Topic 1

Introduction to Financial
Markets
Copyright of Spanish version from María Gutiérrez
Translation into English by Francisco Romero

Universidad Carlos III

Financial Economics

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Topic 1 Introduction to Financial Markets
Table of contents:

SESSION 1
1.1 A brief introduction to Finance
1.2 The concept of Investment
• Investment
• Types of Investments
• Link between Real and Financial Investments
1.3 Quick tour around the Financial Markets
• Financial Assets
• Operations with Financial Assets
• Types of Financial Assets
• Who is who in the Financial Markets

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Topic 1 Introduction to Financial Markets
Learning Objectives:

1. Understand why Finance is important for wealth creation

in the economy.

1. Analyse the concept of Investment and the types of

Investments available in the economy.

1. Learn the different types of Financial Assets and the

operations that can be performed with them.

1. Get a basic knowledge of how financial markets work

and the role of the different market participants.
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 Asset Liability
Investment Firm Sec
Loans
Borrowers
(Firms)

2’ 3 5 2

Financial Capital
Real Inv.
intermediaries markets
Asset Liability
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Loans Deposits 1’ 1
Bank Sec
Lenders
(Families)
Asset Liability
Fam Sec Savings
Deposits
 1.1 Introduction to Finance
What is “Finance”?
• It is an area of Economics that analyses investment and financing decisions and
the exchange of funds that these decisions generate.
• These are fundamental for the well-being and economic development of society:
• Allow families to optimize their consumption, investment and savings decisions
• Allow companies to choose and fund their investments.
• Finance can be split into three main areas:
Area DESCRIPTION COURSES AT UC3M
Asset Valuation Investment decisions in real Financial Economics
and financial assets.
Financial Institutions that enable the Financial System and
Institutions flow of funds (markets, Banking
banks, legal system...).

Financing and Financing Decisions of Financial Management

Corporate firms. and Corporate Finance
Governance
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1.1 Introduction to Finance
What are we going to study in this course?

• To determine asset prices and to optimize investment

decisions.

• We will focus on financial assets and markets because:

• Financial markets enable the agents to fund their
consumption and investment needs in real assets.
• These are the most efficient and transparent markets.

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1.2 The concept of Investment
• Investment: “technology” that transforms current wealth into
future wealth. It creates wealth.
• Types of investments:
• Real Assets (companies and, predominantly, individuals): tangible and
intangible goods.
• Financial Assets (individuals and, predominantly, companies): contracts
that give the right to receive a future payment in exchange for a payment
today.
• Link between Financial and Real assets:
• Each agent chooses its consumption and investment levels in real assets
according to its wealth.
• If Wealth ≥ Consumption + Investment in Real Assets,
• Excess invested in the purchase of financial assets.
• Si Wealth < Consumption + Investment in Real Assets,
• Deficit financed via sale of financial assets.
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1.3 Financial markets: financial assets
• Debt product (loan, bond, bill, etc): Contract that entitles
the purchasing side the right to receive a future stream of
predetermined periodical payments.

• Property rights (shares/stocks): Contract that entitles the

purchasing side the right to:
• Receive a share of the company profits (when applicable).
• Control corporate decision making via voting rights.

• Derivative products: Rather than an asset, it is a bet on the

future value of the asset(s) they are linked to.
• Put and Call options, swaps,…
• Risk management and speculative purposes.

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1.3 Financial markets: operations
• Buy: We invest in financial assets because:
• We wish to transfer current wealth into the future as we don’t want to
increase today’s consumption or investment in real assets any further.
• We expect the value of an asset to increase in the future (speculative
purposes).

• Sell: We sell financial assets because:

• We wish to transfer future wealth into the present in order to finance
today’s consumption or investment in real assets.
• We expect the value of an asset we own to drop in the future.

• Short selling: We borrow a financial asset in order to sell it;

the objective is to repurchase it later (to give it back to the
original owner/lender) at a lower price (hopefully).
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 1.3 Financial markets: operations
• Example (short selling): Three investors have €1,000 euros each and different amounts of Telefónica
shares (valued at 5 euros each).
• Carmen obtains beneficial terms from the bank for giving up her shares’ political rights. She
keeps her share ownership in the long term.
• Ana believes the share price will go down and wants to sell.
• Pedro believes the share price will go up and wants to buy.

