CFA I Reading 36

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market organization and struture

• financial market
  • functions
    • primary functions: transfer risks and assets
    • hedgers (manage risks), borrowers(obtain fund), investors (receive fair return), traders (obtain currencies, commodities, secrurities)
    • saving
    • borrowing
      • rate of return
        • if the rate of the return is too high, people tend to save and less borrow
        • if the rate of the return is too low, people tend to borrow rather than save
        • the total savings = total borrowing in an economy, the rate of equilibrium
    • risk management
      • insurance company (insurance contracts)
    • issuing equity
      • investment banking
    • exchange assets
      • swap contracts
    • utilizing information
  • assets
    • financial assets
      • securities
        • owernship
          • equity securities
            • represent ownership positions
              • common stock
              • preferred stock
                • will receive the dividends earlier than the common stock
              • warranties
                • gives a right to purchase the securities at a certain price
          • debt securities
            • the borrowed will be refunded
        • public vs. private
          • public traded securities
          • private traded securities
      • contracts
        • swap contract
          • exchange interests rates, currencies, securities in the contract
        • forward and future contract
          • sell a asset in the future at a certain price
          • future contract is a standardized contract with fixed price, characteristics, delivery time, etc.
        • option contract
          • gives the owner a right to buy or sell an asset
            • call option
              • gives the owner to buy an asset
            • put option
              • gives the owner to sell an asset
        • insurance contract
        • credit default swaps
          • an insurance contract in case the issuer defaults on its dividends payments
      • derivatives
      • currencies
        • issued by the central government
        • traded in the spot market with immediate delivery
    • real assets
      • physical assets
        • real estates
        • commodities
        • equipments
        • inventories
      • how to trade real assets
        • direct trade on physical assets relevant to a lot of management costs
        • indirect ownership methods
          • real estate investment trust (REIT), master limited partnership
          • buy the stock of the firm owning real estates
  • markets
    • sell different types of securities
      • primary market
        • newly issued securities, IPOs
          • investment banking service
          • indication of interests
            • indication of interests, the investment banks to navigate the willingness of investors to invest
            • book builder, the collectors of indication of interests
            • indication of interests influence the offering price
              • more willingness to buy, the prices up
          • as a result
            • underwritten offering, the investment bank agrees to buy whole shares of securities
            • best effort basis
              • not promise to take all
        • private placement
          • it's always a trap
          • low issuance cost and offer price compared with the public market
          • only qualified investors have access to it
            • problems: information transparency is low
            • dividend reinvestment plan (DRP)
              • use the dividends to reinvest / buy new shares with lower discount
      • secondary market
        • trade the already issued securities, London exchange
          • quote-driven market
            • the dealers maintain an inventory of securities
          • order-driven market
            • order are executed by using trading rules
              • trade priority rules
                • pricing priority
                  • the trade is given to the highest bid and lowest ask
                • secondary precedence rule
                  • the trade is given to the non-hidden orders and the earlies requesting
              • pricing rules
                • uniform pricing rules
                  • given uniform / same price
                • discriminatory pricing rules
                  • limit price orders according to the arrival time
          • brokered market
            • brokers need to find a counterpart to execute the order
            • e.g. art work., real estate, etc.
    • traditional or not
      • traditional investment market
      • alternative market
    • time
      • spot market
        • immediate delivery
      • future, forwards, options
        • owns a right to trade at a certain price
    • maturity
      • money market
        • the maturity is less than one year
      • capital market
        • the maturity is more than one year
  • financial intermediates
    • brokers, dealers, securitizers, depository instituitions, insurance company, arbitrageurs, clearing houses
    • brokers vs. dealers
      • dealers own the assets, buy or sell from its own inventories
      • brokers
        • investment banks
          • help sell equity securities (stock, preferred stock, warranties) and debt securities to investors
          • give advise on mergers and acquisitions
      • exchange
        • London exchange
        • alternative trading system, electronic communication network, multilateral trading facilities.
      • primary dealer:
        • trade with the central bank that may influence the economy's money supply
    • securitizers
      • 鱼龙混杂
      • securitizing a pool of assets and sell interests in the pool to the investors
      • decrease the funding costs for the assets
    • insurance companies
      • 做空的概率，time value of money（通货膨胀）
    • arbitrageurs
      • buy the assets from one market and sell them in another market
• leveraged position
  • buy on a margin
    • borrow some capital from the broker to trade based on certain percentage of the equity
    • there is an initial margin requirement, and when the price reduces there a maintainence margin requirement (minimum requirement of the equity percentage)
  • margin call
    • if the percentage of the equity blows the maintainence margin requirement
    • margin call price
      • = original price * (1-initial margin)/(1-maintainence margin requirement)
• order execution and validity
  • dealer
    • bid price, ask price, and bid-ask spread
    • bid price: the price where the dealer buys, the ask price where the dealer sells, and the bid-ask spread is the compensation that the dealer receives
  • execution instructions
    • how to tade
      • market orders
        • trade immediately but not the best price
      • limit orders
        • limit the price in a range
          • marketable or aggressive limit orders
          • make a new market, inside the market
          • behind the market
          • far behind the market
  • validity orders
    • when to place the order
      • day orders, good til canceled orders, immediate or canceled orders, good-on-close orders, stop orders
      • stop sell orders, stop buy orders
  • clearing instruction
    • standardized instructions by clearing house or custodians
• information
  • informational efficiency
    • this is where consulting / advisory services provide
    • the prices changes quickly in response to the new information, the estimates of the value of the securities
  • operational efficiency
    • capital can be allocated to the most productive use
  • where consulting firm works on
• market regulation
  • if not
    • fraud and theft
    • inside trading
    • costly information
    • defaults on return to the the investors
  • result in
    • low liquidity in the financial market
    • unfunded new/innovative ideas
    • economy declines