Chapter 1 Flashcards
4 main functions of financial services industry
Financial intermediary
Pooling and managing risk
Payments and settlement services
Portfolio management
What do financial intermediary provide channels for
To move funds from savers to borrowers
How do financial intermediaries reduce info and transaction costs
Providing services that allow savers to become investors
Ensuring adequate provision of info
Allowing borrowers to access range of savers that can meet variety of terms
How can savers supply funds
Directly - holding debt or equity
Indirectly - through banks
Who performs financial intermediary roles
Banks
Building societies
Insurance
Pensions
Open ended investment companies
Benefits of pooled investments
Allow investment into wider variety of investments than they would be individually which reduces overall individual risk
How can people manage risk
Insurance allows transfer of risk in return for premium
Derivatives market management risk exposures
Who are settlement services provided by
Clearing houses
What is central bank 3
Sets monetary framework for which financial organisations operate
Set short term i rates
Lender of last resort in illiquidity crisis
Surplus agents
Typically households
Deficit agents
Those who need to borrow - firms and governments
Deposit institutions and what happen sand examples
Accept deposits from economic agents and deposits become liabilities for these institutions
Commercial Banks and building socs
What types of assets do general and life insurnace firms hold
Life - Tend to cover longer periods to hold long term assets
General - shorter term assets due to greater need for cash
Four gov functions?
Providing services that private firms cannot
Regulating firms and markets to protect consumer
Interveni`no in the wealth distribution of private transactions
Stabilising the economy
Two types of financial asset
Debt and equity
Characteristic of bank deposits and normal loans
Not trade able
Most other loans are tradeable
Benfit of indirect investment
Greater diversification
Less transaction costs
Access to specialist expertise
Ability to invest in assets otherwise not investbale
Three parties in unit trust
Manager
Trustee - unconnected from manager
Unit holders
Main role of trustee in unit trust
Ensure fund manager runs funds to its objectives and goals
Characteristic of unit trust
Open ended - new units created when investors want to invest
Use of derivative s
To speculate
Use to access difficult to access assets
What are money markets and capital markets
Money market shave securities of less than a year
Capital markets- maturities of greater than a year
What do security markets do
Raise capital
Transfer risk - derivatives markets
Price discovery -
Creating liquidity
Examples of sell side and buy side
Sell side - IB, Banks, brokers
Buy side - investment managers
Two types of price dissemination and explain them
Pre trade transparent - publishes real time data about quotes and orders
Post trade transparent - publishes trade prices and sizes shortly after trades occur
What do buy side traders value
Transparency - better understand trades
What do sell side traders value
Opaqueness bc they have info advantage over counterparties
What rule requires pre and post trade transparency
MiFID II
What happens to spreads of bid ask prices in times of transparency and opaqueness
Widen in opaque
Narrow in transparent
In order driven markets, how can liquidity be judged
Differences between the best buy and sell prices in order book
What can make a market liquid
Large number of buyers and sellers
Why illiquid assets difficult to sell
Uncertainty about future market value and lack of market depth
Liquidity risk?
Not being able to sell asset quick enough resulting in loss of value
What characteristics mean high operational efficiency and and what is a a buy product of operational efficiency
Transparent market that are liquid with low transaction costs
Leads Informational efficiency as prices reflect all info about asset
Other implicit trading costs
Bid ask spread
Price of impact at trade - usually costs go down with larger trades, or large buys can lead to further demand
Opportunity cost (cost of waiting) - buy trade spread over two days to prevent significant adverse price impact
Explicit costs of trading and examples
Brokerage commission
10-20bps for large trades
100-150 for smaller trades
Taxes on commission made by brokers …
Do not currently attract VAT
Stamp duty reserve tax
Payable on all transactions by the purchaser and is levied at a rate of 0.5%
What is crest
Allows investors to hold shares in electronic format rather than paper
For crest and no crest transactions, how is stamp duty reserve tax done
For crest settled transactions, rounded to nearest 1p
Otherwise it is rounded to nearest £5
What is the PTM Levy
Levy of £1 on all purchases and sales in excess of£10,000 is charged to finance takeover panel
Purchasing rates for gilts
0.5%-1% for purchases below £5000
Purchases in excess of 1 million have no charges
When are gilt transactions settled
The next day
What are gilt purchases exempt from
Stamp duty reserve tax
Purchases that are stamp duty reserve tax exempt
Gilt purchases
Loan stocks
Foreign securities registered outside uk
Bearer securities
Traded options through ICE Futures Europe
Two costs for unit trusts and OEICs
Entry cost
Ongoing charges figure
What is the average ongoing charges cost for active and passive funds
Active = 0.9%
Passive = 0.15%
What do retail customers usually pay per trade
5-12.50 pounds
How can people reduce transaction costs s
Employ skillfull brokers
Electronic algorithms to manage trading
Hidden orders to hide their size
What rule harmonised uk equity trading with Europe
MiFID
Three type of order execution venues permitted under MiFID
Regulated markets
Multi lateral trading facilities
Systematic internalisers
What was the fourth execution venue and when introduced
Organised trading facility
MiFID II
