3 main functinos of financial system?
Allow entities to save, borrow, raise equity, manage risks, trade assets currently or in future, and trade based on estimates of asset value. Save and expect return that compensates for risk. Borrow in order to buy whatever is needed. Issueing equity. Risk management,. Exchanging assets, utiliizing information.
Determine returns that equate the total supply of savings with the total demand for borrowing.
Allocate capital to its most efficient uses.
Equilibruim Interes Rate?
rate at which amount, individuals, businesses, and governemnts desire to borrow is equal to amount indiviudals, businesses, and governemnts desire to lend. Rates vary depending on who is borrowing, liquidity, and other condtions.
Difference between financial derivative contract and physical derivative contract?
Physical is based on physical assets like gold, olild, wheat. Financinal is equities, equity indexes, deb, debt indexes, or other financial contracts
Marets for immediate delivery
Primary Market vs. secondary Markets?
Primary markets are for newly issued securities. Subsequent sales are done on secondary markwet.
Diff between Money and Capital MarketS?
Money markets are markets for debt securities with maturities of one year or less. Cap makts are long term debt or equity securities.
What is the inital sale fo a security called, when it goes public?
Short term securities are how long?Long term?Mid term?
Which one is a bond, note, adn commercial paper. What is a bill and a certfiicate of deposit?
- short are less than one or 2 years.Commercial Paper
- Large are greater than 5-10 years.Bond
- Mid are in between these two. Note
CD is a from a bank. Bill is from Gov't
What is a pooled invesestment vehicle? What are the 4 types? What type of investor ownership?`
- Pooled investment vehicles are:
- -Mutual funds
- -ETF's - traded like closed-end funds but have allow conversion of shares to portfolios secruities. Also callecd depositiories, with shares referred to as depositiory receipts.
- -Asset-backed secruities - Claim to ap ortion of a pool of financial assets. Different tranches representing different levels of risk
- -Hedge funds - organized as limited partnership,
Broker, block broker, investment bank, exchanges, alternative trading system, delaser, broker dealers, primary dealers.
- Broker - help clients buy and sell securities
- Block-Broker help with placement of large trades.
- Investment banks - help coproration sell common stock, prefere,d stock, debt
- Exchanges - provide venue where traders can meet. Sometimes act as brokers. take on rules and regualtion through governmetn or membership agreement.
- Alternative trading system- same as exchanges but no regulatory function. Do no revelea current client orders are called dark pools.
- Dealers- facitlitate trading by buying for or selling from their own inventory. Provide liquidity and profit from a spread.
- Broker-dealers have conflict of interest, bc trying to get best price for client and profit through spreads.
- Primary dealers are dealers trading with central banks when banks buy or sell securities
include banks, credit unions, savings and loans...etc. Do not include payday lenders or factoring companies.
Equity owner of banks , brokers, and othe rintermidiaries absorb losses before depositers. More equity capital an intermediary has, less risk of depositors. Poorly capitalized intermiedars have less incentive to reduce risk of loan portfolio.
Insurance firms provide benefit by managing risk in what 3 things?
- Fraud - insured purposley causes damage or claims fictious losses
- -Advers selction when those most likely to experince lossare are the predominatn buyers of insurance
- Moral Hazard 0 occurs because insured may take most risks once he is protected from losses
act as intermeidary btwn buyer and seller. Provide escrow services, guarantees of contract, assurance margin trader have adequate capital, limit on aggregate net order quantity (buy ordes mius sell orders)
Limit Counterparty Risk
What is short rebate rate? Payment in lieu? Margin loan? Call money rate?Leverage ratio?
- Payment in lieu- short seller mus pay all dividens or interest that lender would have received.
- -Most post proceess of shorts sale as colatteral. Broker earns interset on these funds and may return a portion of interest to short seller at short rebat rate.If securitiy is difficult to borrow, oshort rebate rate may be lower than .01% or negative.
- -Margin loan investors who use leverage to buy securities by borrowing from their brokers
- -Call money rate 0 interes rate paid on funds is called call money rate which is hgiher than governmetn bill rate.
