A stock market, equity market or share market is the aggregation of buyers and sellers of stocks, which represent ownership claims on businesses. Examples of the latter include shares of private companies which are sold to investors through equity crowdfunding platforms. Stock exchanges list shares of common equity as well as other security types, e.g. corporate bonds and convertible bonds. Stocks are categorized in various ways. One way is by the country. For example, Nestlé and Novartis are domiciled in Switzerland, so they may be considered as part of the Swiss stock market, although their stock may be traded on exchanges in other countries, for example, as American depository receipts on U. S. stock markets. As of 2017, the size of the world stock market was about US$79.225 trillion. By country, the largest market was the United States, followed by the United Kingdom; these numbers increased in 2013. As of 2015, there are a total of 60 stock exchanges in the world with a total market capitalization of $69 trillion.
Of these, there are 16 exchanges with a market capitalization of $1 trillion or more, they account for 87% of global market capitalization. Apart from the Australian Securities Exchange, these 16 exchanges are based in one of three continents: North America and Asia. A stock exchange is an exchange where stock brokers and traders can buy and sell shares of stock and other securities. Many large companies have their stocks listed on a stock exchange; this makes the stock more liquid and thus more attractive to many investors. The exchange may act as a guarantor of settlement. Other stocks may be traded "over the counter", that is, through a dealer; some large companies will have their stock listed on more than one exchange in different countries, so as to attract international investors. Stock exchanges may cover other types of securities, such as fixed interest securities or derivatives which are more to be traded OTC. Trade in stock markets means the transfer of a security from a seller to a buyer.
This requires these two parties to agree on a price. Equities confer an ownership interest in a particular company. Participants in the stock market range from small individual stock investors to larger investors, who can be based anywhere in the world, may include banks, insurance companies, pension funds and hedge funds, their buy or sell orders may be executed on their behalf by a stock exchange trader. Some exchanges are physical locations where transactions are carried out on a trading floor, by a method known as open outcry; this method is used in some stock exchanges and commodity exchanges, involves traders shouting bid and offer prices. The other type of stock exchange has a network of computers. An example of such an exchange is the NASDAQ. A potential buyer bids a specific price for a stock, a potential seller asks a specific price for the same stock. Buying or selling at the market means you will accept any ask price or bid price for the stock; when the bid and ask prices match, a sale takes place, on a first-come, first-served basis if there are multiple bidders at a given price.
The purpose of a stock exchange is to facilitate the exchange of securities between buyers and sellers, thus providing a marketplace. The exchanges provide real-time trading information on the listed securities, facilitating price discovery; the New York Stock Exchange is a physical exchange, with a hybrid market for placing orders electronically from any location as well as on the trading floor. Orders executed on the trading floor enter by way of exchange members and flow down to a floor broker, who submits the order electronically to the floor trading post for the Designated Market Maker for that stock to trade the order; the DMM's job is to maintain a two-sided market, making orders to buy and sell the security when there are no other buyers or sellers. If a spread exists, no trade takes place – in this case the DMM may use their own resources to close the difference. Once a trade has been made, the details are reported on the "tape" and sent back to the brokerage firm, which notifies the investor who placed the order.
Computers play an important role for program trading. The NASDAQ is a virtual exchange; the process is similar to the New York Stock Exchange. One or more NASDAQ market makers will always provide a bid and ask price at which they will always purchase or sell'their' stock; the Paris Bourse, now part of Euronext, is an electronic stock exchange. It was automated in the late 1980s. Prior to the 1980s, it consisted of an open outcry exchange. Stockbrokers met on the trading floor of the Palais Brongniart. In 1986, the CATS trading system was introduced, the order matching process was automated. People trading stock will prefer to trade on the most popular exchange since this gives the largest number of potential counter parties and the best price. However, there have always been alternatives such as brokers trying to bring parties together to trade outside the exchange; some third markets that were popular are Instinet, Island and Archipelago. One advantage is that this avoids the commissions
A commodity market is a market that trades in the primary economic sector rather than manufactured products. Cocoa and sugar. Hard commodities are mined, such as oil. Investors access about 50 major commodity markets worldwide with purely financial transactions outnumbering physical trades in which goods are delivered. Futures contracts are the oldest way of investing in commodities. Futures are secured by physical assets. Commodity markets can include physical trading and derivatives trading using spot prices, forwards and options on futures. Farmers have used a simple form of derivative trading in the commodity market for centuries for price risk management. A financial derivative is a financial instrument whose value is derived from a commodity termed an underlier. Derivatives are either over-the-counter. An increasing number of derivatives are traded via clearing houses some with Central Counterparty Clearing, which provide clearing and settlement services on a futures exchange, as well as off-exchange in the OTC market.
