1.

Introduction
p.2
Welcome!

- Name/personal details

- Professionnal backgroup/Financial knowledge ?

- What do you expect from this class?

Course objective
➢ This course is the first module of compulsory training as requested by
the CSSF Circulars 17-665 and 17-670 as part of the implementation of
the MiFID ii.

➢ Purpose of this course is to give an introduction to the general

principles of financial markets and their interactions with the economy

➢ It also allows the introduction of the five-module cycle of training set up

by the Chambre des Salariés in order to meet the needs as expressed
in the CSSF circulars mentioned above.
Course materials

==> Financial instruments and markets - M. Wenda

==> weekly slides

==> proposed readings

2. Economy
P.3
Economics: ethymology definition

“Economy" coming from Latin Oeconomia and coming from the

ancient Greek Oïkonomia, management of the House, made up
of:

- Oikos, House
- Nomos Administer

It is a matter of administering, or managing, a large house

Economics: etymology definition

WHY: survival/better living conditions

HOW:

- « Time is Money »
-

- Allocation?
Economics – a historical approach
Economics - creation of money
Economics and economical theories
➢ Economics until the 18th century referred to microeconomics and
focuses on the actions of individual economic agents (individual,
household, but also enterprise...) and on the various factors likely to
influence their decisions.

➢ macroeconomic vision will come later, during 18th Century with the first
representations of the economy through the concept of exchange and
therefore of flows between agents

➢ More specifically, we define macroeconomics as the part of the

economic science that focuses on studying global economic
phenomena and their relationships and interactions. A global
phenomenon is the aggregation of individual behaviours, the latter
being either on a national or international scale or even that of a sector
of the economy.
Macroeconomics theories: the invisible hand
➢ Adam Smith 1776 Father of capitalism
➢ Government should not take part in markets
➢ Economy is driven by self-interest

SUM(individual choices) ➔ Economic growth

COMPETITION = GOOD
<<PRICE
>>PRODUCT QUALITY
>>SERVICE QUALITY
>>DIVERSIFIED OFFER
 Macroeconomics theories: general equilibrium
Consumers
- Drive demand
- Want to maximize utility
- vs. their budget constrain

Firms
- Drive supply
- Want to maximize profits
- vs. given capital/labor

Equilibrium = allocation of goods and services

by a unique price which is the solution to
every agent’s objective problem
:

 Economics in the 20th century : Orthodox

Keynesian
➢ The true distinction between microeconomics and macroeconomics, in
addition to the invention of these two terms itself, thus emerges at the
end of the first third of 20th century

➢ Keynes the 1936 release of his "General Theory of employment, interest

and money“

➢ Success:

o Response to the 1929 crisis

o Pedagogical and accessible wider audience
Keynes Animal Spirit – Definition
➢ People decision to invest in future activities are driven by irrational
thoughts

➢ When you buy an investment = hope that it will pay = make a guess
about the unknown
Past performance does not guarantee future returns
Keynes Animal Spirit – Tulip bubble mania

Expectation price > price rise

Mania: pay more than intrinsic value

End of mania = collective realisation that

price is excessive
Animal Spirit – Tulip bubble
Animal Spirit – dot-com bubble
Animal Spirit – House bubble
Keynes: “In the long run we will be dead”

EXTRAORDINARY SITUATIONS = INVISIBLE HAND IS BROKEN = STATE INTERVENTIO

People are poor

Factories want to be run but there is no demand
People want to work but there is no demand either

Keynes – in conclusion
The economy is intrinsically unstable and prone to erratic shocks

Because of a crisis, the economy can drag on into underemployment or,

what is the same, take a very long time to return spontaneously to full
employment

The level of production and employment depends mainly on the overall

demand and the public authorities can influence the level of “effective”
demand to ensure a faster return to full employment

Fiscal policy is generally preferred to monetary policy because the effects of

fiscal policy measures are more direct, predictable and faster than those of
monetary policy
Keynes – who pays?

MORE JOBS = LESS UNEMPLOYMENT = MORE SPENDING POWER =

MORE PRODUCTION =

MORE TAX REVENUES FROM BUSINESSES = MORE STATE REVENUES

IS/LM/BP model
➢ The IS/LM model was popularized
in 1939 by John Hicks (1904-1989)
and 1949 by Alvin Hansen
(1887-1975

➢ Used by governments or central

bank governors to explain the
impact of monetary and fiscal
policies

➢ great success until the mid-1970s

but it is considered so practical to
use and describe things that so
few models can still explain
IS Curve I = Investments
S = Savings
R= interest rate
Y= GDP

1. How to read investments if change in interest rates:

If R goes UP = LESS planned investments = LESS

production = LESS GDP

If R goes DOWN = MORE planned investments = MORE

production = MORE GDP

2. How to read savings if change in GD

If Y goes UP = MORE consumer saving/spending = MORE

capital = price for money LOWER = interest rates LOWER

If Y goes DOWN = LESS consumer saving/spending =

LESS capital = price for money HIGHER= interest rates
HIGHER
P

 L= liquidity preference R= Interest rates

LM curve M = money Y= GDP

1. How to read LM curve if GDP goes up:

If Y goes UP = MORE economic activity = MORE transactions =

MORE demand for money = HIGER R

- if you need capital: you have to pay more to have access to

more
- if you have capital: you want people to pay you more to part
with your money

2. How to read LM curve if GDP goes down

If Y goes DOWN = LESS economic activity = LESS transactions

= LESS demand for money = LOWER interest rates

- if you need capital: you will pay less for it

- if you have capital : accept to be paid less to part with the
money
:

 IS/LM IS:
- Negative slope
- Demand exceeds supply on the right hand side
- Temporary imbalances are corrected by horizontal
moves towards IS
- IS moves towards the right if there is an autonomous
increase of aggregate demand.

LM:
- Positive slope
- There is excess demand of money at the right hand
side of LM
- Temporary imbalances are corrected through R, which
means vertical movements towards LM
- Monetary policy operates through real money supply
(M/P) in order to determine the position of LM;
- LM moves to the right if M/P (real money supply)
increases.

 BP curve
BP=Balance of payment
how a country accounts for the different ways that money/payments
INFLOWS in a country VS. money/payments OUTLFOW

Equilibrium

Current account: currency/payments Capital account: IN/OUT purchase of

INFLOWS&OUTFLOWS assets
example: exports/imports, income example: buy/sell actions, bonds, real
(divendend from stock, etc), transfers estate etc…
of money
IS/LM/BP General Equilibrium in open
Economy
Permanent Income
Income VS. future expected income

Current/short-term/non meaningful income VS. stable/permanent higher income

Consumption based on stable/permanent income

[Link]

INFLUENCE ON DEMAND FOR MONEY:

When permanent income is HIGH demand for money HIGH

Retun on assets is LOW demand for money is high

Inflation rate is LOW demand for money HIGH

Natural unemployment

Unemployment: nb of people in the labour force who do not currently have a job and are
- a) currently seeking a job
- b) available to work

Unemployment rate: measures employment as a % of the LABOUR FORCE (vs. the population)

Natural or frictional unemployment: there can no be full employment in a country because of

- a) relocation
- b) entering the workforce
- c) re-entergin the workforce
- ==> TRANSITIONAL UNEMPLOYMENT

FULL EMPLOYMENT = 100% employment rate - 3.4/4% frictional unemployment

Structural unemployment
Structural unemployment: mismatch between skills employers NEED vs. skills employees car OFFER

- Industries collapse in certain regions and skills are no more needed (Moselle for example)

- Advance in technologies reduce employee need and change required skills (process automatisation)

- Student degrees do not match employer skill need (university focus on core skills)

- Relocation can be complicated (family, monetary, cultural reasons)

- Personal preferences or limitations (age)

POTENTITALLY BECOME LONG-TERM

SOLUTION: TRAINING & LABOR REQUALIFICATION

Cyclical unemployment
Purpose of economics
Macroeconomics = study global quantities of an economy = measure the average performance of economy

Variables includes but are not limited to:

- Production

- Investment

- Consumption

- Unemployment rate

- Inflation
Production
Traditional definition:creating goods by combining resources and the result of this activity

Definition from the view of economics:

- production = activity that brings value by the realisation of goods and services
- by transforming factors of production into new products

Scope:
- use limited ressources to answer to unlimited wants
- satisfy human needs by increasing their economic well being by:
==> improving cost/income
==> increasing income with more efficient market production

Market or non market?

