Chapter 1 - Introduction to financial markets Flashcards
1
Q
SECTION 1.1
What are the four main functions of the financial service industry
A
- Financial intermediation
- Pooling and Managing risk -
- Provisions of settlements and payments
- Portfolio Management
2
Q
What are the main types of financial instutions
A
- Central banks
- deposit institutions
- Investment institutions
3
Q
What is Financial Intermediation
A
- Acts as a middleman for financial transactions - provides ways for funds to move from savers (surplus) to borrowers (deficit) agents
- Examples include: Investment Bank, Mutual fund, pension fund
- These intetermediaries provide ways to create efficient markets by reducing infomation and lowering costs
4
Q
How do institutions perform a intermediary function
A
- Banks uses the secruties markets to raise capital and invest
- Investment institutions such as: pension funds, Insurance companies purchase secrutinaised assets of the Bank.
5
Q
What is the significance of pooling and managing risk
A
- Pooled investment products allow mutiple savers to invest in a wider variety of instruments than they would able to indivdually, therefore reduces each indivdual overall exposure
- Insurance comapanies allows indivduals to transfer a risk exposure in return for a premium.
- Dervatives such as: futures and options, allow investors to manage their risk exposure.
6
Q
What role does the Central bank play
A
- It is responsibile for setting monetary framework through 2 ways:
1) Setting interest rates to meet inflation target
2) Acting as lender to banking sector by supplying liqudity in times of crisis.
7
Q
What is the role of an investment institution
A
- Offer protection against unwanted events in exchange for a premium
- Covers life insurance - longer period so insurers generally hold long term assets
- Covers loss or damage and tend to hold shorter term assets so there is more need for immediate cash.
They invest the funds raised in tradeable secruties such as: Bonds and Equities
8
Q
How has capital flows across national boarders increased?
A
- Central banks in other countries purchasing many US treasury in large quantites
- Companies in one country may choose to list on the stock market in another country to raise more liquid capital
- Companies can issue bonds in another country
- Investment institutions increased their holdings in forgien assets which benefits investors in the UK looking to invest internationally.
9
Q
What is the role of the government
A
- Provide services that private firms are either unwilling or not allowed to provide- ‘Market Failure’ examples include: law and order and maintenance of infrastructure.
- Regulation to protect customers - Promote competition and prevent fraud by restircting entry
- Improving distribution of capital - Redistribution of income and wealth through taxes and state benefits
Stablising the economy - Controlling inflation by using interest rates , carried out by MPC
10
Q
SECTION 1.2 - The role of secruties in providing liquidity
Who are the main lenders and borrowers in an economy
A
- Households are the main lenders
- Companies and governments are the main borrowers
11
Q
What is the difference between a real asset and financial asset
A
- A real asset is something material such as: land, gold, buildings
- A financial asset is somehting that will provide a return such as: bonds and secruties
12
Q
What are the types of financial assets
A
1) Debt claims - loans made by lenders to borrowers that are epxected to be paid back with interest
* Example: A bank deposit with fixed or variable rate of interest
2) Equity secruties - A tradeable asset known as Shares
13
Q
Example of tradable and non tradeable debt claim
A
- Non-tradable debt claim is a bank deposit
- A tradable debt claim is a bond (fixed income secruity) issued by the governemnt
14
Q
Whta is the difference between money markets and capital markets
A
- Examples of money markets include: treasury bill debt that have a short term matruity date usually 1-3 months
- Examples of capital markets are bonds and shares that have a longer maturity date
15
Q
How do savers generally invest in bonds and shares
A
- Indirectly through intermediaries such as insurane companies, pension funds and pooled investment products
- The benefits of this is that:
1) Greater diversification - Ability to invest in assets that may not be available to an instituional invetsor e.g. commercial property.
2) Reduced transaction cost - due to intermeidary can trade at lower costs
16
Q
What do invetsment intermediaries use to manage risk
A
- Derivative contracts
17
Q
What are derivatives
A
- Financial contracts based on the value of an underlying asset e.g bonds, stocks, currencies.
- An example of where derivatives contracts are used is by making gains from anticipated movements in the price of an asset. - two parties agreeing on the purchase and delivery of an asset on an agreed upon price and a future date
18
Q
What are the 4 functions of secruties market
Secruties markets brings buyers and sellers together e.g euqties & bonds
A
- Raising capital - Firm can issue equities and bonds - helps with moblisation of savings
- Transfer risk for investors- Use derivative contracts to hedge risk
- Price discovery- In Equity markets equlibrium price changes frequently allows buyers and sellers to agree on a price
- Creating liquiduty - Allows investors to sell their shares if need be
19
Q
What is the difference bewteen primary markets and secondary markets
A
- Primary markets - Initial sale of secrutiy into the market in order to raise capital - IPO
- Secondary markets- Where company has already issued the shares - allows the ability to turn secruties into cash quickly with minimal loss of value
20
Q
What is price disseminiation
A
- Pre-trade transparency - publishes real time data about quotes and orders
- Post trade transparency - publishes trade prices and sizes shortly after the trade occurs
- Both are required under MiFID II
21
Q
What markets do buy side traders and sell side traders prefer
A
- Buy side traders value transparency - better manage their trading and esitmate transaction costs.
- Sell side value opaque markets as they have infomational advantage over counterparties
22
Q
What is the difference between OTC markets and organised markets
A
- OTC markets are where you can sell trade stocks, commodities and currencies without the need for a broker
- Organised markets include London Stock Exchange and tends to be more transparent
23
Q
What is liquidity
A
- Investors assess liquidity of markets by looking at bid-ask spread - the more willing buyers and sellers, the more liquid a market is.
