CM101 - D&B - Securities Overview

Introduction & Overview of Securities Industry 1

FDN-CM101-DB

Study Material for Introduction & Overview of Securities Industry


Table of Contents

Introduction & Overview.....................................................................................................3

Financial Markets ................................................................................................................3

What are Financial Markets? ............................................................................................ 3 Objectives of Financial Markets........................................................................................ 4

Participants in the Financial Markets.................................................................................6

Investors........................................................................................................................... 7 Issuers ............................................................................................................................10 Financial Intermediaries ..................................................................................................12 Infrastructure Providers ...................................................................................................25 Industry Bodies................................................................................................................34

Asset Classes....................................................................................................................36

Equity ..............................................................................................................................37 Fixed Income Securities ..................................................................................................38 Currencies.......................................................................................................................39 Commodities ...................................................................................................................40 Derivatives ......................................................................................................................41 Types of Risks.................................................................................................................42

Types of Markets...............................................................................................................44

Primary Market and Secondary markets..........................................................................44 Money and Capital Markets.............................................................................................45 Markets for Financial Instruments....................................................................................47

Role of Regulators ............................................................................................................51

Securities and Exchange Commission (SEC): .................................................................51 Financial Services Authority (FSA) ..................................................................................56

Recent Developments in Financial Services Industry ....................................................59

Dematerialization.............................................................................................................59 Electronic Trading ...........................................................................................................59 Web Trading....................................................................................................................60 Electronic Communications Networks .............................................................................60 Financial Messaging........................................................................................................60 Shortening of Settlement Cycles .....................................................................................62

GLOSSARY........................................................................................................................62

Sample Questions: US Securities Markets - Introduction and Overview ......................67


Introduction & Overview

Financial Markets

What are Financial Markets?

In any economy, entities such as individuals, organizations and governments may have

surplus funds or may need funds for a variety of purposes. Thus funds need to be

exchanged between those who have surplus of them (called savers/investors/lenders) and

those who need them (called issuers/borrowers). Broadly speaking individuals are the

principal savers while organizations and governments are principal borrowers or fund

raisers.1 This transfer of funds takes place through a mechanism of financial markets.

Individual Investors Fund / Capital Raisers

Funds are

Invest funds through transferred to

What are financial assets or securities?

When investors lend their surplus funds to organizations or governments, investors get an

acknowledgement for the same from organizations or governments in the form of financial

securities. Thus financial securities are issued by those who need capital2 and represent the

fact that such issuers have raised funds from investors. For the investors who have invested

in such securities, such securities become financial assets. These financial assets represent a

claim on the issuer’s earnings or resources. The issuers have certain obligations towards the

investors, the most important among them being providing a return on their investments.

1 The classification of individuals as investors and organizations and governments as fund raisers is only a

broad one. This is because individuals do borrow funds and organizations and governments do invest or lend

funds.

2 Capital is the amount of monetary resources required to run the business

Financial

Markets

Organizations

Or

Governments


Financial securities are primarily of two types i.e. equity shares or stocks and fixed income

securities. Equity share represents an ownership capital i.e. an investor buying equity shares

issued by a company, becomes a fractional owner of the company. Fixed income securities,

on the other hand, is like a loan taken by the company from the holder of fixed income

securities. They are also called debt securities or debt instruments. Both these financial

securities are explained in detail in the section on “Asset Classes”.

As we have already seen, financial markets facilitate transfer of funds between the two

parties. This transfer takes place by issuing financial securities to the investors. The

advantage of these securities is that they are negotiable and thus can be traded. For

example, Organization A issues securities to Investor B. Obviously, investor B has given /

lent money to the organization A. Suppose investor B wants his money back after some

time, he can simply transfer the securities to any other investor, say Investor C by selling the

securities to him. This is what is meant by negotiable instrument and transfer of security

from B to C is called trading in securities.

Objectives of Financial Markets

� Bringing borrowers and lenders together - The most important objective of financial

markets is to bring borrowers and lenders together so that excess funds can be

channelized from lenders to borrowers. Bringing borrowers and lenders together

does not mean that they have to be brought together physically. We are living in a

technologically advanced world and with the help of technology borrowers and

lenders in any part of the world can be brought together electronically.

� Financial intermediation : The process of transfer of funds between issuers and

investors is takes place through intermediaries who operate in financial markets.

Thus one of the objectives of the financial markets is to perform the function of

financial intermediation as efficiently as possible.

� Price Discovery : One of the objectives of financial markets is “price discovery”

which means that when securities are continuously transferred between various

investors, it helps arrive at the correct price at which the security should trade.


� Meeting needs of market participants : Investors and issuers have different needs.

For example, Organization A wants to borrow funds for 1 year while Organization B

wants to borrow for 10 years. Investor A is very young and aggressive and hence is

prepared to take higher risk while investing. On the other hand, Investor B, a retired

employee wants to play very safe. Thus different investors and borrowers have

differing needs and a well developed financial market should provide a wide variety

of financial securities or instruments so that their requirements can be met.


Participants in the Financial Markets

Participants and Vendors in financial markets include

• Investors

� Institutional

� Individual

• Issuers

� Organizations / Corporations

� Governments

� Government Sponsored Agencies

• Financial Intermediaries

� Banks

� Investment Managers / Asset Managers

� Broker / Dealers

� Managed Investment Companies

� Investment Banks

� Insurance Companies

• Infrastructure Providers

� Stock Exchanges, Over the counter markets

� Settlement Service Providers

� Market Data Vendors

• Industry Bodies

• Support Service Providers

� Data Vendors

All the participants have important roles to play. Their roles are described in detail in the

sections that follow.


Investors

Two types of investors participate in the financial markets viz. Institutional and Individual

investors. The features and characteristics of the two types of investors are discussed below.

Institutional Investors

These are the investors who exist as Corporations. As they are corporations, they pool

money from a variety of sources and invest through financial markets. Examples of these

include banks, mutual funds and insurance companies.

o Banks are depository institutions i.e. they collect deposits from individual investors

and business corporations. These deposits are lent to borrowers or invested in

financial securities of issuers.

o Managed Investment Companies collect money from individual investors, business

corporations and other institutional investors and in turn give them mutual fund

units which are again financial securities. On behalf of investors from whom money

has been collected, mutual fund managers / asset managers invest these funds

through financial markets in various securities.

o Insurance companies collect insurance premiums for a variety of purposes from

those who insure their lives or assets. These funds are in turn invested in various

financial instruments.

Let us look at some of the characteristics of these investors.

o An institutional investor has a pool of funds. This pool of funds can be invested in a

variety of assets.

o Since they collect a pool of funds from investors, the resources available to them are

huge compared to individual investors. Hence their investments are in large

amounts.

o They employ one or several investment managers who take investment decisions.

These investment managers are well trained, market professionals and hence these


institutions are considered to have superior market knowledge and access to

information.

o Since transactions are on large scale, they get preferential (competitive) rates from

brokers 3 who execute the transactions on their behalf.

Individual Investors

Individual investors are also called as ‘retail investors’. Retail investors participate in

financial markets either directly or indirectly. Direct participation means investors make

investment decisions on their own and invest money in various securities directly. Else, they

can park their funds with mutual funds who in turn invest in financial instruments. In this

case, investors do not participate in investment decision making process and thus participate

indirectly.. Retail investors are an important part of any financial market.

As against the institutional investors, retail investors have the following characteristics.

Retail investors have limited resources since they use their own funds to invest.

o If they participate directly, investment decision making may not be professional.

o Small sizes of investments.

o Since investment sizes are small, no preferential rates are offered by brokers to

execute the transactions.

3 Brokers actually execute transactions for investors. Detailed information about brokers in mentioned in the section of “Infrastructure Providers”.


Types of Individual/ Retail Investors

It is generally observed that different types of individuals have different investment

approaches supported by a multiplicity of factors together with their propensity for risk4.

The different types of individuals are as follows:

� Professional Investors: This refers to all those individuals who have substantial

investment resources so that they can acquire professional money management

services for their investment portfolio.

� Stock Pickers: Stock Pickers are those individuals who are of the opinion that they can

choose individual stocks 5 for long-term investment on their own. They do their own

research and pick the stocks accordingly.

� Mutual Fund Investors: A majority of the investors do not have adequate resources to

acquire individual professional money management services or adequate time or

penchant to invest on their own. It is these kind of individuals who normally select

Mutual Funds to invest in Securities.

� Day Traders: Yet another category of individual investors is a day trader. A day

trader typically buys or sells securities during the day and does the reverse to close

positions by the end of the day. For example if a day trader purchases /(sells) a

4 Risk refers to the uncertainty of investment return 5 Stocks or equity shares are explained in the section on “Asset Classes”

Professional

Investors

Stock

Pickers

Day

Traders

Mutual Fund

Investors


security of a particular issuer, then he will sell / (buy) the same before the trading

closes for the day. Thus he does not keep his position open overnight i.e. till the next

day. Hence such traders are called day traders. The day trader bets on a very short

term movement in prices of securities, and hence it is considered to be a risky

activity because security prices may not move in desired direction in such a short

period of time.

Issuers

Issuers include government, government sponsored agencies and corporations that desire to

raise funds. They need to raise funds for a variety of purposes.

� Issuers - Governments

Government requires funds for expenditures on infrastructure, health, education etc. as well

as to meet the shortfall in government revenue. Governments issue different forms of fixed

income securities6 to meet their needs. Government includes following categories:

o US Federal Government (or Central government of any country)

o US Government Agencies and Quasi-government Agencies – These are government

formed or sponsored agencies.

o State Governments

o Local Governments such as Counties and Municipalities

� Issuers – Government Sponsored Agencies

The government sponsored agencies get privileges so that they can lend to desired sectors.

For example in the US, a number of special purpose agencies with varying degrees of

federal government sponsorship raise finance so that they can lend to designated sectors of

the economy i.e. agriculture and housing. The principal agencies are as follows.

o Farm Credit System (FCS) - The Farm Credit System (System) is a network of

borrower-owned lending institutions and related service organizations in the US.

These institutions specialize in providing credit and related services to farmers,

6 Fixed Income Securities are explained in detail in the section on Asset Classes.


ranchers, and producers or harvesters of aquatic products. Loans may also be made

to finance the processing and marketing activities of these borrowers.

o Federal Home Loan Mortgage Corporation (FHLMC) - The Federal Home Loan

Mortgage Corporation ("Freddie Mac") is a government sponsored enterprise. It is a

stockholder-owned and a publicly-traded company chartered by the United States

federal government to purchase mortgages7 and related securities. These securities

are then issued in financial markets backed by those mortgages.

o Federal National Mortgage Association (FNMA) – It is a competitor to FHMLC. It is

also a government-backed corporation which purchases mortgages from lenders and

resells them to investors. It is financed by the issue of fixed income securities.

o Student Loan Marketing Association (SLMA) – It is a government-sponsored private

corporation created to increase the flow of funds into student loans by facilitating the

purchase of student loans in the secondary market.

These agencies issue fixed income securities.

� Issuers – Corporations

Corporations need funds for carrying out new projects, expansion projects or to finance

their day to day needs. The securities issued by corporates are of various types and include

both fixed income and equity shares.8

7 A mortgage is a loan that is secured by the underlying real estate. For example when a loan is taken by a home buyer, the house property is mortgaged with the lender. 8 Equity shares are explained in detail in the section on Asset Classes.


Financial Intermediaries

A number of institutions, agencies play an important role in bringing issuers and investors

together. These are as follows.

� Banks


� Broker / Dealers

� Managed Investment Companies

� Insurance Companies

These are called financial intermediaries and perform a vital function of transfer of capital

from one party to another. Let us now look at important financial intermediaries.

Banks

All of us as individuals and even business houses and governments consider banks as a safe

place to deposit money. A number of accounts can be opened with banks which have

different features and allow us to deposit money with them. They are financial

intermediaries because these deposits are in turn lent to those who need them or are used to

invest in financial instruments issued by issuers.

The services offered by Banks for individuals and institutions include:

Services for deposit holders

o Checking accounts also called as demand deposits – These accounts do not earn any

interest for keeping deposits but the deposit holder can withdraw deposit any time

he wants. That is why they are called demand deposits.

o Savings accounts – These accounts pay a low rate of interest. These accounts are

generally very popular amongst individuals who park their surplus funds and

withdraw whenever they want subject to certain restrictions.

o Time deposits that includes Certificates of Deposit – These pay a higher rate of

interest compared to savings deposits. In this case funds have to be parked for a


specific time period, say a six months’ time deposit. Funds can not be withdrawn

before six months.

Services for borrowers

o Secured lending – As mentioned above, banks lend the deposits collected, to

organizations or other entities that need them. By secured lending we mean that the

loan given is secured against any asset that borrower has. For example, a corporation

may obtain a loan from a bank by securing it against the machinery that it has. In the

event that the company is unable to pay off the loan, the bank can sell off the

machinery to recover its dues.

o Unsecured lending – These types of lending are not secured against any asset. Hence

in the event of default i.e. corporate not paying back the loan, the bank can not take

charge of any asset and recover its dues.

Other important services

o Transfer of funds from one bank to another – This service is provided so that

payments can be made by one party to another. Thus when party A issues a cheque

in favor of party B, and when latter deposits it with his bank, funds get transferred

from party A’s account to party B’s account in the same or a different bank.

o Distribution of investment products - Making available a number of investment

products including the mutual funds

o Foreign exchange – When party A which is based in US wants to purchase or sell

any foreign currency say British Pounds or Euros, he can do so through the banks.


Categories of Banks: Various categories of banks are as follows.

o Retail Banks: As the name suggests, these banks basically satisfy the needs of

retailers i.e. individuals. They offer services such as

� Secured and Unsecured Loans: These loans are provided to the retailers for a

variety of purposes.

