Capital Markets and Securities

Question 1

What is a financial market?

Answer 1

The participants, commentators and facilitators which contribute to setting the price of a financial asset.

Question 2

Who are participants within a financial market?

Answer 2

1. Investors

2. Traders - Buying shares/bonds from a seller then selling it on for a higher price.

Question 3

What are financial markets there for?

Answer 3

There to set financial price of asset. Using info from equity analysts.

Question 4

Who provides information in the market?

Answer 4

Equity analysts.

Question 5

Who facilitates financial markets?

Answer 5

Exchanges and banks.

Question 6

What are the 4 main types of financial market?

Answer 6

1. Capital Markets
2. Money Markets
3. Derivative markets
4. Foreign exchage market.

Question 7

What is a capital market?

Answer 7

Involves long term securities one year in the future.

Question 8

what is a money market?

Answer 8

Short-term securities (< 1 year from issue to maturity) (maximum of a year).

Question 9

What is a derivative market?

Answer 9

Futures and options

Question 10

What is a foreign exchange market?

Answer 10

Currencies and forwards

Question 11

What is a security?

Answer 11

A financial instrument that can br traded for a monetary value. E.g. Stock.

Question 12

Who issues securities in the capital market? (primary capital market).

Answer 12

¥ Companies – issue equities and bonds to finance growth

¥ Governments – issue bonds to make up tax shortfall

Question 13

Does the investor have legal reights to recieve future cash flows from the issuer of these securities?

Answer 13

yes.

Equities (shares?) – dividends and liquidation proceeds. Infinite.

Bonds – interest (fixed) and redemption proceeds

Question 14

What happens in a secondary capital market?

Answer 14

Investors buying and selling shares between themselves

Question 15

What is a stock exchange?

Answer 15

Infrastructure for and regulation of:

¥ Primary market (issuance of “new” securities)
¥ Secondary markets (trading of “old” securities)

Question 16

What does a stock market demonsrate?

Answer 16

Security prices
Corporate News
Index Values

Question 17

What does an equity indeces do (page 2 on my word document).

Answer 17

Reflects prices of it’s constituent securities.

Question 18

What does an equity index do?

Answer 18

Provide a weighted average of the prices of however many successful companies. E.g. FTSE 100 is the 100 largest companies. Shows the overall equity of these companies that day.

Question 19

What does an equity index ignore?

Answer 19

Dividends

Question 20

How are equity index’s useful?

Answer 20

They allow us to compare the performance of share prices.

E.g. Can see how meggit compares to other companies of a similar size.

Question 21

Why are equity prices important for shareholders and directors in secondary markets?

Answer 21

1. Shareholder wealth creation
2. Financial efficiency through reselling.
3. Remuneration (i.e. Executive Share Option Schemes.)

Question 22

What does it mean when the price rises in a secondary market?

Answer 22

There is more buyers than sellers.

Question 23

Why do participants trade an equity?

Answer 23

They have different opinions on the intrinsic value of a company’s shares.

Determined by the amount, timing and certainty of it’s expected future cash flows. Subjective and rarely the same as it’s price. Optimism vs pessimism.

Question 24

What factors could make a participant more optimisitic in a secondary market?

Answer 24

1. Financial results and trading updates
2. Management changes
3. Mergers and acquisitions
4. Close competitors
5. Economic data
6. Equity analyst forecast upgrades

Question 25

What terms should a share price performance be stated?

Answer 25

Relative terms to an appropriate equity index. Comparing to the equity index basically. (average of all other companies within this stock market). E.g. -15% shareprice change (individual). -2% Index change. Relative performance of a shareprice: -15% + 2% = -13%.

Question 26

What makes a market efficient?

Answer 26

1. Many participants 2. Low transaction costs 3. readily accessible information

Question 27

What happens to security prices when they are in an efficient market?

Answer 27

They react fully, rapidly and rationally to all new information which is relevant to instrinsic value. Directors can be confident that actions which create or destroy shareholder wealth will be reflected in the share price

Question 28

What are the 3 types of market efficiency?

Answer 28

1. Weak Efficiency 2. Semi - strong efficiency 3. Strong efficiency

Question 29

What are the characteristics of a weak efficient market?

Answer 29

1. ¥ Prices fully, rapidly and rationally reflect all information contained in past prices 2. ¥ Strongly supported by tests of empirical evidence 3. ¥ Not possible to make consistent abnormal returns by predicting future price movements based on past price movements

Question 30

What are the characteristics of a semi - string efficient market?

Answer 30

1. Prices fully, rapidly and rationally reflect all information contained in past prices and all relevant publicly available information. 2. Not possible to make consistent abnormal returns by using past prices or publicly available information 3. Fairly well supported by tests of empirical evidence despite anomalies such as existience of star investors.

Question 31

What are the characteristics of a strong efficient market?

Answer 31

1. Prices fully, rapidly and rationally reflect all information contained in past prices and all relevant publicly available information and all relevant inside information 2. Not possible to make consistent abnormal returns with any information 3. Not well supported by tests of empirical evidence such as abnormal returns by directors dealing in their company's shares.

Question 32

What classification of efficiency are major capital markets and why?

Answer 32

Weak to semi strong efficiency because security prices: 1. Absorb new information quickly and rationally. 2. Fully reflect information contained in past price movements. 3. Do not reflect inside information

Question 33

What's the academic theory of the equity shares valuation?

Answer 33

The intrinsic value of a company is the present value of its expected future cash flows discounted at an appropriate, risk-adjusted, rate - impossible to do with bonds.

Question 34

What is the reality of the equity shares valuation?

Answer 34

1. Future company cash flows are inherently uncertain 2. Many and varying factors affect the discount rate 3. Non-cash flow methodologies to estimate equity value are used in practice which are: The Price Earnings Ratio (PER) The Dividend Yield (DY)

Question 35

What is the formula for the price earnings ratio?

Answer 35

PER = Share price (clean)/ prospective annual earnings per share.

Question 36

What are the 4 considerations for the PER? (Page 8 of word document).

Answer 36

1. Cannot use if company is loss-making 2. Forward looking but inherent uncertainty in forecasts 3. Earnings per share is partly subjective (accounting profits) 4. Measure of relative (not absolute) value.

Question 37

What is the formula for the dividend yield?

Answer 37

DY = prospective annual dividend per share ÷ share price (clean).

Question 38

What are the 4 considerations for the dividend yield? (Page 9 of my word document).

Answer 38

1. Cannot use if company has a zero dividend policy 2. Forward looking 3. Dividends per share are objective 4. Measure of relative and absolute value