Lecture 1 - Introduction to Financial Markets Flashcards

Question

What are the types of financial securities?

Answer 1

1) Debt claims - those who provide debt to a firm in the firm of loans etc - I.e the creditors (banks) etc - have a predetermined cash claim via the rate of interest charged - holding debt securities I.e being a creditor or investing in bonds generally involves lower risks as a fixed income in the form of interest is earned (but if the issuer fails to pay you, you receive nothing - but if the firm or issuer is in financial difficulty they have an obligation to repay you first and then the remainder amount will go to those holding equity hence the lower risk associated with holding a debt security compared to an equity security like a stock) but a creditor/debt security holder does not benefit from a gain if the underlying asset increases (e.g. stock price goes up) in value unlike equity security holders (shareholders) - debt security holders only entitled to interest payment 2) Equity claims - those who own shares in a company e.g. shareholders, stock owners, stockholder etc - only entitled to the cash payment in the form of a dividend which isn’t guaranteed (manager choice/discretion not obligatory and only paid after debt holders paid and if profit made) - these investors face higher risk as there is no guaranteed fixed income like debt security holders but benefit from capital gain if the price of the asset rises Equity investment is riskier than investing in debt or bonds

Answer 2

1) Debt claims - bonds, loans (being a creditor like a bank etc) - tend to be safer as fixed income guaranteed etc but investor does not benefit from any capital gains in the asset 2) Equity claims - shares, stocks in a company etc - involve greater risks as no guaranteed or fixed income but investor benefits from capital gains in the asset

Answer 3

Financial intermediaries, e.g. banks, assist in the transfer of funds from surplus (those who have money) to deficit agents (those that need money) - they recycle funds from those that want to save to those that want to borrow Economic functions: 1) provide a payment system 2) they accept investor funds (in the form of a deposit when buying a house 10-20%) and transform those liabilities into longer term assets such as loans 3) they transform low risk deposits into bundles of riskier loans/assets (riskier because there is a chance that borrowers may not be able to the entirety of the loan back) 4) banks provide liquidity - especially for surplus agents with a large amount of money/funds - they could take this money out at any time and the bank needs to have this cash available for them to do so

Answer 4

1) Primary Markets - when you issue equity for the first time e.g. in an IPO (initial public offering) where shares are issued for the first time - also when you issue bonds for the first time 2) Secondary Markets - deals in financial securities (shares, bonds etc) that have already been issued (where shares are traded - bought and sold) - most securities are on a secondary market - price of the securities on the secondary market helps value a firm (the number of shares issued multiplied by their value gives you an estimate of the value of the firm - the greater the demand for the shares or bonds the greater their value) - a liquid secondary market is vital for investors as it allows them to sell their shares with ease - if there is a lack of liquidity then the issuer of the shares (I.e the firm) will have to pay a liquidity premium to compensate investors for the lack of liquidity

Answer 5

The process by which investment banks guarantee that companies and governments will obtain the funds that they are seeking when issuing debt and equity securities

Answer 6

A company or individual (usually large banks or financial institutions) who actively quote bid offer prices on securities to stimulate demand for them and therefore aim to make the market more liquid

Answer 7

1) Individuals - e.g. retail investors (basically us who are non professional individuals who invest money in their own accounts through brokerage firms like Vanguard or a savings account), households etc 2) Institutional investors - commercial banks (provide services to individual consumers as well as small and medium sized businesses), investments banks (provide services to large corporations and institutional investors), insurance funds (safety nets that protect bankrupt traders from adverse losses and ensure that the profits of winning traders are paid in full), pension funds (fund that accumulates capital by being invested in shares and bonds to be paid out as a pension for employees when they retire at the end of their careers), mutual funds (group investment from multiple shareholders - funds invested in stocks, bonds and other assets - available to the public including the average investor - a way to build a diversified portfolio by contributing to a mutual fund so that you also own shares in whatever the mutual fund has invested in) and hedge funds (different from mutual funds in that they only accept money from accredited investors which have a certain net worth and are considered wealthy to ensure that they can handle the potential risks that hedge funds are permitted to take) 3) Governments (may issue governments bonds, may invest in stocks through sovereign wealth funds (state owned investment funds comprised of surplus money generated by the government - surplus reserves) 4) Brokers - intermediaries who act on behalf of investors wishing to conduct a trade 5) Arbitrageurs - economic agents that buy and sell financial securities to make risk less profits by exploiting/taking advantage of market inefficiencies (think back to the new communication masts/towers with antennas being built in Kent to reduce the signal transfer time from the London Stock Exchange to the Frankfurt Stock Exchange from 6 milliseconds to even less to reduce arbitrage) by simultaneously buying a cross listed asset (e.g. a share listed on multiple stock exchanges) at a lower price and selling it at a higher price to make a profit - they essentially take advantage of the delay in the synchronisation of changes in a share or stock price across exchanges in different parts of the world e.g. London and Frankfurt 6) Hedgers - economic agents who seek to reduce or limit some risk by engaging in the purchase or sale of a financial security e.g. Gold - individual or firm who buys or sells the actual physical commodity and include producers, wholesalers, retailers, manufacturers etc 7) Speculators - economic agents who try to make a profit by predicting the market - by either buying an asset early and selling later at a higher price due to expectations that the asset is likely to be in demand and therefore increase in price - speculators want to increase their risk to increase their return

Answer 8

From about 2010, after the 2008 financial crisis, interest rates were very low (just over 0% called the zero lower bound) and they remained at this rate for about 10 years until 2020 After COVID and the Ukraine war and due to high inflation caused by several setbacks, the current interest rate is high around 5% in order to control inflation (which makes us all poorer)

Answer 9

An interest rate of about 5% means that it is costly to borrow which means that it is more expensive to take out a loan to buy a house and it is more costly for firms to take out loans to finance their operations However saving enables a greater interest/yield so now is the time to save - makes sense why banks like metro can introduce their 5.2% rate which they now have dropped to just under 5% - they are following the governments announcements of interest rates

Lecture 1 - Introduction to Financial Markets Flashcards

(35 cards)