� Checking and savings accounts

� Purchase and sale of mutual funds and securities through specific purpose

subsidiaries

� Electronic funds transfers

� Bank investment products such as Certificates of Deposit

o Commercial Banks: Commercial Banks do not restrict their operations to

individuals; in fact their main clients are business enterprises. These banks offer

different kinds of services, such as:

� Loans to business enterprises that may be both; secured or unsecured

� Loans to brokerage firms for the brokers to finance their purchase of

securities


� Underwriting services9 with the help of bank’s corporate finance

departments

� Securities custody services10

� Clearing of US government securities – Whenever investors buy securities

issued by US government, they need to be transferred from seller of securities

to the buyer. Similarly funds have to be transferred from buyer of securities

to seller of securities. This means that these trades need to be cleared and

settled. Clearing of US government securities is done by banks. Clearing and

settlement of various securities are explained in detail in subsequent

modules.

Recent trends in commercial banking

The commercial banking business has undergone lot of changes over the years. Some trends

in the financial services industry have resulted in the decline in the banking business for

many years. These trends are as follows:

� There is growing disintermediation in financial securities industry. This

simply means that issuers and investors come together without any

intermediary and transfer funds amongst themselves. As a result the bank’s

role as an intermediary gets reduced.

� Traditionally retail investors have preferred to keep their surplus funds in

banks. However, with the availability of new investment opportunities such

as investing in mutual funds, retail investors have shifted to such products

for getting better returns. Hence banks face considerable competition in

collecting deposits.

9 Underwriting Services mean whenever issuers issue securities underwriters ensure that any unsubscribed portion is subscribed to by the underwriters. This ensures that the issuer raises the amount which is required by him. For example, if issuer A wants to issue securities and raise $ 10 million. If the investors’ response is not good, the issuer may not be able to raise the required amount. Underwriters ensure that he gets the full amount. The function of underwriting is explained detail in Equity Module. 10 Custody function is explained in the next section on Custodian Banks


o Custodian Banks : We have already seen earlier that institutional investors have vast

resources at their disposal and hence their investments are large. The securities in

which they invest need to be kept safely and administered in the sense the record of

buying and selling and the stock of securities need to be updated on a continuous

basis. This service is called custody service which is provided by Custodian banks.

Not only securities are administered but cash is also managed by custodian banks. A

custodian may resort to perform its services for institutions and also for those

individuals who are very wealthy private clients, known as High Net Worth

Individuals (HNIs). Banks generally form separate legal entities or departments to

offer these services.

o Trust Banks : The custodial services mentioned above can be provided by the banks

directly or by forming trusts. Such banks are called Trust Banks. For example, an

institutional trust may be formed to take care of employee benefit programs such as

retirement plans for the employees that invest a certain amount regularly for the

benefit of the employees. The proceeds from such investments are payable to the

employees when they retire.


We have already seen that mutual funds provide an opportunity for retail investors and

other investors to invest their funds in instruments or units of mutual funds. Who manage

these funds? The answer is investment managers or asset managers. The investment

managers or asset managers actually take the decisions to deploy these funds in various

investment products / securities. Since they are principally buyers of securities they are

normally considered to be the buy-side of the industry. Investment managers or asset

managers can be structured as sole proprietorships, partnerships and corporations. The

Securities Exchange Commission (SEC) under the Investment Advisors Act of 1940 regulate

all these structures.


The main function of these investment managers is to manage money for pension funds,

high net worth individuals or any other institutions and mutual funds. The functions can be

summarized as below.

o Investment Research and Portfolio Management – They have to identify the right

kind of investment instruments and manage the total portfolio of securities.

o Offering investment advice – In this case, they simply offer investment advice, no

actual portfolio management is done by them.

� Broker / Dealers : Brokers are the intermediaries who provide broking services to

the investors. That means whenever the investors want to buy or sell securities they

do so through brokers. Brokers use the mechanisms established in the financial

markets to make sales or purchases for investors. Thus they act as agents for their

clients and charge a commission for services rendered. Unlike brokers who do

securities’ transactions for their clients, dealers act on their own accounts as

principals. That means they buy or sell securities for themselves. How do dealers

make money? They make money by buying the securities at a lower prices and

selling them at higher prices. The terms Brokers and Dealers are used together

because the same firms may act as brokers or dealers at different times. Hence these

terms are used together at many places throughout the text.

The services offered by brokerage firms can be summarized as follows :

� Supporting clients in buying and selling securities

� Providing research on securities which help the clients make investment

decisions

� Offering a custody service for the securities

� Making available statements of the assets in the account periodically

We saw earlier that investment managers are considered buy side of securities industry.

Brokers are considered sell side because they sell their research on securities and offer

broking services.


Recent trends in broking business

With the changes in securities industry, broking business has also undergone lot of changes.

The recent trends in broking businesses are as follows.

o Increasing competition – Broking business has become fiercely competitive with

a large number of firms offering these services. This increased competition has

brought down brokerage rates. Dealers also face narrowing spreads between the

prices at which they buy and prices at which they sell. Obviously this causes

reduction in their profits. Thus broking business witnesses increased competition

and pressure on profit margins.

o Need for continuous upgradation of technology – The securities industry is

undergoing constant changes due to technological advancements. To give a

simple example, across all the markets there is a trend that the trades be settled

in lesser time. In fact one would like to settle trades on the same day when they

are entered into. This requires significant investment on part of the brokers.

o Changes in the methods of Trading: The trading practice has shown noteworthy

changes during the last few years. This is basically due to the new Alternative

Trading Systems (ATS) and Electronic Communication Networks (ECN)11

provided by a large number of vendors. Similarly internet trading has changed

the way retail investors may trade. All this affects broking firms directly.

o Stringent Regulations: Broker / Dealers are regulated entities and their activities

are closely monitored by the regulators in various markets. The reporting

requirements of brokers are increasing. This requires them to incur some costs

and may restrict their activities in some ways affecting their profitability.

11 Explained in the section on Recent Developments


Categories of Brokers/Dealers

The following are the three major types of brokerage firms:

o Full Service Firms: As the name itself suggests, these broking firms offer a full

range of services. They have large research departments which offer client advice

and research on securities. They also provide additional services such as financial

planning, wealth management etc. The commissions charged by them are higher

compared to discount brokers.

o Discount Firms: These firms have not traditionally offered investment

recommendations along with their implementation and transaction processing

services. They just execute the deals for their clients charging lower commissions.

It should be noted the differences between them are getting blurred as full

service firms may charge lower commissions through their online accounts,

while discount firms have started offering research to their clients.

o Online firms : These may be either virtual firms with no physical existence. Or

they can be online services offered by the full service or discount firms.

However, there is no personal contact or advice in case of online trading.

� Managed Investment Companies : These are formed so that the investments can be

pooled together from a number of investors and invested in various securities.

Managed investment companies create a mutual fund and manage the same by

hiring professional portfolio managers. There are generally more than one mutual

funds created by these companies and each fund has different objectives. Thus it

becomes easier for investors to select the fund that meets their objectives.


Mutual Funds

A mutual fund is a fund collected by Managed Investment Companies that is invested in a

diversified portfolio of securities. The individuals who buy shares or units of a mutual fund

are known as its shareholders or owners. Their investments offer the money for a mutual

fund to buy shares, namely, stocks and bonds.

Need for Investing in Mutual Funds

Mutual funds help in create savings, are simple, accessible and also within an individuals’

reach. The major benefits of mutual funds are:

Diversification: It is said that it is better not to put all the eggs in one basket. This applies to

investments also. The successful investors are aware that diversification of their investment

helps in decreasing the adverse effect of a single investment. Mutual funds bring in

diversification to an investor’s investment portfolio automatically by holding a large variety

of securities. In addition, since the investor pools his assets with those of the other investors,

a mutual fund enables an investor to acquire a more diversified portfolio than one would

perhaps be in a position to comfortably manage on his own and also at a fraction of cost. In

brief, mutual funds give the opportunity to the investors to invest in many markets and

sectors / industries.

Professional Management: In spite of best market conditions, it takes a judicious,

knowledgeable investor to choose investments properly, and a further commitment of time

to constantly supervise those investments. As far as the mutual funds are concerned,

experienced professionals manage a portfolio of securities to buy and also sell based on

wide research. An individual or a team choosing investments that best match the fund’s

objectives normally manage a fund. Along with the changes in economic conditions, the

managers, frequently adjust the combination of the fund’s investments to make sure it

continues to meet the fund’s objectives.


Convenience: The investor can sell or purchase fund shares directly from a fund or through a

broker, insurance or bank agent, financial planner, by mail or over the telephone and also

through the computer. The arrangement can also be made for automatic reinvestment of the

dividends12 paid by the fund. Funds can also offer a large variety of other services, which

include monthly or quarterly account statements, tax information, computer accessibility to

the fund and account information and 24-hour phone service.

Low Costs: Mutual funds normally hold dozens or even hundreds of securities like stocks

and bonds. The basic method through which an investor pays for this service is through a

fee that is based on the total value of an individual’s account. Since the fund industry is

characterized by the possession of hundreds of competing firms and thousands of funds, the

exact level of fees changes. But, in the case of many investors, mutual funds provide

professional management and diversification at a fraction of the cost of making such kind of

investments independently by the investors on their own.

Liquidity: This refers to the ability to voluntarily access investor’s money in an investment.

Mutual fund shares are considered as liquid investments as they can be sold on any

business day. The price per share at which an investor can redeem shares is referred to as

the fund’s net asset value (NAV). NAV is the current market value of all the fund’s assets,

minus liabilities, divided by the total number of outstanding shares.

Protecting the Investors: The mutual funds are not only subjected to rigorous internal

standards, they are also highly regulated by the federal government through the US

Securities and Exchange Commission (SEC). As part of this government regulation, all the

funds are required to meet particular operating standards, should observe strict anti-fraud

rules, and reveal total information to existing and prospective investors. These laws are

stringently imposed and intended to protect investors from fraud and abuse. However,

these laws cannot help the investor in picking up a fund that is appropriate for the investor

12 Dividends are a part of profits that any company / investment institution pays out to the shareholders.


or prevent a fund from losing the money. The individual can still lose money by investing in

a mutual fund.

Types of Funds Basically, there are three types of mutual funds based on asset class :

i. Stock or Equity: Stock mutual funds invest basically in shares of stock issued by

foreign companies or US.

ii. Bonds: These mutual funds invest mostly in bonds.

iii. Money Market: They invest basically in short-term securities issued by the US

government and its agencies, US corporations and state and local governments.

Stock Funds

These funds invest primarily in stocks. A share of stock fund signifies a unit of ownership in

a company. If a company is successful, then, the shareholders earn profits in the following

two ways:

The stock increases in value

The company can pass its profits to shareholders which take the form of dividends

Bond Funds

These funds invest basically in securities known as bonds. A bond is referred to as a type of

security that resembles a loan. Whenever a bond is purchased, money is lent to the

company, municipality or government agency that issued the bond. In exchange for use of

this money, the issuer promises to repay the amount loaned, in other words, the principal,

also known as the face value of the bond, on a specific maturity date. Apart from this, the

issuer characteristically assures to make periodic interest payments over the entire period of

the loan.


Money Market Funds

This fund invests in a pool of short-term, interest-bearing securities. A money market

instrument is a short-term debt instruments issued by the US government, US corporations,

and state and local governments. These instruments have a maturity period of less than one

year.

The short-term character of money market investments makes money market funds less

volatile than any other type of fund.

� Investment Banks: Investment banks offer a number of services including broking

services and underwriting of new securities. Their different businesses may be

considered as buy side or sell side businesses in securities industry. The role of

investment banks and the functions they perform are extremely vital for the

securities industry. The services provided by investment banks are as follows.

o Investment research – In this case, investment banks provide research on

industries, companies to their clients so that the clients can take investment

decisions.

o Portfolio management – The investment portfolios of clients need to be monitored,

altered on a regular basis in response to the developments in financial markets. This

service is provided by the investment banks.

o Trading for the clients – Investment banks act as brokers and trade on behalf of their

clients.

o Private banking – Already explained in the section on Banks.

o Wealth management – This is a service provided to High Net worth Individuals

where their wealth is managed as per their objectives by the investment banks.

o Mergers & acquisitions (M&A) – In the corporate world, developments such as

merger of two companies, acquisition of one company by another company take

place continuously. Investment banks play a vital role in identifying opportunities


for M & A, valuing companies in case of M & A, meeting the necessary regulatory

requirements etc. for their clients.

A point that needs to be remembered is that the operations of investment banks need to be

separated from each other by a Chinese wall. This is because there is chance of conflict of

interest between the operations of different departments of investment banks. For example,

a research analyst in research department should provide an independent opinion about

any company, whether that company is the client of an investment bank or not.

� Insurance Companies: These companies are active in the securities market

through their treasury functions13 and also in the course of their investment

management activities. This means that the premiums collected from the buyers of

insurance need to be invested in various securities so that the insurance companies

can meet their payment obligations smoothly. Their treasury departments watch

cash inflows and outflows carefully and invest surplus funds from the short term

perspective. On the other hand, investment mangers invest these funds from long

term perspective.

13 In simple terms treasury function involves managing short term cash surpluses and deficits.


Infrastructure Providers

Stock Exchanges

Stock exchanges are the institutions which provide trading facilities to all interested parties

who trade through individuals or firms which are the trading members of stock exchanges.

Once the issuers issue securities, these securities are listed on stock exchanges. Listing is a

mechanism through which securities are allowed to be traded by the stock exchanges. Once

the securities are listed, they are traded by the investors through trading members. The most

important objective of getting securities listed is that participants can trade in the securities.

