Capital markets & Securities

Question 1

What is the financial market an ecosystem of

Answer 1

A financial market is the ecosystem of:
- Participants
- Commentators
- Facilitators

Question 2

Who are participants

Answer 2

Participants are investors and traders making buy/sell decisions

Question 3

Who are commentators

Answer 3

Commentators are equity analysists and credit rating agencies who influence opinion and price expectations

Question 4

Who are facilitators

Answer 4

Facilitators are exchanges, brokers, and investment banks that enable transactions

Question 5

What are the different types of financial markets

Answer 5

The different types of financial markets are:
- Capital markets
- Money markets
- Foreign exchange markets
- Derivative markets

Question 6

What is sold on capital markets

Answer 6

Capital markets consists of long-term securities like shares and bonds

Question 7

What do money markets consist of

Answer 7

Money markets consist of: Short-term securities like treasury bills and commercial paper

Question 8

What are foreign exchange markets

Answer 8

Foreign exchange markets are trading of currencies

Question 9

What are derivative markets

Answer 9

Derivative markets are: Futures, options, and other contracts based on underlying financial instruments

Question 10

What happens in primary markets

Answer 10

In primary markets, companies/governments issue new securities to raise capital

Question 11

What happens on secondary markets

Answer 11

In secondary markets securities are brought and sold after issuance

Question 12

Why do companies care about the secondary market prices

Answer 12

Companies care about secondary market prices because:
- They affect shareholder wealth
- They influence executive remuneration
- They signal the company’s financial reputation and impact its ability to raise future capital

Question 13

What does the intrinsic value of a security in theory

Answer 13

In theory the intrinsic value of a security = Present Value (PV) of expected future cash flows discounted at a risk-adjusted rate

Question 14

what is intrinsic value for equity in theory like

Answer 14

In theory for equity: cash flows = dividends + liquidation value

Question 15

what is intrinsic value for bonds in theory like

Answer 15

For bonds: cash flows = interest + redemption value

Question 16

What is intrinsic value like in parctice

Answer 16

In practice:
- Intrinsic value is subjective, varies across investors, and is never precisely known
- This subjectivity creates market movement as prices reflect collective expectations

Question 17

What do share prices adjust in response to

Answer 17

Share prices adjust in response to:
- Company announcements
- Market events
- Analyst forecasts and ratings
- Regulatory changes

Question 18

What is the weak form like in Fama (1970)

Answer 18

Fama 1970
Weak form: Prices reflect past trading data. Technical analysis cannot consistently beat the market

Question 19

What do prices reflect with semi-strong form

Answer 19

With semi-strong form prices reflect all public information

Question 20

What gives advantage with semi-strong form

Answer 20

With semi-strong form only insider info gives advantage

Question 21

What are most real-world markets close to

Answer 21

Most real-world markets are “close to semi-strong efficient”

Question 22

What do prices reflect with strong form

Answer 22

With strong form prices reflect all information, even insider knowledge

Question 23

What are the two types of share prices

Answer 23

The two types of share prices are:
- Cum-dividend (dirty price)
- Ex-dividend (clean price)

Question 24

What do cum dividends include

Answer 24

Cum-dividend (dirty price): Includes declared but unpaid dividends

Question 25

What do ex-dividends (clean price) exclude

Answer 25

Ex-dividend (clean price): excludes pending dividends

Question 26

Clean price =

Answer 26

Clean price = Cum-dividend Price - Declared Dividend

Question 27

What are indices used for

Answer 27

Indices are used for: - Benchmarking performance - Valuation comparisons - Market sentiment indicators - Inputs into CAPM (Capital Asset Pricing Model)

Question 28

What is valuation based on with the theoretical approach

Answer 28

With the theoretical approach valuation is based on discounting expected future cash flows

Question 29

What are common equity valuation techniques

Answer 29

Common equity valuation techniques are: - Price Earnings Ratio (PER) - Dividend Yield (DY)

Question 30

PER =

Answer 30

PER = Clean Share Price / Forecast EPS

Question 31

What does PER indicate

Answer 31

PER indicates how much investors are willing to pay per £1 of earnings

Question 32

What is PER used to assess

Answer 32

PER is used to assess growth expectations and market sentiment

Question 33

When is PER not valid

Answer 33

PER is not valid if EPS is zero or negative

Question 34

DY =

Answer 34

DY = Forecast DPS / Clean Share Price

Question 35

What does DY show

Answer 35

DY shows return based on forecast dividends

Question 36

When is DY not suitable

Answer 36

DY is not suitable if company doesn't pay dividends

Question 37

What are PER and DY useful for

Answer 37

PER and DY are useful for comparing a company against its peers or the market average

Question 38

What should PER and DY be like if a company's share is fair valued

Answer 38

Fairly valued: PER and DY in line with market indices (within ± 10% range)

Question 39

What should PER and DY be like if a company's share is undervalued

Answer 39

Undervalued: Low PER + high EPS growth or high D + stable dividend growth

Question 40

What should PER and DY be like if a company's share is overvalued

Answer 40

Overvalued: High PER + low growth or low DY + no dividend growth

Question 41

What should EPS and DPS be compared with

Answer 41

EPS and DPS growth should be compared with the index average (± 1% range)