- Opaque markets usually havewider bid-ask spread becuase finding the best available price is harder for traders
- Transparency reduces this bid-ask spread which benefits investors
24
Q
What is the difference between liquid markets and illiquid markets
A
- An asset is considered illiquid if it is diifcult to sell because of the uncertanity of its future value or lack of market depth E.G MBS 2008
- When there is uncertanity in the market, secruties may drop in value due to traders pessimesstic view about future value of these secruites
- An example of a liquid market is US treasuries market - Large volume of tranaction, high market depth, low bid-ask spread makes transactions costs low.
25
Pros and Cons of liquid markets
Pros:
* **Increases flow of capital** - Promotes traders to trade and savers to invest in claims issued by borrowers
Cons:
* Investors demand higher retunrs of secruties with low liquidity becuase harder to sell
26
What are the costs when trading secruties
* **Broker commission**
* **Price impact of a trade** - For large instituions this may be the biggest component of a transaction
* **Bid-ask spread price** - smaller, less frequently traded stocks generally have a large spread
27
How can companies reduce transaction costs
* **Employ skillful brokers** to trade on their half and pay out commission - Trade is less liquid markets - more commission
* **Use electronic algotherims** to monitor trading
* **Use dark pool/hidden orders** to hide their size
28
What are round trip costs
* Total costs of completing a transaction - commission, taxes, bread -ask spread
29
Under the introduction of MiFID what components (trading venues) was introduced
* Regulated Markets
* Multilateral trading facilties
* Systematic Internalisers
* Greater trading venues has led to fragmentation of trading
30
What are the trading system offered by the Lodon Stock Exchange
* **SETS** - Electronic limit order book to trade **FTSE 100, 250 shares**
* Secruties such as: **ETF's and ETP** are traded on here
* Order-Driven
* **SETSqx**- Trading platform for **stocks that are less lqiuid** that SETS.
* Invetsors have a choice to trade in either **order-book driven or quote-driven**
31
What is an Order-Driven system
* All buyers and sellers display prices at which they wish to buy and sell (can see **best available price** on electric order book)
* All orders in the book are made up of **limit orders**
32
What is a Quote-Driven System
* Can only see prices brokers display
33
What are market makers
* Financial institutions (hedge funds, sell side) that quote bid and ask prices and be ready to buy these secruties
* GEMM's must deal in all gilt issues or none at all
34
What are the two listing catogeries
* **Preimum Listing**- Only available to OEIC's and large institutions who meet highest level of corporate governance
* Can choose to trade on FTSE 100 indices, LSE and AQSE
* **Stanadard Listing** - opposite of premium listing (meets lightest requirements) - usually for shares and deposit receipts
* Can only trade on LSE and AQSE
35
What are the conditions for premium listing
* Company should have accounts covered up to **3 years** and have secruties value equal to **£700,000 in shares and £200,000 for debt debt secruties**
* Show proof that it has sufficent working capital to cover 12 months of business
* 25% listed secruites must be held by the public
36
What are the conditions to be listed on AIM
* need an a nominated advisor and need to produce an admission document
37
What are the conditions for HGS
| HGS (High Growth Segment) on London Stock Exchange
* Be incorporated in the EEA
* Be a commercial company issuing equity shares only
* Have a minimum free float of 10% at IPO
* Demostrate Historic value of 20% over the last 3 years
38
What are the conditions listed on the AQSE
* Appoint and retain a corporate adviser at all times
* Have at least **24 months**of audited accounts
* Have 10% free float in public shares
* Have a good level of corporate governance including one non executive director.
39
What are the exemptions to prodcue a prospectus
* Where the offer is made to a qualified investor
* Where the offer is made to fewer than 150 persons
* Where the minimum consideration **per investor is greater than £100,000**
* Where the total consideration of an offer is greater than **£5 million over 12 month period**
40
Whats the difference between professional clients and retail investors
* Qualfied investors - those who are professional clients or eligable counterparties
* Retail investors can only be professional clients when:
1) Secruity portfolio greater than **£500,000**
2) Worked at least a year in investment postion than requires knowledge of secruites
3) Have carried out transactions greater than £1000 on secrtuies market
41
When do investors have disclose when buying shares
* Investors must notify a company within two business days when it acquires 3% or more of companies shares
* Must also notify the company when further incriments of 1% above the 3%
42
What are concert parties
* Group of investors who buy shares in the same company with aims of taking over the company. - to prevent control
* They can use combined interest to takeover
43
Who is subjected to the disclosure rule
* When investors owes shares that exceed 3% threshold of a company.
* Public companies must keep a register of those who are interested in buying shares in the past 3 years
44
What is corporate governance in the UK
* Stresses the importance of financial reporting and internal controls to assure shareholders the investments are safeguarded
45
What are the 5 principles of corporate governance in the UK
* **Leadership** - Effective board must ensure the company has suffcient resources to meet its objectives
* **Division of responsibility**- Board should have executive directors and non-executive directors to ensure no one controls decision making
* **Accountability of board**
* **Risk management**
* **Remuneration** - A **seperate remuneration policy must be put into shareholders vote every 3 years in the AGM meeting**
46
What does the section 172 of companies act require
* Requires large companies in the UK to publish a statement on how directors engage with stakeholders
47
What is the UK Stewardship code
* Stewardship is the mangement, allocation and oversight of capital to create long term value for clients leading to sustainable benefits for the economy, social and environemtal.
* 12 policies aimed at asset managers and institutional investors
* 6 policies are aimed at organisations that do not manage investments directly but enable clients to deliver quality stewardship e.g investment consultants
48
How do organisations become signatories
* Must produce an annual stewardship report to explain how they have resonated with the code in the **past 12 months**
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