As seen in table 2, different issuers need funds for different duration depending on their liquidity needs. Hence, they issue different financial instruments according to these needs. Table 3 below describes financial instrument and instrument type issued by either the government or corporations depending on their financial needs.

In equity markets, stocks are traded. As we have seen, a share or stock is an equal ownership in a company. Stocks are traded on stock exchanges. In the United States, there are two major stock exchanges: the New York Stock Exchange (NYSE) and the NASDAQ (the National Association of Securities Dealers Automated Quotations). In the past, there was a difference in the way stocks were traded on these exchanges. While brokers were the primary persons on the NYSE, it was the dealers who were involved in placement and execution of trades on the NASDAQ.

Brokers are persons who are responsible for finding a buyer for a seller and vice versa. However, on most occasions there are so many buyers and sellers that their bids (purchase price) and offers (selling price) are placed in an order that trades can take place once the purchase and/ or sale prices are reached.

Brokers collect orders from investors and the bid and offer orders are listed on the stock exchange. An exchange such as NYSE is a free marketplace where stocks are traded between buyers and sellers via brokers. On the other hand, NASDAQ has traditionally been associated with dealers or entities that are legally required to provide two-way quotes to buyers and sellers — a bid and offer price. The way dealers make money is through the spread on these two-way quotes unlike brokers who earn money through commissions on purchase/ sale of securities. So, instead of looking for a buyer for a seller of financial instruments and vice versa investors can directly approach the “counter” at NASDAQ and place their trade with the dealers who are required to give a two-way quote.

US treasury bonds are also placed via primary dealers. Because of their role in buying as well as selling of instruments, dealers are called market makers. However, in practice it is very difficult to be a market maker for stocks as stocks sometimes constantly lose value for extended period of time. So, there is a risk of dealers going bankrupt during such times.

Delta Air Lines File for Chapter 11 Bankruptcy

The year 2005 became a very turbulent year for Delta as the company filed for bankruptcy protection after racking up more than $10 billion in losses since 2001. Hence, they were not in a position to repay some of the bonds they issued in prior years as well as loans they took from banks. That is why they had to seek Chapter 11 protection. Chapter 11 is a form of bankruptcy protection that involves reorganization of debtor’s business affairs, assets and debt. In addition, if a company is filing for Chapter 11 protection chooses to follow a reorganization plan, it must do so to protect the interests of lenders.

To support its business during Chapter 11 proceedings, Delta negotiated to receive a commitment for $1.7 billion in debtor-in-possession (DIP) financing from GE Commercial Finance and Morgan Stanley as Co-Lead Arrangers (Ramos, 2005). In other words, to fund any financial needs, Delta received a financial support of that amount. Hence this DIP would be a debt market instrument that cannot be traded on an exchange because it is specific to Delta. Sometimes during reorganization of the firm, the company may find that its assets are insufficient to protect all its liabilities even after receiving new financing. This can lead to a haircut for its lenders, a process in which lenders receive only a part of their funds back. However, a haircut is still better than receiving nothing at all.

There were few crucial reasons behind declaration of bankruptcy: rising crude oil price, labor charges and operation of unprofitable routes as a part of its legacy business. Oil prices had been climbing since the year 2003 and reached record highs. Since fuel cost is a considerable part of the cost structure of any airline, rising fuel costs create pressure on profitability of airlines. Fuel costs can typically comprise 20%-30% of the operating expense of an airline company. Factors that influence price of fuel include geopolitical (break in supply) and economic factors (strong demand). However, Delta Air Lines Inc. emerged from bankruptcy on April 30, 2007, following a 19-month hiatus and $3 billion in restructuring cost. The carrier thwarted a hostile takeover, cut costs and jobs, and eliminated some unprofitable routes during this period.

2.2.3 Capital and Money Markets

Finally, there are capital and money markets. These are differentiated exclusively by the term to maturity (recall that term to maturity is the duration in which the instrument will expire) of the instrument that was issued. Any instrument that was issued for more than 1 year is a capital market instrument. The rest are money market instrument. The nature of money market instruments is to tide over short-term liquidity situation for the issuer. So, treasury bills, commercial papers and short-term CDs or Fed funds window for banks are all money market instruments. However, long-term bonds are capital market instruments. So, even if a 30-year bond is due to mature in next week, it is still a capital market instrument because it is a bond that is issued for more than 1 year. Since stocks have no maturity, these are capital market instruments.

The importance of either type of instrument cannot be discounted enough. For example, Delta airlines has a special program for its Sky Miles. Since the program is medium-long term in nature, the bonds issued to finance the program are typically capital market instruments. However, if Delta wants to pay short-term fuel costs, then it could finance that by the way of say a 30-day commercial paper to pay the supplier and offset it by any sales revenues it receives from flying those commercial flights. These commercial papers are a money market instrument. In table 2 above instruments with a life of one year or less are money market instruments and those with term to maturity from issuance date of greater than 1 year are capital market instruments.

2.2.4 Organized Versus Over-The-Counter Markets

Brokers are listed as main participants in organized markets. Therefore, organized markets usually involve brokers to trade with each other. Retail customers can open accounts with brokers and trade through brokers with each other. Up to as late as 2010s, brokers used to charge a fee until new brokers such as Robinhood created a trend of not charging a fee per trade. The rationale behind charging a fee was that brokers needed to contact interested counterparties on the other side of the trade. This involved time and transaction costs. However, with availability of information over the internet, this became more and more easy. Therefore, we do not see brokers falling over each other at exchanges outbidding each other anymore. Stock exchanges all over the world typically operate in organized markets such as the New York Stock Exchange (NYSE).