Let us see how this process works.

Issues securities to Gets securities listed on stock exchanges

Thus the most important function of stock exchanges is that they provide trading a platform

for securities issued. Suppose Investor A has purchased a few securities issued by Issuer B.

The investor is in need of money and wants to sell the securities. This is greatly facilitated

by the stock exchanges since all the market participants who want to trade in particular

types of securities, do so through stock exchanges where the securities are listed. Without

stock exchanges, trading would have been difficult.

In most of the countries there may be a number of stock exchanges but a few usually

dominate in terms of volumes of securities traded. There may be National level stock

exchanges or regional stock exchanges. The stock exchanges operate under the supervision

Issuer

I N V E S T O R S

Trading starts in securities after listing amongst various investors


of market regulators and form their own rules and regulations regarding listing of

securities, allowing membership to market participants etc.

Stock Exchanges in US are:

� New York Stock Exchange

� American Stock Exchange

� Philadelphia Stock Exchange

� Pacific Stock Exchange

� Boston Stock Exchange

� Chicago Stock Exchange

� Cincinnati Stock Exchange

The stock exchanges may require the members to assemble at a place to trade in shares

(called an open outcry system) or may allow trading through computer networks (called a

screen based trading).

Over-the-Counter Market

Unlike the stock exchanges, an Over-the-Counter (OTC) Market for stocks consists of

dealers who buy or sell stocks by negotiating through telephones and computer systems.

OTC market trading in US is done through network of computer systems called National

Association of Securities Dealers Automated Quotations (NASDAQ) System. It was put into

operation by the National Association of Securities Dealers (NASD). This nationwide

communication system allows brokers to know instantly the terms currently offered by all

major dealers in securities covered by the system. The dealers buy stocks for their own

account and sell them to investors at prices higher than their buying prices. A number of

companies are listed on NASDAQ.


� Clearing Service Providers

Before any trade is ready for final settlement (exchange of securities and funds between the

buyers and the sellers), trades need to be cleared. The institutions providing these clearing

services are called clearing service providers.

The main service that is provided by clearing service providers is that of netting. After the

trades are done on each day, trades are netted out amongst the brokers and only the net

amount of securities and funds are actually transferred.

This ensures that number of transactions to be settled goes down.

There are different clearing service providers operating for clearing trades for various

securities.

o Depository Trust Company (DTC)

A member of US Federal Reserve System, Depository Trust Company retains

custody of 2 million securities, most of them in dematerialized form. The depository

also provides the services necessary for the maintenance of the securities it has in

custody.

The mission of DTC is to:-

-Hold securities like equities, bonds & unit investment trusts

-Arrange for the receipt & delivery of securities

-Arrange for the payments during settlement

o National Securities Clearing Corporation

The National Securities Clearing Corporation (NSCC) is the largest of the US

clearing corporations processing approximately, about 20 million transactions in a

day. It provides risk management, clearing and settlement, central counterparty

services14, to money market instruments15, corporate, and municipal debt etc. It also

14 Central counterparty function guarantees that the trade will take place without any default. For example if the buyer of securities fails to make payment for his purchase, the seller is guaranteed money for the securities he has sold through Central Counter party. 15 Money market instruments, corporate and municipal debt are explained in the section on Asset Classes


nets trades16 and payments among its participants, decreasing the volume and

securities and payment that are required to be exchanged by an average of 95% each

day. It clears and settles trades on a T+3 basis17.

o Fixed Income Clearing Corporation (FICC)

FICC was formed by the merger of the Government Securities Clearing Corporation

(GSCC) and the Mortgage Backed Securities Clearing Corporation (MBSCC). It

caters to post-trade processing for the fixed income markets. FICC offers, under one

roof, a unified approach to fixed income processing through a wide array of services

for the government and mortgage-backed securities markets.

It operates through its divisions – i) Government Securities Division which clears

and settles government securities transactions and ii) Mortgage Backed Securities

Division which handles clearing and settlement of Mortgage Backed Securities

o Options Clearing Corporation (OCC)

OCC is the world’s largest equity derivatives clearing organization.

Acts as a clearing house and guarantees the fulfillment of trades which are cleared

by OCC.

OCC clears transactions for a number of derivatives products traded on various

stock exchanges such as American Stock Exchange, Chicago Board Options

Exchange, International Securities Exchange, Philadelphia Stock Exchange etc.

16 Netting of trades is done as a part of clearing process. For example, broker buys 300 units of Security A for Client B during the day and sells 200 units of same security for Client C. In this case, the Clearing Corporation will arrive at a net buy position (300-200) for this broker. Netting reduces the number of transactions. 17 Explained in the section “Recent developments”


� Settlement Service Providers

Settlement service providers provide a variety of services to investors in order to ensure that

trading in securities becomes smooth. For example, suppose investor A buys equity shares

from investor B. After the trade is over, the shares which A has; need to be transferred to B.

Similarly, B has to pay cost of shares purchased and these funds have to be sent to A.

Moreover, A and B may be in the same city, same country or different countries. Hence

transfer of funds and securities need systems to be created which help hassle free

completion of this process. One of the settlement service providers is a bank since it plays an

important role in transferring funds from one party’s account to another. Since the role of

the banks has already been explained, let us look at other settlement service providers.


o Depositories

A depository is an institution which can be compared to a bank. A bank holds money

deposits of deposit holders. On the other hand, a depository holds securities (like shares, or

fixed income securities, units of mutual funds etc.) of investors in electronic form. Thus

depositories play an extremely important role as most of the securities now are held only in

electronic form. The transfer of securities between the two parties is greatly facilitated by

depositories as follows.

Customer A’s account Pre Trade Balance Customer B’s Account

Depending upon whether the depository settles international or national securities, there

are two types of depositories; International Central Securities Depository and Central

Securities Depository.

Depository

100 shares of ABC Company


Suppose B sells 50 shares of ABC Company to A, the post trade balance will look like :




International Central Securities Depositories

The International Central Securities Depositories (ICSDs) emerged as institutions to manage

and settle the Eurobond18 business initially. However, over the years, ICSDs have achieved

global connectivity and now settle most domestic and internationally traded instruments. In

Europe, there are two International Central Securities Depositories (ICSD) namely Euroclear

and Clearstream, AG.

Central Securities Depository

The main function of Central Securities Depositories is to hold dematerialized securities so

that by electronic book entries, the transfer of ownership can be affected. Thus it does not

require a physical settlement to take place. This transfer of ownership may occur in the

books of CSD. If any intermediary holds account with a CSD, the settlement can take place

by a book entry in intermediary’s account. CSD is concerned with the settlement of domestic

securities. For example, Depository Trust & Clearing Corporation is the central securities

depositary in US.

In Europe, a number of CSDs operate in different countries. These CSDs mostly are part of

either the Euroclear or Clearstream groups.

Custodian Banks

Though we have already mentioned about custodian banks in the section on banks, it is

appropriate to mention the role custodian banks or custodians play as settlement service

providers. This role comprises of customer account keeping and the administration of

securities on behalf of customers. In simple terms, customers open accounts (of securities,

just as accounts for money deposits are opened with banks) with custodians and custodians in

18 Eurobonds are fixed income instrument issued in the currency which is not the currency of the country where the bonds are issued. For example, a US dollar denominated bond issued outside US is called a Eurodollar bond.


turn are members or hold accounts in depositories where actual transfer of securities takes

place by book entries.

Custodians not only maintain customer’s accounts wherein changes take place continuously,

but also provide a number of other services. For example, a company declares a dividend

which is to be paid to the shareholders. This dividend is collected and paid to the

shareholders by custodians. There can be two types of custodians; domestic or local

custodians and global custodians.

o Domestic or Local Custodians: As the name suggests, these custodians

process trades19 in domestic securities. For example, local custodians in US

process US securities for both US firms and international firms. They are

accountable for organizing their clients’ transactions between brokers,

investment advisors and the suitable US depository.

o Global Custodians: Unlike local custodians, global custodians process

cross border i.e. international trades. A global custodian in US may operate in

number of other countries through local custodians (also called sub-

custodians) in countries other than US to provide a number of settlement

services.

Some of the firms which act as both global and local custodians (for US markets) are State

Street, Bank of New York, J P Morgan, Citigroup, Mellon Group, Northern Trust etc.

Transfer Agents

When a company issues new shares to investors, the function of actually issuing shares to

investors is done by transfer agents. Moreover, transfer agents also track the movement of

shareholding pattern20 because as we have seen when shares are sold by party A to party B,

the former no longer remains a shareholder. Hence shareholding pattern changes due to

19 Processing of trade means preparing for clearing and settlement of securities and actually settling the trades. 20 Shareholding pattern is a summary of list of shareholders and the number of shares each holder holds.


trading in shares. Transfer agents track these changes in shareholding patterns. They also

act as an intermediary between the company and investors. In case of physical certificates,

transfer agents handle matters regarding lost, destroyed and stolen certificates. Most of the

transfer agents are banks or trust companies but sometimes a company may act as transfer

agent for its securities.

� Market Data Vendors

Market participants need a variety of data or information. Most of the data requirements are

real time. For example, information on prices of securities and corporate announcements

have to come real time. Some data may be received batch wise i.e. end of the day or some

data may be required over a long period of time, say historical data of activities done during

the month. Market data vendors provide this data.

o Real time data on prices are used by brokers and investors to make investment

decisions. Vendors collect this data through the quotes available on stock exchanges

and Electronic Communication Networks (ECNs) and may be a delayed quote by

few minutes. Major real time data vendors include Bloomberg, Reuters, Comstock,

SunGard, Thomson etc.

o Batch wise data are closing prices of securities and may be some notifications of

corporate announcements such as dividends or other information affecting the

shareholders. Some batch data vendors include Standard & Poor’s, Financial

Information Incorporated, J J Kenny, Interactive Data etc.


Industry Bodies

A number of industry bodies operate in the securities industry. Some of them are as follows.

� National Association of Securities Dealers

The National Association of Securities Dealers (NASD) is considered as the rule-making

body governing the over-the-counter brokerage industry. It adopts, administers and

enforces rules of fair practice and also stipulates rules to prevent manipulative and

fraudulent acts and practices and also to promote fair principles of trade to protect the

investors. It also registers member firms, provides rules to supervise their behavior,

scrutinizes them for their conformity. It gives punishment to the faulty firms at the same

time helping the vast majority of the members who obey the rules.

� National Futures Association

The National Futures Association (NFA) was established with the objective of protecting the

public investor by sustaining the reliability of the future’s market place. The board of

directors comprises elected representatives of each category of membership and by

representatives from US futures exchanges and non-futures Board members. Functions of

the NFA :

o Screens all firms and individuals who are desirous of conducting business with the

investing public

o Develops a vast range of investor protection rules and monitor all members for

compliance

o Provides investors with information required to make educated financial decisions

o Adopts fast and efficient methods for settling the disputes


� International Swaps & Derivatives Association (ISDA)

ISDA is an association of member institutions that deal in the privately negotiated

derivatives industry21. It has today approximately 700 member institutions from 50

countries on six continents. ISDA has pioneered efforts to identify and reduce the sources of

risk in the derivatives and risk management business.

• Among its most notable accomplishments are:

– developing the ISDA Master Agreement;

– publishing a wide range of related documentation materials and instruments

covering a variety of transaction types;

– securing recognition of the risk-reducing effects of netting in determining

capital requirements;

– promoting sound risk management practices

� Society for Worldwide Interbank Financial Telecommunication (SWIFT) The need for communicating financial messages across the globe amongst various financial

institutions is fulfilled by SWIFT. Thus SWIFT provides the services of financial data

communication and message processing.

SWIFT has dedicated telecommunication network which ensures that messages are

transferred rapidly, in a cost effective manner and securely.

Financial institutions operating in the areas of securities, payments, foreign exchange,

derivatives and money markets and trade finance use SWIFT messages for communication

24 hours a day.

SWIFT is owned by approximately 2300 banks, broker/dealers and investment6 managers

who use its services.

21 Privately negotiated derivatives means derivative contracts negotiated between two parties which are

popularly known as Over-the-counter Derivatives. Derivatives are explained in the slide on Asset Classes.


Asset

Classes Equity

Fixed

Income

Commodities Derivatives

Currency

Asset Classes

In the earlier sections, we have seen that issuers issue different types of securities. These

securities represent various alternatives available for investments to the investors. Types of

securities which have similar characteristics can be classified into a category called an asset

class. Thus an asset class is nothing but a specific category of assets or investments. The

assets within classes have similar features, are traded in similar market places and are

subject to the same laws and regulations.

Following are the main asset classes.


A brief description of these asset classes are as follows.

Equity

Equity is a share in the ownership of a company. It represents a claim on the company's

assets and earnings. As one acquires more stock, the person’s ownership stake in the

company becomes greater. As an owner, the shareholder is entitled to the company's

earnings (popularly known as dividend) as well as any voting rights attached to the stock.

There are two major types of stocks known as common stock or equity and preferred stock.

� Common Stock

Common stock represents ownership in a company and a claim (dividends) on a portion of

profits. Whenever we refer to equity shares, we are referring to common stock. Common

stock is also known as ordinary stock or shares. Equity shares are listed on stock exchanges

or trade over the counter. The trading in equity shares is very active in well developed

financial markets across the globe.

