Chapter 1: Introduction
Financial asset
Debt vs Equity
Price and risk of financial asset
Financial asset vs tangible asset
Financial market
Role of financial asset
Role of financial market
Classification of financial market
Market participant
Globalization of financial market
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Concept of Financial Asset and Financial
Asset
Asset: Item or resource or anything else on which a
particular party has present ownership claim or
using right based on past transaction with future
benefit expectation is known as an asset.
Financial asset: The paper document against
which the owner has certain amount of financial or
monetary claim to the issuer is called financial
asset. For example - common share, preferred share
and debenture.
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Debt vs equity
instruments:
The financial asset that represents
creditor position of the
holder/buyer/supplier in the issuing
business is called debt instrument
(debenture/bond) and the financial
asset that represents ownership
position of the holder/investor/buyer in
the issuing business is called equity1-3
instrument (common stock).
Islamic equity
instrument
The instrument issued by a corporate form
business for raising capital for investing in
operations where the business must be halal (free
from riba and gharar and maysir) product must be
structured according to shari’ah the way the funds
are structured must conform to Islamic principles,
the principle of profit-loss sharing will be pro-rata
basis and the shares of the company are
negotiable only if the company owns some illiquid
(real) assets is known as Islamic equity
instrument/asset/security.
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The price of a financial asset and
risk:
A basic economic principle is that the price of a
financial asset is equal to the discounted present
value of its expected cash flows at a desired
discount rate, even if the cash flow is not known
with certainty. By cash flow we mean the stream
of cash payments over time by the issuer to the
holder/investor. The price of a financial asset is
directly and inversely related to its expected rate
of return and cash flow stream. This expected
rate of return is directly and positively related to
uncertainty i.e. level of risk. 1-5
Financial asset vs tangible
asset
Financial asset is the paper document that
has no productivity and physical existence. It
documents only the transfer of fund from one
to another. For example, common share,
preferred share and debenture.
Tangible asset is the real or productive asset.
It has physical existence and it helps to
produce product and provide service. For
example, land, building and machinery.
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Role of financial
asset:
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Financial market:
System/process/mechanism/method/w
ay/technique of dealing with financial
assets either for issuing by the issuer
to the investor or for trading
between/among investors is called
financial market.
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Islamic financial market
Islamic financial market upholds the
important role within the Islamic
financial system as conduits of fund
from surplus units to deficit units within
the interest-free realm of shariah,
where transactions for financial assets
must be free from gharar (excessive
uncertainty) and maysir (gambling).
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Role of financial
market:
1. Provides price discovery process
2. Offers liquidity
3. Reduces search cost and information
cost
4. Facilitates transfer of fund from
surplus group to deficit group
5. Provides lending of surplus fund and
borrowing for shortage of fund.
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Classification of financial
market:
By nature of claim: Debt market, where
debt instruments are traded and equity
market, where equity instruments are
traded.
By maturity of claim: Money market,
where financial assets are traded for less
than one year time period and capital
market, where financial assets are
traded for more than one year time
period.
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Classification of financial
market:
By seasoning of claim: Primary market,
where new and fresh financial instruments
are issued by the issuing business to the
investors and secondary market, where
existing financial instruments are exchanged
among investors.
Based on delivery: Cash or spot market,
where transaction is settled down at present
and derivative market, where agreement for
exchanging financial instruments is made at
present but transaction will be settled down
in future through delivery of financial assets.
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Market participants:
Households
Partnership & corporations
Government
Government agencies
Brokers
Dealers
Specialists and
Regulators.
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Globalization of financial
market:
Globalization of financial market
means the integration of financial
markets throughout the world into an
international financial market. Factors
those are leading to the integration of
financial markets are (a) deregulation
or liberalization of markets and the
activities of market participants in key
financial centers of the world
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Globalization of financial
market:
technological advances for monitoring
world markets, executing orders and
analyzing financial opportunities and
(c) increased institutionalization of
financial markets. Global competition
has forced governments to deregulate
or liberalize various aspects of their
financial markets so that their
financial enterprises can compete
effectively around the world.
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Derivative markets:
In some contracts, the contract holder has
either the obligation or the choice to buy
or sell a financial asset at specific future
time. The price of any such contract
derives its value from the value of
underlying financial asset, financial index
or interest rate. Consequently these
contracts are called derivative
instruments.
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Market Efficiency
An efficient market is one in which security
prices adjust rapidly to the arrival of new
information and therefore, the current
prices of securities reflect all information
about the security. In broader sense if the
market price of a particular security can
reflect all relevant information and the
market can settle transactions with
minimum cost then the market is
considered as efficient.
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Market Efficiency
Operational efficiency: If the market
can settle the transactions within
minimum cost easily and quickly then
this is called operationally efficient
market. A market condition that exists
when participants can execute
transactions and receive services at a
price that equates fairly to the actual
costs required to provide them.
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Market Efficiency
Pricing efficiency: If the determined price
in the market can reflect all relevant and
available information about a particular
financial asset then this is called pricing
efficiency. Followers of the efficient markets
theory hold that the market efficiently deals
with all information on a given security and
reflects it in the price immediately, and that
technical analysis, fundamental analysis,
and/or any speculative investing based on
those methods are useless.
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Efficient Market Hypothesis
(EMH)
1. Weak form efficient
market hypothesis
2. Semi-strong form efficient
market hypothesis
3. Strong form efficient market
hypothesis
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