What two market models does the LSE offer
SETS and SETSqx
What’s is SETS
What is traded on them
Electronic limit order book used to trade stocks
FTSE shares
AIM
ETFs
ETPs
How is liquidity of sets underpinned and what does it ensure
Underpinned by provision of market maker electronically executable quotes
Ensure traders trade at least one exchange markets size (EMS)
What is the exchange markets size (EMS)
Market maker is obliged to quote bid/offer prices that are firm for orders up to the EMS
What is the call period
Matching bid/offer executed in a limited timeframe (ten minutes at opening, 5 minutes at close)
What is an uncrossing
When most popular price has been found at the end of call period, orders that can be matched are executed
What’s SETSqx and what does it combine
Stock trading platform that is less liquid than those covered by SETS
Combines periodic electronic trading book with non electric quite driven market making
What occurs during the day for SETSqx
Multiple uncrossing at 8am, 9am, 11am , 2pm and close
What do market makers in SETSqx do
Have wide spreads to mitigate risk from being in illiquid market s
What is SEAQ
Quote display system used as the price reference point for telephone execution between market participants and registered market makers
What is SEAQ used for
Fixed interest securities and AIM securities that aren’t traded on SETS and SETSqx
What is LCH
Central counterparty to all SETS, SETSqx trades
What does LCH aim to do
Clearing members acting on behalf of firms tradin on SETS and SETSqx are not exposed to any risk of default
How does LCH manage risk
Collecting margin from members
What is the international order book
Electronic order book that trades international securities in form of depository receipts on LSE
What is the European quoting service
Quote driven market making and trade reporting platform that supports all liquid EU securities
How do market makers work with European quoting service
Non electronically executable quotes during mandatory quote period
What is the current settlement characteristics for LSE and US markets
Equity transactions settle T+2 working days for LSE, Settlement is made through CREST
T+1 for US
How are gilts settled
CREST,
T+1
What does cap offer
Counter party risk clearing
How does LSE operate for bonds
Electronic order book for retail bonds
Order driven trading service
Who issues gilts and how do they do it
Debt management office
Auction
What must gilt edged market makers do
Continually quote bid ask prices and must trade at these prices so that investors always have liquidity
What are GEMMs also expected to do
Participate in primary gilt issuance
Provide DMO with relevant data
Accept DMO monitoring arranagemnts
Benefits of GEMMs
Eligible to submit cometeive bids for gilts at auction by DMO
Also have opportunity to strip and reconstitute gilts
How are corporate bonds sold
Open offer for sale = lead bank buys bonds and then resells to investors
or private placing
What is bought deal
If lead bank of bond issuance buys bonds and sells them to the syndicate
What is fixed price re offering
Lead manager and syndicate buy bonds together and offer them at a fixed price for certain period
How is market liquidity provided in corporate bonds and how are the counter parties to trading
Liquidity provided by dealers and market participants
Bank or securities firm acting as dealer
What is a dual listed company
Corporate structure in which two corporations function as a single operating business through a legal equalisation agreement
But retain seperate legal identities and stock exchange listings
What do legal contracts for DLC do
Specify how ownership is shared and ensures equal treatment of the two firms shareholders and cahsflows
Benefits of DLC
Capital gains Tax advantages
What do DLCs usually share
Board of dircetors
Types of communication on exchanges
Hand signal
Voice
Discrete electronic message
Computer generated electronic commands
What type of trade is an OTC trade
Off the book
What are multi lateral trading facilities
Trading platforms organised by investment firms or market operators which bring together third party buyers and sellers like banks or pension funds
Why have MTFs been set up and what is largest MTF
To compete with transaction costs of exchanges
BATS Chi-x Europe
Systematic internaliser?
Investment firm that deals on its own account by executing customer order flows in liquid shares outside either regulated market or an MTF
What does MiFID enforce on systematic internalisers
Requires firm to publish and honour buy and sell prices up to the standard market size
What is an organised trading facility
Multilateral system that is not a regulated market or MTF
Where third party interest in bonds and structured products, derivatives and emission allowances are able to interact in system in a way that results in a contract
When was OTFs introduced
MiFID II
What are dark pools
Electronic crossing. Networks that provide liquidity which is not displayed on a conventional order book of an exchange
Benefits of dark pools
Neither price or trader is identified so useful for traders wishing to buy or sell large number of shares without revealing themselves on open market
What are dark pools typically
MTFs that have opted out of pre trade transparency
Four elements to the operation of the multilateral system
Has characteristics of a trading system or facility
Includes third parties
Allows trading interest to interact in he system
Trading interest are in financial instruments
What types of markets are SEAQ and SETS
SEAQ is quote display
SETS is order book (order driven system)
What are order driven systems used for
And what are the two types of order for order driven systems
Highly liquid
Market and limit
What are market orders
Specify quantity to be traded but not a price
What is a limit order
Buyers state the quantity and price willing to pay
What is a quote driven system
How do order and quote driven system compare?