Equity represents ownership capital and being ownership capital, common stocks carry

risks and rewards of ownership. As far as rewards are concerned, the price appreciation is

considered to be the most promising one. A large number of shareholders hold equity

shares because they expect prices to go up. Other reward includes dividends which are paid

out of profits of the company. Apart from this shareholders have a right to vote and right to

information etc. However these rewards do bring along with them risks in terms of decrease

in price of shares or dividends not being paid since they are not mandatory. Moreover, if a

company goes bankrupt22 and liquidates, the common shareholders will not receive money

22 Bankruptcy in simple terms means the company is unable to meet its payment obligations, thus it may fail to make payments for raw materials it has purchased or salaries or interest on loans etc. Such as company needs to be liquidated i.e. its assets must be sold and liabilities (obligations) must be paid off from proceeds to assets sold.


until the creditors, bondholders, and preferred shareholders are all paid. That is why equity

capital is called a residual capital. That means the claims of equity holders are residual

claims.

It has been observed historically that as an asset equities have provided larger returns

during the long-run compared to other asset classes. This higher return comes at greater

risks as mentioned above.

Preferred Stock

Preferred stock represents some degree of ownership in a company but usually it does not

come with the same voting rights. Preferred stock or preference shares have a combination

of features of equity and debt. Normally, the holders of preference shares are entitled a fixed

dividend. This is different than common stock, which has variable dividends that are never

guaranteed. Preferred shareholders are paid off before the common shareholders in case of

liquidation of the company. As for the risk-return profile of preference shares is concerned,

it lies between the fixed income securities and equity.

Fixed Income Securities

Fixed income securities are securities which promise to pay a fixed amount as a return to the

investors. Unlike equities, where dividends or capital appreciation can hardly be

determined when the investment is made, in case of fixed income securities the interest

payments (called coupon payments) and principal payments are determinable at the time of

investments. From the issuer’s perspective, these instruments represent a kind of loan or

borrowing that the issuer has done. Hence these securities are also called debt securities.

The issuers of fixed income securities involve the governments and corporate. For example,

US government and US corporations issue these fixed income products which have varying

maturities. These securities are marketable and provide liquidity to the users. Treasury

securities (fixed income securities issued by the governments) form major chunk of fixed

income securities which are in the form of treasury bills, treasury notes, and treasury bonds.


Apart from the federal government in the US, state and local governments also issue fixed

income securities which are called municipal debt instruments. Federal government

agencies and government sponsored enterprises (GSEs) also issue debt instruments.

Corporate debt instruments are issued by various corporations to meet their current and

future cash requirements. They are listed and traded on various stock exchanges. However

trading in corporate debt (bonds), is not as active as that of equity shares.

Currencies

Currency market refers to market for foreign currencies. All entities may require foreign

exchange for variety of purposes. For example, individuals need them for funding their

education, travel plans, investments etc. Corporations require foreign currency for meeting

their payment obligations in foreign currency, making investments in foreign country or for

trading purposes.

Foreign exchange market is, by most accounts, the oldest, largest, and most extensive

financial market in the world. According to a triennial survey of foreign exchange markets,

the Bank for International Settlements (BIS) estimated average daily turnover in the global

foreign exchange market to be $1.9 Trillion in April 2004. Currently, the daily turnover in

the global forex market is close to $3.0 trillion.

Dollar, Euro, Pound Sterling and Yen are the four most popular currencies that are traded.

Although participants in the foreign exchange market are increasingly scattered around the

globe, most transactions still take place in London, New York, Tokyo, Singapore, Hong

Kong and Switzerland.

Foreign Exchange market consists of spot, forward and derivative products23. Spot

transaction involves exchange of two currencies for settlement as soon as practicable,

23 Explained in next section


typically in two working days. As can be seen in the table below, they account for about one

-third of the transaction volume. Outright forward contract involve exchange of currencies

at an agreed future date beyond the spot two-day period. Foreign exchange swaps, on the

other hand, involve two transactions. One exchange being performed immediately, in the

spot market and the other being performed at a future date, as a reversal of the first one.

Volumes in FX market over time

(Amount in $ Billion)

1989 1992 1995 1998 2001 2004

Spot Transactions 317 394 494 568 387 621

Outright Forwards 27 58 97 128 131 208

Foreign Exchange

Swaps

190 324 546 734 656 944

Gaps in reporting

(Est.)

56 44 53 60 26 107

Total 590 820 1190 1490 1200 1880

Source: Bank of International Settlement, Triennial Surveys

Commodities

Commodities have existed as oldest asset class. As a simple investment strategy, traders

would hold the stocks of a commodity if they felt price of that commodity would go up. The

organized trading in commodities emerged ever since the evolution of Chicago Board of

Trade, an exchange for trading in commodities set up in the year 1848. A number of

exchanges all over the world provide trading in commodities.

As an example, following commodities are traded on the Chicago Board of Trade, which is

one of the oldest commodity exchanges. Agricultural Products: Soybeans, Wheat, Rice,

Corn, Soybean Oil, Soybean meals, Oats, Precious Metals: Gold, Silver. The other


commodities that are usually traded include livestock and meat, base metals like aluminum,

copper, steel, nickel and zinc. Also, energy products like natural gas, oil, and gasoline are

traded very actively.

Derivatives

Derivatives are financial instruments which derive their value from the value of the

underlying asset. The underlying asset can be equity, fixed income instruments, interest

rates, foreign exchange or commodities. The price movements of derivative products are

related to that of the underlying securities.

� Types of Derivatives

o Forward Contracts – A forward contract is a contract between the two parties

which allows them to exchange the underlying asset at some future date at a

price decided today. For example, a buyer may enter into a contract with a seller

to buy shares of company ABC at $ 50 after one month. Thus the actual exchange

takes place after a month but the price is decided today. This removes the

uncertainty for both the buyers and the sellers.

o Futures Contracts – A futures contract is similar to forward contracts except that

futures contracts are traded on a futures exchange. Thus in case of futures

contracts, buyers and sellers execute the same through futures exchange and not

amongst themselves as it happen in case of forward contracts. Because

transactions are done through a futures exchange, the terms of futures contract

are standardized.

o Options Contracts – Suppose in an example given earlier, a buyer and a seller

decide to exchange shares of ABC at $ 50 after one month, but the buyer reserves

the right to sell the shares to B, then this contract is called an options contract.

This means the buyer has the right but not the obligation to sell (in this case) or

to buy the underlying asset. He gets this privilege if he pays some amount when


the contract is entered into. This amount is known as option premium. Options

can be traded on exchange or traded over the counter between two parties.

Types of Risks

Market participants deal in various asset classes. This exposes them to different types of

risks. Broadly the risks are as follows.

� Credit /Counterparty Risk

This refers to the risk that the counterparty fails to meet its obligations.

o For example, if investor has invested in a fixed income security, the issuer

may fail to repay the interest and / or principal of the security.

o Another example is that of a bank loan where the borrower is unable to

repay the loan.

o Suppose buyer A buys 100 units of a particular security from seller B. Both

of them face the credit risk. Buyer A faces the risk that seller B does not

deliver the securities, while Seller B faces the risk that Buyer A does not pay

the due amount.

All these risks can be classified as credit / counterparty risk.

� Market Risk

Market risk is the risk of losses due to movements in financial market variables.

These may be interest rates, foreign exchange rates, security prices etc. So market

risk is the risk of fluctuations in portfolio values because of movements in these

variables.

The market risks which can be talked about are Price risk, Interest rate risk, Forex

risk, Liquidity risk which are explained below.

o Price risk – Prices of securities keep changing continuously. Thus all the

market participants are worried about the adverse changes in market

prices. This is called the price risk.

o Interest rate risk – Interest rate is an important variable which affects

the prices of securities. Fluctuations in interest rates causes prices of


securities to change and this leads to generation of interest rate risk. The

return for those who have invested in fixed income securities also

fluctuates with changes in interest rates.

o Forex risk – Foreign Exchange refers to the currency of foreign country.

Since the value of foreign currency in terms of domestic currency keeps

changing, this leads to foreign exchange risk.

o Liquidity risk – Liquidity refers to ability to liquidate (sell) investments

whenever required at the right price. Sometimes, one may not be able to

sell securities because there are not enough number of buyers or sellers

who are available to trade in that security. Hence an investor may not

be able to sell the securities whenever he wants. This is liquidity risk.


Types of Markets

The Different types of Financial Markets are as follows:

Primary Market and Secondary markets

This classification is based on issue of securities and trading of securities. Primary market is

the market in which securities are sold at the time of their issuance. In other words, sale of

new securities takes place in primary markets. For instance, when the General Electric needs

money to expand its plant and construction activities, it issues new common stocks in the

primary markets. Or when the US Federal government wants to issue treasury bills or

bonds for the first time, it does so through primary market.

A number of market participants are involved in placing the securities for the first time. For

corporate issues, investment banks play an important role. They help the issuer sell the

shares to investors. In fact they underwrite the issue which means that they subscribe to any

unsubscribed portion of the issue, ensuring that the company gets the full amount of the

issue. As far as issue of government securities are concerned the central banks of respective

countries for example, Federal Reserve in case of US play an important role.

Role of primary markets Primary market enables the issuers to raise the capital required from investors. Thus it has a

major role in bringing the investors and issuers together. A vibrant primary market ensures

that a number of corporates issue securities which in turn provides a range of investment

opportunities for the investors. This leads to an increase in market size, attracting more

investors.


Secondary Markets

If primary markets provide investment opportunities, secondary markets provide exit

option to the investors. Secondary market for financial securities, is a market where

outstanding securities i.e. securities which have already been issued by the issuer are

traded. Thus when a corporation issues new shares, it does so through primary market.

Once these shares are issued to the investors, a mechanism is established so that shares can

be exchanged between the interested parties. This is called the secondary market.

Role of secondary market

The main function of secondary market is to create liquidity in financial instruments. In

simple words, it provides entry point to those investors who want to buy the securities and

exit point to those who want to sell them. Thus a vibrant secondary market increases the

market size, attracts more participation from investors and leads to the development of

sound financial markets. In fact, a healthy secondary market will also give a boost to

primary market.

Money and Capital Markets

This classification of financial markets is based on time for which the securities are issued or

the maturity of securities24. The market where, securities with shorter maturities are traded

and issued is referred to as money markets. The money market is a market for short-term

instruments. The short term is generally defined as less than one year. The issuers can be

governments or the corporations.

The money market instruments, their maturities, principal borrowers and the nature of

secondary market in US are described in the following table.

24 Maturity of instruments mean the time period after which the securities no longer exist. For equities there is no maturity period. For fixed income instruments, there is a maturity period attached to each instrument. For example, US Federal Government issues securities with maturities less than an year (called treasury bills), between two to ten years (called treasury notes) and more than ten years (called treasury bonds).


The Money Market

Instruments Typical Maturities Principal Borrowers Secondary Markets

Federal funds Chiefly 1 business day

Depository institutions Active brokers’ market

Negotiable Certificates of Deposits (CDs)

1 to 6 months and longer

Depository institutions Modest activity

Bankers’ Acceptances 90 days Financial and business enterprises

Limited

Eurodollars Time deposits (non-negotiable)

CD (negotiable)

Overnight, 1 week, 1-6 months and longer 1-6 months and longer

Banks Banks

None Moderately active

Treasury Bills 3 to 12 months US government Very active Repurchase Agreements 1 day, and terms of 2

days to 3 months typical; 6 months less typical

Banks, security dealers, other owners of securities, non-financial corporations, governments

None, but very active primary market for short maturities

Federal agencies Discount notes Coupon securities

30 to 360 days 6 to 9 months

Federally sponsored agencies: Farm credit system, Federal Home Loan Banks, Federal National Mortgage Assn.

Active Active

Commercial paper 1 to 270 days Financial and business enterprises

Moderately active

Municipal notes 30 days to 1 year State and local governments

Moderately active for large issuers

Source: US Monetary Policy and Financial Markets, US Federal Reserve Bank of New York p. 81


The Capital Market

Markets dealing with instruments having maturities exceeding one-year are often referred

to as capital markets. Again the issuers can be governments and corporates. Capital market

is again subdivided into equity market and fixed income market which we have already

seen. Thus the instruments of capital market include fixed income securities with maturities

over one year and equities.

Markets for Financial Instruments

Equity Markets

In equity markets equity related instruments are traded. These are as follows.

� Equity Related instruments

o Common Stock – Refer to the section on equity in asset classes.

o Preferred Stock - Refer to the section on equity in asset classes.

o Convertible Bonds – These instruments, when issued, are fixed income

securities to be converted into equity shares after some time. The

conversion into equity shares can be optional or mandatory. The

conversion terms are generally pre-specified so that the investor knows

how many shares he gets after the conversion.

o Equity Warrants – Warrants entitle the warrant holders to subscribe to

equity shares at a particular price sometime in the future. It is similar to

options explained earlier, but equity options traded on the exchanges

are of short term maturity while warrants generally have a long term

maturity. Warrants are generally issued along with another security.

For example, a company at the time of issuing fixed income securities

may issue equity warrants. These warrants may be listed and traded

separately on stock exchanges.

o Equity Indexes – By equity index we mean a weighted average price for

a group of securities which make that index. For example, Standard &

Poor 500 index consists of weighted average price for shares of 500


companies that make this index. Equity index may be traded just like a

single stock. Moreover, derivatives based on equity indexes as

underlying assets are also available.

o Equity Futures & Options – Futures & Options are already explained. In

this case, the underlying assets are equity shares.

Fixed Income or debt markets In this market, fixed income instruments are traded.

� Fixed Income Instruments Fixed income instruments can be classified broadly into three categories:

o Money market instruments,

o US Government Securities

o Corporate Bonds

o Money market instruments :

Commercial paper is a short-term debt instrument issued by both financial and

non-financial companies. These debt instruments are unsecured in nature, that

means, they do not require any charge to be created on the company’s assets. In

simple terms, if the company fails to pay back the investors the amount of

commercial papers after their maturity, the investors can not sell a particular

asset and recover their dues. Commercial papers are discount instruments

which means they are issued at discount and redeemed at face value. For

example suppose the par value or face value of commercial paper is $

1,000,000, and has a three months maturity, it may be issued at say $955,000.

