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SIE Exam Prep > Knowledge of Capital Markets > Flashcards

Knowledge of Capital Markets Flashcards

1
Q

What are securities?

A

Securities are financial contracts, such as shares or bonds, that grant the owner a stake in an asset. They have two key features: they give certain rights to the owner; and they can be traded in the financial markets.

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2
Q

Types of Securities

A
  1. Debt
  2. Equity
  3. Hybrid
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3
Q

Equity Security

A

Equity securities are shares in a company, partnership or trust. Shareholders aren’t usually entitled to regular payments – though many equity securities do pay out dividends. Instead, investors buying equity securities can profit from capital gains when they sell the securities, provided they’ve risen in value. Equity securities also give the holder some influence over the issuing company – for example, through voting rights at its annual general meeting.

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4
Q

Debt Security

A

Debt securities are money that’s borrowed and must be paid back at the end of a fixed term. Examples of debt securities are corporate and government bonds, collateralised debt obligations and certificates of deposit. Holders are usually entitled to regular interest payments and repayment of principal, though not to voting rights. Debt securities can be secured or unsecured.

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5
Q

Hybrid Securities

A

Hybrid securities combine some of the features of equity securities and debt securities. An example of a hybrid security would be convertible bonds – bonds that can be converted into shares of common stock in the issuing company. Equity warrants are also hybrid securities – these are options issued by a company giving shareholders the right to buy stock within a specific period at a particular price.

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6
Q

Securites and Exchange Commission (SEC)

A

Formed in 1934, meant to restore public confidence in U.S. markets, and to regulate the securities industry.

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7
Q

Securities Exchange Act 1934

A
  • commonly referred to as the Exchange Act,
  • was the official establishment of the SEC,
  • granted the SEC jurisdiction and authority to propose, draft, and enact laws to futher its purpose
  • it is NOT the Securities Act of 1933
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8
Q

Divisions of the SEC

A

Most prominent are:

  1. Division of Corporate Finance - focuses on fair & adequate disclosure of information related to securities
  2. Division of Trading & Markets - focuses on fair & efficient capital market operations
  3. Division of Investment Management - focuses on protection of investors
  4. Division of Enforcement - focuses on the investigation, recommendation, and prosecution of securities related matters
  5. Office of Compliance Inspections and Examinations - focuses on examining regulated entities to ensure compliance with regulations
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9
Q

Self-Regulatory Organizations (SROs)

A
  • entities created to regulate industry segments within an organization itself
  • purpose is to self-govern more efficiently in a narrow field
  • allows for more specialized rules and regulations
  • very common on is FINRA (Financial Industry Regulatory Authority)
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10
Q

Chicago Board Options Exchange (Cboe)

A
  • an SRO that owns the largest options exchange in the US
  • established in 1973
  • offers options in S&P 500 Index, S&P Index, Dow Jones Industrial Average, NASDAQ-100 Index, among others
  • CBOE creates the rules for all options exchanges and has the anuthority to enforce them
  • Cboe also calculates the Cboe Volatility Index (VIX)
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11
Q

Financial Industry Regulatory Authority (FINRA)

A
  • an SRO accountable to the SEC
  • develops and implements rules and regulations specifically for brokerage firms and their employees
  • has authority to settle disputes between customers from the general public and banking firms
  • all firms trading securities must be registered with FINRA
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12
Q

Municipal Securities Rulemaking Board (MSRB)

A
  • an SRO overseen by the SEC
  • develops rules for banks and securities firms to follow when they’re involved with underwriting, selling, purchasing, or recommending municipal securities
  • goal is to promote fair trading and prevent fradulent or manipulative practices
  • sets standard of conduct for all broker-dealers, as well as the standards for banks, financial institutions, and municipal advisors
  • not authorized to enforce violations of its rules
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13
Q

Department of the Treasury/IRS

A
  • financial arm of the US federal government
  • works closely with the Federal Reserve to coordinate policies
  • collects taxes
  • initiates borrowing on behalf of the government via treasury bills, treasury notes, and treasury bonds
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14
Q

The Federal Reserve Board (FRB)

A
  • plays a pivotal role in determining the state and direction of the economy of the US
  • a network of regional banks operating under the authority of the federal government
  • responsible for making impactful decisions that affect the stock market and the economy, including settling interest rates and increasing the money supply
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15
Q

