L1 - Introduction and Overview to Capital Markets Flashcards Preview

19ECB004 - Introduction to Financial Economics > L1 - Introduction and Overview to Capital Markets > Flashcards

Flashcards in L1 - Introduction and Overview to Capital Markets Deck (33)
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1
Q

What is the basic overview of the financial system?

A
  • This is more the operational side of the capital markets
  • On the top you have Indirect Finance with Financial intermediaries
  • On the bottom you have Direct Finance with the FInancial Markets
  • On the left you have Lender-savers –> they put funds into both Financial intermediaries and Financial markets
  • On the right you have Borrower-spenders –> these take funds from Financial intermediaries
  • Financial Intermediaries also put money into the Financial markets
2
Q

What is Direct Finance?

A

Where there is a direct connection to the financial markets as indicated by the borrower issuing securities directly on the market.

3
Q

What is Indirect Finance?

A

Indirect finance is where borrowers borrow funds from the financial market through indirect means, such as through a financial intermediary

4
Q

Who are the Lender-savers in the Financial markets?

A
  • Households –> ( normal lifestyles - older) in a broad index fund for pensions
  • Business firms –> (older firms) Apple has alot invested overseas and has made quite abit of money off it
  • Government –> mainly the export economies e.g. government of Thailand, Saudi Arabian, Norway and other Asian countries
  • Foreigners
5
Q

What are the Borrower-spenders in the financial markets?

A
  • Business firms –> start-ups
  • Government –> UK government (debt is 80% of GDP currently)
  • Households –> ( lifecycle - younger) mortgage to buy a house
  • Foreigners
6
Q

What are the three main services provided by capital markets and financial systems?

A
  • transactions (payments, foreign exchange
    securities trading and settlement)
  • allocation of savings to their best possible uses in investment and other spending
  • the pricing, allocation and management of risk
7
Q

What are other names for Government and Corporate Bonds?

A

I prefer to say “government” and “corporate” bonds, some
commentators write “public bonds and private bonds”, but this is a
little confusing because of the distinction in finance between public
markets and private markets

8
Q

What was the big change in 1980 to do with finance?

A

A big change since 1980 is the growth of financial intermediaries (banks, insurance companies and other institutions) which now issue the largest proportion of corporate bonds (around of half of all in the world) and also borrows a lot in short term debt markets (so called money markets)

9
Q

Where are the bigger Financial markets?

A
  • Financial markets (equity and bond markets) are not the same size
    across the world, they are very much bigger in some countries with
    more “market based” financial systems, especially the US and the
    UK
10
Q

How can you find out how much a share it traded on average on an exchange?

A
  • by summing all the value of annual share traded and dividing by the Domestic Market cap (at the end of the year)
11
Q

What does EOB mean when talking about annual share trades?

A
  • Exchange on Board –> reference to the boards in the stock exchange where prices used to be put up
  • means the shares were traded on the exchange
12
Q

What does ND and RT mean when talking about annual share trades?

A

ND = Negotiated Deal
RT = Reported trade
- these are transactions that took place off the exchange
- they report back to the exchange to tell them about it, such as the price how how much was exchange
- Now-a-days especially with equity trading alot at alternative trading venues.

13
Q

How do you find out the volume of trades on an exchange?

A
  • Divide the Value of annual share trades divided by the average trade value
14
Q

What is a flash crash in a financial market?

A

A flash crash is an event in electronic securities markets wherein the withdrawal of stock orders rapidly amplifies price declines. The result appears to be a rapid sell-off of securities that can happen over a few minutes, resulting in dramatic declines.

15
Q

Which is bigger global bond markets or global equity markets?

A
  • bonds are just as big and important as the equity markets, in 2013 the bond market just slightly bigger
16
Q

Where are most bonds issued ?

A
  • in the domestic markets
17
Q

What are a few areas where the financal markets has become global?

A
  • Many “emerging market countries”, including
    China and major oil and gas exporters such as Russia and Saudi Arabia have substantial current account 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)
  • Large gross investments Investors and banks from developed countries (North America, the European Union, also Australia and New Zealand, hold many financial assets and derivative assets) in other developed countries. These holdings are large in gross terms, but they are also mostly offsetting,
  • Direct investment. There is also a lot of direct investment not
    involving financial markets, both companies owning subsidiaries
    and facilities in other countries, and (typically wealthy)
    individuals investing in property.
18
Q

What is the buy side?