- market = sold on a market for a price
- non-market = free of charge or price is inferior to half of the cost of the production
Investment
Investment definition: operation that aims to MAINTAIN or INCREASE capital stock of an economic agent

Example of economic agent:

- individuals = buy a house
- companies = buy a machine
- government = build a road

Productive investment : in the case of a company

= acquire new means of production or improve their performance = prospects of increase profit
= committing a major expense TODAY for a FUTURE profit

Deciding factors: compare expected vs. interest rate

Example of company investments: replacement of obsolete equipment, modernization, financial

investments, strategic investment (endogene, exogene)
Consumption

SAVINGS

CONSUMPTION INVESTMENT
use of goods and ressources which do not use of money to create added value to whole
improve/create value for society - money is society (innovation, production, improvement of
“burned” living standards - at the end > in GDP)

Major factor to measure economic situation DIFFERENT FROM SPECULATION

Investments vs. consumption case study
 Inflation

In ation = the loss of purchasing power of the currency that results in a general and sustainable price
increase without discrimination between the category of agents
- is different from increase in cost of living
- is assessed by a indicator consumer price index : CPI
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 Inflation - 4 main factors
1. In ation by costs:
- price of product increases because manufacturing costs increase, usually because of
increase in wages
- if increased price of abroad raw materials = imported in ation
- Vicious cercle: is price go UP, wages go UP, stimulating prices to go UP, etc

2. In ation by demand
- demand for goods and services increases but supply fail to follow
- companies are putting in place plans to increase production
- as long as demand is not met, prices will continue to increase
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 Inflation - 4 main factors
3. Imported in ation
- The depreciation of a currency in relation to major world trade billing currencies (EUR,
USD, GBP, YEN) generates an increase in the price of imported products.
- Re ected in all sectors of the economy and affects mainly businesses and households
- This can be linked to a signi cant increase in the prices of energy and agricultural products
in world markets.
4. In ation by excess of money supply
- stock of money circulating in the economy is too high compared to the quantity of goods
and services offered
- Created by the commercial banks or by the nancing of the public de cit by the central
bank
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Economic environment & Trade definition
Economic environment = SUM(external economics factors) ==> influence buying habits of consumers
and businesses ==> impact on a company’s performance

Macro factors: Micro factors:

- Employment/unemployment - The size of the available market
- Income - Demand for the company’s product and services
- Inflation - Competition
- Interest rates - Availability and quality of suppliers
- Tax rates - Reliability of the company’s distribution chain
- Exchange rates
- Saving rates
- Consumer confidence level
- Recessions

NO CONTROL OVER FACTORS BUT CAN ASSESS CONDITIONS

Market
Markets = location where supply meets demand (localized or not)

Why? = to make the exchange possible

How? = THE PRICE

- variable that will allow agents to make their buying or selling decisions
- information on value (high price = rarity)
- influences human behaviours & quantities produces by economy
Economic flows
Economic agents = entity, legal person or individual that are subject to external influences, interact
and create exchange

Specialization of economical agent:

- economic agent can’t satisfy all needs
- specialization in the fiels where they are the most effective to optimize income
- great diversity and permanent evolution

Economic trade/flow = movement of goods, services and money:

- Actual or material flows refer to the movement of goods and services
- Monetary or financial flows refer to the movement of money
Example of flows

Business flows with exchanges with: Households flows with exchanges with
- Other companies - Businesses
- Households - Other households
- Financial institutions - Financial institutions
- Public administrations - Public administrations
- The rest of the world - The rest of the world
Money
Characteristics:

- Exchanges and flows not possible without money

- Solves non-double coincidence problem
- Not perisable
- Universal means of payment & guaranteed by the banking system
- Liquid asset:directly available for transaction

The 3 functions of money:

- Exchange instrument: buy good and services without having to provide good and services in
exchange
- Unit of account: standard measurement for valuation - compares the price of one property to the
other
- Saving instrument: can be kept for deferred consumption ==> reserve of value ==> transfer
purchasing power to future (! Inflation !)
Globalization
Definition: primacy of the capitalism system on the whole planet, not only for economic point of view
but also geopolitical

Former brakes:
- Soviet Union
- China
Globalization
Globalization: changed the dimension of the trades ==> transnational logic

Consequences on economics:
- organisation of production on a transnational basis
- globalization of costumer standards - tastes and habits
- competition for the control of ressources and markets

Secondary effects, globalization affects

- borders are not only geographical or physical but also regulatory
- borders become an obstacle to the expansion of capitalism & accumulation of wealth
- engine of its own dynamic outside the control of states
- threatens attributes of sovereignty : money control or management of public finances
Globalisation vs. mondialisation
Mondialization vs. globalization?

Mondialization:
- world as a space, society, relevant scale of analysis - especially for economics
- geopolitical era of 1990’s characterise by scientific & technological progress & free movement of
men, goods, idea, capital

Globalization:
- idea of making “global” something that is “ local”
- internalization and universalization of issues - not only for trade, finance and industrial
transactions but also for politics & social interdependencies
- behaviour or economic agents & financial actors to design activity by searching efficiency at
planetary level
- necessary use of multilateralism to deal with issues
- responsibility at the international community
Trends and perspectives
Globalization:
- already existed in the past
- was not/never always related to economics
- usually followed by fall or empires - “deglobalization”

Globalization became “economic” in the 20the century

- outtakes politics
- extension to the planet of movements of capital, goods and people
- increase inter-dependency of national economies

But still has other related aspects:

- political ==> advancing democracy + internalization of conflicts

- religious ==> return of radical views in religion
- social ==> globalization of delinquency
- linguistic ==> english universal language
Globalization in the 2000’s
A. Globalization continues it’s way : up to 2008

“Universalization of Western liberal democracy as the nal form of human government”

Fukuyama : “End of history and the last men” - book from 1992

B. The world becomes multi-polar : from 2008 to before COVID

- rise of regions to better distribute wealth

- developing country are becoming regional leaders (India, China)
- New regional institutions - “governed democracy”
- Challenges: potential source of political errors, rivalries and geopolitical tensions

C. We are witnessing the end of globalisation : today and the future?

- Slowdown of economic growth and rate

- Damaging macro shocks
- Domination of national champions with consolidated power
- Fragmentation of global with outbursts of financial and military war
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Financial Information
Data in circulation:
- not obvious to understand
- subject to interpretation
- how the info was given etc…

Economic indicators: sign, clue or measure on an event that can have an impact on consumers,
businesses and governments
- info is provided by different sources
- understand logic
- measure consequences

Financial indicator rules:

- Sources: who? why? bias? reliability? verifiable? backed by another source?
- Context: when? topics? context
- Scale: perspective? choice of scale?
Main indicators, definition
Economic indicator: numerical data that measures a certain dimension of an economic activity of a
sector or country
- public
- regular intervals

Typology: based on importance and impact

1. Leading indicators ==> signal future changes, useful for short term predictions BUT not always
accurate
2. Coincidence Indicators ==> economy is evaluated in real time, valuable info on current state of
economy
3. Lagging indicators ==> change after the economy change, used to confirm patterns

Limit: boundaries not always clear-cut between indicators

List of indicators 1
List of indicators 2
Systemic model

Systemic model: all indicators are

interconnected and mutually influencing
forming a continually moving system

3 main player in economy

- consumers = yellow
- companies = green
- state = orange

A box = economic indicator

Arrow = interaction between indicator

Economical cycle and financial markets
Financial market cycle are subjects and linked to economical cycle
- natural and repetitive economical cycle phenomena
- un-natural or influenced by authorities (keep the economy from recession or overheating through
interest rate levels

Financial market cycle TRIO: Stock exchange - Economy - Rates

Theory of cycles: evaluate and predict economic crisis and recoveries in financial markets through the
study of 3 major markets

==> Bond/interest rates market: cf. IS/LM model, if interest rates go UP, GDP goes down and vice versa

==> Stock markets: lag time in relation to bond market due to psychological bias of investors

==> Commodity markets: lagging indicators because based on entire economy (bond&stock markets)
Stock market crisis
1. Economy and crisis
- globalisation
- acceleration of information
- proliferation of credit
- increase in prices + speculation ==> bubble

2. Monetary policies and crisis

- expansion of money/credit by low interest rate
- investments not financed by actual ressource of economy
- economic fluctuations ==> recession

3. Behaviour and crisis

- mimetic behaviour
- self fulfilling forcasts
- ==> speculative bubble
2008 sub-prime crisis
Subprime definition: loan pledge on the housing of the borrower, fixed interest rates for the first year
and the variable

They develop in the US in the 2000’s because:

- Bank less looking into borrowers
- Bankers bonuses paid on contracts
- Bank subject to low requirements in terms of liquidity (low Equity/Loan = Capital Adequacy ratio)
- Up market, housing price was going up
- If the borrower can’t pay anymore the house is sold

What changed?
- Interest rates went UP between 2004 and 2006 to 5.25% ==> DEFAULT
- Too many house for sale ==> house price DROP ==> impossible resale
- Expansion to all over the world through SECURITIZATION of the subprimes
Securitization: from loan to bond
What’s in it for the banks?
transfer the risk loan ==> high Capital Adequacy Ratio ==>continue giving credit
reselling loans = more revenues

What’s in it for the investors?

access new asset class
increase revenues and diversification
Wars and markets

When Pearl Harbour was attacked, it is not possible to say that the macroeconomic indicators were very good either! This morning when I
woke up, I noticed that the value of the action of a British company that I hold had dropped on the London Stock Exchange. It pleased me
and I bought others”.

