7.) The London Stock Exchange

Question 1

Define the acronym LSE

Answer 1

London Stock Exchange

Question 2

Define and briefly describe the different categories of financial instruments traded on the LSE

Answer 2

REMEMBER - the 3 types of INSTRUMENTS traded on the LSE

Debt instruments - have a defined life, final maturity date and agreed terms of interest to the investor, e.g. bonds and commercial paper

Equity instruments - grant an investor a specified share of ownership and rights to a proportionate amount of declared dividend, e.g. ordinary and preference shares

Hybrid instruments - include many features of both debt and equity instruments, e.g. convertible loan stock

Note that, from an investor’s point of view, debt is less risky than equity because if the borrower goes into liquidation, investors holding debt instruments will be repaid BEFORE shareholders

Question 3

Define who on the London Stock Exchange (LSE) matches the needs of borrowers (sellers) with investors (buyers)

Answer 3

Intermediaries, such as brokers and merchant banks

Question 3

Define the characteristics of debt instruments, one of the different categories of financial instruments traded on the LSE

Answer 3

Debt instruments have a defined life, final maturity date and agreed terms of interest to the investor, e.g. bonds and commercial paper

Question 4

Define the characteristics of equity instruments, one of the different categories of financial instruments traded on the LSE

Answer 4

Equity instruments grant an investor a specified share of ownership and rights to a proportionate amount of declared dividend, e.g. ordinary and preference shares

Question 5

Define the characteristics of hybrid instruments, one of the different categories of financial instruments traded on the LSE

Answer 5

Hybrid instruments include many features of both debt and equity instruments, e.g. convertible loan stock

Question 6

Define and briefly describe a primary market, in terms of the LSE

Answer 6

A primary market is one that raises new capital for companies by issuing shares and bonds, and raises new capital for governments by issuing gilts.

E.g. If company X wants to raise capital for the first time, it would do so via seeking an initial public offering in the LSE’s primary market.

A primary market is essential in tracing new shares that are open to the market for the first time

Question 7

Define and briefly describe a secondary market, in terms of the LSE

Answer 7

A secondary market is one that deals with stocks and shares that have already been issued

Any subsequent sales and purchases of company X shares (after their initial public offering on the LSE’s primary market) would take place on the secondary market

The secondary market is essential for trading existing shares between new buyers and sellers

Question 8

Describe the difference between the primary and secondary markets of the LSE

Answer 8

A primary market is one that raises new capital for companies by issuing shares and bonds, and raises new capital for governments by issuing gilts.

A secondary market is one that deals with stocks and shares that have already been issued

E.g. If company X wants to raise capital for the first time, it would do so via seeking an initial public offering in the LSE’s primary market. Any subsequent sales and purchases of company X shares would take place on the secondary market

A primary market is essential in tracing new shares that are open to the market for the first time

The secondary market is essential for trading existing shares between new buyers and sellers

Question 9

Define when the ‘Big Bang’ changes occurred at the LSE

Answer 9

27 October 1986

Question 10

Define the ‘Big Bang’ changes at the LSE, and the key changes that it included

Answer 10

On 27 October 1986, significant changes occurred at the LSE which became known as the ‘Big Bang’, which prompted fundamental revolution in the way in which the London Stock Exchange operated, including:

Traditional floor planning was replaced by screen based trading

Membership restrictions were lifted, with membership opening up to outsiders

Companies were permitted to trade Dual Capacity - they could act as both Principal (buying and selling stocks for themselves) and as Agent (buying and selling stocks for others)

The abolition of fixed minimum dealing commissions, to be replaced by freely negotiated commissions

Question 11

Define the types of functions and roles that began to emerge as a result of Dual Capacity trading systems, a change brought about by the LSE’s ‘Big Bang’ series of changes

Answer 11

Market Makers

Dealers

Agency Brokers

Inter-Dealer Brokers and Stock Exchange Money Brokers

Question 12

Define Dual Capacity trading systems, a change brought about by the LSE’s ‘Big Bang’ series of changes

Answer 12

As a result of the ‘Big Bang’, companies were permitted to trade Dual Capacity - that is, companies could now act as both Principal (buying and selling stocks for themselves) and as Agent (buying and selling stocks for others)

Question 13

Define the function and role of a Market Maker, in terms of being one of the roles that began to emerge as a result of Dual Capacity trading systems, a change brought about by the LSE’s ‘Big Bang’ series of changes

Answer 13

Market Makers can be regarded as the wholesaler of shares. They own shares in their own right and quote prices for buying and selling so that investors who deal directly with them can know exactly what the buying and selling prices for a particular share are.