Derivatives such as futures contracts, Exchange-traded Commodities, forward contracts have become the primary trading instruments in commodity markets. Futures are traded on regulated commodities exchanges. Over-the-counter contracts are "privately negotiated bilateral contracts entered into between the contracting parties directly". Exchange-traded funds began to feature commodities in 2003. Gold ETFs are based on "electronic gold" that does not entail the ownership of physical bullion, with its added costs of insurance and storage in repositories such as the London bullion market. According to the World Gold Council, ETFs allow investors to be exposed to the gold market without the risk of price volatility associated with gold as a physical commodity. Commodity-based money and commodity markets in a crude early form are believed to have originated in Sumer between 4500 BC and 4000 BC. Sumerians first used clay tokens sealed in a clay vessel clay writing tablets to represent the amount—for example, the number of goats, to be delivered.
These promises of time and date of delivery resemble futures contract. Early civilizations variously used rare seashells, or other items as commodity money. Since that time traders have sought ways to standardize trade contracts. Gold and silver markets evolved in classical civilizations. At first the precious metals were valued for their beauty and intrinsic worth and were associated with royalty. In time, they were used for trading and were exchanged for other goods and commodities, or for payments of labor. Gold, measured out became money. Gold's scarcity, its unique density and the way it could be melted and measured made it a natural trading asset. Beginning in the late 10th century, commodity markets grew as a mechanism for allocating goods, labor and capital across Europe. Between the late 11th and the late 13th century, English urbanization, regional specialization and improved infrastructure, the increased use of coinage and the proliferation of markets and fairs were evidence of commercialization.
The spread of markets is illustrated by the 1466 installation of reliable scales in the villages of Sloten and Osdorp so villagers no longer had to travel to Haarlem or Amsterdam to weigh their locally produced cheese and butter. The Amsterdam Stock Exchange cited as the first stock exchange, originated as a market for the exchange of commodities. Early trading on the Amsterdam Stock Exchange involved the use of sophisticated contracts, including short sales, forward contracts, options. "Trading took place at the Amsterdam Bourse, an open aired venue, created as a commodity exchange in 1530 and rebuilt in 1608. Commodity exchanges themselves were a recent invention, existing in only a handful of cities."In 1864, in the United States, corn and pigs were traded using standard instruments on the Chicago Board of Trade, the world's oldest futures and options exchange. Other food commodities were added to the Commodity Exchange Act and traded through CBOT in the 1930s and 1940s, expanding the list from grains to include rice, mill feeds, eggs, Irish potatoes and soybeans.
Successful commodity markets require broad consensus on product variations to make each commodity acceptable for trading, such as the purity of gold in bullion. Classical civilizations built complex global markets trading gold or silver for spices, cloth and weapons, most of which had standards of quality and timeliness. Through the 19th century "the exchanges became effective spokesmen for, innovators of, improvements in transportation and financing, which paved the way to expanded interstate and international trade."Reputation and clearing became central concerns, states that could handle them most developed powerful financial centers. In 1934, the US Bureau of Labor Statistics began the computation of a daily Commodity price index that became available to the public in 1940. By 1952, the Bureau of Labor Statistics issued a Spot Market Price Index that measured the price movements of "22 sensitive basic commodities whose markets are presumed to be among the first to be influenced by changes in economic conditions.
