Section 2 - the role of securities markets in providing liquidity and price transparency Flashcards
Who are the main lenders in an economy
Households - as generally households have a surplus of income after spending.
Who are the main borrowers in an economy
typically companies and governments
How does most lending occur?
Direct lending between lenders and borrowers is uncommon. Mostly, households invest/ lend their savings indirectly in a range of assets through intermediaries.
What is a real asset?
Physical asset such as land, buildings and gold
What is a financial asset/ financial security?
A claim representing the right to some return (such as a bank deposit or bond) or ownership to physical assets. .
What are the two types of financial asset?
Debt claims and equity securities
what is a debt claim?
Debt claims are loans made by lenders to borrowers. Lenders expect borrowers to repay the loan and to make interest payments until it is repaid.
Give a simple e.g. of a debt claim
A bank deposit - may pay a fixed or variable rate of interest over a term.
What is not able to happen with a bank deposit
it is non-tradable
give an example of a tradable debt claim
A bond
What is a tradable debt claim also referred to as
A security
What are bonds also referred to as and why
Fixed-income securities - as they are issued by governments and companies and generally pay a fixed rate of interest.
What are equity securities also known as?
Shares
Are shares tradable?
Yes
How do shares work?
- Shareholders have an ownership stake in the company they have invested in
- Company has no obligation either to repay the money invested by the shareholders or to pay dividends
- Investors expect to make a return by selling their shares at a higher pice than they bought them and possibly, through receiving dividends.
How do savers generally invest in shares and bonds
through intermediaries such as insurance companies, pension funds and pooled investment vehicles. Savers therefore invest in the products created by intermediaries.
what is the benefit for savers of investing in intermediaries?
A reduction of risk due to:
- Greater diversification
- Reduced transaction costs as the intermediary can trade at lower cost than the individual saver
- Access to specialist expertise in the financial assets being invested in
- The ability to invest in assets that would not be available to an individual investor such as commercial property.
Outline how a unit trust works
It is ‘open ended’; when investors want to invest, the fund issues new units in exchange for cash paid by the investor. When existing investors want to withdraw the funds redeems (repurchases) their units and pays out cash.
The fund can therefore grow or shrink according to demand for its units. The fund manager invests the cash and if well managed the value of the units will increase.
What do investment intermediaries use to manage risk
Derivative contracts
What is a derivative contract
a financial contract ‘derived’ from an underlying asset in such a way that the price movements of the derivative and the underlying asset will be highly correlated over time.
How/ what can derivative contracts be used?
- to speculate i.e. make gains from anticipated movements in the price of an index or asset
- if the underlying asset is difficult to buy or has high costs associated with investing in it e.g. buying oil directly is expensive but purchasing a derivative contract is less costly.
When might a foreign exchange market transaction occur?
When e.g. a fund manager in one country wants to purchase securities in a different country using a different currency.
What are foreign exchange markets also referred to as
currency markets
Outline how foreign exchange markets work
For large value transactions - Through a dealer. The dealer will quite bid-and-offer prices representing the prices they buy and sell dollars in relation to pounds.
For smaller value transactions - the purchase will take place with a broker who will arrange for the currency to be purchased.
Where are securities traded - what two general distinctions are made?
Securities are traded in securities markets that bring buyers and sellers of financial securities together.
A distinction is generally made between…
money markets (for securities that have maturity shorter than a year)
Capital markets (maturity longer than a year)
What important functions do securities markets perform?
- Raising Capital (in the capital markets)
- Transferring risk (in the derivatives markets)
- Price discovery
- Creating liquidity
Talk about raising capital in a securities market - what by proxy does this influence also?
A firm can raise capital by issuing equities (ordinary shares) or bonds (corporate bonds). Funds raised can then be re-invested to help the firm grow.
Another essential part of this process facilitated by markets is the mobilisation of savings. The liquidity provided by markets encourages savers to purchase the claims issued by borrowers. This leads to a greater flow of savings into productive investment.
Outline how risk can be transferred in the utilising derivatives?
Derivatives can be used to hedge the risk that the value of an equity may fall by using equity index futures contracts.
Protection has been obtained against the risk but it has not disappeared. Instead the risk has been transferred to the counter-party of the derivatives contract.
The counter-party would be a trader who expected the equity index to rise in the future and would buy futures contracts to take advantage of that expectation
