. Financial intermediary securitize mortgages, car loan, credit card receivables, bank loan, airplanes leases etc. These securities are called asset-backed securities.

·         Mortgages backed securities: banks lend money to homeowners and they pool mortgages and sell shares of the pools as mortgages pass-through security.  Indirect investment in mortgages with less risk than individual mortgages. Interest and principal payment go through investor after deducting servicing cost. Its investors have the same cash flow and risks as pool mortgages do. In Mortgages backed securities have the advantage that default losses early repayment for a diversified portfolio of mortgages than individual mortgages. Banks facilitate investor with efficient service mortgages and having the benefits of diversification and economies of scale in loan service.

·         Securitization: process of buying asset, placing them in a pool, then selling securities that represent ownership of the pool.

·         Securities are easier to price and sell when investors need to raise cash, which raise liquidity in the market and homeowner will get benefit too through higher mortgage prices at lower interest rate.

·         Pass through securities take place on mortgages, banks account. The bank buys mortgages and sell pass through securities whose value depend upon mortgage pool. The mortgages appear on the bank accounts as asset and mortgages-backed securities appear as liabilities.

·         Special purpose vehicles: corporation or trust that buys assets and sell securities. They protect interest better than financial intermediary which can go bankrupt.

·         Tranches: different class of securities in which different rights of cash flow from the asset pools. Possibility of more predictable cash flow from investment. Rights of cash flow depend upon seniority which means that junior tranches bear disproportionate share of the risk

·         Investment companies also create pass-through security based on investment pools. 

Contracts

Contracts

·         An agreement to do something future.

·         Values of contracts depend on the value of underlying assets like commodities, a security and index that represents values of another instrument.

·         Provide physical or cash settlement

o   Physical items like tomato, pork bellies, gold bars, delivery of petroleum, lumber. It could be delivery of financial instrument like bonds, equities. Delivery can be electronic.

o   Cash contracts settle through payment depend on contract formulas such as interest rate, stock indices, credit default swaps

o   Immediate contracts: call for immediate delivery in three or less days at spot market.

o   Futurity: term for all other contracts.

Forward contracts

·         An agreement to trade the underlying asset in the future at a price upon today. E.g. Farmers and flour manufacturer. It reduces risk for both sides so that it is called hedgers.

·         Counterparty risk: other party to a contract will fail to honor the terms of the contract due to large price changes. Mostly longstanding relationship with each other execute forward contracts.

·         In case, liquidity of both parties must be good so that the delivery will be economically efficient and quite certain.

Futures contracts

·         A standardized forward contract for which a clearinghouse guarantees the performance of all traders which leads to succession of delivery from both sides.

·         Clearinghouse: an organization which ensures that no trader is harmed. If the contract fails, one or both sides eliminate their obligation, in this situation clearinghouse is buyers from seller and conversational.

·         Initial margin: A required amount that all participant posts with clearinghouse to protect against default at the time of entering contracts. Loss and profit margin are deducted by clearinghouse from that amount.

·         Maintenance margin: amount that posted by participants. If margin drop below Mm, then the trader must replenish their accounts. If he fails, then broker of trader trade to offset the participant's position.

·         This variation margin payment ensures that liability will not grow.

·         Benefit: reduces counterparty risk with improved efficiency. Traders can close their position by arranging offset trades at the same time they enter in spot market and make or take ultimate delivery.

Swap contracts

·         An agreement to exchange, payment of periodic cash flows that depend on future asset price or interest rate, e.g. Interest rate swap, at periodical interval, one party makes cash, fixed payment to the counterparty in exchange for variable cash payment from the counterparty.

·         The variable payment is based on pre specified variable interest rate such as London interbank offered rate. This swap effectively exchange, fixed interest payment for variable interest payment because the variable rate is set in the future, the cash flow in this contract is uncertain when parties enter the contracts.

·         Investment manager often enters interest rate swaps when own long term income streams that they want to convert cash flow that varies with current short term interest rates or vice versa. The conversion may allow them to substantially reduce the total interest rate risk to which they exposed. Hedger often uses swap contracts to manage risks.

·         Can be commodity swap, currency swap, equity swap.

Option contract:

·         Allows the holder of the option to buy or sell, depending on the type of the option, an underlying instrument at a specified price or before specified date such as individual stocks, stock indices, future contract, currencies, and swaps. Option contracts does not impose any liability. Institution trade many customize option contracts with a dealer in the over-the-counter derivative market.

·         Buy or sell are called exercise. Buy is called a call option and sell is called put option. Specific price is called strike price or exercise price. They use this option depend on the market price of the underlying instrument.

·         European-style contracts: exercise only when contracts are mature. American-style contracts: exercise the contracts early.

·         Option premium: price that the trader pays for the option

·         Writer of an option must trade the underlying instrument if the holder exercise the option.

Other contracts:

·      Insurance contract: pay the beneficiary a cash if an event occurs, e.g. Life, liability, automobile insurance. These could be bought directly from companies or already issued from owners

·      Credit default swaps: to convert risky bonds to more secure investment. An insurance that promises the payment of principle in the event that a a company default on its bond. A trader who believes that a corporation will default on its bonds may buy credit default swaps written on the corporation’s bond if the swap prices are low.

·      Insurance helps in taxation