As such, it serves as one early indication of impending changes in business activity." A commodity index fund is a fund whose assets are invested in financial instruments based on or linked to a commodity index. In just about every case the index is in fact a Commodity Futures Index; the first such index was the Commodity Research Bureau Index, which began in 1958. Its construction made; the first investable commodity futures
In corporate law, a stock certificate is a legal document that certifies ownership of a specific number of shares or stock in a corporation. Certificates may have been required to evidence entitlement to dividends, with a receipt for the payment being endorsed on the back. Over time, these functions have been rendered redundant by statutory schemes to streamline the administrative burden on corporations, to facilitate and streamline trading on a stock exchange. For example, most jurisdictions now impose an obligation on corporations to pay dividends to shareholders registered at a relevant point of time without the need to produce the share certificate as proof of entitlement and the certificate is no longer required to be produced with a transfer of a shareholding. In some jurisdictions today, the issue of paper stock certificates may be dispensed with, at least in some circumstances, many corporations now provide a holding statement in lieu of a share certificate for each parcel of shares owned.
Most jurisdictions now require corporations to maintain records of ownership or transfers of shareholdings, do not permit share certificates to be issued to bearer. Ruben Schalk, history student at the Universiteit Utrecht, discovered the so far oldest share certificate in the world in the Westfries Archief in Hoorn; the certificate was issued by the VOC-chamber Enkhuizen. It was sold to Pieter Hermanszoon Boode; the second page records the payments of dividend. In the United States and other countries, electronic registration is supplanting the stock certificate, with both public and private companies no longer being required to issue paper certificates. In the United States over 420 of the 7,000-plus publicly traded securities do not issue paper certificates; the United States' Central Securities Depository, the DTC, has continued to promote efforts to eliminate paper stock certificates, a process called dematerialization. Countries around the world have adopted similar initiatives with many countries setting deadlines for statutory dematerialization.
Brokers may charge up to $500 for issuing a paper certificate, though this fee can be avoided by either holding share in street name or registering shares directly with the stock transfer agent and having them issue the certificate. Another alternative to both paper and electronic registration is the use of paper-equivalent electronic stock certificates. Forty-seven states have enacted legislation equivalent to the Uniform Electronic Transactions Act, which formalizes equivalency for electronic signatures "in writing" requirements. This, together with the enactment of legislation permitting the use of "facsimile" signatures on certificates, has given rise to software as a service technology for private companies to create and manage paper-equivalent electronic stock certificates. In Sweden, share certificates have been abolished, people using electronic shares instead. Share certificates may exist in Sweden, but only if the shares are not listed on any stock exchange in Sweden, the availability of share certificates has nothing to do with voting in shareholders' general meetings.
Sometimes a shareholder with a stock certificate can give a proxy to another person to allow them to vote the shares in question. A shareholder without a share certificate may give a proxy to another person to allow them to vote the shares in question. Voting rights are defined by the corporation's charter and corporate law. Stock certificates are divided into two forms: registered stock certificates and bearer stock certificates. A registered stock certificate is only evidence of title, a record of the true holders of the shares will appear in the stockholder's register of the corporation. A bearer stock certificate, as its name implies is a bearer instrument, physical possession of the certificate entitles the holder to exercise all legal rights associated with the stock. Bearer stock certificates are becoming uncommon: they were popular in offshore jurisdictions for their perceived confidentiality, as a useful way to transfer beneficial title to assets without payment of stamp duty. International initiatives have curbed the use of bearer stock certificates in offshore jurisdictions, tend to be available only in onshore financial centres, although they are seen in practice.