What if a third World war was declared? “I would buy more shares. The last thing to own during a war is money. The currencies are being
devalued. It is better to have a farm, a house and what affects the well-being of your home. During the Second World War, the stock market
continued to generate income

(Re)bounce
 Financial markets
Definition: a place (physical or not) that allows the meeting between economic agents with a surplus
of capital and agents with financing needs

How: through instruments (stocks, bonds, treasury notes) that allow companies to find financing
means outside the banks

Purpose:
- finance the development of the economy (enterprises, agents, communities)
- ensure mobility and liquidity of investments in securities
- provide regular valuation of securities
- ensure equality between stakeholders
- secure transactions and their clearing
The different markets: equity/bonds
Capital market definition: composed of several markets - financial market, money market, derivatives
and foreign exchange

1. Equity market: trade ownership of shares in company looking for financing

2. Debt market:
- bond market: debt financing for companies and governments
- money market: short term capital market (less than 1 year)
- interbank market
- currency market

3. Commodity markets: energy product, metal, agricultural products

THESE ARE ALL SPOT transactions: settle on the spot which means between 1 and 3 days - product
is settled versus cash (or in case of contractual settlement, product is settle immediately and cash
reco done afterwards)
The different markets: derivatives
Derivatives:
- change the settlement terms in different ways
- each derivatives is linked to another asset (stock, stock index, etc…) of which it is inseparable
- value of derivate will follow the underlying
- high leverage effect ==> min bet, high gain ==> RISKY INSTRUMENTS
- obey strict rules with dissemination and transparency to protect investors
- Clearing houses in the middle to lessen admin work but also manage liquidity/exchange
margins

1. Forwards: postpones the settlement of a transaction in the future which will change price as it will
happen in the future

2. Swaps: changes cash flow of settlement by changing the nature of the payment (fixed rate against
floating rate)

3. Options: makes the market contingent - settlement becomes optional

Primary vs. secundary market
What is being exchanged?
A security=a title=a financial document provided by an agent to another agent who has brought him
an asset on return (currency, another title, material property, know-how, etc…)

1. Shares:
- Titles in limited liability companies or limited partnerships by shares
- Issued when a company is formed or increase of capital
- Each action represents a share of capital & gives set of rights

2. Bonds:
- long-term debt on an issuer (company or state)
- each bond = fraction of the total bond issue
- bond holder is reimbursed amount of the loan+ receives regular interest rate payments

3. Fund shares
- several types of funds based on type of investments
- several types of legal structuring
How exchanges are carried out?
How to enter the market?
==> bank account or transfer agent account in case of fund shares
==> with access to the market through a financial intermediary

Steps when passing an order:

1. customer enter the order ==> 2. goes into the market for confrontation of offers to the purchase and
the sale ==> 3. establishment of a quote ==> 4. post negotiation processing ==> 5. settlement and
delivery

To work it needs:
- Automatic routing of orders to convey them to a central quotation system via a collector or a
negotiator and through different modes of transmit
- Central quotation system = ensure automatic exchange of orders
- System of real time dissemination of info fed bu quotation system
- Securities settlement/delivery system between intermediaries
- Central book order to inform on number of shares of a certain company purchased and sold
Who trades?
SECURITY ISSUERS INVESTORS

Businesses Private investors

looking for financing through issue of shares or Individuals invest to grow savings
bonds Companies to manage cash flow or invest

State/local authorities ==> DEBT only Institutionnal investors

Place funds they receive from masses
ex. insurance companies, pension funds,
investment funds
Financial Institutions ==> looking for Foreign investors
ressources Non resident seeking to invest/diversify

Financial institutions
Make remunerative instruments
How are trades controlled?
Independent authorities responsible for CONTROLLING AND ENFORCING market rules
Critical aspects
Market efficiency hypothesis (invisible hand) : prices reflect all the info available and everyone has
access to the same info

Crisis?

Rating agencies: give independent information on the creditworthiness of issuers, ie. ability to meet
the repayment deadlines

Assessment procedures?
Real independence?
Devastating effects of ratings?

Auditors: objective examination and evaluation of an organisation to make sure that the records are a
fair and accurate representation of the transactions they claim represent
 Interest rate and debt
Definition: the amount that a borrower has to pay, in the form of income, to the person who lent him
money to be able to use it
- % of the nominal value
- price of time

3 parameters:
- duration of the loan : the longer the more expensive (except special cases!!!!)
- risk of default : the riskier the more expensive
- market conditions : the more volatility the more expensive

Short-term (based on monetary policy and central banks) vs. Long terms (based on evolution of the
bond market)
Central bank policy rates
Definition: Impact the rate of loans for individuals and businesses

3 types of policy rates:

- Refinancing rate (repo rate or rate refi) : rate at which commercial banks borrow from CB
- Deposit pay rate: rate at which mandatory cash deposit of commercial banks to the CB are paid
- Marginal rate: rate at which the commercial banks borrow cash from CB by providing as collateral
debt securities they hold

Interbank rate: daily rates calculated by CB and applied to EU banks when lending to each-other - s
- Euribor (EU interbank offered rate): average interest rate at different maturity
- Eonia (Euro overnight Index Average): average interest rate for 24h ==> determine rate of regulated
saving booklets
Additionnal definitions
- Internal rate of return:
- Risk free rate: rate without risk of non-reimbursment
- Bank base rate: min rate offered by banks (Euribor/Eonia + bank margin) for best costumers
- Debit rate: interest rate for ordinary consumers
- Overall effective rate: interest rate including fees
- Nominal interest rate: interest rate fixed at the issue, base for coupon calculation for bonds
- Fixed rate vs. variable rate
- Index rate: indexed on index or any price defined in advance (ex. inflation)
- Market rate: effective interest at given time in given market
- Periodic rate: rate applied to remaining capital to calculate interest at maturity
- Proportional rate: annual rate divided by number of maturities in a year
- Real rate: nominal rate after deduction of inflation rate – if high inflation, rate may be negative =
borrowing
- Revisable rate: revisable interest rate under condition set in the original contract
Impact and influence
Interest rates: IS/LM MODEL!!!!!!!
- define consumption and investment
- Indirectly influence exchange rate and inflation
- hence control by the CB through monetary policies

DECREASE IN INTEREST RATE INCREASE IN INTEREST RATE

Facilitate credit Control overheating of economy

increase consumption and investment limit creates and placement of savings
increase stock market because of decrease price of bonds made less
higher demand interesting by high rates
LIMIT: low rates = soft growth
Bond market – definition
Definition: acknowledge of a debt by an issuer (fraction of a loan issue for which the holder receive
interest – coupons)

Potential issuers:
- public/international organization
- government bonds to finance expenses (AOT, Bund, Gilts, T-bonds)
- public sector bonds: less security than government bonds

- Private company : corporate bonds – price based on company financial health

- Credit institution/banks: certificate of deposit

Bonds – characteristics

Primary/secondary market: issued on primary market, exchanged on secondary market with variable
rates

Issue price and refund value: usually at 100, but can be less or more - reimbursement 100 at maturity

Duration: set at the beginning, can be subject to early redemption (call) at given price, defines
performance (the longer the more)

Quality of issuer: based on rate from rating agencies

Typology based on nature
- Ordinary bonds: fixed term bonds that have an unvarying interest rate for that period- no
advantage in case of bankruptcy
- Preferred bonds: reimbursed in priority in case of bankruptcy guaranteed by certain assets
of the debt
- Subordinate bonds: holders not be reimbursed in case of bankruptcy, until after all other
bondholders (privileged and ordinary creditors) have been reimbursed
- Zero coupon bonds: no coupon bonds, (interest is capitalised until maturity) - lower price
- Indexed bonds: performance is linked to the evolution of one or the other index (for example
Inflation, gold price, stock market, etc…)
- Variable bonds/Floating rate notes: coupon is periodically reviewed based on interest rates
- Convertible bonds: fixed rates and term defined but right to convert in stock under specific
conditions
- Bonds with warrants: linked to a stock, gives the right to buy at preferred pre-set price
- Reverse convertible:
- Perpetual bonds: no term date but accompanied by call
- Structured bonds bonds with capital protection
Bonds Pros&Cons

+++++++ ————
no uncertainty - all caracteristics defined at nominal is paid at maturity
the beginning of the contract
greater remuneration than short term value of the bond on secondary market fluctuates
investment
lower risk than equity monetary erosion because of inflation
low entry price - available for all investors initial conditions only available on primary market
greater remuneration based on risk
Rates and yield curve on government bonds

Anticipation of long term inflation or

budgetary deterioration

long-term interest rate = short term

due to decrease in long-term risk

Shorter interest rates HIGHER then

longer ones (ex: high inflation during
overheating period)
Yield curve gov. Bonds vs. Company bonds
Bonds – risks
Bonds are usually considered the safest asset on the market but there are risks related to
specificity of the bonds

- Default/debtor risk: risk to not hbe reimbursed – higher for corporate bonds, measure by risk
agencies

- Liquidity risk: risk to not find counterparty to resell bond due to low volume of market
transaction

- Rate risk: measure the value of the bond, interest rates go UP, bonds go DOWN. The lower
the maturity, the lower the risk

- Foreign exchange risk: if hold in other currency

- Inflation risk: if inflation goes UP, value goes DOWN

Rating agencies
Equity markets
Definition : % of equity of a company ==> no due date, no fixed income, no fixed value

Based on: financial wealth of the company, external factors & risk levels

Indexes: group of shares with common characteristics (geographical or sectoral) (S&P 500,
CAC40, etc….)

