LM 1: Market Organization & Structure Flashcards
What does the financial system help transfer?
transfer assets, real assets, & financial risks between entities, locations, & time.
What are the 6 purposes people use the financial system? SBRMEI
- saving
- borrowing
- raising equity capital
- managing risks
- exchanging assets
- information-motivated trading
What are the 3 main functions of the financial system? ADC
- Achieve financial purposes for people that use the system
- determine rates of return that allows equilibrium between savers and borrowers
- capital allocation efficiency (allocate capital to best uses.)
What is spot market trades?
trades for immediate delivery
What is information motivated trading?
managers who believe they have knowledge that will allow them to buy low and sell high
What is discover rates of return that equate aggregate savings with aggregated borrowings?
determining expected rate of return between those who demand funds from borrowers and equity issues, and those who supply funds through savings
What is capital allocation efficiency?
economy must use its limited supply of money to allocate money to the most productive uses
What market do governments and companies use to raise funds?
primary capital markets
What are 5 classifications of assets? SCCCR
- securities
- currencies
- contracts
- commodities
- real assets
What is the difference between spot & forward markets?
spot markets transactions are settled immediately, forward market transactions are settled over longer periods
What is the difference between primary markets & secondary markets?
primary markets investors purchase securities directly from issuers, secondary markets investors trade securities with other investors
What is the difference between capital and money markets?
money market are debt securities with durations less than 1 year, capital market securities have longer maturities.
What are the 3 broad categories of securities? FEP
- fixed income
- equities
- pooled funds
What is the difference between public security and private security?
public traded on organized exchange, private sold directly by issuer to investors often only to qualified investors
What are the 3 types of equities? CPW
- common stock
- preferred shares
- warrants
What are pooled investments?
many peoples money put together to buy assets
What are 4 types of pooled investments? MEAH
- mutual funds
- exchange traded funds
- asset backed securities
- hedge funds
What are 4 types of contracts? FFSO
- forward contracts
- futures contracts
- swap contracts
- options contracts
What is counterparty risk?
risk that the other party will fail to deliver.
What is the difference between a forward contract and a futures contract?
forward contract is a private and customizable agreement that settles at the end of the agreement and is traded OTC.
futures contract has standardized terms and is traded on an exchange, where prices are settled on a daily basis until the end of the contract.
What is initial margin?
the initial deposit you must make per contract.
What is the maintenance margin?
the lowest amount of value a contract can fall too before you’re required to deposit more.
What must you do if the value of contracts falls below the maintenance margin?
you must deposit more money until the account value reaches the initial margin
What are swaps?
agreement to exchange rates one fixed rate for a floating rate from another party
What is an option contract?
a contract that gives the holder the right not the obligation to buy or sell an underlying asset at specified price in future
What is the difference between european and american style options?
european can only be exercised at maturity
american can be exercised anytime up to maturity date
What are commodities?
basic goods and materials widely used such as wheat, gold, oil, and cattle.
What is real asset?
tangible properties such as real estate, machinery, and infrastructure.
What are 7 key financial intermediaries? BDSDIAS
- Brokers, exchanges, and alternative trading systems
- dealers
- securitizers
- depository institutions & other financial corporations
- insurance companies
- arbitrageurs
- settlement & custodial services
What are financial intermediaries?
help connect buyers and sellers
What are brokers?
agents that connect buyers and sellers and executes transactions for their clients.
What are broker-dealers?
agents who fill orders for clients and trade with them.
What are block brokers?
broker that provides brokerage services for large trades
What are investment banks and what do they do?
banks that help clients by giving advice & arranging transactions (eg. IPO, Mergers & Acquisitions)
What are exchanges?
a place for traders to trade
What are alternative trading systems?
non-exchange trading venue that matches buyers and sellers
exchange-like trading venues that only regulate conduct within their own trading systems.
What are dark pools?
large transactions that don’t disclose the client
What 3 things do market makers (aka dealers) do?