A stock certificate represents a legal proprietary interest in the common stock or assets of the issuer corporation. The certificate evidences a chose in action against the issuer to collect dividends and to influence the issuer through voting pursuant to the issuer's charter and bylaws, which are implied or incorporated by reference as terms on the face of the certificate. Stockholder rights are subject to the solvency requirements of issuer's general creditors and to any terms and conditions validly placed upon the face of the stock certificate which are part of the total agreement between the particular stockholder and the issuer. Stock certificates are transferred as negotiable or quasi-negotiable instruments by indorsement and delivery, issuer charters require that transfers must be registered with the issuer in order for the transferee to join as a member o
A municipal bond known as a Muni Bond, is a bond issued by a local government or territory, or one of their agencies. It is used to finance public projects such as roads, schools and seaports, infrastructure-related repairs; the term municipal bond is used in the United States, which has the largest market of such trade-able securities in the world. As of 2011, the municipal bond market was valued at $3.7 trillion. Potential issuers of municipal bonds include states, counties, redevelopment agencies, special-purpose districts, school districts, public utility districts, publicly owned airports and seaports, other governmental entities at or below the state level having more than a de minimis amount of one of the three sovereign powers: the power of taxation, the power of eminent domain or the police power. Municipal bonds secured by specified revenues. In the United States, interest income received by holders of municipal bonds is excludable from gross income for federal income tax purposes under Section 103 of the Internal Revenue Code, may be exempt from state income tax as well, depending on the applicable state income tax laws.
The state and local exemption was the subject of recent litigation in Department of Revenue of Kentucky v. Davis, 553 U. S. 328. Unlike new issue stocks that are brought to market with price restrictions until the deal is sold, most municipal bonds are free to trade at any time once they are purchased by the investor. Professional traders trade and re-trade the same bonds several times a week. A feature of this market is a larger proportion of smaller retail investors compared to other sectors of the U. S. securities markets. Some municipal bonds with higher risk credits, are issued subject to transfer restrictions. Outside the United States, many other countries in the world issue similar bonds, sometimes called local authority bonds or other names; the key defining feature of such bonds is that they are issued by a public-use entity at a lower level of government than the sovereign. Such bonds follow similar market patterns as U. S. bonds. That said, the U. S. municipal bond market is unique for its size, liquidity and tax structure and bankruptcy protection afforded by the U.
S. Constitution. Municipal debt predates corporate debt by several centuries—the early Renaissance Italian city-states borrowed money from major banking families. Borrowing by American cities dates to the nineteenth century, records of U. S. municipal bonds indicate use around the early 1800s. The first recorded municipal bond was a general obligation bond issued by the City of New York for a canal in 1812. During the 1840s, many U. S. cities were in debt, by 1843 cities had $25 million in outstanding debt. In the ensuing decades, rapid urban development demonstrated a correspondingly explosive growth in municipal debt; the debt was used to finance a growing system of free public education. Years after the Civil War, significant local debt was issued to build railroads. Railroads were private corporations and these bonds were similar to today's industrial revenue bonds. Construction costs in 1873 for one of the largest transcontinental railroads, the Northern Pacific, closed down access to new capital.
Around the same time, the largest bank of the country of the time, owned by the same investor as that of Northern Pacific, collapsed. Smaller firms followed suit as well as the stock market; the 1873 panic and years of depression that followed put an abrupt but temporary halt to the rapid growth of municipal debt. Responding to widespread defaults that jolted the municipal bond market of the day, new state statutes were passed that restricted the issuance of local debt. Several states wrote these restrictions into their constitutions. Railroad bonds and their legality were challenged, this gave rise to the market-wide demand that an opinion of qualified bond counsel accompany each new issue; when the U. S. economy began to move forward once again, municipal debt continued its momentum, maintained well into the early part of the twentieth century. The Great Depression of the 1930s halted growth, although defaults were not as severe as in the 1870s. Leading up to World War II, many American resources were devoted to the military, prewar municipal debt burst into a new period of rapid growth for an ever-increasing variety of uses.
