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CMA Part 2 > Financial Markets and Securities > Flashcards

Financial Markets and Securities Flashcards

1
Q

What are financial markets?

A

They are not particular places; instead, they are the totality of supply and demand for securities. They facilitate the creation and transfer of financial assets and obligations by bringing together entities who have funds to invest and entities who have financing needs.

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2
Q

List some basic types of instruments for securities.

A

Stocks, corporate bonds, mortgages, consumer loans, leases, commercial paper, certificate of deposit, governmental securities and derivatives of many kinds.

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3
Q

What are money markets?

A

Debt securities with maturities of less than 1 year are traded (short-term and marketable; low default risk) in money markets. These are dealer-driven markets because most transactions involve dealers who buy and sell instruments at their own risk.

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4
Q

Where do money markets exist?

A

London, New York and Tokyo.

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5
Q

List some basic money market securities.

A 
Government treasury bills, notes and bonds
Federal agency securities
Short term tax-exempt securities
Commercial paper
Certificate of deposit; Eurodollar CDs
Repurchase agreements
Bankers' acceptance
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6
Q

List the difference between a dealer and an agent.

A

A dealer is a principal in most transactions; an agent is a stockbroker.

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7
Q

What are capital markets?

A

Long-term debt and securities are traded in capital markets; i.e. NYSE.

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8
Q

What are primary markets?

A

The markets in which corporations and government units raise new capital by making INITIAL offerings of their securities. The issuers receives proceeds of sale in a primary market.

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9
Q

What are secondary markets?

A

The markets that provide trading of previously issued securities among investors.

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10
Q

List examples of secondary markets.

A

Auction markets and dealer markets.

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11
Q

What are auction markets?

A

In auction markets, share prices are communicated immediately to the public. Like NYSE, American Stock Exchange and regional exchanges conduct trading at particular physical sites.

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12
Q

How does a company trade its securities on an exchange?

A

A company must apply for listing and meet certain requirements such as amount and value of shares outstanding, number of shareholders, earning power and tangible assets.

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13
Q

What are specialists in exchange trading?

A

Firms who match buy and sell orders and communicate the orders to brokerages with seats on the exchange. They are obliged to buy and sell particular stocks. They maintain an inventory of stocks and set bids and asked prices.

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14
Q

What is the profit margin of a specialist?

A

It is the spread, which is the excess of the asked over the bid price. Asked prices are the prices at which specialists will buy or sell to keep inventory in balance.

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15
Q

Where are derivates traded at?

A

Stock exchanges and commodities markets.

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16
Q

What are commodity futures?

A

Agreements to buy or sell raw material (oil, livestock, metals, grains, fibers, etc.) at a specific price on a specific date in the future.

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17
Q

What are financial futures?

A

Agreements to buy or sell financial instruments at a specific price on a specific date in the future.

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18
Q

True or false. Commodity and financial futures are both traded on commodity exchanges.

A

Yes. Both futures are traded on commodity exchanges.

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19
Q

What is the OTC (over-the-counter) market?

A

OTC market is a dealer market. It conducts transactions in securities not traded on the stock exchanges. Brokers and dealers are trading throughout the country by telecommunicating.

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20
Q

List some transactions that are handled on OTC.

A

Bonds of US companies
Bonds of federal, state and local governments
Open-end investment company shares of mutual funds
Most secondary stock distributions (whether or not listed on an exchange)

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21
Q

Who is the governing authority of the OTC market?

A

National Association of Securities Dealers (NASD). Its computerized trading system is the NASD Automated Quotation (NASDAQ) system.

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22
Q

Which market has trading in greater dollar volume?

A

The exchanges have greater dollar volume in trading because they list the largest companies although majority of stocks are traded on OTC.

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23
Q

Why are bonds of corporations trading primarily on OTC?

A

Trading is done by large institutional investors (i.e. pension funds, mutual funds and life insurance companies). Very large amounts are exchanged among a few investors, so dealers in the bond markets can feasibly arrange these transactions.

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24
Q

What are financial intermediaries?

A

They are specialized firms that help create and exchange the instruments of financial markets. They increase efficiency through better allocation of financial resources.

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25
Q

How do financial intermediaries work?

A

They obtains funds from savers, issues its own securities and uses the money to purchase an enterprise’s securities. Thus, they create new forms of capital.

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26
Q

List examples of financial intermediaries.

A 
Commercial banks
Life and casualty insurance companies
Private, state and local pension funds
Nonbank thrift institutions (i.e. credit unions and saving banks)
Mutual funds
Money market funds
Finance companies
Investment banks
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27
Q

What is insider trading?

A

Trading of securities while possessing nonpublic information about the securities. This type of trading is illegal because it undermines investor confidence in the integrity and fairness of the financial markets.

28
Q

What is Efficient Markets Hypothesis (EMH)?

A
  1. It states that current stock prices immediately and fully reflect all relevant information. So the market is continuously adjusting to new information and acting to correct pricing errors. Prices are always in equilibrium.
  2. It states that it’s impossible to obtain abnormal returns consistently with either fundamental or technical analysis.
29
Q

What is fundamental analysis?

A

The evaluation of a security’s future price movement based on sales, internal developments, industry trends, the general economy and expected changes in each factor.

30
Q

What is technical analysis?

A

The evaluation of a security’s future price based on the sales price and number of shares traded in a series of recent transactions.

31
Q

What is the expected return under EMH?

A

Expected return is equal to the return required by the marginal investor given the risk of the security. Prices equals its fair value as perceived by investors.

32
Q

What is the strong form of EMH?

A

All public and private information is instantaneously reflected in securities’ prices. Thus, insider trading is assumed not to obtain abnormal returns.