Thus investor pays $ 955,000 at the time of making the investment and gets

$1,000,000 back after the maturity (three months in this case). The difference

represents the income earned by the investors.

o Certificates of deposits (CDs) are interest-bearing deposit at a commercial

bank or saving and Loan association. Jumbo or large denomination CDs are


issued in amounts of $100,000 or more, have a specified maturity, and are

generally negotiable and can be sold by one investor to another. All interest is

paid along with the principal at maturity. Foreign banks that have branches in

US also offer dollar-denominated CDs to investors.

o Bankers’ acceptances are the trade financing instruments. For example,

Company A sells goods worth $500,000 to Company B. The latter does not have

money to pay at present but issues a written promise that it will do so in three

months. This promise is accepted by a bank. Thus the bank obligates itself to

pay the amount if Company B fails to pay on due date. The accepted bill may

be sold by the Company A immediately for a discount to an investor. The

investor in turn may keep it till maturity or trade the same.

o Repurchase agreement is most popular form of money market instruments

that is used by the financial institutions. For instance one investor (a financial

institution) sells to another investor (a financial institution) a security and

agrees to repurchase it at a later date for an agreed price. These agreements

involve little risk to the lenders because the money market instruments used in

a repurchase agreement are of high quality.

o US Treasury Bills are issued at a discount with maturities of up to 52 weeks,

and in denominations of $1000 dollars or more. These instruments are issued in

book entry form; the buyer receives a receipt at a time of purchase that

indicates the bills’ face value at maturity. Offerings of 13-week and 26-week

bills are usually made once in a week and 52-weeks bills are offered every

fourth week.


US Government Securities – Bonds & Notes

o US Treasury bonds are another form of fixed income instruments with

maturities greater than 10 years at the time of issuance. Denominations range

from $1000 upward and some bonds will have call provisions allowing them to

be “called” during a specified period. US government issues notes with

maturities from 2 to 10 years.

Corporate Bonds

o Corporate bonds are similar to the other kinds of fixed income securities in that

they promise to make specified payments at specified dates and provide legal

remedies in the event of default. Restrictions are often placed on the activities

of issuing corporations to provide protection to the bondholders.


Role of Regulators

Regulators play an extremely important role in smooth conduct of the securities industry.

Every country has one or many regulators which are responsible for regulation, supervision

and conduct of securities industry in those countries. Some of the countries and regulators

are as follows.

Country Regulator Australia Australian Securities & Investments Commission

Belgium Banking, Finance and Insurance Commission China China Securities Regulatory Commission France Autorité des marchés financiers Germany Bundesanstalt für Finanzdienstleistungsaufsicht Hong Kong Securities & Futures Commission India Securities & Exchange Board of India Japan Financial Services Agency South Korea Financial Supervisory Commission / Financial Supervisory Service United Kingdom Financial Services Authority United States Securities & Exchange Commission

Securities and Exchange Commission (SEC):

Securities and Exchange Commission (SEC): It administers

the US securities industry. The Congress through the

Securities Exchange Act of 1934 brought it into existence. The

functions of SEC are as follows:

To set the overall rules for the industry and to review the procedures established by

the Self Regulating Organizations to make sure that they comply with the security law

To review the new securities registrations to find out whether they comply with the

laws established by the Congress

To protect the rights of the individual investors and at the same time manage the

securities market place to eliminate any serious disruption in the US financial markets


The executive body of SEC consists of five commissioners, comprising the Chairman

appointed by the President of the US. This appointment is carried with the consent of the

senate for five-year term of office. The executive body consists of no more than three

commissioners from the same political party. The Commission has its headquarters in

Washington DC and operates regional offices around the country.

The mission of the U.S. Securities and Exchange Commission is to protect investors,

maintain fair, orderly, and efficient markets, and facilitate capital formation.

Investing in bonds, equities, and other securities involve the risk of loss in value. Unlike the

banking world where in federal depository insurance cover provides some guarantee to the

depositors, in the securities market such guarantee is not available. Hence investors need to

be careful in investing and government needs to protect the interests of investors by making

appropriate laws.

The laws and rules that govern the securities industry in the United States derive from a

simple and straightforward concept: all investors, whether large institutions or private

individuals, should have access to certain basic facts about an investment prior to buying it,

and so long as they hold it. In order to achieve this, the Securities Exchange Commission

(SEC) requires the public companies to disclose meaningful financial and other information

to the public. This provides a common pool of knowledge for all investors to use to judge

for themselves whether to buy, sell, or hold a particular security. Only through the steady

flow of timely, comprehensive, and accurate information can investors make sound

investment decisions.

The result of this information flow is a far more active, efficient, and transparent capital

market which facilitates the capital formation, that is so important to the nation's economy.

To ensure that this objective is always being met, the SEC continually works with all major

market participants, including the investors in the securities markets, to listen to their

concerns and to learn from their experience.


What does SEC do?

The SEC oversees the key participants in the securities world, including securities

exchanges, securities brokers and dealers, investment advisors, and mutual funds. Here the

SEC is concerned primarily with promoting the disclosure of important market-related

information, maintaining fair dealings, and protection against fraud.

Crucial to the SEC's effectiveness in each of these areas is its enforcement authority. Each

year the SEC brings hundreds of civil enforcement actions against individuals and

companies for violation of the securities laws. Typical infractions include insider trading,

accounting fraud, and providing false or misleading information about securities and the

companies that issue them.

One of the major sources of information on which the SEC relies to bring enforcement action

is investors themselves -- another reason as to why educated and careful investors are so

critical to the functioning of efficient markets. To help support investor education, the SEC

offers the public a wealth of educational information on this Internet website, which also

includes the EDGAR database of disclosure documents that public companies are required

to file with the Commission25.

Organization of the SEC

The SEC consists of five presidentially-appointed Commissioners, four Divisions and 18

Offices. With approximately 3,100 staff, the SEC is small by federal agency standards.

Headquartered in Washington, DC, the SEC has 11 regional and district offices throughout

the country.

The Commissioners

The Securities and Exchange Commission has five Commissioners who are appointed by the

President of the United States with the advice and consent of the Senate. Their terms last

25 In the US, all companies, foreign and domestic, are required to file registration statements, periodic reports, and other forms electronically through EDGAR.


five years and are staggered so that one Commissioner's term ends on June 5 of each year.

To ensure that the Commission remains non-partisan, no more than three Commissioners

may belong to the same political party. The President also designates one of the

Commissioners as Chairman, the SEC's top executive.

Some aspects covered in various laws

Corporate Reporting - Following the registration of stocks with the SEC for public offer by

the companies, corporations must file annual reports and disclose periodic updates on the

functioning of the corporation. Issuers must send the certain reports to the shareholders and

all the information about the corporation is to be electronically filed with SEC website.

Insider Trading - Insider trading refers to the misuse of confidential information about the

company that is not available to the general public. This is in the form of:

buying or selling shares to make profits or avoid losses based on material non-public

information

informing non-public information to others so that they may buy or sell securities

before such information is available to the public.

The SEC has brought numerous civil actions to such practices and Section 16 of the

Exchange Act requires that such information be furnished to the SEC.

Margin Trading – Market participants may purchase securities using borrowed money.

This is referred to margin trading. This borrowing is subject to the limitations prescribed by

the SEC. The objective of margin trading rules is to prevent excessive use of credit for

purchase or carrying of securities. The Board of Governors of the Federal Reserve System is

authorized to set these limits.


Registration with the SEC – The Act requires the following entities to be registered to carry

out their business in the security markets.

Brokers and dealers

Transfer agents

Clearing agencies

Securities information processors

These entities must show that they are organized and comply with the provisions of the

statue as well as rules and regulations of the SEC.

Financial Services Modernization Act 1999 removed the barriers for banks, brokers and

insurance companies to merge and cross sell their products.

Sarbanes-Oxley Act (SOX) of 2002 defines the rules and procedures for corporate

accountability with respect to financial statements and disclosures with the objective: “to

protect investors by improving the accuracy and reliability of corporate disclosures made

pursuant to the securities laws.” The law makes violations of these rules the same as a

violation of the 1934 Act, and imposes the same penalties.

The SOX Act requires chief executive officers and chief financial officers to individually

confirm their company’s financial statements. Corporate audit committees are particularly

responsible for hiring, compensating and supervising the independent auditors and there

are new requirements with respect to the improved financial disclosures.

SOX is applicable to all publicly traded firms listed on any US-based financial exchange, not

considering their domicile. The Act stipulates the annual report of a publicly traded firm to

consist an internal report that:

Identifies the individual who is responsible to establish and maintain the internal

control structure and procedures for financial reporting


Makes an assessment of the effectiveness of internal control structure and the

financial reporting procedures

Disclose all financial and non-financial reports

Update investors with all the latest changes inside the organization both financial

and non-financial

Public certification of financial reports and internal controls by the CFO and CEO

To report company securities trading within two business days

CFOs and CEOs should certify that they are responsible for establishing and

maintaining disclosure controls and procedures

The penalties are:

Criminal penalties for records destruction, securities fraud and failure to report

fraud

A CFO or CEO who knowingly certifies non-complying financials shall be fined up

to $1 million and imprisoned for 10 years

Failure to maintain all audits or review papers for at least five years may result in jail

terms of ten years.

Jail term may go up to 20 years for destroying documents in federal or bankruptcy

investigation while penalty for securities fraud is 25 years

Financial Services Authority (FSA)

Financial Services Authority (FSA) an independent body that regulates the financial services

industry in the UK. It has been given a wide range of rule-making, investigatory and

enforcement powers in order to meet its four statutory objectives:


Objectives

The Financial Services and Markets Act gives FSA four statutory objectives:

market confidence: maintaining confidence in the financial system;

public awareness: promoting public understanding of the financial system;

consumer protection: securing the appropriate degree of protection for consumers;

and

the reduction of financial crime: reducing the extent to which it is possible for a

business to be used for a purpose connected with financial crime.

The objectives also include:

To provide for political and public accountability. The annual report contains an assessment

of the extent to which these objectives are met. Scrutiny of the FSA by Parliamentary

Committees may focus on how to achieve the objectives. It carries out general functions e.g.

rule-making, giving advice and guidance, and determining the general policy and

principles.

The FSA is the single statutory regulator responsible for the authorization and regulation of:

Deposit taking (by banks)

Insurance

Investment Business

Mortgage advice

General Insurance advice

Regulatory Approach

The FSA has been the single regulator for financial services in the UK since December 2001,

when the Financial Services and Markets Act 2000 (FSMA) came into force. Since then , it

has had a single Handbook of rules and guidance for all authorized financial firms carrying

out business in the UK. The Government has increased the scope of the activities it regulates


since November 2004. This includes mortgage business, and since January 2005 general

insurance activities are added. These significant extra responsibilities have resulted in a

marked growth in the size of the organization.

In January 2000 FSA set out the proposed approach to regulation in a New Regulator for the

New Millennium. The regulator stated that its overriding aim was "to maintain efficient,

orderly and clean financial markets and help retail consumers achieve a fair deal". Its

approach is based on a clear statement of the realistic aims and limits of regulation; it

recognizes the proper responsibilities of consumers and of firms' own management, as well

as the impossibility and undesirability of removing all risk and failure from the financial

system.

Progress

The regulator issued three progress reports describing its continuing work in developing

this operating framework. This includes a paper 'The Firm Risk Assessment Framework',

which it published in February 2003, setting out what firms need to know about how risk

assessment works and what it means for them. It now has over two years of working within

its operating framework. Although this has proved to be a key tool for the regulator in

discharging its regulatory duties, as might be expected FSA found it necessary to consider

further refinements to it and to its overall approach towards risk.

FSA’s Handbook presents the standards expected from regulated firms and is a key vehicle

for communicating those standards to the outside world. So it should reflect vision and

values of the Authority. These include an approach to rule-making based as far as possible

on high-level principles, rather than detailed prescription; a focus on senior management

responsibility; and acting in a proportionate and risk-based way.


Recent Developments in Financial Services Industry

Dematerialization

In the past, securities were issued in the certificate form representing ownership of the

security. As trading volumes soared, the processing of security certificates became difficult

to handle through the manual process. Hence the form of securities was changed from

paper form to electronic form called dematerialized form. Thus dematerialization is a

process of eliminating physical certificates and keeping them only in electronic forms.

Securities are initially immobilized26 in a depository, and through dematerialization the

securities become paperless or take the electronic form. In US, it is a compulsory

requirement that before any security can be listed for trading, it must have been made

depository-eligible i.e. it meets the criteria of depository and is available in dematerialized

form.

Electronic Trading

This refers to the trading platform that makes use of global distribution network. For

example, NASDAQ uses a sophisticated computer and telecommunications network, which

transmits real-time quotes and trade data to more than 2 million users in 83 countries. It is

capable of trading all 6700 US securities listed on NYSE, AMEX and NASDAQ on

geographically diverse and resilient network. Electronic trading makes an exchange no

longer be tied to a place.

London International Financial Futures and Options Exchange (LIFFE) is the world’s

leading electronic derivatives exchange. This was established in the year 1982 deals with the

exchange traded derivatives. It offers wide range of derivative products. LIFFE CONNECT

is the most advanced electronic trading platform which provides an opportunity to the

26 Immobilization means placement of physical certificates in central securities depository so that the movement of such securities is reduced and done through a book entry transfer only.


LIFFE’s customers to trade depending on their requirements. It is located in 421 sites in 23

countries worldwide.

Web Trading

Web trading refers to trading of shares by the buyers and sellers using Internet services.

Along with the online broker transactions web trading includes financial transaction

processing. In other words, it supports traditional internet and the brokerage transaction

process network.