Return: Eventual dividend + price fluctuation

Risk: total risk of business and no recover in case of bankruptcy

Rights:
- to dividend: share of profit, varies according to financial health, never guaranteed
- to vote at ordinary or extraordinary general meetings
- to information : usually financial statements
- to distribution in case of liquidation
- to have priority on new shares
- to transmission on listed markets
Typology
Regular stocks:
- shares with or without voting rights
- preferred or preferential: priority to annual profits or distribution in case of liquidation

Non representative shares: no nominal, issued in return for a non-financial contribution, intitled to a
part of benefits or dissolution, limited right to vote

Listed shares: available on the market under certain conditions & regulations
- easier capital rising

- prices are updated in real time (single vs. double fixing)

Valuation: intrinsic value vs. market

++++ ----
- Performance > to bonds - Risky investment
- Income + added value overtime - Variable income
- If listed, high liquidity - Volatility on markets
Sector and influences
Definition: diversification is essential to protect stock portfolio from market changes (not put all eggs
in the same basket) ==> example of diversification: sector

2 main sector classification

- ICB standard maintained by Euronext ==> most used, 10 sectors of activity
- GICS proposed by MSCI ==> advantage to separate cyclical and non cyclical businesses

Economic cycle and sector investment:

- Recession: defensive savings, at the end of the cycle may take interest in cyclical values

- Recovery: most favourable period to invest, all actions go up but cyclical more interesting

- Expansion: strong rise make actors being very selective, higher volatility based on economical
health, cycle favourable for financial operations, capital increase and IPO

- Overheating phase: defensive value

Continuous listing – definition
Continuous listing:
- Negotiate most liquid securities permanently during specific hours
- Quote is changed as executable arrive by confronting offer&demand

Order book:
- synthesises position taken
- For each value orders are classified according to meaning, price and time of arrival
Order book example
Conduct of a continuous quotation
7:15am-9am - Preopening : Orders are recorded in the order book – NO TRANSACTION

9am – Opening auction: The central system determines opening price at which the largest number of
securities

9am-5.30 pm – Session: Introduction of a new orders results in a new quotation for transaction

5:30pm-5:35pm - Preclosing: Orders are recorded – NO TRANSACTION

5:35pm - Closing auction: closing price is determined at which the largest number of securities can
be exchanged

5:35pm – 5:40pm – Last quote negotiation: transmitted orders within closing quote limit are executed
if there is sufficient counterpart at the same price.

After 5:40pm: NO TRANSACTION

Pre-opening
- Trading platform is opened and order arrive automatically
- Tey can be placed, altered or cancelled
- Ex: new purchase order of 900 at 11EUR
 Opening auction
- Based on orders received, opening price is calculated and disseminated
- OPENING QUOTE: PRICE at which MAX amount securities can be exchanged between buyers and sellers
Session
Session:
- possible to enter, modify and cancel orders
- each orders is directly confronted with the others available counterparty
- If no counterparty available, order remains in book

2 priority rules:

- The price priority : a better price limit will have priority

- The time priority: in case of equal price limit, the orders entered earlier will take precedence over
those entered later). When an order is modified (for example, increased by volume or with another
price limit), it will be send at the end of the list.
Monitoring and control
Exchanged are monitored and controlled

Suspension:
- Possibility to suspend orders/limit price fluctuation if too much fluctuations
- Listing stop following a market decision: must contain reason, date and conditions for re-listing

Reservation:
- Reservation threshold: max volatility limit
- Triggers momentarily stop of quotation to enable market to find new balance
- Static threshold: max 10% volatility
- Dynamic threshold: frames the static threshold from one quotation to the next – ex ,%

Fixing:
- Applies to less liquid securities
- Allows exchange of value at fixed price once or twice a day (simple vs. double)
- Follows same pricing as opening and closing auction but 30 min to enter orders
Valuation
Definition: calculate the financial value of a company taking into account the past accounting data
and the development potential of the company
- Different valuation methods
- Plurality of elements to take into account (qualitative & quantitative factors)
- Especially useful for non listed shares

Different valuation for different purposes:

- patrimonial
- pre-IPO/IPO
- acquisition of mergers
- start-up

General principal: evaluate financially the sum that must be paid by a physical/legal parson to acquire
100% of the company + adjustments

2 Main principals:
- actuarial approach : based on ability to generate revenue streams in the medium term
- comparative approach : based on comparison with companies that share a similar profile
CAPM valuation model
Profitability of a stock: SUM(profitability*risk free-risk premium on the market)

Capital asset pricing model: estimate of expected return by the market on financial asset based on
systematic risk

Formula integrates:
- expected profitability on the market
- risk free rate
- systematic risk measurement

2 types of gains:

- Dividends = money transferred to shareholders that reflects and economic reality (good
performance/production)

- Reselling value = speculative resell value has no real economic counter-party but transfer of money
between market players
Risk
Shares: most riskier investments because of possible capital loss between purchase and sale BUT
higher expected return

Liquidy risk: limited possibility of reselling on the market at the requested price
- higher for non-listed securities
- higher for shares traded in unregulated markets (Multilateral trading facilities)

Risk of Capital loss:

- the price of a stock constantly varies depending on the relative quantities of purchase
requests and sales on the market
- influenced by the political and economical environment

Risk of bankruptcy: stocks are the least protected debt in the event of bankruptcy

Foreign exchange risk: for stocks denominated in another currency than the holder’s
Example of foreign exchange risk
AT T=0
French investor buys :
- 1000 shares of an American company
- quote of 15USD
Exchange rate at time of transactions: 1EUR = 1.4USD
Cost in EUR: 10 714 euros ($ 15K/1.4).

AT T+ 6months
French investor sells
- 1000 shares of an American company
- quote of 16 USD (GAIN OF 1USD per share = 16K)
Exchange rate at time of the transaction: 1EUR =1.5USD
Revenu in EUR:10 667 euros ($ 16K/1.5).

DIFFERENCE=10667-10714=LOSS of 47EUR
Indicators, ratios and other tools
To determine value:
- Compare it to a basic financial indicator available from public information
- Stock ratios are popular because easily put into practice/calculated
- Valuation ratios are practical and quick but info must be put into context

Capitalisation: relationship between market cap (nb shares*stock price) and estimated net profits - to be
compared to other capitalisation from the same sector

Earnings per share (EPS): profit divided by number of shares in circulation

Price earning ratio (PER): relationship between market value and it’s profits = Stock price/net earning per
share = official benefit o past financial year.

Price earning growth (PEG) = PER/growth rate net profit over several year ==> PEG>1=overrated value,
and vice versa

Profitability
- Return on equity (ROE) = Current net profit/share capital
- Return on capital employed (ROCE) = operating results/economic assets
- EV/R = market cap+debt-cash/revenues
Currency markets
Currency: mean of payment = value measurement = money = social convention to use this money for
payment

Convention: at all debtors can pay back their debt in that currency and all debt holders are obliged by law
to accept that currency in repayment of the debt (« legal tender »)

Money = TERRITORY

Exchange regimes:
- Fixed exchange rate: currency is pegged to another reference/anchor currency
- Floating exchange rate: one currency fluctuates against all others
- Managed floating: exchange rate influence by BUY/SELL from governments = dirty float

Foreign exchange convention:

- direct quotation: exchange rate expressed as home currency price o unit
- indirect quotation : vice versa

ISO code : 3 letters = 2 for country +1 for currency

Currency codes
Other definitions
Base currency: first currency in a curerncy pair, usually the strongest currency.
- EUR is always base currency
- USD is always base currency except againt EUR, GBP, AUD, NZD

Appreciation/depreciation: rise or decrease in the base currency and vice versa for the 2nd currency

Central bank role:

==> Legal status: monopoly on the issue of notes, independent in theory, still linked to its national system

==> Roles and power: manages state currency, money supply, interest rates, supervise banking sector,
act as lender of last resort for the banking system

==> Reserves and foreign trade : manages country foreign currency and gold reserves, and can act on
FX market to influence exchange rates

==> Terminology :CB=Bank of Country=usually non profit organization

FX players and volumes
FX market:
- where currencies are exchanged
- held by banks and brokers
- transactions around the clock
- liquid but volatile : 90% of trades are speculative
- worldwide market place : currencies traded out of their country or origin
FX pricing theory

One price law: identical products should sell for the same price

The purchasing power parity: exchange rate is calculated by comparing prices of identical products found
in both countries

Absolute vs. Relative PPP: dynamic version of absolute PPP including changes in prices ([Link])
Commodities markets
Commodities markets
==> Agricultural products sold on spot

==> But need for forwards to get financing for planting

==> Transactions: delayed delivery = lag = SPOT

==> Ownership of goods

- documents at the centre of proof of ownership
- Bill of Lading
- Shipped or to be shipped?
- COB: Clean on board
Storage & costs
Risks in commodities
- Price risk and price discovery tools are crucial
- Transportation risks may be signi cant, especially for energy commodities
- “free on Board” FOB: cf oil spills !!
- Freight insurance is well organised with specialised players for commodities: e.g. Lloyds of London
- Risks insured include ordinary and extraordinary (war, riots, strike) risks
- Delivery risk
- Credit risk
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Stock market and regulated markets
Market place: buy and sell goods
Organized vs. regulated markets :
- Organised: centralisation to achieve balance between supply and demand of same unit
- Regulated: supervisory authority with rules and enforcement
Financial markets:
- Confront supply and demand for capital through nancial instruments
- for companies to raise capital outside banks
- Dematerialised for ef ciency gain and internalization
Spot transactions vs. derivatives

INVESTOR PROTECTION : strict rules, regulated, transparency, information, liquidity, central counterparty
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MiFID/MiFID II
MiFID 1993
Change the Competitive context of nancial markets:
- open regulated markets to competition
- harmonise the conditions throughout the EU ==> EU passporting

Increase control of:

- information and classi cation for potential clients
- 3 types of clients: FI ( nancial institution/banks), professional, non-professionnal (individuals)
- policy of execution : formalisation of the order execution process + best execution (costs and speed)
- strengthening organisation requirements for companies (audit, compliance, policies, etc…)
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 MiFID II 2018
Scope: strengthening of the rules applicable to markets
- Ensure that organised markets are carried out via regulated platforms
- Introducing rules applicable for algorithmic and high frequency trading
- Improving transparency and monitoring of nancial assets (including gaps in commodity derivatives
markets)
On rules of conduct & investor protection:
- Communication of data trading activities
- Communication of transaction data to regulatory and monitoring authorities
- Obligation to trade derivatives on organised markets
- Speci c monitoring concerning nancial instruments and positions on derivatives
- Elimination of barriers between organised markets and compensation service providers
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 MiFID II & regulated markets
Art. 45: nominating committee within the governing body
Art. 8:
- Resilience and capacity of regulated market system trading
- Possibility to reject or suspend/ limit orders in case of high volatility
Art. 49: speci c requirements for quoting steps in accordance with ESMA guidelines
Art. 52: Noti cation procedure with competent and various authorities to monitor suspension decisions
- Creation of OTF (organised trading facilities)
- 3 status for basic data services: authorised publication devise, consolidation publication system provider,
certi ed reporting mechanism
- Mechanism for supervising commodity market
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 OTC markets definition
- market on which transaction is concluded directly between the the seller and the purchaser
- less standardise and normalized operations
- more exible regulatory framework
- market rules are set by parties
- nor governed by the intervention of a cleaning house or an organized market
- more attractive price thank regulated markets
- used by institutional investors
fl
+++++ ———

Tailor made contract through possibility of counterparty risk

negociation

Cost effective because no intermediary party default at expiration date

Prices differ for same product

Dark pools
- Networks, usually private exchange networks and forums
- Allow institutional investors to buy or sell without divulging details of the transaction
- no price movement against the seller stock
- restricted access to transactions
Multilateral trading facilities
- System operated by an investment service provider or a market enterprise
- Meeting within certain rules of transactions on nancial instruments de ne by person in charge
- Authorised since 2007 by MiFID
- Rules are transparent and non-discretionary, fair negotiation process and objective criteria
- Communication to regulatory authorities of states having access to them

Advantage to regulated markets:

- present in places were there is no regulated market
- provide greater discretion, delays and lower execution costs
- provide price transparency on asset classes without a negotiating place and which can be only traded on
a voluntary base (convertible bonds)
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MiFID III?
Brexit consequences?
London very heavy in nance
- more than 80% of the EURO interest rate swaps
- 30% of dark pools
- main place of execution for nancial instruments outside of shares
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EMIR/EMIR II
Derivatives exchanged on OTC markets
Regulated since the European Market Infrastructure Regulation
- provide transparency and standardisation
- new market infrastructure : trade repositories (centrally collects and maintain order book)
- all under ESMA regulation
Clearing house/central counter-parties : interposing to guarantee the good end of their operation, imposes,
calls and collects margins rom its member on a daily basis
Setting up risk mitigations technique:
- max time limit for non compensated obligations
- unmatured over the counter OTC need to be valued on market price every day
- Appropriated
Transactions reported
Declaration of transactions related to OTC contracts. 4 types of statements
- Declaration of uncompensated OTC and the number of uncon rmed OTC
- Reconciliation of non-compensated OTC
- Reporting of all OTC
- Reporting for all listed derivatives

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 Proposed amendments to EMIR
Reporting requirements:
- simplify reporting to reduce administrative burden - ex. derivatives on traded stock exchange
- no longer reporting is counter-party is business related entity
- nancial counter-party will report on behalf of small non- nancial counter-parties
Non- nancial counter-party:
- only non hedging instruments will be in scope of compensation if they trigger threshold
Financial counter-parties:
- thresh-hold for small nancial counter-party with low volume and risk
Pension funds:
- enter derivatives to protect against complex market risks
- limited cash collateral: 3 year period to nd solution
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Operations from instruction to posting
Stock exchange order:
- can be made when markets are opened or not
- different types of orders based on strategy
- number of informations must be provided: name, direction, quantity, type, valid date, ISIN
- generate a commission or brokerage
Commun caracteristics
- portfolio: identi es who has conducted the transaction & pro t/center
- negociation: date, counterparty/portfolio, broker or market intermediary
- operation details: date of the transaction, currency, amounts
- following details depend on operation type: quote/rate/price, settlement rules
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 Chain of events
1. Negociation: by phone, online, through a broker or electronic trading platform

2. Entry and validation: automatically created or entered by the trader or an operator on the basis of a ”slip”

3. Con rmation: both counterparty agree on terms, usually automated by SWIFT

4. Payment and setllement-delivery: physical exchange

5. Posting: Consideration of transaction in balance sheet and revenues

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Derivatives and financial instruments
Definition:
- Financial instrument « derived » from the spot market – they change the settlement terms
- Parties negotiate the terms of contract to allow the determination of the financial flows
- There are derivative for all spot marketable assets & all risk
- Loses any value after the expiration date

Exchange may be:

- optional: to buy (call) or sell (put)
- deferred: future or forwards
- or never take place: rate swap

Accounting principle:
- commitment of the bank
- recorded at nominal value off-balance sheet
- value change or final value recorded
Derivatives and financial instruments
3 different ways to change the settlement of a contract:

- Forward contracts: postpones the settlement at in time, puts it in the future

- Swaps: change the cash flow settlement

- May have dates in the future
- Main goal is interest rate swap

- Options: « contingent derivatives » represent a right (to buy, to sell, to borrow etc…) to transact
for the price of a « premium »

Example:
Type of derivative: right to buy EUR/USD (call)
Settlement: in 3 month time
price: 1,15
Amount: 5 mios
Option is exercised if future interest rate > 1,15
Leverage effect

Leverage effect definition:

- possibility to make large profit in relation to a « bet »
- through the payment of the premium
- high risk instrument as bet can be lost

Can be:
- negotiated on organised markets (listed derivatives) or OTC (over the counter)
- regulation push actors to use clearing houses
- specialised markets organise to find counter-party for all demand

Vanilla products vs. complex or exotic products

Purpose of derivatives
Derivatives con be used for the following purposes:

- Hedging:
- « insurance » on value of underlying in case of market volatility
- potential gains will be lowered by the premium

- Speculation:
- « bet » on an anticipated future price variation
- investor does not hold the underlying
- gains and losses can be important

- Arbitrage:
- investor detects an inconsistency in the market value of derivative & underlying
- Investor takes opposite position
- low gain but no risk if inconsistency is correct
- allows to eliminate price inconsistencies in the market
Summary table
Forward and futures
Forward contract: lock a future price for a future investment
- agreement to exchange a specific amount of money
- on given an asset
- at a specific price
- on a specific date

Future contract:
- standardised forward contract
- negotiated on organised markets (Matif, Liffe, CBOT, Eurex, etc…) electronically
- counter-party is the clearing organisation (vs. Individual)
- cleating organisation assumes the counter-party risk and organise margin exchange

Characteristics:
- All type of underlying
- quantity/nominal
- quotation price (percentage or value)
- Term
- Liquidation method: delivery of underlying or cash
Forward and futures
Additionnal information:

- Margins calls are organised on a daily basis and options are price to market
- At maturity contracts are liquidated as stated in the specifications
- Delivery can be cash or underlying
- Possibility at any time to close the contract
- Price follows the price of the underlying
- The closer to maturity the more the 2 markets converge
- players can be looking for seeking protection or speculation

Value of contract:
- Nominal value on which the commitment relates
- for each future contract is assigned a value on the trading unit of the underlying
- Contract value = contract in units x value of an unit of underlying x future contract price

Ex: CAC40, EUR 10 per index point, if CAC40 reaches 5500 at maturity, value=5500x10=55000
Forward and futures
Compensation price is set at:
- fixed time at the end of the session
- based on last quoted prices before this hour
- determines margin calls and valuation of held contracts

Ex: CAC40 Future is set at 18:15 on the average of the last 2 min of cotation of contract
Liquidation of maturing contracts take place on the 3rd Friday of each month

Security deposit:
- amount required prior to any negociation
- blocked on the investor account
- revisable at any time by the clearing house
- around 5 to 10% of the contract value
Clearing price and margin exchanges
Each day positions are fictitious liquidated on the basis of the clearing price

For each maturity the clearing house calculates the losses or gain potentially made in the for of a
margin call that corresponds to:

- On the day of the creation of the contract: difference between clearing price and transaction price

- On the following days: the difference between clearing prices for today and the day before

- At closing: the difference between the transaction price and the clearing price

Additionnel information:
- Investor position = number of contracts at a given date
- Margins call are daily debited or credited
- If the account is not stocked enough, the deposit will be used
SWAP
Definition: 2 counter-parties have cash flow to propose but it is not the same and the deal must be
set-up so that both flows are equivalent
Options
Definition: gives the holder the righ to purchase (call) or sell (put)
- Gives an obligation to the seller if holder wish to process
- Seller receives the premium as remuneration and reflects market value
- predetermined price
- predetermined date
- unlimited number of contracts

Many options are not related to a specific stock but a basket of shares (index)

Treading can be done:

- on the organised markets
- over the counter for specific/tailer-made products
- can be exchanged on the secondary market