- -leverage ratio is value of asset divided by value of equity position for example investor who satisfies intiatl margin requirement with 50% equity has 2 to 1 leverage.
Given the following information:
Share purcahsed 1,000
Purcahse pricer per share:100$
Annual Dividend per Share 2.00$
Intiial margein reuquirement"40%
Call money rate 4%
Commiosion per share .05$
Stock Price after 1 year: 110
Calculate leverage ratio and investors return on margin transaction if held for year.
- 1. leverage ratio is 1/.4= 2.5
- 2. Total purchase price is 100,000. Investor pays 4,000. Remaing 60 K is borrowed. Commision on purchase is 50. Total initial investment is 40,050.
At end of year stock value is 110,000. Gain is 110,000 - 100,050= 9950
Dividend received are 2,000. Interest paid is 2,400. Commisoin on sale is 50. ROE is 9,500/40,050/
Margin Call Price?
Percent of equity falls below certain leve, investor will receive a margin call.
Equation= P0*(1-Initial Margin)/(1-Maitenance Margin)
P0=Initial purchase price
Market Order? Limit Order? Marekteable or aggressivley priceD? Making a new market or iniside the market? Standing limit order? Behind the market? Far from the Market?
- Market Order- is an order telling broker to take immidiate best price.
- Limit order - places a minimum price on sell orders or max price on buys
- Marketable or aggressivle priced - is a limit buy order above the best ask or limit sell below the best bid.
- Making a new market is if limit price is between the best bid and best ask.
- Standing limit order are limit orders waiting to execute.
- Make the marekte, are a limit buy or blimit sell at the best bid/ask price.
- Behind the market is when a limit buy is behind the best bid, and a sell order above the best ask price.
Far from market is when you are FAR from bid ask. AGAIN, limit buy is way below best bid price, and limit sell is way above best ask price.
ALlor nothing orders. Hidden order? Display size?Iceburg orders?
All or nothing is fill the whole order only.
Hiden order, is when only broker or exchange knows the size.
Iceburg order /display size, where only a portion of the order is visible
Good on close order? Good on opern open? Market on close orders?
good on close, are orders only filled at end of trading days? good on open is filled at opening?Market on close is market price at close.
Stop-sell order?Stop-buy order?
set a limit to which you sell or buy. Stop buy is when a price goes up past a certain point, you stop the loss of your short-sell.
These two orders reinforce market momentum.
Book building?Accelerated book build?Best effor basis?
Book building is gathering indications of interes for a stock offering. An accelerated book build occrers when securities must be issued quickly. Best effort basis - investment bank agree's to distrubte shares, and does not take on the loss of there is an unsold portion.
Shelf Registrationl Rights offering?
Shelf registration is a firm makes public disclosured but issues registered securities over time when capital is needed.'
Rights offering, existing shareholders given right to buy new shares at discount price. Tend to dislike rights offering bc ownerhsip is diluted unless they excercise their rights.
Call market vs. continuous markets. Quote driven markets, order driven markets, brokered markets.
Call market stock is only traded at specific times. Oall trades, bids, and asks are declared and then one negotiated price is set that clears the market for the stock.
Constinous market trade occur at any time market is open. Price is set using auction process or dealer bid-ask quotes.
Quote driven wheere investors trade with dealers. Bid-ask prices. Dealers maintaing inventory. Most securities besides stocks are quotes driven,.
Order driven where rulse are used to match buyers and sellers.establish order precedence hirerarchy. Price priority where trades given highest priority are highest bid and lowest ask. Additionally if same prices, there can be secondary precedence which gives priortiy to non-hidden orders and earliest arriving.Uniform matching principal, all orders trade at same price which is price result in hgiest volume of trading. Discriminatory pricing rule uses the limit price of the order that arrived first as the trade price.
Brokered markets where investors use brokers to locate a countpearty to a trade.Good for real estate, artwork, etc.
Dealers prefer pre-trade transparent or post trade transparent markets?