Electronic Communications Networks

Electronic Communications Networks (ECNs) are also known as fourth-market

organizations designed to automatically execute buy and sell orders of investors’ by

computers without the intervention of specialists or dealers. Instinet is the first ECN that

continues to be the largest ECN even though several other ECNs have proliferated due to

the rapid growth of trading volumes. They include Island, Archipelago, and Tradebook.

Investors submit individual trade requests to ECN through online brokerage firms. Most

stocks traded on ECN are NASDAQ securities. For a commission the ECNs attempt to

match buy/sell orders and executes the market order trades.

Financial Messaging

The dynamic nature of financial markets and institutions requires exchanging information with

clients and counterparties efficiently. Financial Messaging involves combining all the financial

service functions including buy sell orders, funds transfers, trade settlement instructions, and

credit card information. It involves infrastructure for a unified standard that encompasses all

phases of a trade or transaction lifecycle. For example, SWIFT (Society for Worldwide Inter-

bank Financial Telecommunication) is a co-operative organisation created and owned by

banks that operate a network facilitating the exchange of payments and other financial

messages between financial institutions throughout the world. It is used extensively for

transmitting post-trade processing messages.


FIX

Financial Information eXchange (FIX) protocol is a technical specification for electronic

communication of trade related messages. It came into being in 1992, as a bilateral

communications framework for equity trading between Fidelity Investments and Salomon

Brothers. Since then it has become an industry standard electronic protocol used for pre-

trade communications and trade execution. Thus market participants have a common global

language for automated trading of securities.

Member firms voluntarily develop the FIX protocol. The coordination of development of

protocol is done through various committees, sub-committees. It is used by institutions,

brokers, exchanges and ECNs.

Market Data Definition Language (MDDL)

Market Data Definition Language (MDDL) is an XML based interchange format and

common data dictionary that allows entities to exchange market data by standardizing

formats and definitions.

In simple words, MDDL ensures that

a common format is provided for market data

in order to efficiently pass this data from one processing system to another

thus MDDL provides a common understanding of market data content as terminology is

standardized

MDDL provides a generic format on the fields needed to describe Financial instruments,

Corporate Events, Market Related Information.


Shortening of Settlement Cycles

A typical Settlement Cycle in US securities is on T + 3 basis. This means that the settlement

i.e. exchange of securities and funds take place within three days of the trade. For trades

done on Monday, settlement has to be completed by Thursday. There are two types of

settlements. The trend not only in US but world over is shortening of settlement cycles. Thus

systems are being developed so that the settlement cycle reduces further to T + 2 or T + 1 as

the case may be.

In order to achieve this objective, Straight Through Processing (STP) helps, which provides

seamless connectivity for the entire trade processing without manual intervention.

GLOSSARY

Asset Class: An asset class is nothing but a specific category of assets or investments. The assets within classes have similar features, are traded in similar market places and are subject to the same laws and regulations. Bankruptcy: Bankruptcy means the company is unable to meet its payment obligations, thus it may fail to make payments for raw materials it has purchased or salaries or interest on loans etc. Such a company needs to be liquidated i.e. its assets must be sold and liabilities (obligations) must be paid off from proceeds to assets sold.

Capital market: Markets dealing with instruments having maturities exceeding one-year are often referred to as capital markets.

Central counterparty function: It guarantees that the trade will take place without any

default. For example if the buyer of securities fails to make payment for his purchase, the

seller is guaranteed money for the securities he has sold through Central Counter party.

Certificates of deposits (CDs): These are interest-bearing deposits at a commercial

bank or Saving and Loan Association.


Commercial paper is a short-term debt instrument issued by both financial and non-financial companies.

Common Stock: Common stock represents ownership in a company and a claim (dividends) on a portion of profits. Convertible Bonds – These instruments, when issued, are fixed income securities to be converted into equity shares after some time.

Corporate bonds are similar to the other kinds of fixed income securities in that they promise to make specified payments at specified dates and provide legal remedies in the event of default.

Custodian Banks: The securities in which they invest need to be kept safely and

administered in the sense the record of buying and selling and the stock of securities need to

be updated on a continuous basis. This service is called custody service which is provided

by Custodian banks.

Day Trader: A day trader typically buys or sells securities during the day

and does the reverse to close positions by the end of the day.

Demand Deposits: These accounts do not earn any interest for keeping deposits but the deposit holder can withdraw deposit any time he wants. Dematerialization: Dematerialization is a process of eliminating physical certificates and keeping them only in electronic form.

Derivatives: Derivatives are financial instruments which derive their value from the value of the underlying asset. Dividends are a part of profits that any company / investment institution pays out to the

shareholders.

Electronic Communications Networks (ECNs) are also known as fourth-market organizations designed to automatically execute buy and sell orders of investors’ by computers without the intervention of specialists or dealers.


Electronic Trading: This refers to the trading platform that makes use of global distribution network. Equity: Equity is a share in the ownership of a company. It represents a claim on the

company's assets and earnings. As one acquires more stock, the person’s ownership stake in

the company becomes greater.

Equity Index: By equity index means a weighted average price for a group of securities, which make that index. Equity Warrants: Warrants entitle the warrant holders to subscribe to equity shares at a particular price sometime in the future.

Financial Markets: Financial markets facilitate the transfer of surplus funds from the (savers/investors/lenders) to those who are in need of funds (issuers/borrowers).

Financial Messaging involves combining all the financial service functions including buy sell orders, funds transfers, trade settlement instructions, and credit card information.

Financial Securities: Financial securities are issued by those who need capital and represent the fact that such issuers have raised funds from investors.

Financial Services Authority: It is an independent body that regulates the financial services industry in the UK.

Fixed Income Securities: Fixed income securities are securities which promise to pay a fixed amount as a return to the investors. Forward Contract: A forward contract is a contract between the two parties which allows them to exchange the underlying asset at some future date at a price decided today.

Full Service Firms: These broking firms offer a full range of services. They have large

research departments which offer client advice and research on securities.

Immobilization: Immobilization means placement of physical certificates in central securities depository so that the movement of such securities is reduced and done through a book entry transfer only.

Individual Investors: Investors who make investment decisions on their own and invest money in various securities directly.


Insider Trading: Insider trading refers to the misuse of confidential information about the company that is not available to the general public.

Investment Managers: The investment managers or asset managers actually take the

decisions to deploy collective investment funds in various investment products / securities.

Issuers: Issuers include government, government sponsored-agencies and corporations that desire to raise funds. They need to raise funds for a variety of purposes.

Managed Investment Companies: They collect money from individual investors, business corporations and other institutional investors and, in turn, give them mutual fund units, which are financial securities.

Margin Trading: Market participants may purchase securities using borrowed money. This is referred to margin trading.

Money Market: The market is one where in securities with shorter maturities are traded and issued is referred to as money markets.

Mutual Fund: A mutual fund is a fund collected by Managed Investment Companies that is

invested in a diversified portfolio of securities.

Net Asset Value: The price per share at which an investor can redeem shares is referred to as the fund’s net asset value. It is the current market value of all the fund’s assets, minus liabilities, divided by the total number of outstanding shares. Netting of Trade: Netting of trades is done as a part of clearing process. For example, broker buys 300 units of Security A for Client B during the day and sells 200 units of same security for Client C. In this case, the Clearing Corporation will arrive at a net buy position (300-200) for this broker. Netting reduces the number of transactions.

Over-the-counter (OTC) market It is a market for stocks consists of dealers who buy or sell stocks by negotiating through telephones and computer systems.

Preferred stock: Preferred stock represents some degree of ownership in a company but usually it does not come with the same voting rights. They have a combination of features of equity and debt.

Price Discovery: “Price discovery” means that when securities are continuously transferred between various investors, it helps arrive at the correct price at which the security should trade.


Primary Market: Primary market is the market in which securities are sold at the time of their issuance.

Processing of trade: It means preparing for clearing and settlement of securities and

actually settling the trades.

Professional Investors: This refers to all those individuals who have

substantial investment resources so that they can acquire professional

money management services for their investment portfolio.

Rolling Settlement: The settlement takes place a given number of business days after the date of the trade. For example, if rolling settlement is T + 3, all the trades, no matter whether they are done on any of the week days, will be settled in three business days subsequent to the trading day.

Savings accounts – These accounts pay a low rate of interest. These accounts are generally

very popular amongst individuals who park their surplus funds and withdraw whenever

they want subject to certain restrictions.

Secondary Market: Secondary market for financial securities, is a market where outstanding securities i.e. securities which have already been issued by the issuer are traded.

Secured Lending: Secured lending means that the loan given is secured against any asset

that borrower has.

Self Regulating Organization: It is an exchange, association, a clearing agency or a

depository. They play an important role as exchanges, clearing agencies or depositories in

trade processing, clearing and settlement.

Shareholding pattern: It is a summary of list of shareholders and the number of shares each

holder owns.


Stock exchanges: They are the institutions which provide trading facilities to all interested

parties who trade through individuals or firms which are the trading members of stock

exchanges.

Stock Pickers: Stock Pickers are those individuals who are of the opinion

that they can choose individual stocks for long-term investment on their

own. They do their own research and pick the stocks accordingly.

US Treasury bonds are another form of fixed income instruments with maturities greater than 10 years at the time of issuance Underwriting Services: Underwriting Services mean whenever issuers issue securities,

underwriters ensure that any unsubscribed portion is subscribed to by the underwriters.

This ensures that the issuer raises the amount which is required by him.

Unsecured lending – These types of lending are not secured against any asset. Hence in the

event of default i.e. corporate not paying back the loan, the bank can not take charge of any

asset and recover its dues.

Web Trading: Web trading refers to trading of shares by the buyers and sellers using Internet services.

Sample Questions: US Securities Markets - Introduction and Overview

Answers are marked in green


1. Issuer A issues securities to investors which are not subsequently listed on an exchange.

Hence we can say that the securities issued are

a non-negotiable

b non-tradable

c unlisted

d Both b & c above

2. A large number of buyers and sellers trade in the securities at different prices in financial

markets. Hence we can say that trading by large number of buyers and sellers helps in

a financial disintermediation

b discovery of price for the securities

c generation of profits for the issuer

d none of the above

3. When an underwriting service for an issue of securities is carried out by a bank, it means

that

a. Bank markets the issue to other investors

b. Bank guarantees subscription to unsubscribed portion of the issue

c. Bank decides the price at which the securities are to be offered to

investors

d. Bank helps in preparing prospectus for the issue

4. Identify from the following who is not a financial intermediary

a Broker/ Dealer

b Banks

c Government

d Insurance Company

5. A corporation wants to raise capital for financing its project by issuing shares to

investors. If the corporation raises funds by issuing shares this will lead to ---------


a financial disintermediation

b financial intermediation

c financial securitization

d financial integration

6. Which of the following statements is true ?

a Mutual fund managers create managed investment companies to collect

funds from investors

b Managed investments companies are owned by investors who subscribe

to mutual funds created by managed investment companies

c Managed investment companies hire mutual fund managers to manage

the funds raised from mutual fund investors

d Mutual fund investors hire mutual fund managers to manage their fund

7. Mr X is an individual investor. He visits the stock exchange daily and sits in retail dealing

room of his broker. He buys and sells securities very frequently for a very short period of

time. He is likely to be called ------

a A professional investor

b A stock picker

c A mutual fund investor

d A day trader

8. An insurance company is active in the security markets because _____________

a it has to offer clearing services to the clients

b it has to deploy funds collected by way of insurance premium

c it has the responsibility of providing underwriting services to the issuers

d it provides settlement services to its clients

9. US Federal Government needs funds for two years. Hence it should issue ---------------

a equity shares


b treasury bills

c fixed income securities

d derivatives

10. Federal Home Loan Mortgage Corporation and Federal National Mortgage Association

issue --------------------

a municipal debt

b fixed income securities

c bankers’ acceptances

d mortgages

11. Which of the following statements is not true ?

a Commercial banks offer custody services

b Commercial banks offer loans to broking firms

c Commercial banks do not offer clearing services for US government

securities

d Commercial banks do not offer clearing services for equity shares

12. Which of the following does not compete with bank deposits in generating funds from

investors?

a Mutual funds

b Equity shares

c Corporate fixed income securities

d None of the above

13. As far as the fixed income security market is concerned, secondary market is

one

a. where new fixed income securities are issued

b. market in which only corporations can issue new fixed income securities

c. where existing fixed income securities are traded


d. None of the above

14. Which of the following is not a fixed income or debt security?

a. Government bonds

b. Intel stock

c. Corporate debt

d. Municipal debt

15. For its employee retirement plan, ABC Corporation will set some amount

aside each year to be invested in various securities. The management of such

funds will be done by forming a separate legal entity in the form of -------

aaaa an investment bank

bbbb a depository

cccc an institutional trust

dddd a subsidiary company

16. Investment managers can be structured as

a sole proprietorships

b partnerships

c corporations

d All of the above

17. S & S Financial Services offers investment advice to its investors. It executes deals on

behalf of its clients. The firm can be called

a A broker

b A dealer

c Both a & b above

d A portfolio manager


18. Identify from the following which is a benefit of investing in a mutual fund

industry

a Diversification

b Illiquidity

c Professional investment management

d Both A & C above

19. Money market mutual funds consists of securities of

a. Less than one year

b. Above one year

c. Exactly one year


20. The organization in the US that is responsible for setting up and implementing security

markets related policies and regulating the same, is:

a. Federal Open Market Committee

b. Federal Reserve System

c. Securities Exchange Commission

d. Exchange Commission

21. An institution offers advice to corporates on valuing companies so that some of them can

be taken over / acquired by the companies seeking the advice. This institution is likely to be