A
  • people and institutions who purchase the securities
  • The buy side of the market are the 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 their agents the “asset managers”, who provide
    portfolio management services to long term investors.
19
Q

What is the sell side?

A
  • sell side is the people and institutions who sell the securities on behalf of issuers.
  • The sell side of the market are the investment banks who sell newly
    issued securities to long term investors. This activity is known as “underwriting” (for bonds).
  • In the case of equities these issues are
    usually called an initial primary offering or IPO (when equities are issues
    for the first time) and a secondary offerings or seasoned offering (when
    additional equities are offered to the market)
20
Q

What are the 3 markets in the financial system?

A
  • Primary market for issuing securities
  • Secondary market for trading securities
  • Tertiary (derivative) markets for risk
21
Q

Who operate in the primary market on the sell side?

A
  • Principals (security
    issuers) companies and
    governments
  • Agents
    (underwriters
    bookbuilders)
22
Q

Who operates in the second market on the sell side?

A
  • Intermediaries

- Dealers, market makers –>providing liquidity

23
Q

Who operates in the tertiary market on the sell side?

A
  • Intermediaries (operate in both second and tertiary markets)
  • Dealers, market makers –>providing liquidity

Intermediaries
- Interdealer brokers

24
Q

Who operate in the primary market on the buy side?

A

Principals –> (investors) pension funds, insurance
companies, corporates, households governments

  • Agent (asset managers)
25
Q

Who operate in the secondary market on the buy side?

A

Principals (operate in primary and secondary) –> (investors) pension funds, insurance
companies, corporates, households governments

  • Agent (operate in primary and secondary) (asset managers)
  • Agents (brokers, banks)
26
Q

Who operate in the tertiary market on the buy side?

A
  • Agents ( operate in the secondary and tertiary markets) (brokers, banks)
  • Agents (hedge funds)
27
Q

How are most bonds issued?

A
  • Some government bonds (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. - Corporate bonds or international bonds issued by emerging market governments are normally underwritten by an investment bank or a “syndicate” of investment banks.
28
Q

Why is there tension between the sell side nad the buy side?

A
  • There is a tension between the Sell side and the Buy side.
  • 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.
  • They must also be careful about what they are buying : is the prospective return high enough/ the price low enough to compensate for the risks of the security?
29
Q

Where is there a distinction between the buy and sell side?

A
  • The distinction between buy and sell side is clear in the primary market,
    the underwriters/ bookbuilders (investment banking divisions of capital market banks such as Goldman Sachs, Morgan Stanley) represent companies or government issue equity or bonds.
  • The asset managers (many, including UBS wealth management, Blackrock, Vanguard, Fidelity, operating funds for investors) represent the final investors.
30
Q

What about the distinction between the secondary and tertiary markets between the buy and sell side?

A
  • The distinction is not so clear in secondary and tertiary markets – 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’. On the other side are dealers/ market makers providing liquidity.
  • But liquidty may also be provided by other market participants.
31
Q

What is research bundling?

A
  • Before MIFID – and in the US even today –
    sell side brokers were allowed to bundle research analysis together with their trading fees –> used it as a marketing for their securities.
  • Asset managers – or rather the funds they operate – pay brokers execution fees for buying and selling securities or for purchasing derivative contracts.
  • Dealers (market makers in “over the counter” of OTC markets) similarly bundled research together with their
    bid-ask spreads, though this is primarily an equity market concern.
32
Q

What is MiFID?

A

The markets in financial instruments directive (MiFID) is a regulation that increases the transparency across the European Union’s financial markets and standardizes the regulatory disclosures required for particular markets.

33
Q

What is the unbundling of research?

A
  • This is a major policy issue because of a new European regulation, the
    “Markets and Financial Instruments Directive II” (or just MIFID II). MIFID
    came into force in January 2018. Amongst many provisions, MIFID has outlawed the bundling of research. We will briefly discuss the issues.
  • After MIFID 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. Most have chosen to pay directly out of their own revenues.
  • What are the consquences? is it a good or bad thing? is it economically efficient?