Equity Flashcards
Three main functions of the financial system:
- Allow entities to save/borrow money, raise equity capital, manage risks, trade assets currently or in the future, and trade based on estimates of asset values.
- Determine the returns (i.e., interest rates) that equate the total supply of savings with the total demand for borrowing.
- Allocate capital to its most efficient uses.
Preferred stock
an equity security with scheduled dividends that typically do not change over the security’s life and must be paid before any dividends on common stock may be paid (similar to a bond)
Warrants
the right to purchase a company’s stock at a specific price and at a specific date - issued directly by a company to an investor.
Block brokers
help with the placement of large trades.
An information trader
expects to earn a positive risk-adjusted return
An investor
expects to earn fair (equilibrium) returns over time
‘buy on margin’
using borrowed funds to purchase equity
‘margin loan’
the borrowed funds used to purchase equity
‘call money rate’
the interest rate paid on borrowed funds used to purchase equity
Initial margin requirement
minimum equity % at time of purchase
equity % = (stock value - loan) / stock value
Maintenance margin
minimum equity % after purchase
equity % = (stock value - loan) / stock value
Leverage ratio
1 / initial margin
e.g. if the leverage ratio is 2.5 (40% equity, 60% loan, 1/0.4 = 2.5) a return of 10% on the stock would result in a return of 25% return to the investor
Margin call
Occurs when equity < maintenance margin (i.e. when the value of an investment falls and the debt proportion of the deal represents too much in relation to equity).
In this scenario, the investor must add cash or marginable securities, or close the position.
Margin-call / trigger price
Initial purchase price * ( ( 1 - initial margin ) / ( 1 - maintenance margin ) )
market order
instructs the broker to execute the trade immediately at the best possible price
limit order
places a minimum execution price on sell orders and a maximum execution price on buy orders.
These can either ‘make the market’, be ‘behind the market’ or be ‘far from the market’
All-or-nothing orders
deals with the volume of trade - only executed if the whole order can be filled.
Hidden orders
deals with the visibility of the trade - hidden orders are those for which only the broker or exchange knows the trade size
display size/iceberg orders
where only some of the trade is visible to the market
Immediate-or-cancel / fill-or-kill orders
cancelled unless they can be filled immediately
Good-on-close orders
Executed at end of trading day
e.g. market-on close orders
Stop / stop-loss orders
executed unless the stop price has been met
indications of interest
Investors, identified by the investment bank, who agree to buy part of the issue of a public offering.
This is described as book building
private placement
securities are sold directly to qualified investors, typically with the assistance of an investment bank
shelf registration
enables an equity issuer to issue securities bit by bit
dividend reinvestment plan
allows existing shareholders to use their dividends to buy new shares from the firm at a slight discount.
rights offering
existing shareholders are given the right to buy new shares at a discount to the current market price
call and continuous markets
Call: the stock is only traded at specific times
Continuous: trades occur at any time the market is open
With respect to a well-functioning securities market, a market that exhibits operational efficiency will have
low transaction costs and liquid markets.
operationally efficient market
low transaction costs
Informational efficiency
prices in the market reflect all information currently available to participants
Price continuity
prices do not adjust much from one transaction to the next unless new information about firm value becomes available
An order placed to protect a short position is called a:
stop loss buy.
stop loss buy
A limit order that is placed above the market price. When the stock price reaches the stop price, the stock is sold
When is a limit buy order behind the market
if its limit price is below the best bid.
When is a limit sell order behind the market
if its limit price is above the best ask
Securitizers
Financial intermediaries that assemble large pools of similar financial assets, such as mortgages or loans, and issue securities that represent interests in the pool.
A crossing network
an example of an order-driven market. Orders are batched together and crossed (matched) at specific times during the trading day at prices based on those of another exchange.
pre- and post-market transparency
Pre-market transparency: if investors can obtain pre-trade information regarding quotes and orders
Post-market transparency: if investors can obtain post-trade information regarding completed prices and sizes.
Characteristics of a well-functioning financial system
- Investors are able to save for the future at fair rates of return
- Creditworthy borrowers can obtain funds
- Hedgers can manage their risks
- Traders can obtain the assets they need
Objectives of market regulation
- protect unsophisticated investors
- require a minimum standard of competency and make it easier for investors to evaluate performance
- prevent insiders from exploiting other investors
- require common financial reporting requirements so information gathering is less expensive
- require minimum levels of capital
Problems that persist within financial markets
- fraud + theft
- insider trading
- costly information
- defaults