33
Q

What is the semi-strong form of EMH?

A

All available public data are reflected in securities’ prices, but private or insider data are not immediately reflected. Thus, insider trading can result in abnormal returns.

34
Q

What is the weak form of EMH?

A

Current securities’ prices reflect all recent past price movement data, so technical analysis will not provide a basis for abnormal returns.

35
Q

What is empirical data in EMH?

A

It has refuted the strong form of EMH but not the semi-strong and weak form. Investors should be aware of economic information about the firm’s markets and the strength of the products of the firm.

36
Q

What is a rating agency?

A

It’s an agency that a firm pays to in order to have its debt rated.

37
Q

List the most used rating agencies.

A

Standard & Poor’s, Moody’s and Fitch.

38
Q

How is debt rated?

A

Rating is based on the probability of default and the protection for investors in case of default. Ratings are determined from corporation information, such as financial statements. Rating may change due to periodic review of outstanding securities by the agencies.

39
Q

What are important factors in debt rating analysis?

A
  1. The ability of the issuer to service its debt with its cash flows
  2. The amount of debt it has already issued
  3. The type of debt issued
  4. The issuer’s stability of cash flow
40
Q

What factors may trigger a rating review?

A

New issue of debt; intended merger involving an exchange of bonds for stock; material changes in the economic circumstances of the firm.

41
Q

What does a high rating of debt mean?

A

Higher rating means lower risk of default; thus, lower interest rate for the firm.

42
Q

What are the AAA and AA ratings?

A

Highest rating and highest quality, which means little change of default.

43
Q

What are the A and BBB ratings?

A

They are of investment grade. They have strong principal and interest paying capabilities. Bonds with these ratings are the lowest-rated securities that many institutional investors are permitted to hold.

44
Q

What are the BB and below ratings?

A

These are high risk bonds.

45
Q

What are CCC and D ratings?

A

The likelihood of default is significant, or the debt is already in default (D rating).

46
Q

What are junk bonds?

A

These are the bonds in the BB and below ratings. They are high yield or low grade.

47
Q

What’s the plus-minus system in S & P’s rating?

A

A plus indicates a stronger rating in a category, and a minus indicates a weaker rating.

48
Q

What is investment banking?

A

Investment bankers serves as intermediaries between businesses and providers of capital. They sell new securities, assist in business combinations, act as brokers in secondary markets and trade for their own accounts.

49
Q

What is an investment bank’s role in the sale of new securities?

A

They help determine the method of issuing and the price to be charged, distribute the securities, provide expert advice and perform a certification function.

50
Q

What are best-efforts sales?

A

The investment bank provides NO guarantee that the securities will be sold or that enough capital will be raised. It receives commissions and is obligated to provide its best efforts to sell securities.

51
Q

What are underwriting deals?

A

The investment bank agrees to purchase the entire issue and resell it. The issuer doesn’t bear the risk of not being able to sell. This typically doesn’t happen unless the amount is relatively small.

52
Q

What is syndicate?

A

The investment bank (the lead or managing underwriter) forms an underwriting syndicate with other firms to share the risk of overpricing the issue or of a market decline during offering period. Members of the syndicate share the commission but their risk is limited to the percentage of their participation.

53
Q

What are flotation costs?

A

Costs of issuing new securities. They are relatively lower for large issues than small ones. They are greater for common stocks than preferred stocks; they are greater for stocks than for bonds.

54
Q

List types of flotation costs.

A
  1. Underwriting spread: difference between price paid by purchasers and net amount received by issuer.
  2. Incurred expenses such as filing fees, taxes, accountant’s and attorney’s fees. These are usually fixed.
  3. Indirect costs because of management time devoted to the issue
55
Q

What is an Initial Public Offering (IPO)?

A

It’s a company’s first issuance of securities to the public.

56
Q

What is a subsequent offering?

A

The company offers additional shares which are usually issued from the company’s treasury.

57
Q

What is a secondary offering?

A

The company issues new stock for public sale.

58
Q

What are advantages of IPO?

A
  1. Ability to raise additional funds
  2. Establishment of the company’s value in the market
  3. Increase in the liquidity of the company’s stock
59
Q

What are disadvantages of IPO?

A
  1. Costs from reporting requirements of the SEC and other agencies
  2. Access to company’s operating data by competitors
  3. Access to net worth information of major shareholders
  4. Limitations on self-dealing by corporate officers and major shareholders
  5. Pressure from outside shareholders for earnings growth
  6. Stock prices may not reflect the company’s true net worth
  7. Loss of control by management
  8. Need for improved management control as operations expand
  9. Increase in shareholder servicing costs
60
Q

What is a cash offer?

A

It’s made to any interested party through IPOs.

61
Q

What is a rights offer?

A

It gives existing shareholders an option to purchase new shares before they are offered to the public.

62
Q

What is a preemptive right?

A

It gives an option to existing shareholders to purchase new shares so that the percentage of ownership for those shareholders is not diluted. Under this right, a rights offer is mandatory.

63
Q

What terms are stated on stock warrants?

A

The subscription price, the number of rights required to purchase one share and the expiration date. Shareholders may exercise the rights, sell them or allow them to expire.

64
Q

What is standby underwriting?

A

It is when an underwriter (investment bank) agrees to buy undersubscribed shares.

65
Q

What is a green shoe option?

A

It allows the underwriter to issue additional shares of an IPO due to strong demand for the stock. It will stabilize the stock price by increasing supply. This is the only type of price stabilization measure permitted by the SEC.

66
Q

What is unmodified opinion?

A

It is the audit opinion that provides the highest level of assurance. It means that the financial statements are presented, in all material respects, in accordance with all applicable reporting framework.

CMA Part 2 (8 decks)

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