Lecture 2 Flashcards
What is direct financing?
Finance arranged through issuing securities to investors in the financial markets in order to raise funds for deficit units
What are the two kinds of financial institutions that raise funds for deficit units?
Merchant and investment banks
Merchant banks: Prepare documentation, market the issue, earn fees for these services
Fund managers- purchase securities and in turn charge a fee for their services
Who aids suplus units in investing funds?
Fund managers
What are the four mismatches between surplus and deficit units?
1) Amount of funds
2) Length of contract
3) Risk exposure
4) Returns
What is the spread of funds for direct?
The cost of funds for deficit units and the returns to surplus units
What is the spread for direct financing represented by?
For surplus units: The rate of return- fund manager fee
For deficit units: The rate of return + fund manage fee
The difference between the overall rate of return and fund manager fee represents the spread
What is the spread for indirect financing (i.e. depositing funds in ADIs)?
The difference between the interest rate paid to surplus units and the interest rate charged to deficit units
What is the difference between the primary and secondary markets? Who regulates each market?
Primary market- for the initial issuing of securities (where the issuer will receive the money) ASIC regulates the primary market
Secondary market- the subsequent trading of securities:
Securities exchange: ASX
Over the counter: Australian Financial Markets Association
Under what kind of contract do merchant banks issue securities?
Under the best efforts contract
What are the requirements under the best efforts contract
1) Make sure issue is complying with the law
2) Aid in preparing prospectus
3) Arrange an auditor
4) Marketing for bonds/ securities issues
HOWEVER, they are not required to guarantee that all securities are sold
Under what kind of contract will merchant banks guarantee that all securities on offer will be sold?
Standby underwriting contract
What are the roles of rating agencies? Who are they paid by and for what purpose
Provide an expert opinion about the expected performance of securities and financial institutions. Paid by the issuer ad are required for securities to be issued- will determine rating
Who are the main issuers of ratings in Australia
Standards and Poor’s, Moody’s and Fitch Ratings
How are securities cleared?
Through the clearinghouse- which is Austraclear in Australia
What is the role of the clearing house (Austraclear)
1) Maintain the security register
2) Clear trades that change ownership
3) Feed payment instructions in RTGS
What are the role of secondary markets?
1) A trading planform that enables trading
2) Trading rules and procedures to promote efficient and fair trading
3) Settlement arrangements to organise payments
How are secondary markets organised? What is the trading platform for equity?
Either:
a) A securities exchange (the ASX)
b) An over-the-counter (OTC) basis by an association of market dealers Australian Financial Markets Association
The securities exchange is the trading platform for equity
What types of securities do exchange markets organise?
The share market and also some derivatives
Who arranges trading the the exchange market? What are they responsible for?
Brokers:
- Act as agents on behalf of clients
- Aid the sale and purchase of securities on behalf of their client
- Responsible for each trade- will ensure clients actually pay or have shares to actually sell - Earn a commission
What kind of a market is the exchange market?
Order driven market- orders taken form traders to by or sell
What does a trading order specify?
- Buying or selling
- The security
- The quality
- The price
What are the two types of prices?
Limit price: Either maximum or minimum buying or selling price
At-market price: which is at the best available price (therefore will not sit in the BUY or SELL part of commsec)
What are over-the counter markets? What types of securities do they typically include? Who operates in the market?
Money, bond and FX markets and some of the derivative markets. Dealers operate in the market
What do dealers do?
- Act as their own principal
- Trade with each other and with wholesale clients (large banks and institutions)
- Hold inventory of securities which they provide and offer
- Earn their income as a spread- the difference between the buy and sold price
When will a spread be a ‘round trip’ transaction?
When dealers buy at a low price and sell for a higher price
What are the two types of markets dealers operate in?
Dealer client and inter dealer markets
What is the ‘bid’ and ‘Offer’
What is the market spread
What is the dealer spread?
Bid= the amount willing to buy for Offer= the amount willing to sell for
How are funds in over the counter markets settled?
Through the back-office clearinghouse of each dealer and broker involved in the trade
What are the market rules included in the ASX?
Trading hours, pricing practices, trading protocols, transaction sizes
How do secondary markets assist primary markets?
a) Provide investors with liquidity
b) Price discovery function
What are the three measures of liquidity? How does this benefit primary markets?
1) Daily turnover
2) Bid-ask spread
3) Price resilience
This gives primary markets to re-sell securities, hence increasing confidence within the market
What does price discovery involve? How does it aid primary markets?
Markets generate fail prices, interest rates and exchange rtes they regard as ‘fair’ when they are a result of trading by informed traders- typically within efficient markets.
Aid primary markets as they can:
- monitor the value of investments
- Informs potential issuers of securities of their expected proceeds, or what price is reasonable for new securities
What does the efficient market hypothesis state?
Security markets efficiently use information to generate ‘fair’ prices that move randomly
What are the three levels of informational efficiency?
Weak- form: efficiently use past price data- current prices reflect all past prices (useless studying them)
Semi- strong: efficiently uses all published information (prices reflect all publicly available information)
Strong form- prices reflect all available information include insider information (price also reflect information in the external enviornment and internal environment- insider trading)
How should prices move in an efficient market?
Take a random work
What are price bubbles?
Prices exceed fair value and are followed by a share correction
What are bear and bull markets?
Bull= long periods of generally rising prices Bear= Refers to periods where prices are generally falling
