Class 1

Question 1

Why regulate securities?

Answer 1

1. because of the importance of the capital market and investments for the economy
2. because of the Importance of investments to people relative to other decisions people make
3. because investments are intangible; and
4. Because of the collection action problems among investors

Question 2

What is the basic definition of a security?

Answer 2

financial contract that can be traded in a financial market

assets involved: hard assets (property), financial assets (shares)
Qty. and unit: one share, ounce of gold
Price
Date
Payment/settlement terms

Question 3

What are the types of securities?

Answer 3

Common Stock
Preferred stock
bonds

Question 4

What are the characteristics of common stock?

Answer 4

cash flow rights: residual and discretionary dividend
Liquidation rights: residual
Maturity/term: indefinite
governance
Elect board/fiduciary duties

Question 5

What are the characteristics of preferred stock?

Answer 5

Cash flow rights: fixed and discretionary dividend
Liquidation rights: medium
Maturity/term: fixed or indefinite/contingent
Governance: stock rights/contingent voting

Question 6

What are the characteristics of bonds?

Answer 6

Cash flow rights: fixed and certain interest payment
Liquidation rights: highest
Maturity/term: fixed
Governance: covenants

Question 7

What is included in the primary market?

Answer 7

(Trade between investors/issuer)

• private placements
• Initial Public Offerings
• Other offerings

Both markets have broker-dealers (investment banks, securities analysts)

Underwriters, attorneys, accounting firms, institutional investors

Question 8

What is included in the secondary market?

Answer 8

(trading between investors but does not raise funds for issuers- a liquid secondary market greatly assists the operations of the primary market)

large volume of shares: secondary distribution

Both markets have broker-dealers (investment banks, securities analysts)

securities exchanges, OTC markets, ATS/ECNs

Question 9

List the Securities Exchanges

Answer 9

e.g. NYSE, NASDAQ

Question 10

What is an OTC Market?

Answer 10

e.g. Pink sheets

Question 11

What is an ATS/ECN?

Question 12

What are the three main functions of the secondary market?

Answer 12

1. provide investors with liquidity (this transforms the maturity of funds)
2. Identify the price (or value) of the securities. This is known as price discovery.
3. Identify investors who are interested in securities-who could be approached to supply funds in the primary market.

Question 13

What is a maturity transformation?

Answer 13

companies can issue long term securities to short term investors because the investors can trade (in the secondary market)

Question 14

how does the secondary market enhance a security value by providing liquidity?

Answer 14

investors are more likely to buy securities in the primary market if they can be traded in the secondary market

Question 15

how are share prices characterized and who is it useful to?

Answer 15

share prices provide the market’s valuation of a company’s shares
value is reflected in:
the company’s market capitalisation = the share price X the # of shares

Question 16

How are debt markets characterized and how are they useful?

Answer 16

Discovers (or identifies) the current interest rate (or yield) for funds reflecting both
- the general level of interest rates and
- the security’s credit risk (and liquidity risk) premium
Useful in pricing new loans

Question 17

What is a security’s credit risk premium?

Question 18

How does the secondary market identify potential investors in new securities and this assist the primary markets?

Answer 18

by reducing search costs and creating access to large-scale fundraising opportunities

Question 19

Borrowers/issuers pay a return to compensate lenders/investors for what?

Answer 19

deferring their use of the funds and the risk they face.

Question 20

What is a yield?

Answer 20

interest rate on a tradable security (usually yield to maturity-rate of return assuming security is held to maturity)

Question 21

What is present value (P)?

Answer 21

the starting amount invested or borrowed, or value today of future payments

Question 22

what is Future value (F)?

Answer 22

the terminal value of a loan or investment.

Question 23

Equation for FPI that reflects the time value of money

Answer 23

F= P + I

Question 24

What is the Interest equation?

Answer 24

I = P x r x t

I= interest
P= starting amount
r-nominal interest rate per annum
t = length of loan in years

Question 25

What is the simple interest formula?

Answer 25

F = P (1 + rt)

Question 26

What is the compound interest formula?

Answer 26

F = P (1 + r) ^t

Question 27

Valuing debt/debt securities

Answer 27

Single payment for interest and borrowed funds: F= face value

F (face value) = P (issue price) + I (interest)

Referred to as discount securities: trade below the face value

Question 28

what is a perpetuity?

Answer 28

a series of payments that does not terminate

Question 29

How do we value equity?