Market makers maintain liquidity and efficiency in trading.
Orders driven systems Automatically gives investors best price possible which isn’t the case in quote driven
What are market makers
Continually quote bid and ask prices for a given security and are ready to buy and sell at those prices
Algorithmic trading?
Refers to electronic platform for entering orders whereby an algorithm decides on aspects of the order such as timing, price or volume
What is high frequency trading
Kind of algorithmic trading in which computers make decisions to initiate orders based on info that is processed more quickly than what humans can process
Four key HFT (high frequency trading strategies)
Market making based on order flow
Market making based on tick data info
Event arb
Stat arb
What does MIfID II and SEC say about HFT
Contain info about trades up to 5 years with sufficient detail
Who decides is firm becomes listed and what are the rules called
FCA
Listing rules
What’s included in listing rules
Prospective directive and transparency directive
What new listing rules is being implemented
Less burdensome regime that will boost IPOs
What is the new rule for boosting ipos
Whats it replacing and explain each
One category of listing for commercial companies instead of two which are premium and standard
Premium - used by large firms looking for a large profile and liquid market - more expensive
Standard - meet minimum requirements to be listed
What was required to be a FTSE company
Needs to be premium listing
Most important conditions for premium listing5
Normally published accounts that cover 3 years
At least £30,000,000 for shares issued and £200,000 debt issued
10% of the listed securities held by public
Sufficient working capital to cover next 12 months
Sponsor is required in connection with admission
Rules for standrd listing
£30 mill shares
200k debt
10% shares held by public
Uk prospectus regs require publication of prospectus when
Securities admitted to trading on regulated market in UK
Firm making public offer in UK
What should prospectus disclose
All info investor would need, like SOFP, PnL etc
Prospectus of issuer
Rights attached to securities
What does AIM not stipulate
Minimum criteria for company size, trading record and number of shares held by public
What do AIM listed companies need
Nominated advisor (nomad)from an approved register who is responsible to the LSE
What is AIM classified as
MTF
How is high growth sector differ to AIM
Typically larger than AIM companies and aim to become premium listing eventually
What must HGS companies abide by
Incorporated by EEA
Only issue Equity shares
Minimum free float of 10% at IPO
Demonstrate historic revenue of 20% over 3 years
Criteria for listing on growth market include
Appoint and retain on AQSE corporate advisor at all times
At least 24 months of audited accounts
At least 10% free float
Good corp gov
Reasons for exemptions to produce prospectus
Where offer is made to qualified investors
Where offer is made to fewer than 150 persons in UK
Minimum consideration per investor is greater than 100k
Shares representing less than 20% of the number of shares are already admitted to trading
Retail clients who become professional must meet at least 2 of the following
At least 10 transactions per quarter of Transactions of over 1k for past 4 quarters
Portfolio greater than 500k
At least on year in the financial sector
What does uk market abuse regs do
Sets out reporting of transactions in a companies securities, including derivatives, by persons discharging managerial responsibilities.
What must person discharging managerial responsibility do and then what should listed company do
Notify the listed company and FCA within three business days of transaction
Listed company should notify public asap
When do disclosures of major interests need to be shown
When investor holds greater than 3% of the listed firms stock
What are concert parties
Individual owns worship of shares is less than 3% but individuals agree to combine interests so effectively their ownership combined is greater than 3%
What is the aim of the PSC (persons with significant control) register
Companies owners are identified
AIM is got combat tax evasion, money laundering and terrorist financing
Who does PSC rules apply to
All uk companies except those subject to DTR 5
Who sets corp gov code in UK
FRC
Main principles of uk corp gov code (5)
Board leadership and purpose
Division of responsibility
Composition, succession and evaluation
Audit and internal risk control
Remuneration
Main principles of board leadership and company purpose
Effective board who want long term sustainable growth and generate wealth for shareholders
Establish core values and act with integrity
Resources in place to meet objectives
Engage with shareholders
Workforce policies consistent with values
Principles Division of repsonsibility
Chair leads the board
Consist of execs and non execs such that no individual group dominates
Need time and resources in order to function effectively
Principles of composition and succession
Appointments go through rigorous testing with effective succession plan
Committee should have combination of skills and diverse
Principles of risk and audit controls
Establish transparent policies
Provide fair assessment of company
Establish procedure to mitigate risk
Principles of remuneration
Designed to promote growth and support strategy
Linked to company performance objectives
Transparent procedure for remuneration
How does uk corp gov code operate
Comply or explain approach
Shareholders rights directive aim
Aim to tackle perceived lack of shareholder engagement
Shareholder engagement policies and transparency of investment policies have been put in place
What applies to all pension sunder £1bn AUM
Climate reporting obligations
What is group think?
