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FIN3703 > Financial Markets > Flashcards

Financial Markets Flashcards

1
Q

What are financial markets?

A

A structure where financial assets are exchanged or traded.

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2
Q

Provision of Liquidity (Role of Financial Markets)

A
  1. Provide a place of gathering of WILLING buyers & sellers.
  2. Enforces regulation to protect buyer & seller. (Standardised the contract per trade)
  3. Matches buyers and sellers –> Efficient allocation of resources.
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3
Q

Price discovery process (Role of Financial Markets)

(2)

A
  1. Determining the price of financial assets. (A point where everyone agrees)
  2. Determining the amount of return for each financial asset.
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4
Q

How is the price discovery process influenced?

4

A
  • Liquidity
  • Risk
  • Information
  • Transaction

*Ultimately, the demand and supply forces

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5
Q

Reduction of transaction costs (Role of Financial Markets)

A
  1. Reduce search time and cost

2. Reduce contracting cost and risk (no need for a lawyer to draw up the contract)

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6
Q

How does the risk decrease by trading in the Financial Markets?

A

CENTRAL COUNTER PARTY

  • Clearing members contribute security funds to cover default costs.
  • They mainly come from financial institutions.
  • Allow their clients to trade.
  • Acts as a guarantor for transactions
  • Prevents the risk of default by one of the trading parties
  • Even if someone goes bankrupt we will still get our revenue

THEREFORE, counterparty risk is minimised since buyer is dealing with the clearing house/dealer and not directly with the seller, vice versa.

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7
Q

What is “Too big to bail”?

A

Too big to save

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8
Q

What is “Too big to fail”?

A

Government/regulator will protect these institutions to prevent failure and wastage of national resources. (i.e. taxpayers money)

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9
Q

What are the 9 types of financial markets?

A
  1. Primary
  2. Secondary
  3. Asset class
  4. Money
  5. Capital
  6. Exchange
  7. Over-the-counter (OTC)
  8. Spot
  9. Future/Foward
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10
Q

What financial assets are in the primary market?

A
  1. IPO - Initial Public Offering: Company sell shares for the first time
  2. SEO - Season Equity Offering: Company have already went through IPO, but want to sell more new shares.
  3. Private Placement: New shares for institutional investors (Large banks, mutual funds, insurance companies, pension funds)
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11
Q

What financial assets are in the secondary market?

A
  • Trading of issued assets

- Exchanging existing assets between owners

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12
Q

What is a counterparty risk?

A

Counterparty risk is the likelihood or probability that one of those involved in a transaction might default on its contractual obligation.

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13
Q

How does a broker represent his/her client?

A

Be a clearing member.

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14
Q

What does a clearing member needs to pledge?

A
  • Collateral

- Safety Fund

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15
Q

What happens if the clearing member fails?

A
  • Collateral from the clearing member
  • Safety fund from the clearing member
  • Exchange capital
  • Other clearing member
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16
Q

What financial assets are in the asset class market?

4

A

1) Debt/Bonds
2) Equity/Stocks
3) Foreign Exchange
4) Derivatives (Options & Instruments)

17
Q

What financial assets are in the Money market?

6

A

Short-term ones (1 year or less)

1) Discount Windows
2) Federal funds
3) Certificates of deposits (negotiable & non-negotiable: Cannot trade/contract cannot be adjusted)
4) T-bills
5) Repurchase Agreement
6) Commercial papers

18
Q

Example of short-term financial assets in the money market?

A

12-mth T-bills

19
Q

What are discount windows?

A

An instrument of monetary policy that allows eligible institutions to borrow money from the central bank.

“CENTRAL BANK DISCOUNT RATE”

  • Usually on a short-term basis
  • Allow these institutions to meet temporary shortages of liquidity caused by internal or external disruptions

*Central bank is the lender of last resort (when company is really desperate and credit is not very high)

20
Q

Function of fed funds?

A

Inter-bank borrowing.

  • Rates that banks charge each other for loans that are used to hit the reserve requirements
  • Lend their excess reserves to other banks who are in deficit overnight
21
Q

What is the rate that the fed funds use?

A

Central Bank: F.O.M.C. –> They control the fed funds rate

CURRENT: 0%-0.25%

22
Q

How does the F.O.M.C. control the fed funds rate?

A

They set up a target band (discount windows) that they want to see the interest rate in.

  • But they are not obliged to transact at that rate.
  • If i/r is transacted outside of the target band, the central bank will OMO and let market forces decide.
23
Q

What is a repurchase (REPO) agreement?

A

Selling securities and simultaneously agreeing to repurchase the same after a specified time at a given price/set time.

24
Q

How does the selling securities take place in a REPO agreement?

(2)

A

Financial institutions can borrow from each other very quickly at a low cost for a short period of time.

Underlying securities serve as a collateral.

25
Q

What is the process in a REPO agreement?

A

1) Borrower sells T-bills to the lender. (coupon still goes to the borrower)
2) Lender pays borrower in cash which the borrower needs.
3) then the lender buys back the T-bills (can be at a higher price, and thus, earn profit)
4) Borrower pays the lender in cash

26
Q

What are commerical papers?

A
  • Short-term unsecured promissory notes issued by corporations and foreign governments
  • Less than 1 yr
  • No collateral is pledged
  • Therefore, its a RISKY loan as there is nothing to fall back on.
27
Q

Comparing different interest rates for different durations

A

3-yr: 8%
3-mth: 6%

  • Liquidity risk
  • Since funds are tied up for a longer period of time, liquidity risk increase, thus, higher interest rates
  • After allocated period of time, the loan will roll over, not good to keep on delaying
28
Q

What are the assets in a capital market?

2

A
  • More than 1 yr
    1) Stocks
    2) Bonds
29
Q

How does the Exchange Market function?

A
  • Formal Financial market

- Trade, clear, and settle in and by an exchange (or its clearing house)

30
Q

What are the advantages of an exchange?

4

A
  • Facilitates liquidity
  • Provides transparency (Ensure fair and orderly trading + efficient dissemination of price information for any securities trading on that exchange)
  • Maintains current market price
  • Matches buyers and sellers together
31
Q

How does OTC (Over-the counter) market function?

A
  • Off-Exchange trading
  • Two parties directly trade
  • Trade is faciliated like broker-dealer
  • Therefore, there is counterparty risk, buyers and sellers bear their own risks.
32
Q

How does the Spot market function?

A
  • Cash/Physical market
  • Immediately delivery (ASAP): Commodities or financial instruments are bought and sold for immediate delivery/within a couple of days
  • Spot price
  • Public financial market
33
Q

How does the future/forward market function?

A
  • Contrast with spot market
  • Future delivery
  • Traders purchase & sell futures contract
  • Payment and Delivery on a future date

FIN3703 (12 decks)

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