Securities Investor Protection Corporation (SIPC)

A
  • protects the interests of investors and bank customers
  • protects clients of brokers and dealers in case of financial failure of the broker
  • covers up to $500k of equity balances
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16
Q

Fedreal Deposit Insurance Corporation (FDIC)

A
  • similar to the SIPC, but for traditional banks
  • up to $250k
  • audits and monitors member banks to ensure they are adequately capitalized, that they are not taking excessive risk, that they have sufficient systems in place to prevent fraud, and they follow regulations and guidelines
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17
Q

Investor Types

A
  1. Institutional Investors
  2. Retail Investors
  3. Accredited Investors
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18
Q

Institutional Investors

A
  • immense amount of capital, ex: large financial instituions such as commercial banks, investment banks, insurance companies
  • are the core drivers of the price of securities in capital markets
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19
Q

Retail Investors

A
  • individuals investing for their future through common vehicles such as mutual funds, exchange-traded funds, and individual stocks and bonds in standard brokerage or retirement accounts such as individual retirement accounts (IRAs) and 401(k)s
  • individually, they have almost no effect on the price of securities in capital markets
  • tend to follow a herd mentality and may help sustain a movement in prive initiated by larger financial insitutions
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20
Q

Accredited Investors

A
  • different type as defined by the securities-related acts
  • investors with sufficient net worth, annual income, and/or expertise and experience in investing such that they do not require the same amount of protecting as the retail investor
  • they are given the opportunity to purchase and sell unregistered securities, commonly referred to as private equity
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21
Q

Private Equity

A
  • securites that are unregulated and only available to be purchased by accredited investors
  • governed by Regulation D of the Securities Act of 1933
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22
Q

Broker-Dealers

A
  • financial insitutions that affect securities transaction on behalf of individuals and entities or for their own accounts
  • when transacting on behalf of others, acting as an agent, i.e. a broker
  • when transacting for their own accounts, acting in a principal capacity, i.e. a dealer
  • technically the person themself is the registered representative when they transact
  • investment advisor when giving advice
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23
Q

Introducing Brokers

A

future market equivalent of a registered representatvie in the equities market

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24
Q

Clearing brokers

A

work for firms that ensure proper settlement of transactions so that investors are ensured their transaction is completed properly

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25
Q

Prime brokers

A
  • provide many different services to select clients who need more specialized, higher level services
  • often used by hedge funds that require sophisticated services to ensure that their funds operate properly and are compliant with applicable laws
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26
Q

Investment Adviser

A
  • an individual or employee who provides investment advice, recommends the purchase or sale of securities, issues research reports, or otherwise analyzes securities and is paid for doing so
  • individuals who meet the criteria of investment advisers must register with the SEC (over $25M) or state securities (under $25M)
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27
Q

Municipal Advisors

A
  • entities that specialize in the intricacies of financing operations of local governments
  • can vary greatly because each municipality has its own laws and processes
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28
Q

Best-efforts underwriting

A
  • investment bank is required to place as much of the issuance as is possible given market conditions
  • if unable to sell all of the shares, not legally obligated to purchase the remaining shares itself
  • not ideal for the issuer, but protects the investment bank
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29
Q

Two most common types of underwriting arrangements

A
  1. Best-efforts underwrtiing

2. Firm commitment underwriting

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30
Q

Firm commitment underwriting

A
  • investment bank is required to purchase the entire issuance of the offering if any remaining after public offering
  • more ideal for the issuer, less so for the investment bank
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31
Q

Issuers and Underwriters and going public (explanations)

A
  • in the event a business wants to go public, the business (the issuer) needs an investment bank to underwrite the offering
  • investment bank will provide guidance on the appropriate type, amount, and timing of the securities offering
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32
Q

Secondary Market

A

Where investors buy and sell securities from other investors (think of stock exchanges). For example, if you want to buy Apple stock, you would purchase the stock from investors who already own the stock rather than Apple. Apple would not be involved in the transaction.

Examples: are the National Stock Exchange (NSE), the New York Stock Exchange (NYSE), the NASDAQ, and the London Stock Exchange (LSE).

