WEEK 1: Capital Market Participants Flashcards

1
Q

What are the three main services that the capital markets and financial system provides?

A

(a) Transactions (payments, foreign exchange
securities trading and settlement), this is the operational side of capital markets
(b) Allocation of savings to their best possible uses in
investment and other spending;
(c) The pricing, allocation and management of risk.

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2
Q

What is the main distinguishing factor for how people become lenders and savers?

A

life cycle

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3
Q

What is the difference between indirect finance and direct finance?

A

Indirect Finance: through a financial intermediary such as a bank or insurance company
EXAMPLE: A bank that accepts savings deposits and lends to small companies

Direct Finance: No intermediary is involved
EXAMPLE: “dragon’s den” where angel investors interview small businesses and invest in them directly (buying a share of their equity)

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4
Q

What has been a big change in the financial industry since 1980?

A

-Growth of financial intermediaries
(banks, insurance companies and other institutions)

-which now issue a large proportion of corporate bonds and also borrows a lot in short term debt markets (so called money markets)

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5
Q

How has investing become global with the influence of Governments and other instruments?

A

o Net investment: Many “emerging market countries”, including China and major oil and gas exporters (Russia and Saudi Arabia) have high CA surpluses.

They Invest these overseas, so their governments and citizens purchase financial assets (government bonds and money market instruments, also property, corporate bonds and equities)

o Large gross investments:
Investors and banks from developed countries hold many financial assets and derivative assets in other developed countries. Large in gross terms, but they are also mostly offsetting,
e.g.
(North America, the European Union,Australia and New Zealand)

o Direct investment. Investment not involving financial markets,
i.e.
both companies owning subsidiaries and facilities in other countries, and (typically wealthy) individuals investing in property.

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6
Q

Who makes up the buy side of the market?

A

Long term institutional investors, such as pension funds; insurance companies, and sovereign wealth funds who buy and hold securities (bonds and equities).

-Also on the buy side of the market are asset managers”, who provide portfolio management services to long term investors.

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7
Q

Who makes up the sell side of the market?

A

The investment banks who sell newly
issued securities to long term investors (underwriting for bonds)

-Case of equities these issues are
usually called an initial primary offering or IPO

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8
Q

How are government bonds issued?

A

-(e.g. German, US, UK governments are issued
through auction and investment banks (‘bond dealers’) bid in these auctions. Afterwards they sell the bonds to buy side investors.

  • Euro area government bonds are often issued through allocations to leading investment banks.
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9
Q

How are corporate/international bonds issued?

A

Emerging market governments are normally underwritten by an investment bank or a “syndicate” of investment banks.

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10
Q

What is the tension between the Sell side and the Buy side?

A

-The sell side
want to get as high a price for securities as possible.
-The buy side
investors want to pay as little as possible.

Is the prospective return high enough/ the
price low enough to compensate for the risks of the security?

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11
Q

What is the primary market for issuing securities (IPOs, bond underwriting)?

A

IPOs, Bond Underwriting also called the new issue market (NIM)

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12
Q

What is the secondary markets for trading securities?

A

Aftermarket and follow on public offering is the financial market

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13
Q

What is the tertiary market for trading risk?

A

Derivatives

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14
Q

What is the distinction between the primary and secondary market?

A
  • The underwriters/ book-builders represent companies or government issue equity or bonds (BUY SIDE)
    e. g. Goldman Sachs, Morgan Stanley
  • The asset managers represent the final investors (SELL SIDE)
    e.g. UBS wealth management, Blackrock, Vanguard,
    Fidelity,
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15
Q

Why is the distinction between secondary and tertiary markets not so clear?

A
  • Buyers and sellers are the same, either buying (taking long position) or selling (taking short position) as they adjust portfolios and hedge risk
  • There are ‘brokers’ who act as their agents, looking for ‘best execution’
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16
Q

What is research bundling?

A

Sell side brokers were allowed to bundle research analysis together with their trading fees

Dealers (market makers in “over the
counter” of OTC markets) similarly bundled research together with their bid-ask spreads (equity market)

17
Q

What is MIFID II and what did it do for research bundling?

A

“Markets and Financial Instruments Directive II”

Came into force Jan 2018

  • Outlawed the bundling of research
  • funds must pay separately for research. They can do so in two ways, directly out of their own revenues or they can pass the costs onto clients
18
Q

What are the two ways funds pay for research?

A
  • Directly out of their own revenues
  • They can pass the costs onto clients

Most have chosen to pay directly out of their own revenues

19
Q

What are the consequences of the MIFID II?

A

Is it good to “bundle” services or goods and
services?

  • If have to pay separately can guarantee research quality improve
20
Q

POTENTIAL READINGS

A
  1. Introductory. From the economist (we have university subscription
    via the library, so you should have access)
    https://www.economist.com/finance-andeconomics/2018/01/09/investment-banks-cull-of-company-analystsbrings-dangers
  2. More complicated from Oliver Wyman
    https: //www.oliverwyman.com/content/dam/oliverwyman/v2/publications/2017/sep/Oliver_Wyman_Unbundling_Research_POV.PDF
  3. A theory paper (if you are thinking of a PhD) we have university
    subscription via the library, so you should be able to download.
    https://www.sciencedirect.com/science/article/pii/S1544612318300965