Risk: unlimited for the seller - may lose more than the premium
Warrants
Definition: similar to options as they are « rights » but are securitised, e.i. exchange like
financial assets

Several important differences with options:

- Warrants are financial securities issued by banking institutions (vs. Contracts for options)

- It is only possible to sell if warrant if it’s in a portfolio

- Max potential loss is limited to the amount invested in warrants

- Number of warrants limited to the quantity issued

Pricing options
“In the money”: intrinsic option value

Example:
- right to buy (call) at EUR 15 underlying stock X
- Stock X is valued 20: intrinsic value is 5 ==> IN THE MONEY
- Stock X is value at 15: intrinsic value is 0
- Stock is valued below 15: intrinsic value is still 0

Intrinsic value = price of underlying - exercise price

Time value = price of the option - intrinsic value

Value (or premium) depends on several factors:

- Exercise price of the option

- Price of underlying asset
- The time remaining before the option expires
- The volatility of the underling asset
MiFID scope and principles
MiFID « Markets in Financial Instrument Directive

Scope: harmonise investor protection across Europe

Traditional stock exchanges & all services provided by investment firms

3 principles:

- Act in an honest, equitable and professional manner for investor’s best protection against
company holding a dominant position due to being a finance professional

- Provide correct, clear and non-deceptive information for better understanding of products
and service

- Take into account individual situations to align products and services with investor
knowledge
MiFID II pillars
MiFID II:

- Extension of MiFID to all financial products and financial institutions

- Increased transparency on financial transactions (MiFIR Regulation)

- Increased protection for financial institutions customer by strengthening the assessment of

the client risk profile
- Understand the client investment psychology - can’t be self-assessed
- Use scientific methodologies (behavioural finance) to assess investor profile
- Evaluate the risk aversion of the client

- Harmonisation of the current regulations to all countries

- Widen scope for authorities from obligation to report to the right of sanctions
In scope financial instruments
- Money Market instruments

- Shares of collective investment companies, mutual funds

- Option contracts, futures contracts, swaps, forward rate agreements and any other derivative on:
- securities, currencies, interest rates or yield
- raw materials
- climatic variables, freight rates or inflation rates or other official economic statistic
- any other derivative contracts relating to assets, rights, obligations, indices and measures
not otherwise mentioned

- Derivative Instruments used to transfer credit risk

- Financial contracts for differences

- Emission quotas composed of all units recognized as complying with the requirements of Directive
2003/87/EC (Emissions rights trading system)
European MiFID Template
Financial product and distribution strategy information
• Information for identifying and defining the financial instrument.
• Particular information such as the issuer, guarantor, leverage or optional character.
• Product distribution framework: advisory, simple RTO (Reception and transmission of order),
advisory and discretionary mandate

Target Market Information

• The type of the target investor: Non-professional, professional, eligible counterparty.
• Experience, knowledge and expertise in financial investment
• Its ability to bear losses, even beyond the capital invested.
• Its investment objectives, especially if they are specific (for example: The customer accepts an
early reimbursement of his investment)

Financial charges and product costs

- One-time and recurring expenses and costs.
• Fees and commissions for management, distribution, transaction costs and structuring.
Expenses incurred at entry, exit, in the event of early redemption or closing, acquired or not by the
producer or the issuer, etc.
Investment products : Equities & Bonds
Equities:
- Title that represents a fraction of equity of its issuer - each holder is a "shareholder".
- The shareholder is entitled to profits through dividend or resale
- Depends on % to participation
- Economical wealth of the company & performance
- Different types of risk (market, of economic situation, sectorial risk and risks specific to the
company)
- Admission of shares to regulated markets does not guarantee liquidity

Bonds:
- Title that represents the debt of an issuer vis-a-vis an investor
- Lend an amount of money to issuer which is a debt that must be reimbursed
- Rate, amount and frequency of payments of interest are indicated in the documentation of the
issue
- With or without coupons
- The yield = difference between the capital paid at the date of issue and the amount refunded at
maturity
- Risks: default, liquidity risk, interest rate
Investment products : Money Market
- Short-term debt securitites (maturity < 1 year)

- Value can be determined at any moment

- Allow the investor to receive interest rate

- Different types:
- ex. certificates of deposit issued by a bank
- commercial bills issued by a company
- treasury bille issued by the government

- Traded in domestic money markets (organized by the local central bank) or on international market

- Less risky because guaranteed by the bank, the company or the state that issued them

- Still exposed to: interest rates risk, liquidity and issuer credit default.
Investment Funds
- Vehicle that allows a number of separate and unconnected investors or a group of individuals or
companies to make investments together

- Capital consolidation allows:

- to share costs
- to benefit from the profits that result from the placement of larger sums (diversification, risk
distribution)

- Multitude of ways to establish and manage an investment fund depending on the needs of the
investor

- The number of investors is not fixed

- They may have an indefinite life or be designed for a fixed period of time
- They can invest in traditional assets or exotic assets as wines, art pieces or royalties
- They can generate income for investors or seek to maximize the capital value of their investments
- They can be open for sale to any particular investor or be limited to sophisticated investors such as
financial institutions and very wealthy families.
 Investment Funds : stakeholders
Management Core Operating
Governance Functions Functions
Related Functions

Board of directors General Partner Depositary

MANCO/AIFM

Central
Delegated Administration
Manager Domiciliation
FUND

Transfer
Advisor agent&Registr
ar
Support Functions

Other delegated Auditors

Broker TAX advisor Legal External Valuer
Functions

153

 Investment products : Fund shares
- A undertaking for collective investment ("UCI"):
- Receives the sums paid by the investors
- Is managed by a professional that invests in different financial instruments

- Several types of UCI according to their structures or their classifications

- Management strategies
- "coordinated“ UCITS

- "undertakings for collective investment in transferable securities (UCITS)“ limit investor risk
- Invested in liquid assets and in accordance with diversification rules
- Easily marketable in the Member States of the European Economic Area

- The risks associated depend on the nature of the assets that make up its portfolio

- Portfolio composition varies according to:

- the management/risk strategy (dynamic, balanced or defensive)
- degree of appetite for risk

- Can benefit from a guarantee mechanism or a total or partial protection of the capital invested
Available Fund Regimes
Less
REGULATED FUNDS regulated

Lux Partnership**

S.A.R.L S.A
S.C.A

Securitization
More
Vehicle* More
Regulated Flexible
RAIF
SIF
SICAR

UCI

UCITS Less
Flexible
NON REGULATED FUNDS
 Multi-compartment Funds
- Consist of many sub-funds

- Which operate as separate investment funds

- While being part of the same legal entity

- This structure allows to:

- Create funds with different strategies

- Designed for different types of investors in the same legal entity

- Reduce costs by sharing at umbrella level

- It is generally cheaper for investors to move from one fund to another within a multi-compartment
fund

- Reduces the time to launch a new sub-fund

 Fund general organization
Governn
Board members

Fund Level Umbrella

Compartment Level Sub-fund 1 Sub-funds 2 Sub-fund 3 Sub-fund X

Asset Level ▪ Strategy 1 ▪ Strategy 2 ▪ Strategy 3 ▪ Strategy X

Investor Level Investors

157

FCP Funds
- FCP : " fonds commun de placement” or mutual fund

- Comparable to UK trusts in the United Kingdom

- Contract between the fund manager and investors, analogous to a partnership

- Does not have a separate legal identity

- The management company or the GP has the legal personality

- Investors hold units in a FCP

- Can be advantageous or not depending on taxation

 FCP Funds
General Partner

Board of General Partner

BIL Manage Invest S.A. BIL AIF Depositary

XXXXXXX BIL Fund&Corp Services
FCP
Delegated Manager/advisor PWC Luxembourg

Sub-fund I Sub-Fund II Sub-fund III

Your Fund

159

SICAV Funds
- SICAV refers to the : Société d’Investissement à Capital Variable

- Fund itself has the status of a public limited company with its own legal entity

- The amount of the capital of the company depends on the payments of the investors

- Like the FCP, the shares in a SICAV are bought and sold according to the value of the assets of the
fund (NAV)

- For individual investors, there are technically few practical differences between a FCP and a SICAV

- However, there may be separate tax implications that you need to look at carefully with your investment
advisor.
 White-Label BMI SICAV
M Frédéric Sudret - Jérôme Nèble - Yvon Lauret

BIL Manage Invest S.A. RBC Investor Services

Lux Multimanager SICAV Bank S.A.
Delegated Manager/advisor
PWC Luxembourg

Binckbank - Global Dev Binckbank - Euroo Bond Bainbridge Equity

THEMA Equities Fund
Markets Equity Fund Market Neutral Fund

Finserve Global Security Kuylenstierna&Skog

Europe Equity Select Kavaljer Quality Focus
Fund I Equities Fund

Kavaljer
Your Fund Investmentbolagsfund

161

 Capitalization and distribution
- 2 types of income: dividends and market value

- Choice between:
- units of distribution, which regularly distribute income such as the interest of bonds or dividends
- capital units or shares that automatically re-invest the income from the assets in the fund
- Value of distribution units or shares may increase over time

- Distribution shares or units

- are good to make an additional regular income
- investment will not grow as quickly since decrease the assets of the fund and therefore the price of
the units

- Capitalisation units or shares are appropriate if you invest in the long term as for example for your
retirement

- Tax liability vary according to the rules in place in your country of residence
 Summary of available products
SCS & SCSp
UCITS SIF/RAIF SICAR (managed by an authorized
AIFM)

