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IMC Unit 1 - Chapter 1 > Chapter 1 - Introduction to financial markets > Flashcards

Chapter 1 - Introduction to financial markets Flashcards

1
Q

SECTION 1.1

What are the four main functions of the financial service industry

A
  • Financial intermediation
  • Pooling and Managing risk -
  • Provisions of settlements and payments
  • Portfolio Management
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2
Q

What are the main types of financial instutions

A
  • Central banks
  • deposit institutions
  • Investment institutions
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3
Q

What is Financial Intermediation

A
  • Acts as a middleman for financial transactions - provides ways for funds to move from savers (surplus) to borrowers (deficit) agents
  • Examples include: Investment Bank, Mutual fund, pension fund
  • These intetermediaries provide ways to create efficient markets by reducing infomation and lowering costs
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4
Q

How do institutions perform a intermediary function

A
  • Banks uses the secruties markets to raise capital and invest
  • Investment institutions such as: pension funds, Insurance companies purchase secrutinaised assets of the Bank.
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5
Q

What is the significance of pooling and managing risk

A
  • Pooled investment products allow mutiple savers to invest in a wider variety of instruments than they would able to indivdually, therefore reduces each indivdual overall exposure
  • Insurance comapanies allows indivduals to transfer a risk exposure in return for a premium.
  • Dervatives such as: futures and options, allow investors to manage their risk exposure.
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6
Q

What role does the Central bank play

A
  • It is responsibile for setting monetary framework through 2 ways:

1) Setting interest rates to meet inflation target
2) Acting as lender to banking sector by supplying liqudity in times of crisis.

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7
Q

What is the role of an investment institution

A
  • Offer protection against unwanted events in exchange for a premium
  • Covers life insurance - longer period so insurers generally hold long term assets
  • Covers loss or damage and tend to hold shorter term assets so there is more need for immediate cash.

They invest the funds raised in tradeable secruties such as: Bonds and Equities

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8
Q

How has capital flows across national boarders increased?

A
  • Central banks in other countries purchasing many US treasury in large quantites
  • Companies in one country may choose to list on the stock market in another country to raise more liquid capital
  • Companies can issue bonds in another country
  • Investment institutions increased their holdings in forgien assets which benefits investors in the UK looking to invest internationally.
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9
Q

What is the role of the government

A
  • Provide services that private firms are either unwilling or not allowed to provide- ‘Market Failure’ examples include: law and order and maintenance of infrastructure.
  • Regulation to protect customers - Promote competition and prevent fraud by restircting entry
  • Improving distribution of capital - Redistribution of income and wealth through taxes and state benefits

Stablising the economy - Controlling inflation by using interest rates , carried out by MPC

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10
Q

SECTION 1.2 - The role of secruties in providing liquidity

Who are the main lenders and borrowers in an economy

A
  • Households are the main lenders
  • Companies and governments are the main borrowers
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11
Q

What is the difference between a real asset and financial asset

A
  • A real asset is something material such as: land, gold, buildings
  • A financial asset is somehting that will provide a return such as: bonds and secruties
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12
Q

What are the types of financial assets

A

1) Debt claims - loans made by lenders to borrowers that are epxected to be paid back with interest
* Example: A bank deposit with fixed or variable rate of interest

2) Equity secruties - A tradeable asset known as Shares

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13
Q

Example of tradable and non tradeable debt claim

A
  • Non-tradable debt claim is a bank deposit
  • A tradable debt claim is a bond (fixed income secruity) issued by the governemnt
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14
Q

Whta is the difference between money markets and capital markets

A
  • Examples of money markets include: treasury bill debt that have a short term matruity date usually 1-3 months
  • Examples of capital markets are bonds and shares that have a longer maturity date
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15
Q

How do savers generally invest in bonds and shares

A
  • Indirectly through intermediaries such as insurane companies, pension funds and pooled investment products
  • The benefits of this is that:
    1) Greater diversification - Ability to invest in assets that may not be available to an instituional invetsor e.g. commercial property.
    2) Reduced transaction cost - due to intermeidary can trade at lower costs
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16
Q