Today, in addition to the 50 states and their local governments, the District of Columbia and U. S. territories and possessions do issue municipal bonds. Another important category of municipal bond issuers which includes authorities and special districts has grown in number and variety in recent years; the two most prominent early authorities were the Port of New York Authority, formed in 1921 and renamed Port Authority of New York and New Jersey in 1972, the Triborough Bridge Authority, formed in 1933. The debt issues of these two authorities are exempt from federal and local governments taxes. Municipal bonds provide tax exemption from federal taxes and many state and local taxes, depending on the laws of each state. Municipal securities consist of long-term issues. Short-term notes are used by an issuer to raise money for a variety of reasons: in anticipation of future revenues such as tax
A stock exchange, securities exchange or bourse, is a facility where stock brokers and traders can buy and sell securities, such as shares of stock and bonds and other financial instruments. Stock exchanges may provide for facilities the issue and redemption of such securities and instruments and capital events including the payment of income and dividends. Securities traded on a stock exchange include stock issued by listed companies, unit trusts, pooled investment products and bonds. Stock exchanges function as "continuous auction" markets with buyers and sellers consummating transactions via open outcry at a central location such as the floor of the exchange or by using an electronic trading platform. To be able to trade a security on a certain stock exchange, the security must be listed there. There is a central location at least for record keeping, but trade is less linked to a physical place, as modern markets use electronic communication networks, which give them advantages of increased speed and reduced cost of transactions.
Trade on an exchange is restricted to brokers. In recent years, various other trading venues, such as electronic communication networks, alternative trading systems and "dark pools" have taken much of the trading activity away from traditional stock exchanges. Initial public offerings of stocks and bonds to investors is done in the primary market and subsequent trading is done in the secondary market. A stock exchange is the most important component of a stock market. Supply and demand in stock markets are driven by various factors that, as in all free markets, affect the price of stocks. There is no obligation for stock to be issued through the stock exchange itself, nor must stock be subsequently traded on an exchange; such trading may be off over-the-counter. This is the usual way that bonds are traded. Stock exchanges are part of a global securities market. Stock exchanges serve an economic function in providing liquidity to shareholders in providing an efficient means of disposing of shares.
The idea of debt dates back to the ancient world, as evidenced for example by ancient Mesopotamian city clay tablets recording interest-bearing loans. There is little consensus among scholars as to; some see the key event as the Dutch East India Company's founding in 1602, while others point to earlier developments. Economist Ulrike Malmendier of the University of California at Berkeley argues that a share market existed as far back as ancient Rome. One of Europe's oldest stock exchanges is the Frankfurt Stock Exchange established in 1585 in Frankfurt am Main. In the Roman Republic, which existed for centuries before the Empire was founded, there were societates publicanorum, organizations of contractors or leaseholders who performed temple-building and other services for the government. One such service was the feeding of geese on the Capitoline Hill as a reward to the birds after their honking warned of a Gallic invasion in 390 B. C. Participants in such organizations had partes or shares, a concept mentioned various times by the statesman and orator Cicero.
In one speech, Cicero mentions "shares that had a high price at the time". Such evidence, in Malmendier's view, suggests the instruments were tradable, with fluctuating values based on an organization's success; the societas declined into obscurity in the time of the emperors, as most of their services were taken over by direct agents of the state. Tradable bonds as a used type of security were a more recent innovation, spearheaded by the Italian city-states of the late medieval and early Renaissance periods. While the Italian city-states produced the first transferable government bonds, they did not develop the other ingredient necessary to produce a fully-fledged capital market: the stock market in its modern sense. In the early 1600s the Dutch East India Company became the first company in history to issue bonds and shares of stock to the general public; as Edward Stringham notes, "companies with transferable shares date back to classical Rome, but these were not enduring endeavors and no considerable secondary market existed."
The VOC, formed to build up the spice trade, operated as a colonial ruler in what is now Indonesia and beyond, a purview that included conducting military operations against the wishes of the exploited natives and of competing colonial powers. Control of the company was held by its directors, with ordinary shareholders not having much influence on management or access to the company's accounting statements. However, shareholders were rewarded well for their investment; the company paid an average dividend of over 16% per year from 1602 to 1650. Financial innovation in Amsterdam took many forms. In 1609, investors led by Isaac Le Maire formed history's first bear market syndicate, but their coordinated trading had only a modest impact in driving down share prices, which tended to remain robust throughout the 17th century. By the 1620s, the company was expanding its securities issuance with the first use of corporate bonds. Joseph de la Vega known as Joseph Penso de la Vega and by other variations of his name, was an Amsterdam trader from a Spanish Jewish family and a prolific writer as well as a successful businessman in 17th-century Amsterdam.
