EQUITY MODULE 39

Question 1

39.1 What are the functions of the financial system?

Answer 1

Question 2

39.1 What are the 7 types of assets in the financial system?

(+what are the common classifications within this?)

Answer 2

Question 3

39.1 What types of markets can we get to trade assets? (5 points)

Answer 3

primary - when the market is used to raise capital

call markets - first ten minutes which attempts to settle initial auctions

continuous - a market where there is always a price

money markets - trading in short term debt instruments (maturity of up to a year)

capital markets - everything else

traditional - shares, bonds

Question 4

39.1 Describe the financial intermediaries:
- brokers
- dealers
- exchanges

Answer 4

note - can trad eon things not actually called exchanges - as this needs much regulation

ATS - alternative trading systems
ECN - electronic communication networks
MTFs - multilateral trading facilities

Question 5

39.1 Describe the financial intermediaries:
- securitizers
- depositary institutions
- insurance companies
- clearing houses

Answer 5

securitizers - allows the banks to make more loans (mortgage backed securities)

clearing houses - sit behind exchanges, make sure that the exchanges work properly

Question 6

39.1 What are the two types of positions we can take in an investment?

Answer 6

unlimited losses for short positions if the stock price rises

Question 7

39.1 Describe the idea of ‘buying on margin’, or, a leveraged positions:

Answer 7

Question 8

39.1 What is the call money rate?

Answer 8

effectively the interest rate
- the interest rate that you have to pay on the money you borrowed from the broker

Question 9

39.1 What is the margin loan?

Answer 9

margin is the term used here from what you borrow.

borrowed funds from your broker.

Question 10

39.1 What is the initial margin requirement?

Answer 10

this is the investor’s own part of the investment that goes into the trade

watch out about the word ‘equity’ - used interchangeably. equity is of the investor’s own equity, but also of the equity being bought with the leverage.

Question 11

39.1 What is the maintenance margin?

Answer 11

minimum investor’s equity

Question 12

39.1 What is the margin call?

Answer 12

When the broker demands the investor put more money into the position otherwise they will close it

Question 13

39.1 What is the leverage ratio?

Answer 13

ratio of value of position to value of equity that supports it

Question 14

39.1 How does the leverage ratio link too the return on equity of a leveraged trade?

Answer 14

2.5 leverage ratio. share price rises 20%, but the investors ROE is 2.5x the 20% - therefore 50% ROE.

SAME VICE VERSA - also magnifies losses

Question 15

39.1 If the maintenance margin is 25%, what does this mean?

Answer 15

That if the broker has a 75% stake in the investment, they want to end the position unless the investor puts more capital in

Question 16

39.1 What is the equation we can use to work out at which share price there would be a margin call?

Answer 16

Question 17

39.1 Example:

Answer 17

8$

at this point this is where the maintenance margin will be requested

Question 18

39.1 What are the two types of trades?

Answer 18

difference - whether there is a price specified

Question 19

39.1 Describe the execution instructions for trades:
- size conditions
- validity instructions

Answer 19

all or nothing - want to whole order size requested or nothing

hidden orders - placing a big trade and only want some slices of it are shown to the market at a trade (these are sometimes called iceberg orders)
- this can prevent the market moving against you

GTC - be careful with this and the good on close. GOC means you want that trade to execute at the end of the day

IOC - more immediate than all or nothing

stop orders - makes sure there is some sort of certainty on price

Question 20

39.1 Example of order books and execution instructions - how does it work?

Answer 20

Question 21

39.1 Describe the primary vs secondary market.

What do secondary markets provide?