Legal forms FCP FCP FCP FCP

SA, SCA, S.àr.l., SCS, SCSp, SCo
SICAV: SA SICAV/SICAF: SA, SCA, SA SCS : with legal personality
S.àr.l., SCS, SCSp, SCo SA
SICAF: SA, SCA, S.à r.l., SCSp : without legal
SCS, SCSp personality
SA, SCA, S.àr.l.,, SCo

Eligible investors All types of investors Well-informed (min. € 125.000,-) All types of investors

Eligible assets Plain vanilla Unrestricted Risk Capital (+ value creation) Unrestricted

Diversification Yes No

Multiple sub-funds Possible Not possible

Depositary Mandatory Lux based

Central Administration Mandatory Lux based

MANCO/AIF/delegated Luxembourg based or in equivalent EU countries

manager

(*) Information provided for information purposes only. BIL does not accept any responsibility or liability of any kind with respect to its accuracy or completeness. For any advice, you should contact a financial or other professional adviser

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 Fund cost structure and drivers
Intital Costs Maintenance costs Service provider fees Costs drivers

Notary EUR 2,000 – EUR 5,000 N/A ➢MANCO/AIFM fees ➢ Number of sub-funds
Fees ➢
➢Portfolio/advisory fees ➢ Number of share-classes
CSSF Single sub-fund : EUR 4,000 Single sub-fund : EUR 4,000 ➢
fees* Multiple sub-funds: EUR 8,000 Multiple sub-funds: EUR 8,000 ➢Depositary fees ➢ NAV frequency
➢
Legal UCITS/SIF: EUR 50,000 – EUR Only if changes in the legal fund ➢Administrator fees ➢ Nb&type of investments
fees 60,000 structure ➢
RAÎF: EUR 40,000 – EUR 50,000 ➢Audit fees: depending on ➢ Nb&type of investors
fund size and complexity
➢ Distribution strategy
Other Advisory fees, tax fees, etc…. director fees, distribution fees,
costs etc…

* Not applicable to RAIF

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Fund typology 1
Monetary funds: Invest predominantly in short-term liquidity and securities (less than one year), such as
term deposits, cash certificates, close-maturing bonds, commercial paper and deposit certificates

Medium term funds : Invest in fixed-income securities with maturity between one and three years.

Bonds funds : Invest primarily in fixed-income values with maturity of more than three years

Equity funds : Invest mainly in company shares, and incidentally in derivatives such as warrants, etc…

Capital protection funds : A minimum reimbursement amount is provided for the investor
- Amount = full (100%) or partial protection of the initial investment (less any fees and taxes)
- The underlying values in these funds can be very different in nature (usually stocks and bonds)
- Double dipping: return the starting bet at maturity & Fund performance

Mixed funds: Invest in both stocks and bonds according to their risk profile:
o "Defensive" - risk-free investments (min 75% in bonds - stable currencies)
o "Neutral" 50/50
o "Dynamic" or "aggressive" - risky investments (min 75% are invested in equities).
Fund typology 2
Pension funds:
- mixed investment funds with privileged status (tax) to encourage individual pension savings
- generally subject to certain legal restrictions

Real estate funds: Invest mainly in real estate

Fund of funds: Funds that invest in other mutual funds - manager selects a region, a sector, a theme…

Hedge funds :
- deregulated funds using so-called "alternative" or “non-traditional” portfolio strategies
- coverage purposes against (hedging) Stock Exchange fluctuations
- speculative purpose + leveraging

Index funds: follow as closely as possible the evolution of a reference index

Trackers: index fund listed on the stock exchange, directly linked to performance of the index
- Investor can within one transaction access a diversified equity portfolio
- Combines the benefits of stocks (simplicity, listing) to those of traditional funds (access to a wide
range of values, diversification).
Pros
Diversification: diversified portfolio offering risk distribution.

Management by professional managers:

- More profitable and more effective
- Professionals react more quickly to the circumstances of the market
- For investors who do not have the time, envy or the knowledge required

Economies of scale: possible to benefit from reductions in fees and to obtain better returns.

Investments tailored to the investor's needs: The multiplicity of existing funds, strategies, etc…

Low initial investment: to access several markets, currencies, strategies, therefor diversification

Access to specific markets

- difficult or not at all accessible to isolated individuals (e.g. Asian markets)
- sophisticated financial products (options, futures)

• Liquidity and transparency: Net assets value is calculated and published regularly (from daily)
- compulsory information dissemination (prospectus, KIIDs, EMT etc…)
- freely internet sites of financial institutions publications (technical data & information
Cons & Choices
Cons:
- Risks are linked to the investment policies of the funds (the more alternative the more riskier)
- No performance guaranteed
- Costs (main cost and access costs)

Choices:
- Investor can rely on the documents issued by the fund and in particular the prospectus
- Objectives and investment strategies
- Risks
- Performance
- Information for investors
- Attention to publication data as prospectus
- KIID (Key Investor Information Document)
- for clear, simple and concise information - enough for investor to decided on investment
or not
- Includes brief description, investment policy objectives, operation details, risks, costs
- Are compulsory for UCITS
- One document per class (because of different currency, hedging, non hedging, etc…)
ESG Introduction
The EU has set up a dedicated Action Plan on Financing Sustainable Growth in order to
increase investment having a positive environmental and social contribution.

Review of EU Directives:
- As regards the sustainability risks and sustainability factors to be taken into account for
UCITS & AIF

- MIFID II & IDD – Better advice for clients on sustainability

Review of Regulation: EU Benchmark Regulation 2016/2011 –Climate benchmark and

benchmark on ESG

New Regulations:

• Sustainability investment and sustainability risk disclosure –regulation 2019/2088

• Taxonomy Regulation
ESG Introduction
Harmonised rules for Financial Market Participants and Financial advisers on transparency with
regard to the integration of sustainability risks and the consideration of adverse
sustainability impacts in their processes and the provision of sustainability-related
information with respect to financial product.

ESG Classification
SFDR / Products level / Categorisation
SFDR / Taxonomy regulation / Effective
01/01/2022
- Establishes the criteria for determining whether an economic activity qualifies as environmentally
sustainable for the purposes of establishing the degree to which an investment is environmentally
sustainable
- An environmentally sustainable investment means an investment in one or several economic
activities that qualify as environmentally sustainable

SFDR / Taxonomy regulation- Effective

01/01/2022
MiFID Cost structure
MiFID 2 objective is INVESTOR PROTECTION

- Transparency & information regarding costs

- Final investor and strategy identified to provide better clarity on the costs

- Distributors are responsible for producing a stricter reporting

- Retrocessions but also cost&charges

MiFID II request aggregates information on:

- the costs of the financial instrument

- the cost of the investment services and related services
- how the costumer can pay costs
Costs, fees and taxes related to products
All costs related to financial products must be presented to the customer
- actual costs explicitly dissociating from recurring
- non-recurring
- transaction-related costs charged on ancillary services
- still outstanding, such as performance and carry commissions
- ex-ante and ex-post communication is required.

The cost information must be provided in an understandable and aggregate form - client can request
more info

Four categories of costs can be distinguished:

- Single costs: Entry costs and exit costs
- Recurring costs
- Transaction costs
- Variable costs related to performance

SCOPE: enable investor to measure the cumulative effect on the performance of the financial instrument.
Costs, fees and taxes related to products
Four categories of costs must be done in:

• In absolute value (in euros),

• and in relative value (in % of the investment amount, or its nominal, or any other relevant basis,
if any),

• Before the operation is put in place,

• And after that, at least annually

And above all:

• On a personalised basis,

• The amount to be related with the investment performance

• With regard to the estimation of costs and ex ante costs, the latter must be based on
“reasonable estimation", if these are not accurately known
Costs, fees and taxes related to services
Information on costs and charges for service delivery:

- Must be forwarded to the client irrespectively of their categorisation

- May be limited for professional investors (depending on service and if derivative)

The information is to be provided:

- During the transaction or supply of service

- During the business relationship

Retrocessions
The MIFID II Directive strengthens supervision of the retrocession of commissions (inducements)
Commissions and bene ts are prohibited in the context of the following investment services:
• Independent Investment Consulting

• Management under mandate

For independent investment advisory and management under mandate: prohibited with the provision of
services - exception is the minor non-monetary bene ts (improve service quality)

For other investment services (including non-independent advisory activities), retrocessions are
permitted under conditions:

• They are designed to improve the quality of service to the customer

• They do not interfere with the obligation to act in an honest, equitable and professional manner
in the best interests of its clients

• The customer is clearly informed of their existence, nature, amount or method of calculation,
upstream of the supply of the service
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Research
Investment research will not be considered an inducement (and therefore allowed):
- If it is funded directly by the recipient (the portfolio manager)

- If it can be nanced by the portfolios, under certain conditions:

o Setting up a segregated account

o Ex ante establishment of a research budget and assignment by portfolio

o Obtaining prior agreement from the customer and ex post information on the budget
allocated to his portfolio

o Control of the utility for the client of the research costs that he is required to bear
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Transparency of costs and reporting
obligation
Info to be transmitted BEFORE transaction: written statement containing the given advice:
• specifying how it responds to the customer's preferences/characteristics/objectives of its portfolio
• document is forwarded to the customer prior to the execution of the transaction
• This declaration must be provided on a durable medium
• In addition, before executing on a structured product, the customer must receive a speci c
information document describing the product:
- the nature
- key features
- lifespan (if known)
- potential risks and performance of the product
- fees and costs it will incur.