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33
Q

Hedging

A

a process where traders take positions to reduce the risk of other positions

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34
Q

Proprietary Traders

A

market participants that engage in capital markets for a variety of reasons for their own account

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35
Q

Market Maker

A
  • most secondary markets have a designated market maker known as a specialist
  • responsible for maintaining fair and orderly markets, making sure there is sufficient liquidity for specified firms that are traded on an exchange
  • helps to reduce volatility in the stock price
  • point of contact for the company and keeps them informed as to who ahs been trading the stock and what conditions have been like for the company’s stock
  • usually required to provide quotes for a specific percent of the time
  • cannot trade on their own stock, although possess the same knowledge as floor traders, only know information after trades have occurred, no insider knowledge
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36
Q

Depository Trust and Clearing Corporation (DTCC)

A
  • serves as a custodian and clearing for a significant amount of all securities transactions across the globe
  • maintains an electronic database identifying the proper owner of securities
  • serves as a clearing agent for transactions
  • ensures all required settlements procedures are honored
37
Q

Speculator

A

An individual or financial institution that places short-term bets on the securities based on speculations. Rather than focusing on the long-term growth prospects of a particular company, they would take calculated risks on a stock with the potential of yielding a higher return.

38
Q

Depository Trust and Clearing Corporation (DTCC)

A
  • serves as a custodian and clearing for a significant amount of all securities transactions across the globe
  • maintains an electronic database identifying the proper owner of securities
  • serves as a clearing agent for transactions
  • ensures all required settlements procedures are honored
39
Q

Auction Market

A
  • establishes a price through competitive bidding
  • most have these rules:
    • first bid has priority
    • the hgih bid and low offer “have the floor”
    • a new auction begins with all bids at a certain price are exhausted
    • there are no secret transactions
    • bis and offers must be audible
40
Q

Options Clearing Corporation (OCC)

A
  • guarantees that contracts on each side of an options contract are fulfilled
  • basically means that the seller (or writer) received a premium and the buyer received the underlying security
41
Q

Third Market

A
  • provides another avenue of facilitating trades
  • traded in the over-the-counter (OTC) markets
  • usually where unlisted securities trade
  • smaller companies because do not meet criteria to be listed on an exchange
42
Q

Primary Market

A

The financial market where new securities are issued and become available for trading by individuals and institutions.

43
Q

Fourth Market

A
  • dark market (or dark pool), unlike other markets that are lit up on an exchange
  • an electronic network utilized specifically and only by insitutions
  • a common reason for institutions to trade here is to buy large amounts without affecting stock prices
44
Q

Monetary Policy

A
  • primarily concerned with how the money supply can be utilized to maximize economic growth
  • administered by the Federal Reserve
  • uses open market operations
  • monetary economists beleive that an increased money supply will lead to increased economic growth
45
Q

Fiscal Policy

A
  • primarily concerned with government taxation and expenditures
  • increased taxation will lead to less economic growth because there will be less capital to invest, decreased taxation will lead to growth
  • similarly, decreased goverment expenditures will lead to less economic growth due to the government investing less capital
  • Keynesian economists believe the level of government expenditures will determine the level of economic growth
46
Q

Open Market Activities

A
  • initiated and executed by the Federal Reserves to affect the money supply and economic growth
  • Federal Reserve sells US Treasury securities from and to primary dealers
  • ## when the Fed Res wants to increase money supply, it will buy US Treasury securities on the open market
47
Q

Federal Funds Rates

A
  • the rate that the largest banks charge each other for overnight loans of $1M or more
  • most volatile interest rate, and short-term interest rates are linked to this
48
Q

Prime Rate

A
  • rate banks charge low-risk customers (namely corporations) with excellent credit
  • fluctuates based on the money supply based on the Federal Reserve Board
49
Q

Discount Rate

A
  • interest rate that the FRB charges to the Federal Reserve Banks when the bank is issuing short-term loans
50
Q

Broker Loan Rate

A
  • the rate that banks charge brokers and dealers when lending money for a customer’s margin accounts
  • also known as the call loan rate or the money rate
51
Q

Margin Account

A

A brokerage account in which the broker lends the customer cash to purchase stocks or other financial products. The loan in the account is collateralized by the securities purchased and cash, and it comes with a periodic interest rate. Because the customer is investing with borrowed money, the customer is using leverage which will magnify profits and losses for the customer.