Post trade transparent, bc they want buying prices to be hazy so that bid-ask prices can be bigger.
Characteristics of a "complete market". 3 main Characteristic fo a well funcitongin financli system?
Completle markets have - investors can save for future at fair rates of return - creditworthy borrowers can obtain fudns-hedgers can manage their risks-traders can obtain the ucrrencies commodities and other assets they need.
Well functioning has complete markets that are operationally and informationally efficient with prices that reflect fudnamental values. And capital is allocated to it's most productive use, in allocationally efficient market.s
- Operationally efficient if market can perform fucntions at low trading cost
- Informationally efficient if prices reflect all information associated with fundamental value in a timely fashion
Objectives of market regulation?
Protect unsophisticated investors, establish mimnimum standars of competency, help investors to evaluate perfomrance, preven insiders from exploiting other investors, promotoe common financial reporting requiremnts, require minimu levels of capital so participants can fulfull the commitments,.
Security marekt Index?
Security market index is uesed to repsrent performance of asset class, security market or segment.They are coproised of constituenmt securities.
Price index uses only prices of constituant securities. Price return? How do you determine total return over multiple years?
Price return is Rate of return calculated based on price index.
Just multiply 1+Annual return by all periods.
What are different weighing methods in an index?
Price weighted index is arithmetic mean of prices of index. Divisor, which is # of securities in index, must be adjusted for stock splits and chages in composition over time.
Equal weighted index assigns same weight to each constituent securite
- -market capitalization-weighted index gives consittuent security a weight equal to portion of total market value of all securities in index. Can bea djusted for a securities market float or free float(share that are not avaialbel to foreign buyers excluded) to reflect fact that not all outstanding share are avaible for purchase.
- Fundamental weighted index uses weights independant of f secuitiey prices, such as earning, revenue, etc.
Price Weighted Index Equation?
Sum of stock Prices/Number of shares adjusted for splits.
3 stocks at 20 10 and 90. 90$ stock splits. you take original 90+10+20/3=40. then you take adjusted which is 45+10+20/?=40, then solve for ? whic is 1.875
Marekt Cap Weighted Index =
(Current total market value of index stocks/Base year total market value of index stocks)*base year index value
Index proverds periodically rebalanc eweights of constituen securities, that is most important for equal weighted indexes.
Reconsittuion - refers to changing in securities that are included in index. Must be done when securities mature.
What is informationally efficient market?
In informationally efficient capital market, security prices reflect all avaialble information fully, quickly and rationally. More efficient a market is , quicker reatinon to new information. Only unexpected info should elicit a repsonse from traders.
Market value vs intrinsic value
market value is price can be bought or sold. Intrinsic value is fundamental value
What are the three Types of markets in the Efficient market Hypothesis.
The Weak form - states that an abnormal profit can't be made using technical analysis and that makret prices reflect all historical price and volume info.
The semi-strong for states secruity prices fully reflect all publicly information as well as technical infor (weak form). Fundamental analysis does not give abnormal returns.
Strong form efficient, active investment management does not consistently reuslt in abnormal profits. Fully reflect both public and private information.
Bc of insider trading, markets shouldn't reflect all private information, evidenc supports view that markets are not strong form.
Something that deviates from efficient makret hypothesis. Most evidence suggest anomalies are not violoations of market efficientcy but are de to methodologies used in anomaly research such as data mining or failitn to adjust risk adequatley.
Anomalies that have been identified in time series data inclde calendar anomalies like january effect, overreatction anomalies (stock returns subsequentyly reverse), momentum anomalies (high short-term returns are followed by continued high returns)
Anomalies have been identified in crose ssection data including size effect (small cap outperform large cap) and value effect (value stocks outperform growth stocks.)
Other identified anomalies involve closed end investment funds selling at discount, slow adjustment to earnigns suprises, investoer overreatciton to long erm underpormance of IPOSs, and relationship to stock returns and prior economic fundamentals.
Examines whether investors behave rationally, and how it affect markets.