Lecture 2

Question 1

What is direct financing?

Answer 1

Finance arranged through issuing securities to investors in the financial markets in order to raise funds for deficit units

Question 2

What are the two kinds of financial institutions that raise funds for deficit units?

Answer 2

Merchant and investment banks
Merchant banks: Prepare documentation, market the issue, earn fees for these services
Fund managers- purchase securities and in turn charge a fee for their services

Question 3

Who aids suplus units in investing funds?

Answer 3

Fund managers

Question 4

What are the four mismatches between surplus and deficit units?

Answer 4

1) Amount of funds
2) Length of contract
3) Risk exposure
4) Returns

Question 5

What is the spread of funds for direct?

Answer 5

The cost of funds for deficit units and the returns to surplus units

Question 6

What is the spread for direct financing represented by?

Answer 6

For surplus units: The rate of return- fund manager fee
For deficit units: The rate of return + fund manage fee

The difference between the overall rate of return and fund manager fee represents the spread

Question 7

What is the spread for indirect financing (i.e. depositing funds in ADIs)?

Answer 7

The difference between the interest rate paid to surplus units and the interest rate charged to deficit units

Question 8

What is the difference between the primary and secondary markets? Who regulates each market?

Answer 8

Primary market- for the initial issuing of securities (where the issuer will receive the money) ASIC regulates the primary market
Secondary market- the subsequent trading of securities:
Securities exchange: ASX
Over the counter: Australian Financial Markets Association

Question 9

Under what kind of contract do merchant banks issue securities?

Answer 9

Under the best efforts contract

Question 10

What are the requirements under the best efforts contract

Answer 10

1) Make sure issue is complying with the law
2) Aid in preparing prospectus
3) Arrange an auditor
4) Marketing for bonds/ securities issues
HOWEVER, they are not required to guarantee that all securities are sold

Question 11

Under what kind of contract will merchant banks guarantee that all securities on offer will be sold?

Answer 11

Standby underwriting contract

Question 12

What are the roles of rating agencies? Who are they paid by and for what purpose

Answer 12

Provide an expert opinion about the expected performance of securities and financial institutions. Paid by the issuer ad are required for securities to be issued- will determine rating

Question 13

Who are the main issuers of ratings in Australia

Answer 13

Standards and Poor’s, Moody’s and Fitch Ratings

Question 14

How are securities cleared?

Answer 14

Through the clearinghouse- which is Austraclear in Australia

Question 15

What is the role of the clearing house (Austraclear)

Answer 15

1) Maintain the security register
2) Clear trades that change ownership
3) Feed payment instructions in RTGS

Question 16

What are the role of secondary markets?

Answer 16

1) A trading planform that enables trading
2) Trading rules and procedures to promote efficient and fair trading
3) Settlement arrangements to organise payments

Question 17

How are secondary markets organised? What is the trading platform for equity?

Answer 17

Either:

a) A securities exchange (the ASX)
b) An over-the-counter (OTC) basis by an association of market dealers Australian Financial Markets Association

The securities exchange is the trading platform for equity

Question 18

What types of securities do exchange markets organise?

Answer 18

The share market and also some derivatives

Question 19

Who arranges trading the the exchange market? What are they responsible for?

Answer 19

Brokers:

• Act as agents on behalf of clients
• Aid the sale and purchase of securities on behalf of their client
• Responsible for each trade- will ensure clients actually pay or have shares to actually sell - Earn a commission

Question 20

What kind of a market is the exchange market?

Answer 20

Order driven market- orders taken form traders to by or sell

Question 21

What does a trading order specify?

Answer 21

• Buying or selling
• The security
• The quality
• The price

Question 22

What are the two types of prices?

Answer 22

Limit price: Either maximum or minimum buying or selling price
At-market price: which is at the best available price (therefore will not sit in the BUY or SELL part of commsec)

Question 23

What are over-the counter markets? What types of securities do they typically include? Who operates in the market?

Answer 23

Money, bond and FX markets and some of the derivative markets. Dealers operate in the market

Question 24

What do dealers do?

Answer 24

• Act as their own principal
• Trade with each other and with wholesale clients (large banks and institutions)
• Hold inventory of securities which they provide and offer
• Earn their income as a spread- the difference between the buy and sold price

Question 25

When will a spread be a 'round trip' transaction?

Answer 25

When dealers buy at a low price and sell for a higher price

Question 26

What are the two types of markets dealers operate in?

Answer 26

Dealer client and inter dealer markets

Question 27

What is the 'bid' and 'Offer' What is the market spread What is the dealer spread?

Answer 27

``` Bid= the amount willing to buy for Offer= the amount willing to sell for ```

Question 28

How are funds in over the counter markets settled?

Answer 28

Through the back-office clearinghouse of each dealer and broker involved in the trade

Question 29

What are the market rules included in the ASX?

Answer 29

Trading hours, pricing practices, trading protocols, transaction sizes

Question 30

How do secondary markets assist primary markets?

Answer 30

a) Provide investors with liquidity | b) Price discovery function

Question 31

What are the three measures of liquidity? How does this benefit primary markets?

Answer 31

1) Daily turnover 2) Bid-ask spread 3) Price resilience This gives primary markets to re-sell securities, hence increasing confidence within the market

Question 32

What does price discovery involve? How does it aid primary markets?

Answer 32

Markets generate fail prices, interest rates and exchange rtes they regard as 'fair' when they are a result of trading by informed traders- typically within efficient markets. Aid primary markets as they can: - monitor the value of investments - Informs potential issuers of securities of their expected proceeds, or what price is reasonable for new securities

Question 33

What does the efficient market hypothesis state?

Answer 33

Security markets efficiently use information to generate 'fair' prices that move randomly

Question 34

What are the three levels of informational efficiency?

Answer 34

Weak- form: efficiently use past price data- current prices reflect all past prices (useless studying them) Semi- strong: efficiently uses all published information (prices reflect all publicly available information) Strong form- prices reflect all available information include insider information (price also reflect information in the external enviornment and internal environment- insider trading)

Question 35

How should prices move in an efficient market?

Answer 35

Take a random work

Question 36

What are price bubbles?

Answer 36

Prices exceed fair value and are followed by a share correction

Question 37

What are bear and bull markets?

Answer 37

``` Bull= long periods of generally rising prices Bear= Refers to periods where prices are generally falling ```