52
Q

Stages of Business Cycle

A

Phase 1 - Expansion: business conditions are good and economic indicators remain strong. During this phase, stock prices, house prices, and wages are high, and job opportunities are plentiful
Phase 2 - Peak: The high point of expansion phase when economic indicators tend to be on the downswing. During this stage, there’s less investing and spending activity
Phase 3 - Contraction: Commonly identified as a recession or, in extreme cases, a depression
Phase 4 - Trough: Downtrends begin to level off and the stop, which sets the stage for a new cycle of expansion

53
Q

Indicators

A

Leading indicators - based on certain signals (e.g. homes under construction or recent stock market activity) help to predict where the economy is headed

Coincident indicators - reflect the state of the economy
at any given time and are tied directly to economic shifts

Lagging indicators - signals that the economy is either improving or declining, may include higher or lower than normal profit reports of Fortune 500 companies, significant increase or reductions in wages, or changes in debt-to-income ratios among consumers

54
Q

Yield Curves

A
  • forecast economic changes
  • represent interest rates for bonds of the same credit rating with different maturities
  • one of the most common compares U.S. Treasury debt for maturities 3 months to 30 years
  • in a healthy economy, the curve appears to be “normal”, meaning interest rates in crease along with the bond’s maturity, so the curve has an upward slope
  • an inverted curve typically signifies a future recession since bonds with longer maturity have a lower yield curve
  • flat curves are indicative of minimal to no difference between short-term and long-term yields
55
Q

Inflation

A

decreases the purchasing power of currency by lowering the value of future cash flows

56
Q

Bond Yield

A
  • the return an investor realizes on a bond
57
Q

Defensive Industries

A
  • economy sectors that sell products that are in high demand regardless of the state of the economy
  • ex: food and tobacco
  • investment here is typically safer, due to predictability, but not likely to have large earnings or profits
58
Q

Cyclical Industries

A
  • opposite of defensive industries
  • comprised of companies that tend to perform extremely well in bull markets, but poorly in a bear market
  • ex: luxury goods, automobiles, or raw materials that produce high-end goods
  • stock values are dependent on whether or not customers are in the market to buy more more expensive items
59
Q

Keynesian Economic Theory

A
  • continued demand is what supports the economy
  • since increase or steady demand for products or services leads to more businesses being created
  • in this theory, the federal government must sustain the economy by spending tax money on projects that stimulate the economy
60
Q

Monetarist Economic Theory

A
  • inflation and deflation are the direct result of the available money supply - more money creates inflation, less, deflation
  • in this theory the federal government must regulate the money supply and stay out of the market
  • the only way to keep demand for goods and services steady without risking inflation is to gradually increase the money supply
61
Q

U.S Balance of Payments (BOP)

A
  • more comprehensive than the balance of trade (BOT) for a country because it tracks all the inflows and outflows of the country over a given time period
  • this includes intangible exchanges, dollar amount of all imports & exports, and records of all financial transactions between different countries
  • a positive BOP indicates a net inflow of money, while a negative indicates an outflow
62
Q

Gross Domestic Product (GDP)

A

A complex calculation including consumer consumption, investment, governmental expenditures, and net exports/import

63
Q

Gross National Product (GNP)

A

Essentially the same as GDP, plus or minus the economic output that occurs outside of a nation’s border, income earned from foreign investments, and income earned by foreign residents inside the country

64
Q

Spot Exchange Rate

A
  • the current price level in the market to directly exchange one currency for another, for delivery on the earliest possible value date
  • generally set by the forex market, but can be set through other mechanisms such as a currency peg
65
Q

Interbank Market

A
  • where banks exchange the currencies of various countries
  • can be for customers or for the banks’ own accounts
  • about half of all foreign currency transactions occur here
66
Q

Spot Market

A
  • where financial instruments, such as commodities, currencies, and securities, are traded for immediate delivery
  • delivery is the exchange of cash for the financial instrument.
67
Q

Futures Market

A
  • an auction market in which participants buy and sell commodity and futures contracts for delivery on a specified future date.
  • exchange-traded derivatives contracts that lock in future delivery of a commodity or security at a price set today.
68
Q

Eurobonds

A
  • bonds that pay principal and interest in Eurodollars (i.e. U.S. dollars held in banks outside the U.S.)
  • not registered with the SEC
  • typically lower costs and regulatory issues for the issuer
  • typically sold with a lower interest rate than a comparable bond in the U.S.
69
Q

