Market Organization and Structure Flashcards
Spot Market
- immediate delivery for exchanging assets
A financial asset is
- a claim on a real asset and future income generated by those assets
ie stocks, bonds
Forward market
- contracts that call for the future delivery of assets and include forwards, futures, and options
Money market
- securities with maturities of one year or less
Currencies trade in which markets
FX
spot
forward
or futures markets
Commodities trade in which markets
spot
forward
and futures markets
Forward contracts
- agreement to trade the underlying asset at a future date at a prespecified price
- between private parties
- used to hedge risk
- ex. lock in a set price for selling crops
Futures contracts
- a standardized forward contract
- higher liquidity
- trade on an exchange
- a clearing house guarantees the performance of all traders
Swap contract
- agreement to swap payments of one asset for the other
- interest rate swap: floating rt swap for fixed for a specified per
- currency swap: currencies swap at a fixed point
- equity swap: returns on one investment are swapped for other
Credit default swap
- insurance to bondholders
- they make payments to a bondholder if a borrower defaults on its bonds
Brokers
- search for sellers and buyers (counterparties)
- do not trade with clients directly
Dealers
- trade directly with their clients by taking the opposite side of their trades
- provide liquidity by buying or selling from their own inventory
- profit off the spread
Securitization definition
- the process of buying assets, placing them in a pool, and then selling assets that represent ownership of the pool
ie a mortgage-backed security - can be done with car loans, credit cards, etc
Benefits of securitization
- improves liquidity in the mortgage markets
- reduces cost of borrowing for homeowners
- diversification of portfolio
- losses from default and early prepayments are more predictable
Leverage ratio equation
= value of the position / value of the equity investment in it
= A / E
the denominator is what the investor puts in
Initial margin requirement def
- the minimum percentage of the purchase price that must be paid by the trader (trader’s equity)
Maintenance margin requirement def
- minimum amount of equity to be maintained in the positions
Margin call def
- occurs when equity falls below the maintenance margin requirement
Margin call formula
Margin call price =
P * ((1 - initial margin) / (1 - maintance margin))
Call money rate
- the interest paid on a margin loan
Total return of equity investment in levered position formula
Proceeds from sale - borrowed funds - margin interest \+ dividends received - sales commission = remaining equity
% change: remaining equity - initial investment / initial investment
Buy at the ____ price and sell at the ____ price
Buy at BID
Sell at ASK
Call markets v continuous markets
- call markets: trading takes place only at specific times of the day, bid-ask quotes are used to arrive at one negotiated price, highly liquid when in session, illiquid with not.
- continuous markets: trades occur at any time the market is open, quote-driven or auction-driven
4 characteristics of a well-functioning financial system
- “complete markets”
- liquid market with low cost of trading
- timely and accurate financial disclosures
- prices that reflect fundamental values (informationally efficient)
