Chapter 1 Flashcards
What is the financial system comprised of?
Financial market, financial intermediaries and other financial institutions
What are the 4 sectors of Lenders and borrowers
Household, business, government or foreign
What are financial intermediaries?
They are institutions that expedite the flow of funds from lenders to borrowers. (Bank, insurance companies, pension funds and collective investment schemes)
What are the characteristics of a good financial market?
Accurate pricing
Liquidity
Internal efficiency
Informational efficiency
What is a broker?
A broker is an entity that act as conduits between lenders and sellers in return for a commission
What are the elements of the cash market
FX, Money, Bond, Equity, Commodities, Property Markets
What is the primary market?
It is the market for the original sale (or issue) of new securities. Issuers may be raising capital for new investment or they may be going public
What is the secondary market?
It is the market where previously issued securities are resold. The proceeds from the sale does not go to the issuer but to the seller
What is an interbank market?
It is a wholesale market for the offering of deposits between banks in a range of currencies ( usually for periods not exceeding 12 months )
What are the different financial market rates?
1) Exchange rates
2) Interest rates
3) Holding Period Return
What is fundamental analysis?
It is analysis that estimates the intrinsic value of a share by examining the companies characteristics
What is technical analysis?
It is analysis that predicts the share prices from the study of graphs on which prices and (sometimes) trading volumes are plotted.
What are the 3 forms of EMH (Efficient market hypothesis)
Weak: All past market prices and data are fully reflected in asset prices
Semi-Strong: All publicly available information is fully reflected in asset prices
Strong: All information (public and private) is fully reflected in asset prices. Implies that not even insider information can be used to beat the market
What is the definition of the financial system?
The financial system is a system that performs the essential economic function of channelling funds from those with a surplus to those who wish to borrow.
It is comprises the financial markets, financial intermediaries and other financial institutions.
What is the role of financial markets?
It is a platform where instruments are sold and traded
What is the role of financial intermediaries?
They act as a middle man between borrowers and savers
What is the role of financial instruments?
They represent the claim on assets or future cash flows
What are the different participants in the financial markets?
1) Borrowers - issue securities
2) Lenders - buy/invest in securities
3) Financial intermediaries - expedite the flow of funds from lenders to borrowers
4) Brokers - act as conduits between lenders and borrowers in return for a commission
5) Financial advisors - provide investors with recommendations, guidance or proposals for purchase of instruments
6) Dealers - buy and sell securities for their own account
7) Market makers - ready to buy or sell certain securities at all times
8) Hedgers - exposed to the risk adverse market price movements and mitigate risk by using hedging instruments
9) Speculators - try to make a profit by taking a view on the market
10) Arbitrageurs - attempt to make profits by exploiting inefficiencies in market prices
What are cash markets?
Cash markets are markets where financial and physical assets trade
What are foreign exchange markets?
Foreign exchange markets are global decentralised markets for trading and exchange of currencies
What is the money market?
A marketplace for trading short-term debt instruments
What is the bond market?
A marketplace for trading long-term debt issues
What is the main difference between the money market and the bond market?
The difference in maturities of the instruments sold on each of the markets
What is the commodity market?
A marketplace where physical assets are traded
What is the derivative market?
A marketplace where derivatives are traded
What are hybrid financial instruments?
Instruments that are part of 2+ markets (convertible bond, preference shares)
Is the derivative markets more or less liquid than the underlying cash market?
The derivative markets are more liquid than the cash market
What is the spot market?
A market where the financial instruments are traded for immediate delivery and payment (actual date of settlement depends on specific market conventions)
What is the forward market?
A market in which contracts are entered to buy/sell financial instruments or commodities at some future date
What is the primary market?
A market for the original sale/issue of securities. Used to raise capital for new investments or they may be going public
What is the secondary market?
A market in which previously-issued securities are resold. Sale of such securities goes to the seller and not the issuer
A secondary market can be a call market or a continuous market. What is the difference between a call market and a continuous market?
Call market: Individual securities trade at specific times. Buy and sell orders are accumulated for a period, then a single price is set to satisfy the largest number of orders
Continuous market: Securities trade at any time the market is open
Whats the difference between order-driven (auction markets) and quote-driven (dealer markets)?
Order-driven: Buyers and seller submit bid and ask prices of a particular share where the orders are matched by a broker.
Quote-driven: Individual dealers act as market makers by buying and selling shares for themselves. Investors go to a dealer and prices are determined principally by dealers
What is an exchange?
A formal marketplace where financial instruments are traded. They are governed by law and exchanges’ rules and regulations
What is an OTC ( over-the-counter ) market?
A market in which transactions are concluded off formal exchanges through private negotiations between buyers and sellers
Is the OTC or exchange more liquid?
Exchange traded securities are often more liquid than OTC securities
What is a major advantage for OTC markets?
The ability to tailor-make securities to meet specific needs.
Who implemented measures to improve the transparency and oversight of OTC derivatives?
G-20 leaders
What is the interbank market?
A wholesale money market for the offering of deposits between banks in a range of currencies usually for periods not exceeding 12 months
What are the 2 roles that the interbank market plays in the financial system?
1) It can be used by central banks to transmit the influence of monetary policy by adding or draining liquidity from the financial system more effectively
2) They effectively channel liquidity from banks with a surplus of funds to those with a liquidity deficit.
What are financial market benchmarks used for?
They are used to help set prices, measure performance, calculate performance fees, determine amounts payable in terms of financial instruments and contracts
What is the interest rate benchmark?
It is a benchmark used in interbank markets as reference rates for a large volume and broad range of financial products
What are financial market indexes?
They are indexes that attempt to reflect the overall behaviour of a group of shares or other securities. S&P 500
What are financial market indexes used for?
1) A benchmark to measure portfolio performance
2) To create and track index funds
3) Estimate market rates of return
4) Predict future share price movements in technical analysis
5) A proxy for the market portfolio when estimating systematic risk
What are the core functions of the financial system?
Facilitate financing (channel savings into real investment)
Manage personal finances
Clearing and settlement of payments
Managing risk
Providing information
What are the 3 financial market rates?
Interest rates
Exchange rates
Holding period return
What are interest rates?
It is the price paid by the borrowers for the use of money received from lenders expressed as a percentage
What are exchange rates?
It is the price at which one currency is exchanged for another currency
What are holding period returns?
It is the total return on an asset or portfolio of assets over the period it was held
What are the 2 techniques used to study financial market securities and their expected prices to make investment decisions?
Technical and fundamental analysis
How does fundamental analysis work?
It estimates the intrinsic value of a company by examining its characteristics and environment
How does technical analysis work?
It predicts share price changes from the study of graphs on which prices (and sometimes volumes) are plotted
What assumptions underly technical analysis?
Market value of a share is determined solely by supply and demand. It ignores minor fluctuations.
What are the different forms of efficient markets hypothesis?
Weak - all past market prices and data is fully reflected in asset prices
Semi-strong - all publicly available info is fully reflected in asset prices
Strong - All information is fully reflected in asset prices, not even insider info can beat the market.
What are some challenges to EMH (effective market hypothesis)?
Stock market anomalies: Reliable and inexplicable patterns
Behavioural finance: Psychological factors that impact asset pricing
What is the role of the IMF (international monetary fund) and the World Bank?
They assess a countries’ adherence to recognised international standards and codes to help implement reforms where needed
What is South Africa’s primary piece of legislation for the regulation of financial markets?
The Financial Markets Act (FMA)
