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Financial Markets 2 > L1 - Introduction & Structure > Flashcards

L1 - Introduction & Structure Flashcards

1
Q

financial system

A

comprises markets, institutions, instruments
main aim to put spending units with SURPLUS with DEFICIT (channelling the savings of the former towards the latter)
EFFICIENCY measured by:
a) the more savings are channelled
b) the more it contributes to eco. growth

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2
Q

Financial intermediation

A

DIRECT FINANCE:
Lenders/net savers:
- households, firms, government, non-residents
through Financial Markets:
- money market and capital
Borrowers/net spenders:
- households, firms, government, non-residuals

INDIRECT FINANCE:
through financial intermediaries:
- credit institutions, other monetary financial institutions
- but this in turn also take funds from FM

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3
Q

Instruments

A

Financial Instruments allow for temporary transfer of funds
Liabilties or Investment:
- transfer funds between economic agents
- they generate a liability (payment obligation) where buyers obtain returns
- transfer part to risk in their activities to buyers

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4
Q

Profitability

A

related to instruments´capacity for producing returns (int, dividends, tax benefits)
compensation for temporarily renouncing PP, risk buyer assume
high profitability –> greater risk; low liquidity

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5
Q

Liquidity

A

measured in terms of the ease and cost of trading it for cash

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6
Q

Risk

A

risk inherent in an instrument depends on prob. of the issuer complying with payment clauses

a) when it reached maturity (fixed income)
b) or on variations between actual and expected dividends (variable income)

high return - high risk (risk premium) - less secure
(Nasdaq vs 13w treasury bills)

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7
Q

Type Instruments

A

different criteria:

  • whether or not they are issued by financial intermediaries
  • their relative liquidity (money = completely liquid instrument)
  • the nature of the issuer: public vs private
  • the market where transfer takes place
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8
Q

Example - type of Instruments

A

bonds; shares; derivatives (O,F, S, CDS);
mortgage-backed securities
collateralised debt obligation (CDO)

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9
Q

Financial Intermediaries

A

put together borrowers&lenders
this activity reduces costs&allows for the transformation of instruments (increasing attractiveness)
they issue financial instruments which allow
a) savers to realised their savings (deposits)
b) facilitate mobility of funds to finance borrowers (reduce costs &logistics)
negative IR policy currently happening (ECB)

Service offer:

  • transform risk of diff. instruments by diversifying heir PF
  • transform terms of financial instruments
  • generate &manage payment/ compensation mechanisms
  • vehicles for monetary policy
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10
Q

Financial Markets

A

=mechanism or place where an exchange of instruments can be carried out
price is determined by demand/supply
functions:
- put agents in contact
- act as an appropriate mechanism for determining prices
- provide liquidity for instruments (ease of converting instruments into cash without losses)
- reduce term &brockerage cost

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11
Q

How to F.M. work?

A

majority of markets are ELECTRONIC

  • price efficiency = market efficiency (degree to which stock price reflect all available, relevant info.)
  • market should be open continuously to reflect cont. change in prices throughout the day
  • ease &quality of access = electronic way facilitates connection by all operators (HFT)
  • huge volume of trades (taking orders) by computer systems carry out (otherwise impossible)
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12
Q

F.M. classification

A

According to instrument traded:

a) MONEY market:
- ST instruments with high liquidity and low risk
- maturity less than 1 year
b) CAPITAL market:
- longterm instruments with higher risk
- LT debt and stock market

According to phase of trading:

a) PRIMARY: newly created instruments (Public offering: underwriting, best effort, shelf registration,auction or Private Placement)
b) SECONDARY: already created (Stock Exchange or OTC)

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13
Q

F.M. - stock exchange

companies with SH whose aim is to earn money

A
  • make most of its revenue by fees (fixed)
  • high volatility - high volume traded - increase in revenue
  • competition in market share and where to be listed o traded
  • place and trades will be affected by market rules (M influences market costs or pice determination)
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14
Q

Market Environment

A

brokers can carry ou share transactions in different markets it is important for market to offer high-quality conditions:
-fees, liquidity etc?

objectives of trading system:
- fair, cost-effective trade execution
- accurate pice determination
depends on market architecture

procedures, rules, protocols determine how orders are handled/translated into price

market rules influences cost &liquidity
trading is a costly activity (MA vs PD)

Assumption: frictionless (costless) trading in a perfectly competitive market:

  • many shared - homogeneity
  • many investors - competitive environment

but not true: transaction &execution cost

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15
Q

Costs in FM

A

quality is defined by costs

a) explicit costs: transaction costs, commissions, taxes
- all the costs one must add to the effective volume of the operations
b) execution costs: liquidity (implicit?)

high competition among brokers
commission rates are set freely - law only gives max
commission changed to carry out transaction is shared between:
- market
- broker
-entity performed the operation (clearing house)
more institutions –> higher cost

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16
Q

Fees

A

a) traditional:
- market charges to liquidity makers (providers) and liquidity takers

b) maker-taker fees
- offer transaction rebate to provider (MM)
- charging customers who take liquidity
- aim of fee is to stimulate trading activity within an exchange by extending to firms the incentive to post orders - facilitating trading

c) Taker-Maker fees:
- offer a rebate to takers
- charges to liquidity providers

Important for brokers who are calculating volume of transaction
depends on venue

17
Q

Type of Markets

A 
electronic= computers
non-elect. = pysical location (people)
continuous = market open Monday - Friday
non-cont. = market opens in a certain timetable
  1. noncont &nonelect
    - all investors have the same information
    - only little time each day
    - corros
  2. noncont &electronic
    - electronic auction - preopening auction
    - help to agglutinate information
    - only take place few times a day
  3. continuous &nonelectronic
    - NYSE, CBOT
    - markets with trading floors that open all day
    - they have parallel elect. market
    - increasingly significant
    - most important: investors learn
  4. continuous &electronic
    - Euronext, NASDAQ, Hybrid-NYSE
18
Q

Continuous &electronic

markets do not all work the sam

A

a) price-driven market: markets with MM (forex)
- -> always be offering quotes (price diven) - obligation

b) order driven markets: markets that allow for placement of orders (Madrid bolsa)
- -> it is no an obligation (driven by orders)

c) hybrid (all inv, specialist, MM) (euronext, NYSE)
- -> Mikel compets with obligated BBVA own account

only MM have the possibility to provide liquidity

19
Q

Transaction cost

explicit vs implicit

A

broker - help to evaluate how well trading strategy is
exchange - how liquid market is
regulators - to check liquidity in the exchanges - and change policies to reduce costs

a) explicit = actual out of the pocket expenses
- -> taxes, fees, commissions (big)
- -> easy to identify

b) implicit: not obvious but still impose for traders
- -> estimate price impact on trade - what would have happen if trade wouldn’t exists?
- -> benchmark - midpoint, closing/opening price etc.

20
Q

Dark pools

A

private asset exchanges designed to
a) provide additional liquidity and anonymity for trading b) large blocks of securities away from the public eye.

provide pricing and cost advantages to buy-side institutions (MF, ETF) which claim that these benefits ultimately accrue to the retail investors who invest in these funds.

BUT lack of transparency makes them susceptible to conflicts of interest by their owners and predatory trading practices by HFT firms.

21
Q

Which type of market is better?

A

depends on market situation
each market has its own rules - competition structure depends on: Liquidity and Cost
Markets try to mix up advantages of all systems

Execution in LOB: Priority (P/time or P/depth)
order types: Lo, Mo, Iceberg, execution cond.
ticks
types of intermediaries, functions
level of transparency, liquidiy

22
Q

Type of orders

A

Market order:
request for trade to be carried out immediately at best price available in the market

Limit order:
spec. particular price
the order can ONLY be executed at that price o more favourable one

Stop-loss order:
executed at best available price once bid or offer is made that that particular price or less favourable (prevents from price going into less favourable)

Stop-limit order:
combination of stop loss and limit order
becomes limit order as soon as bid/offer is made at that part. pice or less favourable
2 prices needed: STOP price or LIMIT price

23
Q

What is an order book?

A

list of orders exchange uses to record the interest of buyers and sellers in financial instruments

Interest of buyers - place bids (orders to buy)
highest price buyer is willing to pay

interest of sellers - place offers (orders to sell)
(lowest price seller willing to accept)

CHECK perspective:
Price takers - accept ORDERS
buy at the ask price and sell at the bid price
if you want to buy you check the supply side (ask)

market maker - makes ORDERs
buys at the bid price and sells at the ask price.

24
Q

Primary Dealers

A

bank has agreement with the country to promote its debt with certain rights and obligations
both in 1st and 2nd markets

Financial Markets 2 (9 decks)

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