- participates in the market at all times
- buy securities from sellers and sell securities to buyers
- providing liquidity
What are primary dealers?
dealers that buy and sell bills, notes, and bonds from central banks to enforce monetary policy and decrease & increase money supply.
What are securitizers?
firms that buy and repackage securities or other assets to create new financial products
What are depository institutions?
banks, credit unions, etc that raise funds from depositors to lend to borrowers
What are insurance company’s?
help people and companies offset risk. policy holders pay premiums for protection against losses.
What are arbitrageurs?
no capital requirement of the simultaneous purchase and sale of the same or similar asset in different markets in order to profit from tiny differences in the asset’s listed price.
What are settlement & custodial services?
Firms that provide settlement and custodial services such as executing trades, preventing theft.
What is a clearinghouse?
eliminate counterparty risk by requiring collateral, and guaranteeing contract performance for their members and only members.
What is a long position and what price direction does it benefit from?
long positions are owned & benefit from price appreciation
What is a short position and what price direction does it benefit from?
short positions are owed and benefit from price depcreciation
What is a leverage position?
buying securities by borrowing portion of the purchase price
What is margin loan?
amount borrowed
What is call money rate?
interest rate paid for borrowed amount
What is leverage ratio and the formula?
how much of the total value of position you must initially deposit
leverage ratio = value of position / value of equity (margin)
What is a margin call?
a request for additional money or equity if equity falls below minimum amount of equity required
What is a warrant?
like an option contract, warrant grants the holder the right to purchase the issuer’s shares at a pre-specified price.
What is an order and what 3 pieces of information does it provide? WWH
request by buyers and sellers to communicate with brokers and exchanges.
Specify:
1. what instrument to trade
2. whether to buy or sell
3. how much to trade
What are execution instructions, validity instructions, and clearing instructions?
- Execution instructions: How to fill the order (eg. market, limit)
- Validity instructions: When the order may be filled (immediate or cancel, good til cancelled, etc)
- Clearing instructions: How to settle the trade (which party responsible for clearing and settling trade)
What is bid price and ask price?
bid price = buy at
ask price = sell or offer price
What is the market bid ask spread?
difference between the best bid (buy price) and best offer (sell price).
What is the difference between make the market, take the market, and make a new market?
Those who offer a trade are said to make the market
those who accept those offers are said to take the market.
Those who place a trade between the best ask and the best buy are said to make a new market.
What are 5 executions instructions (how to fill order)? MLAHI
- market order
- limit order
- all or nothing (AON) orders
- hidden orders
- iceberg orders
What are all or nothing orders, hidden orders, and iceberg orders?
- All-or-nothing (AON) orders will only be executed if the entire quantity can be filled.
- Hidden orders can only be seen by brokers or exchanges, not by other traders.
- Iceberg orders only display a fraction of the amount the trader is really willing to transact.
What are 7 validity instructions (when an order may be filled)? DGIGSSS
- day orders
- good til cancelled (GTC)
- immediate or cancel orders
- good on close orders
- stop orders
- stop loss orders
- stop buy orders
What are day orders, good til cancelled, and immediate or cancel orders?
- Day orders expire at end of the business day if not filled.
- Immediate or cancel orders expire if they are not filled (at least partly) immediately upon being received.
- Good-till-cancelled (GTC) orders are valid until executed.
What is good on close orders and stop orders?
- Good-on-close orders are filled at close of trading.
- Stop orders cannot be filled until the stop price condition has been met. then it’ll execute the stop loss or buy
What is stop loss orders and stop buy orders?
- Stop-loss orders are often used to limit losses.
- Stop-buy orders can be used to limit losses on short positions or to ensure that an undervalued stock is not purchased until interest from other investors bids the price over a certain threshold.
What are clearing instructions?
tell brokers and exchanges how to arrange final settlement of trades
What are secondary offerings?
sale of shares owned by an investor to the general public on the secondary market after IPO.
What is book building?
when investment banks line up subscribers to buy the security in a process called book building
What is the difference between underwritten offering and best efforts offering in investment banking?
underwritten offering: commits to pay the offering price for any shares that go unsubscribed.
best efforts offering: investment bank does not agree to act as a buyer if the issue is undersubscribed; rather, it simply acts as a broker.