Answer 21

Question 22

39.1 Describe the following aspects of public offerings:
- underwritten offer
- best efforts
- private placement
- held registration
- dividend reinvestment plan
- rights offering

Answer 22

underwritten offer - the IB buys up any shares that the market doesn’t want to have

best efforts - the IB acts as a broker - they will put there best efforts towards selling the ashes but won’t buy any that aren’t sold

shelf registration - go through the shares issuing gradually - you have approval then can continue with issuing without further approval

rights offering - legally in UK they have to offer existing shareholders are given first refusal of any new shares

Question 23

39.1 Describe: trading sessions - call markets vs continuous markets

Answer 23

Question 24

39.1 Describe the following market structures:
- quote-driven
- order-driven
- brokered markets

Answer 24

Question 25

39.1 What are characteristics of a well-functioning financial system?

Answer 25

Question 26

39.1 What are the objectives of market regulation?

Answer 26

Question 27

39.1 An investor who buys a government bond from a dealer's inventory is said to obtain a:

Answer 27

financial asset in a secondary market transaction. Buying a bond from a dealer is a secondary market transaction. A primary market transaction is an issuance of securities by an entity that is raising funds.

Question 28

39.1 A financial intermediary buys a stock and then resells it a few days later at a higher price. Which intermediary would this most likely describe?

Answer 28

DEALER This situation best describes a dealer. A dealer buys an asset for its inventory in the hopes of reselling it later at a higher price. Brokers stand between buyers and sellers of the same security at the same location and time. Arbitrageurs trade in the same security simultaneously in different markets.

Question 29

39.1 What would we call this trade: buying a short position in the underlying asset?

Answer 29

Buying a put is most similar to a short position in the underlying asset because the put increases in value if the underlying asset value decreases.

Question 30

39.1 An order placed to protect a short position is called a:

Answer 30

stop loss buy A short position profits from declines in stock price and experiences losses as the price rises. A stop loss buy is a limit order that is placed above the market price. When the stock price reaches the stop price, the limit order is executed curtailing further loses.

Question 31

39.1 what does 'behind the market', 'inside the market', and 'aggressively priced mean?

Answer 31

"Behind the market" refers to a buy order with a limit price less than the best bid, or a sell order with a limit price higher than the best ask. A limit order that is behind the market (i.e., an order to buy for less than the market price or sell for more than the market price) will not be filled unless the market price moves to the order's limit price. "Inside the market" refers to orders with limit prices between the best bid and best ask. "Aggressively priced" refers to a buy order with limit prices higher than the best ask or a sell order with a limit price lower than the best bid. Aggressively priced limit orders are most likely to be filled immediately.

Question 32

39.1 Financial intermediaries that issue securities which represent interests in a pool of similar financial assets are best characterized as:

Answer 32

Securitizers Securitizers are financial intermediaries that assemble large pools of similar financial assets, such as mortgages or loans, and issue securities that represent interests in the pool. ASIDE: Block brokers assist their clients with large trades of securities. Arbitrageurs simultaneously buy and sell the same asset in different markets to take advantage of different prices for the same asset.

Question 33

39.1 An investor sold a stock short and is worried about rising prices. To protect himself from rising prices he would place a:

Answer 33

stop order to buy. Because: A limit order to buy is placed below the current market price. A limit order to sell is placed above the current market price. A stop (loss) order to buy is placed above the current market price. A stop (loss) order to sell is placed below the current market price. A stop order becomes a market order if the price is hit.

Question 34

39.1 An electronic crossing network is best described as:

Answer 34

an order-driven market. A crossing network is an example of an order-driven market. Orders are batched together and crossed (matched) at specific times during the trading day at prices based on those of another exchange. Price-driven markets and quote-driven markets are other terms for dealer or over-the-counter markets.

Question 35

39.1 A trading system that matches buyers and sellers based on price and time precedence is most likely a(n):

Answer 35

order driven market In an order-driven market, buy orders and sell orders are matched up by the exchange according to order matching rules. In a quote-driven market, customers trade with dealers at bid and ask prices set by the dealers. In a brokered market, brokers organize trades among their clients.

Question 36

The buyer of an option (either a call or put) is said to be ____ the option and the writer of an option is said to be ____ the option.

Answer 36

LONG, SHORT The buyer of an option (either a call or put) is said to be long the option and the writer of an option is said to be short the option. Note that with put options, the long (put option holder) benefits when the price of the underlying asset decreases, while the short (put option writer) benefits when the price of the underlying asset increases. We say that a put buyer is long the option but has short exposure to the underlying asset price.