Overview of Financial Markets, and making investment decisions

Question 1

Explain efficient market hypothesis

Answer 1

Concept that markets reflect available information so market price is a fair reflection of information available at the time

Question 2

Explain what the capital asset pricing model is

Answer 2

Concept giving method to maximise returns fo any given level of risk that an investor is willing to accept (where the risk is systematic)

Question 3

Explain systematic vs non systematic risk

Answer 3

Systematic risk is a marketwide risk that is non-diversiafiable, Non systematic risk can be eliminated by diversification

Question 4

What is the Formula for CAPM

Answer 4

Expected returns = Rate on risk free investment + (expected market return - rate of risk free investment) x Beta of investment

Question 5

What is the market risk premium

Answer 5

Expected market risk - Retrun on risk free investments

Question 6

Explain another view on markets being competition and how does one take this approach

Answer 6

Another view is markets are highly competitive. You can make a lot of money if you have a competitive edge over other participants, Taking the competitive approach requires:
Fit health and peak psychological health of investors
Fine-tuned range of technical skills
Sensible understanding of success rate

Question 7

When/ What type of investor should relay on market theories in finance

Answer 7

If participants don’t believe they have a competitive edge they may like the theoretical framework of making investment decisions outlined in EMH or CAPM. They do not need to engage in competitiveness but often means they will not make a lot of money. (Full strength EMH means there is no money to be made). Also relying on these theories means requiring others to take a competitive approach.

Question 8

What are the two types of elements to investment decisions

Answer 8

Objective and subjective elements or quantitative and qualitative.

Question 9

How does one improve their investment decision making skills

Answer 9

Quantitative aspects can be learned and practised. Qualitative aspects are an art and require astute judgement necessary to be a good investor.

Question 10

Explain narrative and analysis

Answer 10

Narrativen means the big picture or mental frameworks within which analyses are carried out. Narratives dominnate and limit any analyses we carry out. Understanding these terms also means understanding a narratives limits

Question 11

What are important qualities of your narrative

Answer 11

Has to be deep and bright enough to show the full story without taking sides, it must not be a shallow narrative as this can result in persuasive and misleading rhetoric prevailing over reason and logic

Question 12

Why do disagreements generally arise betwene narratives

Answer 12

Finding common ground between peoples narratives that are on one extreme or the others - must not take a side with a narrative.

Question 13

What is consequences of shallow narratives

Answer 13

Shallow narratives often lead to another shallow narrative being able to contradict it.Can also result in persuasive and misleading rhetoric prevailing over reason and logic

Question 14

How do individuals or households interact with the investment markets

Answer 14

Through an intermediary primarily unless they have DMA

Question 15

How do groups of individuals interact with the investment markets?

Answer 15

Contributing to a pension fund or group saving scheme

Question 16

How do companies contribute to the invetsment market??

Answer 16

Interact with market through corporate finance side of business, during mergers or when investing any surpluses

Question 17

How to financial organisations interact with investment markets?

Answer 17

Banks investment amnagers insurers and hedge funds: can create new instruments depending on cash flows and risks of other instruments

Question 18

Give examples of non financial organisations or government bodies that interact with investment markets?

Answer 18

Endowment funds, sovereign wealth funds, charities, regulatory bodies, state organisations

Question 19

Name some financial intermediaries

Answer 19

Broker, market-maker, dealer, trader

Question 20

Define a broker

Answer 20

Agents hired to fina the other side of a desired deal and earn money from their commissions

Question 21

Define a market/maker

Answer 21

Willing to quote two way bid offer prices and buy and sell at the respective price. They make money from the bid offer spreads. Market maker is responsible for the positions created, even if they are limited in the size of their positions

Question 22

Define a dealer

Answer 22

Willing to quote two way bid offer prices and buy and sell at the respective price. They make money from the bid offer spreads. Dealer executes a clients order but has little or no responsibility for the subsequent position.

Question 23

Define a position

Answer 23

Amount of a security/ asset that si ownder or sold sort by an entity

Question 24

Define an exchange

Answer 24

Provide the places where trades can be arranged and executed. They regulate trade in who and what si traded, brokers, dealers, makret makers and traders as well as online platforms link to exchanges.

Question 25

Define and give examples of types of online trading paltforms

Answer 25

Alternative trading systems (ATS) or electronic communciation networks (ECN) or multilateral Trading facilities(MTF) are all trading paltforms that fuction like exchanges but do not exercise regulatory authority over their users, except for conduct of trading on the system.

Question 26

Define dark pools

Answer 26

Online platforms that don’t show all client orders on the system are dark pools

Question 27

Name some professional investment decision makers

Answer 27

Investment analysts/ traders
Investment strategists
Investment management companies and other financial institutions
Consultants advisors- typically employed by financial instituions

Question 28

What is the role of investment analysts/ traders?

Answer 28

Make judgements on investments, analysts just research and role is limited to advocating for a certain investment

Question 29

What is the role of investment strategist?

Answer 29

Create the narrative within which investments will be made

Question 30

What is the role of investment managers?

Answer 30

Could be a corporate entity or a manager that manages the fund of their clients

Question 31

What is the role of clearing houses and custodians?

Answer 31

Provide services to ensure deals are settled, maintain accurate share registers and verify holdings are only used once for collateral

Question 32

What is important to consider when examining the role of all investmnet market participants

Answer 32

All participants have their own interest their own agenda as well as differnet constraints, attitudes to risk , different expertise and different behaviours. Critically analysing other patricipants behaviours could lead to an advantage.

Question 33

Describe back office roles in the investment industry

Answer 33

Task driven roles, dealing with regulatory issues, compliance and trade settlement

Question 34

Describe middle office roles in the investment industry

Answer 34

Involved in risk management and more judgement or strategy roles

Question 35

Describe front office roles in the investment industry

Answer 35

Direct involvement with making decisions on behalf of the organisation or its clients, dealing and trading etc

Question 36

Describe front office roles in the investment industry

Answer 36

Direct involvement with making decisions on behalf of the organisation or its clients, dealing and trading etc