----

a An investment bank

b A trust bank

c A Broker / dealer

d Managed investment company

22. The rule making body governing over-the-counter brokerage industry is

a. National Association of Securities Development


b. National Futures Association

c. International Swaps and Derivatives Association

d. National Association of Securities Dealers

23. Insider Trading Act deals with

a. Trading based on inside information of the firm

b. Misuse of non-public information

c. the extent to which a broker can finance purchase of securities for his clients

d. Both A & B above

24. An equity research analyst, Mr X, employed by an investment bank seeks an advice of

his friend Mr Y, who is working in corporate finance department of the same bank. Mr X

especially checks with Mr Y before giving a sell recommendation on a stock of any

company. Which of the following is true in this case?

a This is a normal industry practice

b Mr X should check with Mr Y especially in case of sell recommendation, as

the company may turn out to be client of investment bank

c This gives rise to conflict of interest and there should be no interaction

between Mr X and Mr Y on this matter

d Mr Y should let the company know about sell recommendation if the

company is client of an investment bank

25. Mr X is employed by an insurance company. He keeps a close watch on surpluses and

deficits of cash and takes a decision where to invest surpluses and where to generate funds

to finance deficits in cash for the short term. He is likely to be ----

a Insurance manager

b Treasury manager

c Research analyst

d Asset Manager


26. Which of the following is true?

a Stock exchanges operate under the supervision of central banks of the

countries

b Investors can buy or sell securities directly through stock exchanges without

intermediation by brokers

c Stock exchanges form their own rules regarding listing of securities, allowing

membership etc.

d Both a & c above are true


a In case of over-the-counter market, investors assemble near the counters

where shares are traded and trade in shares

b In case of over-the-counter market, investors trade in securities through a

network of computers

c New York Stock Exchange provides the facility for over-the-counter trading

d None of the above

28. Netting of trades in securities is done by ------

a Clearing service providers

b Settlement service providers

c Stock exchanges

d Brokers

29. Government securities and Mortgaged Backed securities are cleared in US by -------

a National Securities Clearing Corporation

b Options Clearing Corporation

c National Association of Securities Dealers

d None of the above

30. Which of the following offer clearing services?

a International Central Securities Depositories


b Custodians

c Fixed Income Clearing Corporation

d Local custodians

31. Which of the following is not a settlement service provider?

a Global custodian

b Transfer agents

c National Futures Association

d Central Securities Depository

32. A firm keeps the record of shareholders of various companies and tracks the changes in

shareholding patterns of various companies. This firm is likely to be ----

a An investment bank

b A custodian

c A transfer agent

d A broker/dealer

33. Settlement means exchange of funds and __________________

a Interest

b Securities

c Dividend

d Returns

34. A Central Securities Depository in US is

a Depository Trust & Clearing Corporation

b Euroclear

c Clearstream

d State Street



a. Investors open account with depositories, which are in turn members of

custodians, for keeping their shares in electronic form

b. Investors open accounts with custodians, which are in turn members of

depositories, for keeping their shares in electronic form

c. Investors open accounts with custodians which are in turn members of stock exchanges, for keeping their shares in

electronic form

d. Depositories allow trading in shares through them as they are the members of

stock exchanges

36. Checking accounts in the banks are

a Interest bearing accounts

b Non-interest bearing accounts

c also called savings accounts

d None of the above

37. ABC Corporation declares a divided of 20% of its net income. This dividend is collected

from the company and paid to the shareholders by ----

a. A commercial bank

b. A custodian bank

c. A trust bank

d. A clearing service provider

38. A transfer of securities in the electronic form is done by book entry. This transfer is done

by ----

a. Depository

b. Buying and selling brokers

c. Custodian banks

d. NASD

39. Which is not a function of an Investment manager?


a Research and portfolio management

b Trading for their own account or for the client portfolios when they have

discretionary authority

c Offering investment advice when they do not have discretion to invest on

their own

d Promising a fixed return to the investors

40. Treasury bills are issued at a _____________

a Premium

b Discount

c Face value

d None of the above

41. International Swaps & Derivatives Association ------

a. is an association of member institutions dealing in exchange traded

derivatives

b. is an association of member institutions dealing in privately negotiated

derivatives

c. is an association of member institutions dealing in over-the-counter

derivatives

d. Both b & c

42. The clearing house for equity derivatives in the US is ----

a. Chicago Board Options Exchange

b. International Securities Exchange

c. American Stock Exchange

d. Options Clearing Corporation

43. National Securities Clearing Corporation -----


a. Does not provide central counterparty services to money market

instruments and debt

b. Provides central counterparty services to money market instruments and

debt

c. Provides clearing services to money market instruments and debt

d. Both b & c above

44. Which of the following type of a mutual fund is expected to be least volatile in terms of

returns provided to investors?

a. Equity fund

b. Bond fund

c. Derivatives fund

d. Money market mutual fund

45. Mutual funds in US are highly regulated by -------

a. Association of Mutual Funds of US

b. Securities Exchange Commission

c. Federal Reserve Bank of US


46. Identify from the following which entity is not an Issuer of debt in the US

a States

b U S Federal Government

c Municipalities

d None of the above

47. Student Loan Marketing Association ----

a. is a government sponsored association

b. is a private association not sponsored by the government

c. facilitates purchase of student loans in secondary markets


d. both a & c above

48. Country A has a well developed banking system. Hence residents of this country put

their savings mostly in banks which are considered safe. For risk loving investors, no risky

investment opportunities are available. Similarly, for those who want to invest for long

term, hardly any investment products are available. This can be a description of ------

a. a well developed financial market

b. an underdeveloped fixed income securities market

c. an underdeveloped equity market

d. Both b & c above

49. Which of the following can not be the issuer of equity shares?

a. Stock exchange

b. Local government

c. Commercial Bank

d. Both a & b above

50. Equity capital provides a ________ claim on assets of the issuer to the investor

a total

b residual

c preferential

d None of the above

51. NASDAQ represents ----

a. an over-the-counter market

b. a market for listing shares of information technology companies

c. a market for fixed income securities

d. a market where brokers assemble to trade in equities

52. Certificate of Deposit is ____________________


a a non-negotiable instrument

b a negotiable instrument

c is also called a time deposit

d None of the above

53. Spot transaction involves exchange of two currencies for settlement as soon as

practicable, typically in __________working days

a Three

b One

c Two

d Five

54. Identify from the following which is not a function of a custodian bank?

a. Keeping track of income collection

b. Safe keeping of securities

c. Trading on behalf of customers

d. Providing settlement service to customers

55. Equity shares can not be traded _____________.

a over-the-counter

b on the floor of the Exchange

c through a network of computers

d None of the above

56. If financial markets are classified on the basis of issue and trading of securities, we can

classify them as ----------

a Money and capital markets

b Spot and forward markets

c Primary and Secondary markets

d Equity and Fixed Income markets


57. Convertible bonds are

a Money market securities

b Equity shares

c Fixed income securities with an option to convert into equity shares

d Derivatives

58. Primary markets enable issuers to raise ---

a Both equity and debt capital

b Only equity

c Only debt

d None of the above

59. Underwriting is done by a

a Trust bank

b Investment bank

c Commercial bank

d Custodian Bank

60. Mr X has invested in securities issued by a company. He is entitled for a fixed dividend.

However he has not received the dividend for the last two years. He must be holding ----

a. Common stock

b. Preferred stock

c. Convertible bond


61. Mr X, Mr Y and Mr Z have invested is common stock, preferred stock and fixed income

securities respectively issued by the same issuer. In terms of level of risks assumed by them,

we can say that -----

a. All of them have the same level of risk since the issuer is same


b. Mr Y has lowest level of risk amongst them

c. Mr Z has highest level of risk amongst them

d. Mr X has highest level of risk amongst them


securities respectively issued by the same issuer. In terms of returns expected by them, we

can say that --

a. All of them have the same level of return expectations since the issuer is

same

b. Mr X has lowest level of return expectations amongst them

c. Mr Z has lowest level of return expectations amongst them

d. Mr Y has highest level of return expectations amongst them


securities respectively issued by the same issuer. Unfortunately the company in which they

have invested in is being wound up. The proceeds from the sale of company’s assets will be

distributed to them in the following priority.

a 1st – Mr X, 2nd – Mr Y, 3rd – Mr Z

b 1st – Mr Z, 2nd – Mr Y, 3rd – Mr X

c 1st – Mr Y, 2nd – Mr Z, 3rd – Mr X

d All of them will have same priority


securities respectively issued by the same issuer. This year the issuing company’s

performance has been very good and earnings have doubled compared to the last year. Who

will derive the maximum benefit of company’s good performance?

a Mr X

b Mr Y

c Mr Z

d All of them equally


65. Which of the following is the dominant part of fixed income securities market in US?

a Municipal debt

b Corporate debt

c Treasury securities

d Agency securities

66. Net Asset Value refers to

a value of a bond

b value of a share

c current market value of all the mutual fund’s assets minus liabilities divided

by the number of units

d None of the above

67. Under T+3 Settlements for trades done on Wednesday settlements have to be completed

by_______________, assuming there are no holidays in between

a Monday

b Thursday

c Saturday

d Friday

68. Brokers are considered as _________________ of the market

a Sell-side

b Buy-side

c both the buy and sell side

d None of the above

69. A person who invests his own capital and also trades on behalf of a client is known as

a. Broker

b. Broker/Dealer


c. Investment manager


70. These broking firms charge lower commissions and execute deals for the clients and do

not provide investment advice : -------------------

a full service firm

b discount firm

c online firms

d None of the above

71. Dematerialization refers to

a Holding securities in physical form

b Holding securities in electronic form

c Safe keeping of securities

d None of the above

72. Identify from the following which is not a function of a transfer agent

a Issuing and canceling certificates to reflect changes in ownership

b Acting as an intermediary for the company

c Handling lost, destroyed or stolen certificates

d Handling safe custody of securities

73. Central Counter-party function guarantees _______________

a Returns to the investors

b Transparency of the transactions

c Trading of securities

d Settlement of securities

74. National Securities Clearing Corporation settles and clears trades on ___________basis

a T+2


b T+3

c T+1

d T + 5

75. Preferred stock has the features of

a Equity

b Debt

c Both equity and debt

d None of the above

76. Typical maturity of Fed Funds is chiefly____________

a Three days

b Two days

c Below 90 days

d One day

77. _______________play a major role in issuance and underwriting of new securities in the

primary market

a Trust banks

b Commercial banks

c Investment banks

d Retail banks

78. Futures contracts are _________________

a. Standardized

b. Non-standardized

c. Traded on exchange

d. Both (a) and (c)

79. Identify from the following which is not an investment option for a bond fund


a. Stocks

b. Bonds

c. Treasury instruments

d. Municipal debt

80. An investment manager who manages a money market mutual fund is exploring

possibilities to invest in a number of securities as given below. Identify a security in which

he can not invest as a money market mutual fund manager.

a. A commercial paper issued by ABC Corporation

b. US Treasury Bills

c. A fixed income security issued by ABC Corporation with a maturity of

two years

d. A municipal note maturing in 270 days

81. Which of the following is expected to be least volatile in terms of returns earned?

____________

a. Bond fund

b. Money market mutual fund

c. Equity fund

d. Derivatives fund

82. The average maturity of an instrument in a money market fund is lower than

a. 270 days

b. One year

c. Three years

d. Ten years

83. Derivatives are

a. traded only on exchanges

b. traded only Over-the-counter


c. traded both on exchanges and over-the-counter

d. not traded in the secondary market

84. Which of the following is true in case of options

a. The terms of options contracts are standardized.

b. The terms of options contracts are customized to the requirements of

buyer and seller of options

c. The terms of the options contracts can be standardized or customized

depending upon where they are traded


85. Separation of money and capital markets is based on the _______________

a. Type of instruments

b. Maturity of the instruments

c. Return on the instruments

d. Issue of the instruments

86. Repurchase agreements are a part of

a. Equity markets

b. Derivative markets

c. Money markets

d. Fixed income markets

87. Commercial paper

a is an unsecured paper

b is a secured paper against assets of the issuer

c can be both unsecured or secured paper

d is secured by bank guarantee


88 . Equity warrants

a represent free equity shares allotted to the investors who invest in a

security issued by the issuer

b entitle the warrant holders to subscribe to equity shares in future at a

particular price

c can not be listed and traded on the exchange

d Both b & c above

89. Mr X subscribes to a fixed income security issued by ABC Corporation. The issuer

also allots him another instrument which entitles him to apply for one equity share per

instrument at a particular price. This instrument is likely to be -----

a a debenture

b a right equity share

c an equity warrant

d a put option on equity

90. Certificates of deposits are

a issued at discount and redeemed at face value

b issued at face value and redeemed at face value plus interest

c issued at premium and redeemed at par

d issued at discount and redeemed at premium

91. Mr X has subscribed to a commercial paper issued by ABC Corporation. The

company defaults on the payment of commercial paper at maturity. Mr X along with

other holders of commercial paper plan to take a charge of company’s plant and

machinery and dispose it off to recover their dues. Which of the following is correct in

this case?

a The holders of commercial paper can do so as this is normal industry

practice


b The holders of commercial paper can do so if approved by Securities &

Exchange Commission

c The holders of commercial paper can not do so because commercial

papers are unsecured and no charge against specific asset is created

d None of the above

92. PQR Corporation is not a regular customer of ABC Inc. The former approaches ABC Inc.

for purchase of machinery costing $ 1,000,000 and asks for a credit period of four months. To

finance this and to get a security against the payment by PQR, ABC Inc -----

a can issue commercial paper

b can draw a bill on PQR and get it accepted from a bank

c can go for a working capital loan from a bank

d None of the above

93. A bank wants to subscribe to a 13 week treasury bill issued by US Federal government

through primary market . It can do so every ----- .