Counter currency

A
  • currency used as the reference or second currency in a currency pair
  • often referred to as the second currency or the quote currency
70
Q

Investment Bank

A
  • a corporation that advises companies when they begin to operate in capital markets
  • basic activities are:
    • raising equity capital (sometimes in an IPO)
    • raising capital through debt issuance
    • launching new financial products & instruments
      (derivatives, credit default swaps, new forms of
      securitization, etc.)
    • proprietary trading of the firm’s own capital,
      including speculation, arbitrage, and other complex
      trading strategies
71
Q

Derivatives

A
  • contracts involving two or more parties with a value based on an underlying financial asset
  • often a means of risk management
72
Q

Public Offering

A
  • all the SEC requirements must be fulfilled
  • investment bankers and investors agree on the offering price
  • sales to 35 or more people are typically deemed to be public
73
Q

Private Offering

A
  • sold directly to the investor

- not required to be registered with the SEC

74
Q

Initial Public Offering (IPO)

A
  • issuer’s first attempt to raise capital from the general public to help grow their business
  • facilitated by an investment bank or a group of investment banks known as a syndicate
75
Q

Secondary Offering

A
  • a second sale of the issuer’s securities

- can either be dilutive or non-dilutive

76
Q

Dilutive secondary offerings

A
  • reduce the vale of the share price because additional new shares are now available
  • company’s value does not change, just more pieces of the same pie
  • also called follow-on offerings
77
Q

Nondilutive secondary offerings

A
  • does not reduce the value of the share price, because no new shares are issued
  • previously registered and in existence at the same time as the IPO, just not available to the public
  • company’s value does not change
78
Q

Underwriting Commitment

A
  • also known as a firm commitment

- when the underwriter guarantees the purchase of all the securities being offered in a sale

79
Q

Best Effort Commitment

A
  • the underwriting bank does not have to buy any remaining unsold shares in an offering
80
Q

Shelf Registration

A
  • allows a corporation to have shares registered and ready for issuance when market conditions become most favorable
  • reduces the cost of multiple filings
  • usually lasts for 3 years
  • only available to companies with established reputations with SEC
81
Q

Offering Document

A
  • must disclose all necessary information to potential investors
  • location, type of business, contact information, and any type of jurisdictional information
  • offering price, number of shares being issued, the form of securities being offered, how escrow is handled, and how proceeds will be used (to fund operations, develop new products, purchase new equipment, etc.)
  • management’s experience, all risks involved with the investment, and the type of industry
  • financial position of the company
82
Q

Prospectus

A
  • similar to an offering document but is issued with mutual funds, stock, and bonds
  • provided to potential investors by brokerages, underwriters, and investment bankers
  • includes financial status of the company, financial statements, information on executive compensation, pending litigations, profiles on manager, CEO, and the BOD
  • must be filed with SEC
  • typically a preliminary one is filed before a final, which may be amended
83
Q

Red Herring Prospectus

A
  • preliminary
  • issued when a public offering of securities is made
  • must be filed with SEC
  • clearly states that the offering is subject to change
  • investments cannot be made solely on this information, only indication of interest
84
Q

Final Propectus

A
  • used as the legal offering document for an IPO
  • must be given to any potential investor that is offered the security or any actual investor of the security
  • must be delivered at or before the time of the sale of the IPO
85
Q

Mutual Fund Prospectus

A
  • contains information of the fund’s risks, investment strategy, performance, investment types, fund manager profiles, fees, and expenses
86
Q

Official Statement (for municipal bonds)

A
  • the equivalent of a bond prospectus
  • includes the interest rate, the manner of principal payments, the minimum denomination, redemption terms, sources of funds for payment, guarantees, consequences of default, covenants, trust agreement, and any legal matters
  • usually has a preliminary statement as well
  • has a notice of sale, which advertises the offering to the public
87
Q

Securities Act of 1933

A
  • requires the registration of securities before they are sold to the public
  • first major federal legislation to regulate the offer and sale of securities
  • ensures the public will receive all necessary financial information in the offering prospectus for securities being sold
  • confirms no fraud or misrepresentation by any parties involved (the syndicate or the issuing corporation)
88
Q

Quiet Period

A
  • once a registration statement is filed
  • typically 20 days long
  • only limited information may be released to the public so as not to influence the value of the stock offering
  • first day after is the effective date

SIE Exam Prep (2 decks)

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