Lecture 1 Flashcards
What is an investment?
Current commitment of money or other resources the obtain future benefits
What are some examples of investments?
Stocks
House
Education
What are real assets?
They determine the productive capacity and net income of the economy
What are some examples of real assets?
Land
Buildings
Machines
Knowledge used to produce goods and services
What are financial assets?
Claims on real assets
What are some examples of financial assets?
Equity
Bonds
Derivatives
What is a portfolio?
A collection of assets
What is money?
Anything that is generally accepted in payment for goods or services or in the repayment of debts
Tell me about medium of exchange
Standardised
Widely accepted
Divisible
Easy to carry
Durable
What is unit of account used for?
To measure value
What is store of value used for?
To save purchasing power and its liquid
Financial markets bring together…
Those people who have excess funds and those who have shortage of funds
Who are lenders?
Those with surplus funds
Households (individuals) and some institutions that act on their behalf
Who are borrowers?
Government
Firms
Individuals
Foreigners
What are the governments direct responsibilities?
Fiscal policy/tax
National debt management
What are the governments devolved responsibilities?
Monetary policy
Cash/liquidity management
Regulation
What are the roles of financial markets?
Reduction in transaction costs
Information role
Consumption timing
Allocation of risk
Separation of ownership and management
What is the information role (role of financial markets)?
Capital flows to companies with best prospects
What is consumption timing (role of financial markets)?
Use securities to store wealth and transfer consumption to the future
What is allocation of risk (role of financial markets)?
Investors can select securities consistent with their tastes for risk
What is separation of ownership and management (role of financial markets)?
With stability comes agency problems
What are the issues in financial markets?
Corporate government and corporate ethics
Accounting scandals
Auditors (watchdogs of the firm)
Analyst scandals
Sarbanes-Oxley act
What is the Sarbanes-Oxley act?
Tighten the rules of corporate governance
What are financial intermediaries?
Bring those with countervailing needs together
Lenders and the borrowers
Pool and invest funds
What are some examples of financial intermediaries?
Investment companies
Banks
Insurance companies
Credit unions
Tell me about money markets
Short term
Low risk
Highly liquid debt securities (e.g. treasury bills)
Tell me about capital markets
Long term
Debit markets (e.g. government bonds, commercial paper)
Equity markets (e.g. shares)
Derivative markets for futures and options
What are primary markets?
They are used for the issue of new stocks, bonds or other securities to the public (IPO)
What are secondary markets?
Where securities are subsequently traded markets
E.g. LSE, NYSE, NASDAQ
What are some characteristics of secondary markets?
Broad - wide variety of different types of investors
Deep - small adjustment of prices from previous trades
Liquid - ease and speed with which a position can be taken or unwound
Efficiency
What are brokers/what do they do?
Agents
Take orders from investors
Submit them to the market trading mechanisms and charge commissions
What are dealers/what do they do?
Principal trades
Post bid-ask quotes by choice
What are market-makers/what do they do?
Principal traders
Obligated to trade in the securities in which they are registered
What are broker-dealers?
Can act as both agents and principals
Dual-capacity trading
What is the investment process
Asset allocation
Security selection
What is assets allocation (investment process)?
Choice among broad asset classes
What is security selection?
Choice of which securities to hold WITHIN asset class
Security analysis to value securities and determine investment attractiveness
What are the three types of financial assets?
- Fixed income or debt
- Common stock or equity
- Derivative securities
What is fixed income?
Payments fixed or determined by a formula
Tell me about money market debt
Short term
Highly marketable
Usually low credit risk
Tell me about capital market debt
Long term bonds
Can be safe or risky
What is common stock?
Equity or ownership in a corporation;
Payments to stockholders are not fixed but depend on success of firm
What are derivatives?
Their value derives from the price of other securities (e.g. stocks and bonds)
Used to transfer risk
What is a direct search market?
Buyers and sellers seek each other
What is a brokered market?
Brokers search out buyers and sellers
What are dealer markets?
Dealers have inventories of assets from which they buy and sell
What are auction markets?
Traders converge at one place to trade
What is a bid?
The price bid to buy the security by a participant
What is the ‘ask’ (bids and asked prices)?
The price asked for by the participant to sell the security
What is the ‘touch’ (bids and asked prices)?
The difference between bid and ask spread
What are the determinants of the bid-ask spread?
Information asymmetry
Volatility of the asset
Liquidity of the asset
Exchange restrictions
What are call (batch) markets?
Usually auction markets
Buyers and sellers submit their orders in some manner ands process begins to match them
Open outcry; written order entry
What are continuous markets?
Non-batch markets where a transaction is allowed whenever two parties agree to trade
Dealer or quote-driven markets; order-driver markets
What happens in a quote driven system?
There are quotes called exposure orders
Traders accepting a quote with a hit order (when trader sells at current bid price in a market)
What happens in an order-driven market?
The type of order that a trader submits depend on the pursued strategy
Main order types are:
At best (UK)/market (US) order
Limit order
What are alternative limit orders?
Instructs broker to buy or sell only at a certain price
What is a trailing stop order?
Designed to protect gains
Enables a trade to remain open and continue to profit as long as price is moving in investor’s favour
Order closes trade if price changes direction by a specified percentage or dollar/pound/euro etc. amount
What are the order types in continuous markets?
Stop, or stop-loss, order on sell side
Stop-buy order
Trading stop order
Expiry date or time
Single fill order
What is SETS (trading platforms on the London Stock Exchange)?
Order driven market
Back up liquidity provided by money makers
What is SETSqx (trading platforms on the London Stock Exchange)?
Quote-driven market with 4 electronic auctions per day
What is SEAQ (trading platforms on the London Stock Exchange)?
Quote driven platform
Which stock is the most liquid in the London Stock Exchange?
SETS (most)
then SETSqx
Then SEAQ (least)
Why is post-trade anonymity important?
Because otherwise trading strategies can be revealed by small trades
Why is transparency important?
Because the credit risk is borne by the trading parties
I.e. they need to know with whom they are trading
What is the central counterparty?
They act as a counterparty to every trade for clearing members of the London Stock Exchange
What are brokerage fees?
Approx 1.5% but varies according to type of account and frequency of trade
Usually a minimum charge will apply
What is dealer’s spread?
From 0.5% for the most liquid stock
To 15% for the least
Varies throughout the day
What are stamp duty and other taxes?
0.5% of value for purchases
Zero for sales
What are settlement costs?
Approx 30p per trade
What are the operational costs?
Brokerage fees
Dealers spread
Stamp duty and other taxes
Settlement costs
Other costs (custodian charges, exchange trading levies etc.)