Can occur in boards where people conform to same ideals without analysing other options to avoid conflict
Remuneration report of a company must be in two parts…
Remuneration policy
Implementation report setting out actual payments to directors and a link between performance and pay
How is remuneration policy decided
At AGM and voted on by shareholders
What is section 172
Requires directors to act in good faith and to promote success of the firm
What should companies include when doing section 172 reporting
Issues and factors they consider relevant when complying with 172
Min methods used to engage with stakeholders
Information of the effect of decisions
What does the FRC also operate
UK stewardship code
What are the stewardship codes aimed at
12 principles aimed at asset managers and asset owners
6 principles aimed at service providers
What is stewardship
Responsible allocation and management of capital
Hw often is stewardship report created
Annually
LSE requirements to keep SH informed are (2)
Approval of meetings and circulars to holders of securities
Notify market of profit announcements, dividends, acquisitions, director changes, chnage in major SH,.
AGM rules and who made them
Companies act 2006
Companies must hold AGM within 6 months of financial year end
Intervals must be no more than 15 months
At least 21 days notice of meeting
Discussion points in AGM
Declaring dividend
Evaluating financial statements, directors and Audit reports.
Electing new directors if needed
Appointing and remunerating auditors
Notice period for general meetings
14 calendar days
When are directors also bound to call a meeting
When 5% or more of SH request it
Duty of chairman
Preserve order
Proceedeing are conducted
Sense of meeting is aserctaiend
Take questions
When can a poll at meeting be demanded
5 or more members who have right to vote
By one or more members who have 10% of voting rights
Chairman
Two main types of resolution at general meetings
Ordinary resolution - majority wins
Special resolution - 75% of voting favour required to pass rule
What are the two types of proxy
General proxy - vote as they see fit
Special proxy - specific vote for or against a particular resolution
One concern of overseas investment
Foreign exchange risk
What is the primary order processing system in NYSE
Universal trading platform
Challenges of investing in EM
Quality of market regs
Corp gov
Transparency and accounting standards
Political risk
Eurobonds? And what are they also called
Bonds that are denominated in a currency different to that of the country its issued in
Bearer bonds
Characteristic of Eurobonds/ bearer bonds
Not centrally registered so Eurobonds held anonymously
Why do people hold Eurobonds
Mitigate tax liability
Diversify portfolios
Several participants in issuing euro bonds (3)
The issuer
The bank - sells bonds to nderwriter
Underwriter - keep or sell on the market
What is the primary and secondary market for euro bonds
The syndicate that the bonds are initially sold is the primary
When underwriter sells to general public - secondary
What is the general rule for overseas gov, quasi gov bills, bonds and notes
Traded otc between banks and settlement system operated by central banks
How are corp bonds generally settled overseas
Listed and traded through central clearing depository systems associated with the exchange
How do South Korea settle bond transactions
Rolling basis and T+1 to facilitate a delivery vs payment settlement system
How does G30 settle and Thailand settle
G30= T+3
Thailand = T+2
What do local and global co custodians do
Local custodians - responsible for safekeeping of securities in a given national market
Global co custodians - supervises the safekeeping of securities in local depositories
Two systems for settling Eurobonds
Euroclear and Clearstream
What do clear stream and euroclear provide
Securities clearance and settlement services
Money transfer services
Custody services
Security lending
Borrowing services
What are the ICMA rules
Eurobonds settled T+2 but confirmed T+1
What is agency costs
Costs that occur due to separation of ownership and control
Solutions to principle agent problem
Aligning incentives of owners and managers - rewards in the form of shares
Monitored by board of directors
Sell shares in times of bad performance to push share price down to incentise manager to work harder in order to prevent takeover
Shareholder activism
Front running?
Broker buys shares before placing a large client order so that he benefits from the uptick on price
If someone holds more than 3% of the company, when should they notify company again
If percentage ownership increases by at least 1%
When does crest settle for equities and gilts
Equities is t+2
Gilts is T+1
Who is AIM regulated by
LSE
What is round trip transaction costs
Total costs of completing a transaction including bid ask spread, commission and taxes
How does FRC get institutional investors to engage in corp gov
Uk stewardship code
What org is responsible for setting rules for Eurobond market
International capital markets association
ICMA
