Chapter 1

Question 1

What is a Security?

Answer 1

Securities have some type of financial worth

Question 2

Name the two types of securities?

Answer 2

Equity and Debt Security

Question 3

What is Equity security?

Answer 3

Ownership of a company such as a stock/share

Question 4

What is Debt security?

Answer 4

Investment that involves borrowing money e.g bond

Question 5

What does a market maker do?

Answer 5

Quotes continuous price in shares over the trading day;
The price they offer reflects how many shares they have;
More shares - keen to sell;
Less shares - keen to buy

Question 6

What is the Bid and Asking price?

Answer 6

Bid - the price a buyer is willing to pay;

Ask - the price the seller is willing to sell.

Question 7

What is a bid-ask spread?

Answer 7

The difference between the bid and asking price.

Question 8

Bid Price - £50
Ask Price - £65
What is the bid-ask spread?

Answer 8

£15

Question 9

Calculate the bid-ask spread in %

Answer 9

(spread/ask price x 100)

£15/£65 x 100 = 23%

Question 10

What happens in the Primary Market?

Answer 10

1. Securities are created;
2. Stocks and Bonds are sold to the public for the first time;
3. IPOs take place;
4. Governments and Public sector institutions raise money through bond offerings;
5. Securities are purchased directly from an issuing company.

Question 11

What happens in the Secondary Market?

Answer 11

1. It includes NY Stock Exchange, LSE & NASDAQ;
2. Investors trade amongst themselves;
3. Investors trade previously issued securities without the issuing companies involved.

Question 12

How do you trade on a stock exchange?

Answer 12

It’s auction or order driven or both.

Question 13

What is quote-driven order?

Answer 13

When market makers quote (buy & sell)/two-way prices at which they are prepared to trade in securities throughout the trading day/mandatory quote period.

Question 14

What’s an order driven system?

Answer 14

1. Based on an electronic order book where sell orders are entered anonymously;
2. System pairs up matching buy & sell orders for the same price, and executes them automatically during continuos trading;
3. Order unexecuted lapses or is withdrawn.

Question 15

What is Liquidity?

Answer 15

1. The measure of how quickly assets and securities can be sold in the market without affecting the asset’s price.

Question 16

What happens if a share is illiquid?

Answer 16

1. It may not trade as there aren’t many buyers or sellers within the desired volume;
2. it has a wide spread, so you’re selling too cheaply or buying too expensive.

Question 17

What is a Block Trade?

Answer 17

1. Order or trade submitted for the sale or purchase of a large quantity of securities;
2. Involves a significantly large number of equities or bonds being traded at an arranged price between two parties;
3. Conducted through an intermediary (block house);
4. Bonds $200,000 dollars and over;

Question 18

What is a program trade?

Answer 18

1. Computerised trading used by institutional investors for large volume trades;
2. Orders from the trader’s computer are entered directly into the markets computer system and executed automatically.

Question 19

What happens when a trade is executed?

Answer 19

It has to be cleared and settled.

Question 20

What is clearing?

Answer 20

Checking that all the details of a trade match.

Question 21

When does clearing take place?

Answer 21

At the end of each trading day.

Question 22

What happens if the volume of trades is high?

Answer 22

Clearing happens several times a day called intra-day clearing.

Question 23

When does settlement take place?

Answer 23

When the trade is paid for and the shares change hands.

Question 24

How does settlement take place?

Answer 24

1. On the LSE, this is done through a system called ‘CREST’, a paperless share settlement system;
2. When a trade is executed its details are sent by both parties to ‘CREST’, which matches the messages and checks there is enough in the sellers account to make a sale;
3. On settlement ‘CREST’ instructs market maker’s bank to make payment to seller’s account;
4. ‘CREST’ updates its own account to record the new shareholder’s shareholding;
5. Settlement takes place T+3 (three days after the trade) in the larger markets;
6. It takes up to a week in the smaller market.

Question 25

Explain Short selling

Answer 25

1. The sale of a security that is not owned by the seller, or that the seller has borrowed;
2. It’s motivated by the belief that a security’s price will decline, enabling it to be bought back at a lower price to make profit;

Question 26

Provide a short selling example.

Answer 26

1. You short sell a share at today’s price;
2. Borrow the share from someone who has it;
3. Deliver it at settlement;
4. Go into the market and buy the share at a lower price;
5. Give the share back to the owner you borrowed it from.

Question 27

What is Stock lending?

Answer 27

1. Providing shares to enable short selling;

2. It earns you a fee paid by the borrower, via the profit they make from selling.

Question 28

What is an Electronic Communication Network (ECN)?

Answer 28

1. Virtual electronic platform which enables banks, brokers and institutional investors to by pass markets and create their own system.
2. It works by sifting through data (posted by traders) in order to match buy & sell offers.

Question 29

What are dark pools/crossing networks?

Answer 29

Alternative trading system that gives institutional investors the opportunity to place orders and make trades without publicly telegraphing their intentions, until the sale has been executed.

Question 30

What is insider dealing?

Answer 30

Buying and selling shares on the basis of market-sensitive information that is not in the public domain.

Question 31

What must exchanges ensure that they do?

Answer 31

1. Ensure companies are transparent about what they’re doing and how well they’re doing it;
2. Ensure investors are operating on a level playing field and not trying to gain unfair advantages over each other.