What do invetsment intermediaries use to manage risk

A
  • Derivative contracts
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17
Q

What are derivatives

A
  • Financial contracts based on the value of an underlying asset e.g bonds, stocks, currencies.
  • An example of where derivatives contracts are used is by making gains from anticipated movements in the price of an asset. - two parties agreeing on the purchase and delivery of an asset on an agreed upon price and a future date
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18
Q

What are the 4 functions of secruties market

Secruties markets brings buyers and sellers together e.g euqties & bonds

A
  • Raising capital - Firm can issue equities and bonds - helps with moblisation of savings
  • Transfer risk for investors- Use derivative contracts to hedge risk
  • Price discovery- In Equity markets equlibrium price changes frequently allows buyers and sellers to agree on a price
  • Creating liquiduty - Allows investors to sell their shares if need be
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19
Q

What is the difference bewteen primary markets and secondary markets

A
  • Primary markets - Initial sale of secrutiy into the market in order to raise capital - IPO
  • Secondary markets- Where company has already issued the shares - allows the ability to turn secruties into cash quickly with minimal loss of value
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20
Q

What is price disseminiation

A
  • Pre-trade transparency - publishes real time data about quotes and orders
  • Post trade transparency - publishes trade prices and sizes shortly after the trade occurs
  • Both are required under MiFID II
21
Q

What markets do buy side traders and sell side traders prefer

A
  • Buy side traders value transparency - better manage their trading and esitmate transaction costs.
  • Sell side value opaque markets as they have infomational advantage over counterparties
22
Q

What is the difference between OTC markets and organised markets

A
  • OTC markets are where you can sell trade stocks, commodities and currencies without the need for a broker
  • Organised markets include London Stock Exchange and tends to be more transparent
23
Q

What is liquidity

A
  • Investors assess liquidity of markets by looking at bid-ask spread - the more willing buyers and sellers, the more liquid a market is.
  • Opaque markets usually havewider bid-ask spread becuase finding the best available price is harder for traders
  • Transparency reduces this bid-ask spread which benefits investors
24
Q

What is the difference between liquid markets and illiquid markets

A
  • An asset is considered illiquid if it is diifcult to sell because of the uncertanity of its future value or lack of market depth E.G MBS 2008
  • When there is uncertanity in the market, secruties may drop in value due to traders pessimesstic view about future value of these secruites
  • An example of a liquid market is US treasuries market - Large volume of tranaction, high market depth, low bid-ask spread makes transactions costs low.
25
Q

Pros and Cons of liquid markets

A

Pros:
* Increases flow of capital - Promotes traders to trade and savers to invest in claims issued by borrowers

Cons:
* Investors demand higher retunrs of secruties with low liquidity becuase harder to sell

26
Q

What are the costs when trading secruties

A
  • Broker commission
  • Price impact of a trade - For large instituions this may be the biggest component of a transaction
  • Bid-ask spread price - smaller, less frequently traded stocks generally have a large spread
27
Q

How can companies reduce transaction costs

A
  • Employ skillful brokers to trade on their half and pay out commission - Trade is less liquid markets - more commission
  • Use electronic algotherims to monitor trading
  • Use dark pool/hidden orders to hide their size
28
Q

What are round trip costs

A
  • Total costs of completing a transaction - commission, taxes, bread -ask spread
29
Q

Under the introduction of MiFID what components (trading venues) was introduced

A
  • Regulated Markets
  • Multilateral trading facilties
  • Systematic Internalisers
  • Greater trading venues has led to fragmentation of trading
30
Q

What are the trading system offered by the Lodon Stock Exchange

A
  • SETS - Electronic limit order book to trade FTSE 100, 250 shares
  • Secruties such as: ETF’s and ETP are traded on here
  • Order-Driven
  • SETSqx- Trading platform for stocks that are less lqiuid that SETS.
  • Invetsors have a choice to trade in either order-book driven or quote-driven
31
Q