What is a private placement?
securities that are sold to small group of qualified investors
What is dividend reinvestment plan (DRIPS)
allow investors to purchase new shares with dividends
what is rights offerings?
grant existing shareholders the option to purchase additional shares at a below-market price.
What is shelf registration?
allows a company to register a security, but instead of selling it immediately, the company can offer its securities to the market over as much as three years.
What is the importance of the secondary markets to primary markets?
easier for companies to raise funds in the primary market if investors believe there will be an active secondary market
What are the 2 types of trading sessions?
- call markets
- continuous trading markets
What is a call market and continuous trading market?
- call markets: trades only take place when market is called at specified time & place
- continuous trading markets: trades can take place anytime the market is open.
What is quote driven markets and order driven markets?
- Quote-driven markets, customers trade with dealers (aka OTC markets)
- Order-driven markets are based on a matching system run by an exchange or broker to match traders.
What are brokered market?
brokers arrange trades between customers.
What is the 3 sequences to when orders get filled in an order driven markets? PDT
- Price: highest buy orders and lowest sell executed first.
- Display Status: orders with displayed quantities given priority over non displayed.
- Time of Arrival: Those placed earliest get priority.
What are the 3 rules to trade pricing rules under order driven markets? UDD
- uniform pricing rules
- discriminatory pricing rules
- derivative pricing rules
Describe uniform pricing rules, discriminatory pricing rules, derivative pricing rules.
- uniform pricing rules (all trades execute at same price)
- discriminatory pricing rules (they fill orders incrementally, starting with the most aggressively priced orders)
- derivative pricing rules (uses the price from another market or exchange to settle trades)
What are 2 types of market information systems describe them?
- pre-trade transparent (publishes information about quotes and orders in real time.)
- post trade transparent (execution prices and trade sizes are published soon after trades are completed.)
What 4 characteristics does a well-functioning financial system have? ICRC
- Investors can easily move money from the present to future
- Creditworthy borrowers can easily obtain funds
- Risk exposures can be easily hedged
- Currencies can be easily exchanged for other currencies or commodities
What is a complete market?
financial system that offers the assets or contracts necessary to meet 4 characteristics of a well-functioning financial system
What is operationally efficient and informationally efficient?
- operationally efficient if trading costs are low.
- informationally efficient if prices reflect all available information.
What are 6 things financial intermediaries can do to work toward a well functioning financial system? ECBLSI
- Establishing and organizing exchanges that match buyers and sellers
- Clearinghouses to ensure settlement of trades and contracts
- Maintaining a banking system that matches borrowers and lenders
- Providing liquidity on demand
- Securitizing assets to create attractive investment vehicles
- Offering insurance products that pool risk
What are 6 general objectives of regulators besides maintaining a fair and orderly market? PMPEDE
- Preventing fraud
- Managing agency problems
- Promoting fairness
- Establishing mutually beneficial standards
- Discouraging excessive risk
- Ensuring that long-term liabilities are funded
In a open end fund and a closed end fund who do investors sell their shares too?
Open end fund sells shares back to fund
Closed end funds sell shares to other investors in the secondary market
What kind of market does fixed income securities and currencies trade in, and what kind of markets do stocks typically trade in?
Fixed income securities and currencies trade in quote driven markets
Stocks typically trade in order driven markets
What is leveraged return formula?
leveraged ratio * return
What is the formula for the price that a margin call will occur?
Margin call = initial purchase price * [(1- initial margin)/ (1-maintenance margin)]
Who are the issuers of commercial paper and certificates of deposit?
Certificates of deposit are issued by commercial banks.
Commercial paper is issued by corporations.
What is margin?
margin is the collateral that an investor has to deposit with their broker or exchange
How to you get return on investment if there are dividends received, call money rate, leverage ratio?
net gain or loss (sale proceeds+ dividend’s- cost proceeds-interest paid) / initial equity.