The prices quoted by the market makers are available to see via SEAQ screens

Question 14

Define the function and role of Dealers, in terms of being one of the roles that began to emerge as a result of Dual Capacity trading systems, a change brought about by the LSE’s ‘Big Bang’ series of changes

Answer 14

Not all companies wish to act in a Dual Capacity (I.e. as both Principal and Agent). As principals, they will buy and sell shares on their own account, quoting a two-way price. Or, they may choose to act as only agency brokers.

Question 15

Define the function and role of Agency Brokers, in terms of being one of the roles that began to emerge as a result of Dual Capacity trading systems, a change brought about by the LSE’s ‘Big Bang’ series of changes

Answer 15

Company chooses to perform a pure agency function, whereby they act ad intermediaries between investors and market makers.

They will look up prices on the SEAQ screen and deal with the market makers offering the best price

Question 16

Define the function and roles of Inter-Dealer Brokers and Stock Exchange Money Brokers, in terms of being two of the roles that began to emerge as a result of Dual Capacity trading systems, a change brought about by the LSE’s ‘Big Bang’ series of changes

Answer 16

Their main function is to ensure adequate liquidity of stocks and shares in the market by offering to lend stock to the markets.

Question 17

Define and briefly describe the London Stock Exchange, and the types of borrowers who use it

Answer 17

The London Stock Exchange (LSE) is a capital market, as it provides a means for borrowers to raise capital, at a price, from investors who have money available.

Borrowers range from:

Large international companies

Governments

Banks

Question 18

Define liquidity

Answer 18

The degree to which an asset or security can be quickly bought or sold in the market without affecting the asset’s price.

Question 19

Define stock exchange

Answer 19

A market in which securities are bought and sold

Question 20

Define securities

Answer 20

A security is a financial instrument that represents an ownership position in a publicly-traded corporation (stock), a creditor relationship with governmental body or a corporation (bond), or rights to ownership as represented by an option.

Question 21

Define the two ways in which the LSE is regulated and supervised

Answer 21

Self-assessment by the LSE itself

Legislation and external regulation

Question 22

Describe how the LSE is regulated and supervised via self-assessment

Answer 22

The LSE has its own regulations, to which member firms must abide.

The Council of the Stock Exchange can enforce disciplinary proceedings against firms that do not adhere to its standards.

Stock Exchange member firms undergo rigorous admission procedures, which includes employees obtaining specific qualifications showing competency in a number of areas, as prescribed by the LSE

Question 23

Describe how the LSE is regulated and supervised via legislation and external regulation

Answer 23

The Financial Services and Markets Act 2000 governs all trades executed on the LSE. This legislation covers all aspects of the financial industry, both investments and banking, and is overseen by the Financial Conduct Authority (FCA), who is the sole regulator

The LSE is a Recognised Investment Exchange (RIE)

Investors who lose money as a result of fraudulent activity or negligent advice given by a Stock Exchange member firm will receive compensation, up to a maximum of £48,000. This is broken down as 100% of the first £30,000, and 90% of the next £20,000

Question 24

Define the acronym RIE

Answer 24

Recognised Investment Exchange

Question 25

Define the ‘correct’ name for the LSE

Answer 25

The International Stock Exchange of the United Kingdom and Republic of Ireland Limited

Question 26

Describe the dealing process for buying/selling stocks or shares on the LSE

Answer 26

For a private investor wishing to buy or sell stocks and shares, their first point of call would be via their agency broker. The broker would require specific info as to whether the investor wanted to:

Buy or sell shares

What shares they are looking to buy/sell

The amount of the investment

Whether the deal is to be executed at the best price possible or whether it is a limit order

Should the instructions to the broker be a buy deal, the broker would consult his SEAQ screen and telephone a market maker showing the best quote. Once the deal is agreed, the investor becomes the owner of the shares and the broker will forward a contract note with full details of the deal. The contact note will act as evidence until receipt of the Share Certificate by the investor