In over-the-counter markets there are no brokers but broker-dealer networks. Institutions can issue or trade instruments not in a listed exchange, but more or less through the broker dealer network. Securities listed on over-the-counter (OTC) markets do not need to follow all the stringent requirements of securities listed on stock exchanges and organized markets. Securities in over-the-counter markets could also be traded by limited participants. As an example, government bonds, corporate bonds or penny stocks could be traded in these markets. To buy or sell these securities, all that is needed is a counterparty that has opposing view and is willing to act on it. For example, if we want to sell government bonds, we need someone to buy it. OTC markets do not have a centralized source of all necessary information. OTC markets are not located at a single location, i.e., these are decentralized. Bonds, debentures, commercial papers and tradeable certificate of deposits, penny stocks, venture markets are some examples of securities traded and deals being made at OTC markets.

2.2.5 Other Markets

There are other types of financial markets, particularly relevant to aviation. These are foreign exchange markets, commodity markets and derivatives. These are all very important for a finance professional in aviation.

 Commodity Markets

In commodity markets, goods such as crude oil, jet fuel, grains, metals and raw materials are exchanged between buyers and sellers. Since delivery of commodity takes place much later than the spot deal, there are two types of prices: spot prices and futures. The spot price is the cash cost of a commodity for immediate delivery. However, not all commodities can be delivered instantaneously.

For example, in crude oil markets, futures prices are available for delivery 2 months to 1 year out. When we estimate that future demand for crude oil is going to be higher than today (such as during the middle of the pandemic in May 2020), the spot price may be much lower than future prices. Such a type of market is said to be in contango. On the other hand, there is a huge immediate demand for crude oil. Then spot prices tend to shoot up as compared to the future prices.

During the 2022 period when inflation was spiking due to crude oil shortages from geopolitical tensions, spot prices were much higher than future prices because it was expected that oil companies would bring back online those production units/ refineries etc. to create greater capacity for delivery. Such a market is said to be in backwardation.

Commodities are traded on exchanges such as The Intercontinental exchange (popularly known as ICE futures US or Europe), the Chicago Mercantile Exchange (CME), the London Metal Exchange (LME), Tokyo Commodity Exchange (TCE)^[3]. Figure 2.1 below shows the crude oil futures as of June 26, 2022. What is worth noting that commodities, futures and cryptocurrencies can keep trading even when financial markets in any given country are closed because potentially other countries are still open. However, sometimes the liquidity is really low, meaning that there are not enough buyers and sellers to provide sufficient price discovery.

 Foreign Exchange Markets

Foreign exchange markets are another type of market that are particularly important for those airlines that fly international routes and/ or cater to international customers through travel agents abroad. In foreign exchange markets, currency needs to be converted from payments received from customers abroad into domestic currency. Currency conversion involves foreign exchange markets. Foreign exchange markets are typically existent among banks. However, large multinational corporations have their own foreign exchange divisions that oversee foreign exchange transactions. Banks send funds through SWIFT or society for worldwide interbank financial telecommunications. Payments are made in foreign account of domestic banks and then sent though SWIFT. Currency conversion is based on complex set of economic theory such as interest rate and inflation expectations, protectionism and central bank support and other macroeconomic conditions.

 Derivatives Markets

As discussed above, businesses use commodities and other financial instruments for their operations. The prices of products and instruments such as foreign currencies, jet fuel, and other commodities are highly volatile. The fluctuations in their prices may lead to significant risk in their business. To mitigate such risks, businesses widely use financial instruments, called derivatives, whose value is derived from the values of one or more underlying assets. The process of reducing risk by using derivatives and other strategies is called hedging. The market where these derivative instruments are traded is called derivatives markets. Besides using these derivatives by businesses for hedging, many investors buy and sell derivatives for speculative purposes. So, there is a vast derivatives market. The most common derivatives instruments are forwards, futures, options, warrants, and swaps. The five largest derivatives exchanges in 2021 by the number of contracts traded are: the National Stock Exchange of India, A Bolsa do Brasil (B3), CME Group, Intercontinental Exchange, and Nasdaq.

Finally hedge funds are funds managed by institutions meant for large net worth individuals (typically ranging in 100s of thousands to millions of dollars per investor). These assets utilize fancy trading strategies such as investment in derivatives, short selling, currencies and commodities, international markets and cross border investments to achieve profits for clients.

Many scholars believe that trying to beat overall markets (i.e. doing better than stock market investments through mutual funds and ETFs) is futile, particularly over medium to long run. We will see this “efficient markets hypothesis” in chapter 7. Some other investors, particularly in behavioral finance contest the notion of efficient markets hypothesis. There was a famous challenge between famous investor Warren Buffet and hedge funds in 2008^[5]. Warrant Buffet contested the stipulations of efficient markets and challenged hedge funds to produce better than market returns in ten years. At the end of 2016, when he shared the results, it was clear that the “Oracle of Omaha” had won the bet. Over the ten-year period the S&P 500 index had averaged 7.1% annually while hedge funds’ annual average was 2.1%.