Ana Pedro Carmen

Initial balance Balance 1000 1000 1000

Nº of shares 0 0 100
Ana short sells 100 shares to Pedro for Balance 1500 500 1000
Nº of shares -100 100 100
€5.00
Dividend payment of €0.10 per share Balance 1490 510 1010
Nº of shares -100 100 100
Ana buys 100 shares to Juan for €4.00 Balance 1090 510 1010
Nº of shares 0 100 100

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 1.3 Financial markets: types
• Financial Markets: Markets where financial assets are issued and exchanged.
• Classification:
● According to the type of financial asset negotiated:
●Public or private debt markets
●Stock markets
●Derivatives markets
● According to the level of regulation:
●Organized markets: regulated markets where operations are
standardized and liquidity tends to be high.
●Unregulated markets and OTC (over-the-counter): each operation
is unique.
● According to its function:
●Primary markets: markets where financial assets are issued and
sellers obtain funds.
●Secondary markets: already issued assets are exchanged, providing
liquidity to their owners.
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1.3 Financial markets: who is who?
• Investor: Person or institution that buys or sells financial assets.

• Speculator: Person or institution that buys or sells financial

assets in order to profit from favorable fluctuations in prices.

• Regulator: Institution responsible for determining the laws and

rules that govern what financial institutions can do.

• Commercial Bank: Institution whose main business is to

receive deposits and to give loans accordingly.

• Investment Bank: Institution that enables corporate financing

processes (IPOs, debt issuance…).

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1.3 Financial markets: who is who?
• Company: Corporations are the main issuers of financial
assets.
• Other issuers are: public sector (public debt) and individuals (loans)
• They are the major investors in real assets which they
fund issuing financial assets.
• A company can be defined as a set of investment and financing
decisions.
Assets Liabilities
(Investment) (Financing)
• Two types:
• Listed Company: bonds and shares are quoted and traded in
secondary markets.
• Unlisted Company

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1.3 Financial markets: who is who?
• Analyst: individual who analyses asset characteristics with
the objective of estimating asset values.
• The analyst scrutinizes the annual accounts and meets key people at
corporate and industry levels.
• They can focus on a particular company, industry or geographical area.
• They tend to work for investment funds, brokerage firm, or investment
banks, in order to support the decision making process of these
institutions or their customers’.
• Analysts write reports with a buy, sell or hold recommendation.
• Two main types of analysis are prepared:
• Fundamental analysis main focus on financial reports and
“qualitative” parameters (management, competitive advantages,
potential risks…)
• Technical analysis main focus on market historical data (prices and
volumes); charts are widely used.

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1.3 Financial markets: who is who?
• Trader individual who buys or sells financial assets
• It could be an individual investor, and, more often, an investment
bank employee who operates on behalf of the bank according to its
own decisions.
• Broker Individual or company that intermediates a transaction
between a buyer and a seller.
• Investment Fund Manager Individual or company that
manages a group of investors’ funds, who receive in turn
proportional shares.
• The salary is linked to the how the value of the fund evolves.
• Two main investment funds management techniques:
• Active Management: select best investment opportunities based on prior
analysis.
• Passive Management: buy and hold a portfolio representing a specific
market/index.
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1.3 Financial markets: who is who?
• Arbitrageur: individual who looks for arbitrage opportunities
and usually works for investment banks or investment funds
• An arbitrage opportunity allows investors to obtain riskless profits at
no initial cost.
• If an asset is quoted in two different markets at a different price there
is an arbitrage opportunity since it is possible to buy in the cheap
market via short-selling in the expensive one.
• If the market works correctly, the arbitrage opportunity gradually
disappear (by a supply-demand argument)
• Example: let’s assume that the exchange rates (including market fees) in
Frankfurt are €10 = $13 =£5, while in London £5= $15= €12.

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 Useful URLs
• Bolsa de Madrid
• [Link]/esp/[Link]
• NYSE New York Stock Exchange
• [Link]
• CNMV Comisión Nacional del Mercado de Valores
• [Link]
• SEC Securities & Exchange Comission
• [Link]
• Standard & Poor’s
• [Link]
• Moody’s
• [Link]
• MEFF Mercado Oficial de Futuros y Opciones Financieros en España
• [Link]
• LIFF London International Financial Futures
● http:// [Link]
• Chicago Mercantile Exchange
● http:// [Link]/market-data/delayed-quotes/[Link]

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Bibliography
• 1. Grinblatt , M. y [Link], “Mercados Financieros y
Estrategia Empresarial”, McGraw-Hill 2003.
• Chapter 1

• 2. Brealey, R., S. Myers y Allen, “Principios de

Finanzas Corporativas” 8ª edición, Mcgraw-Hill 2006
• Chapter 1

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