Question 27

Define limit order

Answer 27

A limit on the price of the shares above which a purchaser mustn’t be made, and below which a sale mustn’t be carried out

Question 28

Define the six different trading systems operating within the LSE

Answer 28

SEAQ - Stock Exchange Automated Quotation System (Domestic Stocks)

SEAQ International - Stock Exchange Automated Quotation System (International stocks)

SAEF - Stock Exchange Automatic Execution Facility

SEATS PLUS - Stock Exchange Automated Trading Service

SETS - Stock Exchange Electronic Trading Service

CREST - Certificate-less Register of Electronic Stocks and Shares Transfer

Question 29

Define SEAQ, in terms of being one of the trading systems operating within the LSE

Answer 29

Stock Exchange Automated Quotation System (Domestic Stocks)

A screen-based, quote driven system used for trading middle-ranking domestic (UK) stocks

The system acts as an electronic price list, displaying market makers two-way quotas to the market, therefore keeping both market makers and agency brokers up to date with the security prices on offer, in order to obtain the best possible price for their clients

SEAQ also provides an audit trail to check for suspicious price movements that could indicate insider dealing or other fraudulent activity

Question 30

Define SEAQ International, in terms of being one of the trading systems operating within the LSE

Answer 30

Stock Exchange Automated Quotation System (International stocks)

SEAQ International provides market price information for the leading international stocks from many countries

Question 31

Define SAEF, in terms of being one of the trading systems operating within the LSE

Answer 31

Stock Exchange Automatic Execution Facility

SAEF enables member firms to enter buy and sell orders and then automatically match them against the best quotas held in SEAQ (Stock Exchange Automated Quotation System)

For the broker/dealer, SAEF enables them to place smaller orders without them having to engage with a market maker, thus speeding up the transaction

Question 32

Define SEATS PLUS, in terms of being one of the trading systems operating within the LSE

Answer 32

Stock Exchange Automated Trading Service

SEATS PLUS trades shares, which are dealt infrequently and in low volumes, plus shares, which are quoted on the Alternative Investment Market (AIM)

Question 33

Define what the acronym AIM stands for

Answer 33

Alternative Investment Market

Question 34

Define SETS, in terms of being one of the trading systems operating within the LSE

Answer 34

Stock Exchange Electronic Trading Service

SETS is the central trading system for blue chip securities comprising the FTSE 100, and FTSE 100 Reserve (those companies recently removed from the FTSE 100)

Settlement time is T+3, with no minimum order size

Question 35

Define the bid offer spread

Answer 35

The difference between the buying or selling price (of a share) plus speed of execution

Question 36

Define how the trading system SETS works, in terms of being one of the trading systems operating within the LSE

Answer 36

It is an order-driven system, where orders to buy or sell shares are matched automatically by computers. This system removes the market maker and therefore investors should benefit from a reduction in the bid offer spread, I.e. The difference between the buying or selling price (of a share) plus speed of execution should be quicker

Once an order has been placed in the order book, it will be automatically matched against a corresponding order. If there’s no corresponding order to match against, it will simply stay on the order book until it’s matched or it will be returned, in part or full, to the member who entered it into the system originally. The system is totally anonymous: there is a Ventral Counterparty Service that acts as seller to each buyer, and as buyer to each seller

Settlement time is T+3, with no minimum order size

Question 37

Define T+3, in terms of settlement time

Answer 37

Investors must settle their security transactions in three business days. This settlement cycle is known as “T+3” — trade date plus three days

This rule means that when you buy securities, the brokerage firm must receive your payment no later than three business days after the trade is executed

T+3 is the standard settlement time for UK equities and corporate bonds held within SETS and CREST, and is referred to as a Rolling Settlement.

All monies/share certificates must be received and remitted by brokers within this time span

Question 38

Define the 4 main types of buy and sell orders/SETS order types

Answer 38

(Remember ‘Patrick Bateman’ for types of buy and sell orders/SETS order types)

At best order

Limit Order

Fill or Kill

Execute or Eliminate

Question 39

Define and describe the SETS order/buy and sell order type known as ‘At best’ order

Answer 39

Only specifies the volume of shares to be traded, it doesn’t specify a price

An at best order requests that the requested volume of shares be executed at the best price available on the order book

This being the highest buy price on the Oder book from a seller’s perspective and the lowest sell price on the order book from a buyers perspective

An at best order will execute, in full or in part, against eligible orders in the order book. Any unmatched order will be rejected from the system

Question 40

Define and describe the SETS order/buy and sell order type known as ‘Limit’ order

Answer 40

Specifies the volume of shares to be traded and a limit price, I.e. no worse than price.