His 1688 book Confusion of Confusions explained the workings of the city's stock market. It was the earliest book about stock trading and inner workings of a stock market, taking the form of a dialogue between a merchant, a shareholder and a philosopher, the book described a market, sophisticated but prone to excesses, de la Vega of
A corporation is an organization a group of people or a company, authorized to act as a single entity and recognized as such in law. Early incorporated entities were established by charter. Most jurisdictions now allow the creation of new corporations through registration. Corporations come in many different types but are divided by the law of the jurisdiction where they are chartered into two kinds: by whether they can issue stock or not, or by whether they are formed to make a profit or not. Corporations can be divided by the number of owners: corporation corporation sole; the subject of this article is a corporation aggregate. A corporation sole is a legal entity consisting of a single incorporated office, occupied by a single natural person. Where local law distinguishes corporations by the ability to issue stock, corporations allowed to do so are referred to as "stock corporations", ownership of the corporation is through stock, owners of stock are referred to as "stockholders" or "shareholders".
Corporations not allowed to issue stock are referred to as "non-stock" corporations. Corporations chartered in regions where they are distinguished by whether they are allowed to be for profit or not are referred to as "for profit" and "not-for-profit" corporations, respectively. There is some overlap between stock/non-stock and for-profit/not-for-profit in that not-for-profit corporations are always non-stock as well. A for-profit corporation is always a stock corporation, but some for-profit corporations may choose to be non-stock. To simplify the explanation, whenever "Stockholder" or "shareholder" is used in the rest of this article to refer to a stock corporation, it is presumed to mean the same as "member" for a non-profit corporation or for a profit, non-stock corporation. Registered corporations have legal personality and their shares are owned by shareholders whose liability is limited to their investment. Shareholders do not actively manage a corporation. In most circumstances, a shareholder may serve as a director or officer of a corporation.
In American English, the word corporation is most used to describe large business corporations. In British English and in the Commonwealth countries, the term company is more used to describe the same sort of entity while the word corporation encompasses all incorporated entities. In American English, the word company can include entities such as partnerships that would not be referred to as companies in British English as they are not a separate legal entity. Late in the 19th century, a new form of company having the limited liability protections of a corporation, the more favorable tax treatment of either a sole proprietorship or partnership was developed. While not a corporation, this new type of entity became attractive as an alternative for corporations not needing to issue stock. In Germany, the organization was referred to as Gesellschaft mit beschränkter Haftung or GmbH. In the last quarter of the 20th Century this new form of non-corporate organization became available in the United States and other countries, was known as the limited liability company or LLC.
Since the GmbH and LLC forms of organization are technically not corporations, they will not be discussed in this article. The word "corporation" derives from corpus, the Latin word for body, or a "body of people". By the time of Justinian, Roman law recognized a range of corporate entities under the names universitas, corpus or collegium; these included the state itself and such private associations as sponsors of a religious cult, burial clubs, political groups, guilds of craftsmen or traders. Such bodies had the right to own property and make contracts, to receive gifts and legacies, to sue and be sued, and, in general, to perform legal acts through representatives. Private associations were granted designated liberties by the emperor. Entities which carried on business and were the subjects of legal rights were found in ancient Rome, the Maurya Empire in ancient India. In medieval Europe, churches became incorporated, as did local governments, such as the Pope and the City of London Corporation.
The point was that the incorporation would survive longer than the lives of any particular member, existing in perpetuity. The alleged oldest commercial corporation in the world, the Stora Kopparberg mining community in Falun, obtained a charter from King Magnus Eriksson in 1347. In medieval times, traders would do business through common law constructs, such as partnerships. Whenever people acted together with a view to profit, the law deemed. Early guilds and livery companies were often involved in the regulation of competition between traders. Dutch and English chartered companies, such as the Dutch East India Company and the Hudson's Bay Company, were created to lead the colonial ventures of European nations in the 17th century. Acting under a charter sanctioned by the Dutch government, the Dutch East India Company defeated Portuguese forces and established itself in the Moluccan Islands in order to profit from the European demand for spices. Investors in the VOC were issued paper certificates as proof of share ownership, were able to trade their shares on the original Amsterdam
In finance, a credit derivative refers to any one of "various instruments and techniques designed to separate and transfer the credit risk" or the risk of an event of default of a corporate or sovereign borrower, transferring it to an entity other than the lender or debtholder. An unfunded credit derivative is one where credit protection is bought and sold between bilateral counterparties without the protection seller having to put up money upfront or at any given time during the life of the deal unless an event of default occurs; these contracts are traded pursuant to an International Swaps and Derivatives Association master agreement. Most credit derivatives of this sort are credit default swaps. If the credit derivative is entered into by a financial institution or a special purpose vehicle and payments under the credit derivative are funded using securitization techniques, such that a debt obligation is issued by the financial institution or SPV to support these obligations, this is known as a funded credit derivative.
