Role and Structure of Securities Markets

Question 1

What is an investment?

Answer 1

Current commitment of money or other resources to obtain future benefits Stocks; House; Education.

Question 2

what are real assets

Answer 2

Real Assets determine the productive capacity and net income of the economy (Land, buildings, machines, knowledge used to produce goods and services)

Question 3

what are financial assets

Answer 3

Financial Assets are claims on real assets (equity, bonds, derivatives)

Question 4

What is a portfolio?

Answer 4

A portfolio is a collection of assets

Question 5

What is money?

Answer 5

Money—anything that is generally accepted in payment for goods or services or in the repayment of debts

Question 6

what are the features of money

Answer 6

Medium of Exchange: standardized; widely accepted; divisible; easy to carry; durable Unit of Account: used to measure value Store of Value: used to save purchasing power and it is liquid

Question 7

what is the purpose of financial markets

Answer 7

Financial markets bring together those people who have excess funds and those others who have a shortage of funds

Question 8

government responsibility

Answer 8

Direct responsibilities • Fiscal policy/taxation. • National debt management. Devolved responsibilities • Monetary policy. • Cash/liquidity management. • Regulation (?)

Question 9

The Role of Financial Markets

Answer 9

Reduction in transaction costs • Information Role: Capital flows to companies with best prospects • Consumption Timing: Use securities to store wealth and transfer consumption to the future

Question 10

• Sarbanes-Oxley Act

Answer 10

Tighten the rules of corporate governance

Question 11

Financial intermediaries

Answer 11

Brings those with countervailing needs together; the lenders and the borrowers. They pool and invest funds (Investment Companies; Banks; Insurance companies; Credit unions)

Question 12

Money market

Answer 12

Short-term, low-risk, highly liquid debt securities, e.g. T-bills

Question 13

Capital markets

Answer 13

• Long-term, debt markets e.g. government bonds, commercial paper. • Equity markets, e.g. shares. • Derivative markets for futures and options

Question 14

Primary vs secondary markets

Answer 14

Primary markets are used for the issue of new stocks, bonds or other securities to the public (IPO).
• Secondary markets are where these securities are subsequently traded markets, e.g. LSE, NYSE, NASDAQ

Question 15

Characteristics of secondary markets

Answer 15

• Broad - wide variety of different types of investors. • Deep - small adjustment of prices from previous trade. • Liquid - ease and speed with which a position can be taken, or unwound. • Efficiency.

Question 16

who are Internal participants

Answer 16

Brokers: Agents, take orders from investors, submit them to the market trading mechanisms and charge commissions. Dealers: Principal traders, post bid-ask quotes by choice. Market-makers: Principal traders, obliged to trade in the securities in which they are registered.
Broker-dealers: Can act both as agents and principals (dual-capacity trading).

Question 17

what are 3 types of Financial Assets

Answer 17

Three types: 1. Fixed income or debt 2. Common stock or equity 3. Derivative securities

Question 18

features of fixed income

Answer 18

• Payments fixed or determined by a formula
• Money market debt: short-term, highly marketable, usually low credit risk
• Capital market debt: long-term bonds, can be safe or risky

Question 19

what are Derivatives

Answer 19

• Value derives from prices of other securities, such as stocks and bonds • Used to transfer risk

Question 20

what is Touch

Answer 20

the difference between bid and ask spread

Question 21

Determinants of the bid-ask spread

Answer 21

Information asymmetry; Volatility of the asset; Liquidity of the asset; Competition; Exchange restrictions

Question 22

Order types in continuous markets

Answer 22

• Alternative limit orders Stop, or stop-loss, order on sell side. Stop-buy order. Trailing stop order - broker generated. • Order options Expiry date or time: day orders, GTC (good-tillcancelled) orders. Single fill order.

Question 23

Trading platforms on the LSE

Answer 23

London Stock Exchange 1) SETS - order-driven market with back-up liquidity provided by market-makers. 2) SETSqx - quote-driven market with 4 electronic auctions per day. 3) SEAQ - quote-driven platform. Which stock, which platform? SETS is the most liquid, then SETSqx, and SEAQ the least liquid.

Question 24

Post-trade anonymity vs. transparency

Answer 24

• Post-trade anonymity Important because otherwise trading strategies can be revealed by small trades.
• Transparency Important because the credit risk is borne by the trading parties; i.e. they need to know with whom they are trading.
• Central counterparty They act as a counterparty to every trade for clearing members of the LSE.

Question 25

Operational Costs

Answer 25

-Brokerage fees Approximately 1.5% but varies according to type of account and frequency of trade. Usually a min. charge will apply. -Dealer’s spread From 0.5% for the most liquid stocks to 15% for the least. Varies throughout the day. -Stamp Duty and other taxes 0.5% of value for purchases, zero for sales. -Settlement costs Approximately 30p per trade -Other costs (Custodian charges, exchange trading levies etc.)