Any unmatched order will remain on the order book for 90 days waiting to be matched, after this time it will be automatically deleted

Question 41

Define and describe the SETS order/buy and sell order type known as ‘Fill or Kill’

Answer 41

Specifies the volume of shares to be traded, but a specified price is optional.

A fill or kill order can also be described as an ‘all or nothing’ order.

If the entire order cannot be executed at this price or better, the entire order is rejected.

Question 42

Define and describe the SETS order/buy and sell order type known as ‘Execute and Eliminate’

Answer 42

Specifies a volume of shares and a limit price with the order to execute as much of the order as possible, up to a specified price.

Any unexpected part of the order is rejected from the order book

This order type can also be described as ‘do what you can and reject the rest’

Question 43

Define CREST, in terms of being one of the trading systems operating within the LSE

Answer 43

CREST is the settlement system used for UK equities

CREST is owned by a company called CRESTco Ltd

Investors are able to hold their securities in dematerialised form, I.e. no share certificates will be issued or in certified (paper) form

Question 44

Define how the trading system CREST works, in terms of being one of the trading systems operating within the LSE

Answer 44

Once a deal has been executed, the transaction must then be settled, which is the process of finalising payment and delivery of the security. This is the point at which legal title changes due to a change in ownership.

The standard settlement time for UK equities and corporate bonds held within CREST (and SETS) is T+3, also known as a rolling settlement. All monies/share certificates must be received and remitted by brokers within this time span

Question 45

Define and briefly describe some of the different functions of CREST

Answer 45

Maintaining a record of all its members eligible stock holdings

Responding to members requests to transfer stock from one CREST account to another

Authenticating instructions received against member accounts

Moving stock and cash from sellers account to the buyers account

Notifying the stocks registrar within 2 hours of the transfer in the system

Question 46

Define and briefly describe some of the different participants operating within CREST

Answer 46

Regulators and tax authorities - FCA has access to CREST to enable it to perform its regulator oversight, whilst the tax authorities have access to collect any tax due, I.e. stamp duty where applicable

Payment banks - require access to settle the cash element of the transactions

Registrars - require access to update company registers with new owners

Member firms - hold shares in their own name within the CREST system

Question 47

Define the 3 choices that shareholders/investors will have when undertaking a trade

Answer 47

Sponsored CREST membership

Nominee Account Arrangement

Continue to trade and receive share certificates

Question 48

Define and describe sponsored CREST Membership, a choice that shareholders/investors will have when undertaking a trade

Answer 48

This will enable the shareholder to remain the legal owner of their shares and will allow them to deal electronically. There will be a fee for membership rights and usually minimum volume of trade dealings will apply

Question 49

Define and describe Nominee Account Arrangement, a choice that shareholders/investors will have when undertaking a trade

Answer 49

Under a nominee account arrangement, shares would be registered in the name of a nominee company who would then hold the shares on behalf of the investor.

Legally, the nominee (the broker) would become the legal owner of the shares, and the investor would become the beneficial owner.

As the shareholding would be registered in the name of the nominee, any communication or rights accruing from the owning of shares will be attributed to the nominee, not the actual investor

Question 50

Define and describe the code of conduct for operating nominee account services launched by Proshare, as it relates to Nominee Account Arrangement, a choice that shareholders/investors will have when undertaking a trade

Answer 50

In order to protect investors and provide for best practices, Proshare, a company promoting private share ownership, launched a code of conduct for operating nominee account services. Basic provisions of the code included:

All charges should be disclosed by the nominee

Nominees should supply a form by which clients can order hard copies of documents issued by companies in which they invest

Nominee will use its reasonable endeavours to claim shareholder perks on behalf of the client

Nominees must arrange for investors to attend and speak at AGMs, or proxy votes if they wish

Question 51

Define and describe the choice to continue to trade and receive share certificates, a choice that shareholders/investors will have when undertaking a trade

Answer 51

Investors still have the choice as to whether they wish to receive share certificates (paper form) or whether they’re happy to accept the security of a dematerialised form