Products, Markets and Players Flashcards
Discuss about Financial Market
• Market information – past prices – trading volumes – current “bid” and “ask” prices – volume of short sales outstanding • Market information should be – accurate – transparent to ALL investors • Markets should be “liquid” (note financial crises....firesales) – can trade large numbers of shares at prices that don’t vary substantially from past prices until new information enters the market
What are the types of instruments on Market?
Types of instruments (assets)
• treasury bills - short term, low return (money market)
• government bonds - long term, govt guaranteed, low return (fixed income)
• Corporate Bonds - long term, large firms, low return (fixed income)
• Common stock - high return - two types, high risk (equity)
• Derivative securities – similar features to underlying assets
Money Market Securities – Treasury Bills – Repurchase Agreements (Repos) – Other Short-Term Instruments eg CDS – The London Interbank Offered Rate (LIBOR)
• Capital Market Securities – Fixed Income Securities • Treasury Notes and Bonds • Municipal Bonds • Corporate Bonds – Not-So-Fixed Income Securities • Preferred Stock • Mortgage-Backed Securities – Common Stock (Equity) • Derivative Instruments • Indirect Investing eg mutual funds, hedge funds etc
Assets - payoffs • Returns should be seen in context of inflation • note risk and return trade-off • assets combined together in portfolio • receive average return of assets • receive < average risk of assets • -> diversification possible
Types of traders
- Speculators: Enter markets and take risky positions for the purpose of gaining a short-term profit
- Hedgers: Unlike speculators and investors who bear risk, hedgers are traders who are in the market with a view to reducing or eliminating risk
- Arbitrageurs: People who engage in arbitrage trades. Arbitrage is the act of simultaneously buying and selling equivalent assets for the purpose of making certain, guaranteed profits. An arbitrage trade is a riskless trade
Trading mechanics
• Quote-driven system
– market makers provide liquidity by quoting firm “bid” and “ask” prices throughout the day e.g. London Stock Exchange, NASDAQ
• Order-driven system
– orders grouped together
– price determined by supply and demand
– two main types of order
• market order implies client wishes to trade regardless of the auction price
• limit order imposes maximum (minumum) price at which client will buy (sell) e.g. Tokyo, Paris
• Hybrid system
– specialists act as market makers and auctioneers
– order “book” is transparent only to specialists e.g. NYSE
Costs of trading
• Commission: fee paid to broker for making the transaction
• Spread: cost of trading with dealer
– Bid: price dealer will buy from you
– Ask: price dealer will sell to you
– Spread: ask - bid
• Combination: on some trades both are paid
Margin trading
• Investor uses credit to buy security - borrows from broker, deals on a/c, encourages greater market participation
• Features of margin buying
– initial margin deposit
– maintenance margin - minimum threshold that equity can reach before investor must add additional funds used to ensure against default
• Margin arrangements differ for stocks and futures
Short selling
• Investors can sell securities they don’t own
• Investor borrows the security from a broker who is holding it (on behalf of another investor) “in street name” and sells it
• Original owner will not know that the security has been sold
• Company which issued the security will pay any dividends to the purchaser, not to the original owner
– original owner must be compensated by the investor who sold the security short
• At some point in the future, short seller will repurchase the shares (in the open market) in order to restore them to the original owner
• Why sell a security short?
– short seller expects the value of the security to decline and wishes to profit from the decline
– reduces the sensitivity of the return on the investor’s portfolio of securities to market movements (“systematic risk”)
Investment strategies
• Passive Management
– “buy and hold” a well-diversified portfolio of assets
• Active Management
– Security selection attempts to identify securities that have been mispriced
• “buy low / sell high”
– Market timing tilts the portfolio composition in favour of (away from) equities when the investor is “bullish” (“bearish”) about the Stock Market
• Portfolio Insurance
– use derivatives to “manage risk”
Trading Characteristics – Share Issues
• Primary
– New issue
– Key factor: issuer receives the proceeds from the sale
• Secondary
– Existing owner sells to another party
– Issuing firm doesn’t receive proceeds and is not directly involved
Investment Banking Arrangements
• Underwritten vs. “Best Efforts”
– Underwritten: firm commitment on proceeds to the issuing firm
– Best Efforts: no firm commitment
• Negotiated vs. Competitive Bid
– Negotiated: issuing firm negotiates terms with investment banker
– Competitive bid: issuer structures the offering and secures bids
Public Offerings • Public offerings: registered with the SEC and sale is made to the investing public • Initial Public Offerings (IPOs) – Evidence of underpricing – Performance
Private Placements • Private placement: sale to a limited number of sophisticated investors not requiring the protection of registration • Dominated by institutions • Very active market for debt securities • Not active for stock offerings
Examples of major markets
• Organised exchanges -
– operates like an auction with centralised excecution
– people bid for shares at certain prices
– securities traded on exchange are listed
– different types of members - eg. NYSE -
commission brokers, floor brokers, floor traders, specialists
• Over the Counter Markets (OTC) - market dealing without centralised execution
– eg. NASDAQ - uses automated quotation system
– user friendly dealer system - eg caters for small orders
• EG of minor markets - Irish Stock Exchange: • very small - thin trading • very few companies raising capital • primary and secondary markets exist • market generally volatile • future uncertain