What is an Order-Driven system

A
  • All buyers and sellers display prices at which they wish to buy and sell (can see best available price on electric order book)
  • All orders in the book are made up of limit orders
32
Q

What is a Quote-Driven System

A
  • Can only see prices brokers display
33
Q

What are market makers

A
  • Financial institutions (hedge funds, sell side) that quote bid and ask prices and be ready to buy these secruties
  • GEMM’s must deal in all gilt issues or none at all
34
Q

What are the two listing catogeries

A
  • Preimum Listing- Only available to OEIC’s and large institutions who meet highest level of corporate governance
  • Can choose to trade on FTSE 100 indices, LSE and AQSE
  • Stanadard Listing - opposite of premium listing (meets lightest requirements) - usually for shares and deposit receipts
  • Can only trade on LSE and AQSE
35
Q

What are the conditions for premium listing

A
  • Company should have accounts covered up to 3 years and have secruties value equal to £700,000 in shares and £200,000 for debt debt secruties
  • Show proof that it has sufficent working capital to cover 12 months of business
  • 25% listed secruites must be held by the public
36
Q

What are the conditions to be listed on AIM

A
  • need an a nominated advisor and need to produce an admission document
37
Q

What are the conditions for HGS

HGS (High Growth Segment) on London Stock Exchange

A
  • Be incorporated in the EEA
  • Be a commercial company issuing equity shares only
  • Have a minimum free float of 10% at IPO
  • Demostrate Historic value of 20% over the last 3 years
38
Q

What are the conditions listed on the AQSE

A
  • Appoint and retain a corporate adviser at all times
  • Have at least 24 monthsof audited accounts
  • Have 10% free float in public shares
  • Have a good level of corporate governance including one non executive director.
39
Q

What are the exemptions to prodcue a prospectus

A
  • Where the offer is made to a qualified investor
  • Where the offer is made to fewer than 150 persons
  • Where the minimum consideration per investor is greater than £100,000
  • Where the total consideration of an offer is greater than £5 million over 12 month period
40
Q

Whats the difference between professional clients and retail investors

A
  • Qualfied investors - those who are professional clients or eligable counterparties
  • Retail investors can only be professional clients when:
    1) Secruity portfolio greater than £500,000
    2) Worked at least a year in investment postion than requires knowledge of secruites
    3) Have carried out transactions greater than £1000 on secrtuies market
41
Q

When do investors have disclose when buying shares

A
  • Investors must notify a company within two business days when it acquires 3% or more of companies shares
  • Must also notify the company when further incriments of 1% above the 3%
42
Q

What are concert parties

A
  • Group of investors who buy shares in the same company with aims of taking over the company. - to prevent control
  • They can use combined interest to takeover
43
Q

Who is subjected to the disclosure rule

A
  • When investors owes shares that exceed 3% threshold of a company.
  • Public companies must keep a register of those who are interested in buying shares in the past 3 years
44
Q

What is corporate governance in the UK

A
  • Stresses the importance of financial reporting and internal controls to assure shareholders the investments are safeguarded
45
Q

What are the 5 principles of corporate governance in the UK

A
  • Leadership - Effective board must ensure the company has suffcient resources to meet its objectives
  • Division of responsibility- Board should have executive directors and non-executive directors to ensure no one controls decision making
  • Accountability of board
  • Risk management
  • Remuneration - A seperate remuneration policy must be put into shareholders vote every 3 years in the AGM meeting
46
Q

What does the section 172 of companies act require

A
  • Requires large companies in the UK to publish a statement on how directors engage with stakeholders
47
Q

What is the UK Stewardship code

A
  • Stewardship is the mangement, allocation and oversight of capital to create long term value for clients leading to sustainable benefits for the economy, social and environemtal.
  • 12 policies aimed at asset managers and institutional investors
  • 6 policies are aimed at organisations that do not manage investments directly but enable clients to deliver quality stewardship e.g investment consultants
48
Q

How do organisations become signatories

A
  • Must produce an annual stewardship report to explain how they have resonated with the code in the past 12 months
49
Q
A

IMC Unit 1 - Chapter 1 (2 decks)

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