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Transparency of costs and reporting
obligation
Info to be transmitted AFTER transaction:
- a notice con rming the execution of their order, no later than the rst working day following the
execution of the said order
- This notice mentions a whole series of information such as:
- the day and time of the transaction
- the type of order
- the place of performance,
- the identi cation of the instrument
- the quantity, the unit and total price and the amount of commissions and charges invoiced

- Non applicable for customers who have opted for discretionary mandate
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Transparency of costs and reporting
obligation
Info to be transmitted on a REGULAR quarterly basis: statement including
- the composition and value of the portfolio
- performance
- details of each nancial instrument
- the total amount of income collected during the period covered by the statement
- MiFID II directive encourages more emphasis on the costs associated with the transactions and
services provided during the period

Info to be transmitted in the event of a SIGNIFICANT move:

- value of portfolio has decreased by 10% since previous statement
- for each multiple of 10%
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 Documentation of investment products
MiFID II innovation: introduction of rules steering the governance of nancial instruments
- Applicable to producers who design products
- Distributors who distribute them, distributors
New rules for producers:
- Need for a process for validating the products they design
- De ning a target market for these products
- Distribution strategy that is appropriate for the set target market
- Provide distributors with all necessary information about the products - including market target
- Assess regularly whether the product:
- continues to meet the needs, characteristics and objectives of the target market de ned
- whether the planned distribution strategy remains appropriate
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 Documentation of investment products
New rules for distributors:
- put in place the necessary measures to obtain the relevant information about the products they
intend to make accessible to their customers
- will have to assess the compatibility of these products with the needs of their customers
- remains obliged to de ne a target market for the product concerned
- take the necessary measures to obtain from the producer adequate and reliable information
The distributor must regularly assess whether the investment products it proposes or recommends and
the services it provides remain consistent with:
- the needs
- characteristics
- objectives of the target market de ned
- whether the distribution strategy is still appropriate.
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Documentation of investment products
 Financial information and prospectus
Information must now specify:
- Type of client: retail customers vs. professional customers (EMT)
- The description of the risks including constraints or restrictions in case of resale
- Illustrate the possible means of exit and their impact
Information is also reinforced on the following elements:
• If instrument is composed of two or more nancial instruments or services, the regulated
institution must provide an adequate description of the legal nature of the nancial
instrument, the components of the instrument and the impact of the interaction between the
components on the risk of investment

• In the case of nancial instruments incorporating a guarantee or protection of capital, the

regulated institution must provide the customer or potential customer with information about
the scope and nature of this guarantee or protection of capital. When the guarantee is
provided by a third party, the guarantee information includes suf cient details about the
guarantor and the guarantee for the existing or potential customer to be able to properly
assess it.
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 Financial information
A minimum base of information is de ned: the performance, the nancial positions, as well as the
important changes of the shareholding
Listed companies must publish ASAP any signi cant information likely to have an impact on the
stock market price
This information may be recurring, disseminated to the authorities and the public by issuers at
regular intervals, in particular on an annual or biannual basis.
Among these we nd:
• The annual nancial report.

• The approval of the accounts

• The report on internal control and corporate governance

• The total number of shares and voting rights composing the share capital

• The description of the share redemption programs

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 Prospectus
De nition: detailed information document that a company/fund must produce to be able to issue
securities (e.g. shares) to the general public
- Includes complete, truthful and clear statement of all the material facts of the securities issued
- type of operation (initial public offering, capital increase, etc.)
- number and nature of the securities offered
- timetable of the operation
- Must disclose all the items that may affect the value or price of the security being invested
- Standard visual so that the investor can compare various investment opportunities
- Allows investors to assess their assets, nancial situation and results and to appreciate their
prospects as well as the risks to which they are exposed.
- Each operation = speci c prospectus scheme
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 Prospectus : stocks
In case of stocks, the prospectus contains the accounts of the last three nancial years which must include
at least:
• The balance sheet

• The pro t and loss statement;

• The cash ows statement;

• Accounting methods and explanatory notes.

In addition to this information on the accounts, the prospectus must provide:

• A statement of net working capital certifying that capital is suf cient for current obligations/need
(1 year) if not, mitigation process

• A statement on equity and debts - info must be presented according to a standard table de ned
by the Committee of European Securities regulators (CESR).
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 Prospectus - forecasts
If a company includes forecasts, they need to be in line with regulation;
• Main assumptions on which the forecast is based must be stated;

• Must be subject to a report by the statutory auditors

• If fund shares, the forecasts made public previously are presumed to provide signi cant
information that needs to be reintegrated into the prospectus

• forecasts are presumed to provide signi cant information that needs to be reintegrated into the
prospectus.
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 Prospectus - risk factors
The prospectus must contain a "Risk Factors” heading
- Highlight the risk factors speci c to their activity - avoid generic risks not quanti able
- At a minimum: market risks (rate, currency, action, credit), industrial risks and legal risks.
- Information is given by type of risk and classi ed in order of importance

For each speci c risk type, it has three parts:

- Links between activity and identi ed risks;
- Risk assessment: quantitative measure of the risk whenever possible;
- Implemented procedures to ensure monitoring
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 Prospectus - dissemination
For dissemination to be effective, i.e. take one of the following forms:
1. Publication in one or more newspapers, national or widespread circulation;

2. Free provision at the company headquarters, stock market company and with nancial intermediaries;

3. On the website of the company and, where applicable, on the site of the nancial intermediaries
(when they have such a site);

4. Online on the website of the stock market company.

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 Prospectus - Fund prospectus
Investment objectives and strategies:
- investment policy and the categories of assets used to achieve these objectives
- if pertinent comparative values (benchmarks), especially for passive investment funds
- restrictions and investment limits to which the fund is subject ([Link] cation rules

Risk:
- Risks to which the fund is confronted, for example, credit, liquidity, interest rate, currency and market
risks.
- details about the risk pro le of a typical investor - check suitability
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 Prospectus - Fund prospectus
Performance:
- information on the performance to see if the fund has achieved its performance objectives
- graphs can provide a clear visual analysis of performance and volatility
- compare performance results with those of funds with similar objectives
- unequivocally indicated that past performance is no guarantee of future performance

Investor information
- includes information on how the investment fund is assessed
- details on how the net asset value (NAV) tis calculated
- rules to buy or sell units of the fund and what the costs are
- Where applicable, details of the minimum investment capital imposed upon the purchase of shares
 Compliance
De ntion:
- Financial compliance is the regulation and enforcement of the laws and rules in nance and the capital
markets.
- It ranges through the entire nancial spectrum, from investment banking practices to retail banking
practices.

Why:

- Financial compliance became a serious matter for regulators and other concerned parties after the 2008
crisis
- Financial compliance in 2008 could’ve saved people’s retirement funds, houses, pensions, and
decreased the overall magnitude of the recession
- Financial compliance is important in order to maintain the public’s trust in capital markets and the
banking system.

Who: state (regional, federal, national), regulators, international organisations (FATF)

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 KYC
Know Your Customer - processes of Customer Due Diligence (CDD)

- Veri cation of client identity: name, address, contact information, id card,

- Identify the risks before making a person/entity part of the system

- Periodic checks are conducted - frequency depends on level of risk (1,3,5 years)

- Information is collected and available for authorised external parties to review (auditors, regulators, etc…)

- Enhanced Due Diligence (EDD) can be performed gathers additional information from customers on:

• Geographical factors
• Property and assets information
• Transactions types
• Occupation information
• Banking information

- Financial intermediaries also in scope

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AML : anti-money laundering
AML:

- intend to eliminate the incidences of money laundering and terrorist nancing

- detect suspicious transactions happening in the nancial system through continuous transaction
monitoring
- Businesses are evaluated with respect to in-house AML techniques and procedures
- global regulators evaluate the AML norms of countries and present amendments accordingly

Steps that help business comply with AML:

- stay updated with AML changing rules

- keep on reviewing the company norms and improve them accordingly
- KYC: It is necessary to know who you are facilitating with your services
- Identify the high-risks associated with the business (vendors, third parties and customers)
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Appendixes
Russia-Ukrainian war
financial consequences - economical sanctions
- Financial “nuclear” bomb SWIFT cut for Russian banks
- Asset freeze - individuals but also institutions (including 300bn of Russia central bank)
- Movement of population - air/train/road
- Companies compulsory or freely desertion from Russian soil and/or business

- MT0xx System Messages

- MT1xx Customer Payments and Cheques
- MT2xx Financial Institution Transfers
- MT3xx Treasury Markets
- MT4xx Collection and Cash Letters
- MT5xx Securities Markets
- MT6xx Treasury Markets – Metals and Syndications
- MT7xx Documentary Credits and Guarantees
- MT8xx Travelers’ Cheques
- MT9xx Cash Management and Customer Status M
Russia-Ukrainian war
financial consequences - currency
Russia-Ukrainian war
financial consequences - interest rates
Russia-Ukrainian war
financial consequences - Country rating

Credit ranking: Moody’s from B3 to CA

- second-lowest rung of its ratings
ladder
- central bank capital controls that are
likely to restrict payments on the
country's foreign debt and lead to
default
- the recovery expectations are at 35 to
65%
- considered “junk” investment territory