This synthetic securitization process has become popular over the last decade, with the simple versions of these structures being known as synthetic collateralized debt obligations, credit-linked notes or single-tranche CDOs. In funded credit derivatives, transactions are rated by rating agencies, which allows investors to take different slices of credit risk according to their risk appetite; the market in credit derivatives started from nothing in 1993 after having been pioneered by J. P. Morgan's Peter Hancock. By 1996 there was around $40 billion of outstanding transactions, half of which involved the debt of developing countries. Credit default products are the most traded credit derivative product and include unfunded products such as credit default swaps and funded products such as collateralized debt obligations. On May 15, 2007, in a speech concerning credit derivatives and liquidity risk, Geithner stated: “Financial innovation has improved the capacity to measure and manage risk.” Credit market participants and courts are using credit derivative pricing to help inform decisions about loan pricing, risk management, capital requirements, legal liability.
The ISDA reported in April 2007 that total notional amount on outstanding credit derivatives was $35.1 trillion with a gross market value of $948 billion. As reported in The Times on September 15, 2008, the "Worldwide credit derivatives market is valued at $62 trillion". Although the credit derivatives market is a global one, London has a market share of about 40%, with the rest of Europe having about 10%; the main market participants are banks, hedge funds, insurance companies, pension funds, other corporates. Credit derivatives are fundamentally divided into two categories: funded credit derivatives and unfunded credit derivatives. An unfunded credit derivative is a bilateral contract between two counterparties, where each party is responsible for making its payments under the contract itself without recourse to other assets. A funded credit derivative involves the protection seller making an initial payment, used to settle any potential credit events. Unfunded credit derivative products include the following products: Credit default swap Total return swap Constant maturity credit default swap First to Default Credit Default Swap Portfolio Credit Default Swap Secured Loan Credit Default Swap Credit Default Swap on Asset Backed Securities Credit default swaption Recovery lock transaction Credit Spread Option CDS index productsFunded credit derivative products include the following products: Credit-linked note Synthetic collateralized debt obligation Constant Proportion Debt Obligation Synthetic constant proportion portfolio insurance The credit default swap or CDS has become the cornerstone product of the credit derivatives market.
This product represents over thirty percent of the credit derivatives market. The product has many variations, including where there is a basket or portfolio of reference entities, although fundamentally, the principles remain the same. A powerful recent variation has been gathering market share of late: credit default swaps which relate to asset-backed securities. A credit linked note is a note whose cash flow depends upon an event, which may be a default, change in credit spread, or rating change; the definition of the relevant credit events must be negotiated by the parties to the note. A CLN in effect combines a credit-default swap with a regular note. Given its note-like features, a CLN is an on-balance-sheet asset, in contrast to a CDS. An investment fund manager will purchase such a note to hedge against possible down grades, or loan defaults. Numerous different types of credit linked notes have been structured and placed in the past few years. Here we are going to provide an overview rather than a detailed account of these instruments.
The most basic CLN consists of a bond, issued by a well-rated borrower, packaged with a credit default swap on a less creditworthy risk. For example, a bank may sell some of its exposure to a particular emerging country by issuing a bond linked to that country's default or convertibility risk. From the bank's point of view, this achieves the purpose of reducing its exposure to that risk, as it will not need to reimburse all or part of the note if a credit event occurs. However, from the point of view of investors, the risk profile is different f