Financial Markets

Question 1

Benefits of investing in emerging markets - key points:

Answer 1

• Faster economic growth: developing countries usually grow at a faster rate than countries with more mature economies
• Savings rates: usually higher in developing countries. Incoming foreign investment capital will boost the economy and company profits.
• Inefficient pricing: market efficiency may not be as strong in more mature markets.
• Industry representation: foreign investment capital can gain exposure to industry sectors that may not be prevalent in developed economies (i.e. large-scale commodities mining).
• Valuations: EM have historically traded at a discount to valuations in developed economies.
• Diversification: low correlation between returns in emerging and developed markets.

Question 2

Drawbacks of investing in emerging markets - key points:

Answer 2

• Restrictions on foreign ownership: foreign investors may only be able to buy shares in certain companies or may only be allowed to own a certain “class” of share (China and India, for example).
• Foreign exchange restrictions: repatriation of investment capital to the home country may be difficult.
• Taxation: local, regional or state taxes may increase tax burden.
• Costs: custodian and F/X commissions will also increase cost.
• Lack of transparency: lack of high-quality information may exist.
• Corporate governance: there may be low standard of corporate governance and law than that existing in more developed countries.

Question 3

Risks of investing in emerging markets - key points:

Answer 3

• Political: emerging market countries are often less politically stable than developed market countries. Nationalisation of companies and/ or a new government passing new legislation can have a hugely negative impact upon foreign investment holdings.
• Volatility: EMs exhibit higher volatility than developed ones. “Information risk” can mean that foreign investment capital is concentrated in a small number of companies, in essence, a “herding effect”.
• Liquidity: Shares in EM trade with wider bid-offer spreads and may be difficult to sell in times of high market volatility.
• Custodian: Custody, dividend collection and settlement all crease the opportunity for counterparty default and fraud. language misunderstandings also increase risk.
• Currency: EM currency tend to have more volatile and weaker currencies. F/X losses can negate investment gains.

Question 4

UK Market - Stock Exchange Electronic Trading Service (SETS) - definition and order types:

• A** B***
• L****
• E***** and e********
• F*** or k***
• M*****
• I******
• H***** l****
• H***** p*****

Answer 4

• SETS is an electronic, order-driven platform that provides trading in FTSE 100, FTSE 250 and FTSE Small Cap shares.
• SETS allows eight different order types to be submitted when buying and selling shares:
  
  • At Best
  • Limit
  • Execute and eliminate
  • Fill or kill
  • Market
  • Iceberg
  • Hidden limit
  • Hidden pegged

Question 5

SETS order types and definitions:

• A* B***
• L****
• E****** and E********
• F*** or K***

Answer 5

• At Best orders: executed at best available price. No limit price is specified. Executed at as many different prices as necessary. Any unfulfilled excess is eliminated as only Limit Orders remain on the system.
• Limit orders: submitted on order book with a specified size and price. Either held on order book or executed in part or full, at no worse than limit price. Can be held on order book for up to 90 days.
• Execute and Eliminate orders: similar to Limit Orders, except as much of the order will be executed immediately at the limit price or better. Any remainder will be rejected rather than being left on the Order Book.
• Fill or Kill orders: submitted to the Order Book with a specified size and with (or without) a specified limit price. They are either immediately executed in full against the order book or are rejected in full.

Question 6

SETS order types and definitions:

• M***** orders
• I****** orders
• H***** L**** orders
• F***** P***** orders

Answer 6

• Market orders: at best orders that are entered into the system during the opening and closing auction all period. Specified size but no price. Executed at price set by Limit orders or at the reference price set by the exchange.
• Iceberg orders: a special type of large Limit Order that can be partially hidden from market view with only the peak exposed. Peak size is the maximum volume that will be shown to the market at any given instant. Once peak dealt with system reintroduces orders until entire amount dealt.
• Hidden Limit orders: Limit orders where both price and volume are hidden. Unlike Iceberg orders, there is no information as to whether there is any order remaining or not. Only available for large orders that meet certain thresholds.
• Hidden Pegged orders: allow participants to peg their order to the best Bid or Offer Price.