a day

b week

c fortnight

d month

94. Which of the following need not be registered with Securities and Exchange

Commission?

a Broker / dealers

b Transfer agents

c Clearing agencies

d None of the above


95. Mr X approaches his broker and requests to purchase a few securities for him by

providing finance to him. The broker informs Mr X that he has already exceeded his limit of

borrowing for purchase of securities. This is as per the regulations regarding ---

a insider trading

b Sarbanes-Oxley Act

c margin trading

d financial services modernization act

96. DTCC is a central securities depository of US. Physical certificates are placed with it so

that the movement of such securities is reduced. This is called --------

a immobilization of securities

b freezing of securities

c blocking of securities

d none of the above

97. Mr X is working as an equity analyst with a managed investment company which runs

five mutual fund schemes. He is approached by Mr Y who is an analyst with a broking firm

advising him to sell certain stocks. In this case, Mr X can be referred to as ------.

a sell side analyst

b buy side analyst

c fund manager

d portfolio tracker

98. Protection of rights of the individual investors is done by ____________

a Clearing Corporation

b Securities Exchange Commission

c Broking firm

d NASD


99. Corporate bond has

a a legal remedy

b a government guarantee

c no legal remedy

d None of the above

100. Financial messaging involves

a Sending credit card information

b Sending buy/ sell orders information

c Sending funds transfers instructions

d All of the above

101. Unlisted securities -------

a can be traded over the counter

b can not be traded between two parties

c can not be classified as negotiable instruments

d are primarily fixed income instruments

102. Financial disintermediation is --------

a a risk factor for banks

b expected to give a boost to banking business

c a risk factor for custodians

d a risk factor for regulators

103. ABC Corporation came out with an IPO of $5.5 million. The issue price was kept in the

range of $ 20 to $ 25. However, the issue did not receive a good response and was

undersubscribed. This resulted in cancelling the issue. We can conclude from this -----

a. the investment banks that were engaged in underwriting the issue, did

not do proper marketing of the issue

b. there were a number of IPOs planned at the same time


c. the institutional investors did not participate in the issue

d. the issue was not underwritten

104. The state government of California may participate in the US securities industry as ---

a. intermediary

b. settlement service provider

c. regulator

d. issuer

105. Mr X has been tracking the stock market for last 10 years. He tracks the movement of

stocks very regularly and selects the stocks for investment doing his own research.

According to him, his average holding period of any stock is 2 to 3 years. He can be

described as -----

a a day trader

b a professional investor

c a stock picker

d none of the above

106. Mr Y does not believe on the ability of mutual fund managers to provide a very good

return on investments. Hence he has employed two independent investment managers who

conduct in-depth research, track daily movements in prices of securities and manage his

funds. Mr Y is a -----

a. a professional investor

b. a stock picker

c. a fund manager

d. a day trader

107. A security issued two years back by US Federal government is maturing in 26 weeks.

This security must be a -----


a treasury bill

b treasury note

c treasury bond

d municipal note

108. An investor wants to invest in equity shares. He wants to invest in equity shares

directly, not through mutual funds. Which of the following arguments, that he makes, do

you agree with?

a. I want to invest directly since Managed Investment Companies hire

professional investment managers who demand fat salaries, making

mutual funds a costly proposition.

b. I can invest in whichever stocks I select and hence can achieve a better

diversification.

c. Since the mutual funds do not reveal important information, it is difficult

to make a choice between various funds


109. Mr A is arguing with Mr B regarding risk return profile of various investments. He has

drawn the risk return profile as follows.

Equity Fixed Income Securities Preferred Stock

Moderate Risk Low Risk Highest Risk

Do you agree with Mr A? Why or why not?

a. Yes I agree with him, since fixed income securities have a priority of

claims over equity and preferred stock, while equity has priority over

preferred stock

b. No, I do not agree with him. Fixed income securities carry highest risk

because they are not listed and hence it is difficult to trade them

c. No, I do not agree with him. Preferred stock carries lowest risk since it

has both the features of fixed income securities & equity. Fixed income

securities rank next, followed by equity which carries highest risk.


d. No, I do not agree, since equity is residual capital, it carries highest risk

while fixed income securities and preferred stocks carry lowest and

moderate risk respectively.

110. Smart Financial Services operates in fixed income markets. It provides a continuous

buy sell quotes to its customers and transacts on its own account. The firm is –--------

a. a broker

b. an investment bank

c. a dealer

d. a fixed income securities issuer

111. Mr A is a director in a construction company who actively participates in the

management of the company. The company has performed very well and has bagged a

number of large contracts. The company is expected to announce results of its operations

on April 10th . Mr A buys shares of the company on April 8th . He can be charged to have

violated -------

a Sarbanes-Oxley Act

b Financial Modernization Act

c Insider Trading regulations

d None of the above

112. Mr A is a senior employee in the accounts department of a company who finalizes the

accounts. The company announces the results of its operations on April 10th . It has

performed poorly in the recent quarter. Mr A sells shares of the company on April 11th .

Which of the following is correct?

a. Mr A has violated insider trading rules

b. Mr A has not violated insider trading rules

c. Mr A has acted on non-public information

d. Mr A has violated Sarbanes – Oxley Act


113. Mr X sells shares of a listed company to Mr Y. Since they know each other, Mr X

transferred the shares to Mr Y’s account maintained at a local custodian and Mr Y

transferred funds to Mr X’s account. Which of the following can be said about this

transaction?

a. The transaction can not take place since a broker is required to execute

the transaction

b. Transaction can take place since the parties know each other and can be

executed over –the-counter

c. Transaction can not take place since it has to be executed on the floor of

the exchange


114. On April 5th , clients of broker A have bought 500 shares of ABC Corporation while

clients of broker B have sold 700 shares of ABC Corporation. Going through these records,

the stock exchange instructs broker B to give a delivery of 200 shares. This process is called -

--------

a. trade matching

b. netting

c. trade settlement

d. trade allocation

115. Mr X has purchased a financial instrument. The value of that instrument varies with

equity shares of a company. This instrument is likely to be ------

a an equity warrant on company’s shares

b a derivative instrument on company’s share

c a fixed income security issued by the same issuer

d both a & b above

116. In case of option contracts, the buyer of the option has

a the obligation but not the right


b the right and the obligation

c has the right but not the obligation

d none of the above

117. Mr X has sold a fixed income security to Mr Y. Mr X has the securities ready to be

delivered. Till Mr Y pays, we can say that Mr X is taking -----

a a price risk

b a market risk

c a liquidity risk

d a credit risk

118. Which of the following type of risks is not a part of market risk?

a Foreign exchange risk

b Interest rate risk

c Counterparty risk

d Price risk

119. Mr A purchased certain fixed income securities three years back. He needs to sell these

securities since he wants funding for his new car. However, these fixed income securities

are not traded frequently and hence Mr A is finding it difficult to sell. He is facing a ------

a price risk

b market risk

c liquidity risk

d counterparty risk

120. Mr X and Mr Y have invested in fixed income securities and equity shares respectively.

Changes in interest rates in the country will affect -------

a returns for Mr Y more than that of Mr X

b returns for Mr X more than that of Mr Y

c only returns of Mr Y


d returns for none of them

121. In the US, the regulations about reporting by corporates are laid down by ------

a The US Federal government

b Respective stock exchanges where the shares are traded

c Financial Services Authority

d Securities & Exchange Commission

122. As per Sarbanes – Oxley Act, ------- are responsible for hiring, compensating and

supervising independent auditors.

a Chief Executive Officers

b Chief Financial Officers

c Both a & b above

d Corporate audit committee

123. Sarbanes – Oxley Act applies to --------

a All unlisted companies in US

b All listed domestic companies in US

c All listed companies in US, whether domestic or foreign

d All listed foreign companies in US

124. East West Bank is a bank in UK which offers various types of deposits to investors. The

bank must be regulated by ----

a Securities & Exchange Commission of UK

b Financial Services Authority

c London Stock Exchange

d The Government of UK

125. An industry standard electronic protocol for pre trade communications used by

institutions and ECNs is ------


a MDDL

b SWIFT

c FIX

d None of the above

126. A portfolio of mutual fund is given below. Identify which type of mutual fund it is

likely to be ?

Issuer Security

US Federal Government 26 Week Treasury Bill

ABC Corporation Commercial Paper

PQR Industries Bankers’ Acceptance

XYZ Bank Certificates of deposits

a Bond fund

b Equity fund

c Money market fund

d Derivatives fund

127. A securities dealer tries to make money in the market by ----------

a charging a commission for the transaction

b creating a spread between buying and selling prices

c sharing profits with brokers

d none of the above

128. Central counterparty services for municipal debt is provided by -----

a NSCC

b OCC

c FICC

d DTC


129. Options on shares of ABC Corporation are listed on American Stock Exchange. These

options are cleared by -----

a NSCC

b OCC

c FICC

d DTC

130. Mr X subscribes to a commercial paper with the face value of $5000. Mr Y purchases a

certificate of deposit of $ 5000 face value which pays 5% interest. Which of the following

statements is true?

a The initial investment of Mr X is higher than that of Mr Y

b Both of them start with an initial investment of $ 5000

c The initial investment of Mr Y is higher than that of Mr X

d Mr Y can not sale certificate of deposit to other investors while Mr X

can sell commercial paper to other investors

131. Mr P invests in debt securities and Mr Q invests in equity shares. Which of the

following is true in this case?

a The possibility of capital gains is higher in case of Mr Q

b Mr Q takes a lower risk than that of Mr P

c The possibility of capital losses is higher in case of Mr P

d Both a & c above

132. Which of the following is not true in case of investment banks?

a Investment banks do not offer broking services

b Investment banks offer portfolio management services

c Investment banks play an important role in underwriting the new

issues

d Both a & b


133. The brokers who trade in shares on stock exchanges are called -----

a clearing members

b dealers

c trading participants

d trading members

134. Which of the following is true in case of settlement service providers?

a Banks are not a part of settlement service providers

b Transfer of shares is done by a book entry by custodians

c Transfer of shares is done by a book entry by depository

d Transfer of shares is done by a book entry by transfer agents

135. Duplicate Financials is a broking house which buys and sells securities over-the-counter

in US. The employees of the firm have followed fraudulent practices while dealing in

securities. The firm is expecting some strict action against it. This action is likely to be

taken by -----

a NASDAQ

b NASD

c Stock Exchanges

d FSA

136. An investor in US purchased certain securities on Friday. His broker has promised him

the delivery of these securities as soon as the broker gets them i.e. on Monday. The

settlement cycle in this case is on ---- basis.

a T + 1

b T + 2

c T + 3

d T + 5


137. A company approaches a bank to purchase foreign exchange after a month from the

company. This transaction should be categorized as --------

a spot transaction

b futures transaction

c forward transaction

d options transaction

138. A sell side analyst recommends buying of shares of ABC Corporation. He is likely to be

employed at present by ----.

a Managed Investment Company

b Mutual Fund

c Broking firm

d Stock exchange

139. ABC Corporation’s shares are listed on a stock exchange. They are generally traded

once in a week. Hence, in this context, we can say that the investors holding the stock of

this company suffer from -----

a price risk

b market risk

c liquidity risk

d credit risk

140. Price of a company’s share fell down by $10 during the day. The short sellers who took

such positions in the stock in the morning are likely to have -------

a gained

b lost

c not experienced any losses or gains

d not covered their positions


141. Mr X has purchased a house by taking a home loan. The house property is mortgaged

with the institution from which this loan is taken. Which of the following institutions will be

interested in purchasing such mortgages?

a. Home Credit System

b. Federal National Mortgage Association

c. Student Loan Marketing Association

d. Both a & b above

142. Which of the following is true in case of time deposits with banks?

a. They offer a lower rate of interest compared to checking accounts

b. They offer lower rate of interest compared to savings deposits

c. They are negotiable

d. They offer higher rate of interest compared to savings deposits

143. A secured lending means -----------

a. the borrower is not likely to default

b. the borrower may default but the entire amount is recoverable

c. the borrower may default but the loan is secured by a charge created on

assets which can be disposed off in case of default

d. lender is secured against interest rate fluctuations

144. For trade processing, ------ provides seamless connectivity for the entire trade

processing without manual intervention.

a. automated processing

b. direct processing

c. straight through processing

d. accelerated processing

145. Mr X is developing an XML based generic format in order to describe financial

instruments in standardized forms. This is likely to be -----

a. MDDL


b. FIX

c. SWIFT


146. Mr X purchases and sells a type of money market instrument on a daily basis. He can

easily sell or buy a large quantity of this money market instrument in a short time. Which of

the following is true in this context?

a. This indicates heavy trading, hence the instrument must be commercial

paper

b. This indicates thin trading, hence the instrument must be commercial

paper

c. This indicates heavy trading, hence the instrument must be treasury

bills

d. This indicates thin trading, hence the instrument must be treasury bills

147. If Primary markets are witnessing heavy activity, we can say that ----------

a. the trading in shares and fixed income securities is very heavy

b. a large number of companies are listed

c. a large number of companies are raising debt or equity capital

d. market capitalization of individual companies is going up

148. Mr A sits at home and buys / sells securities through the internet. Hence we can

conclude that ------

a. he is engaged in electronic trading with no broker in between

b. he is engaged in web trading with no broker in between

c. he is engaged in web trading through an online broking firm

d. he is engaged in electronic trading through online services of stock

exchange


149. Securities belonging to same asset class ---

a. offer same returns

b. have same liquidity

c. have similar characteristics

d. have same issuers

150. International Swaps and Derivatives Association --------

a. issues derivative instruments

b. promotes sound risk management practices among member

institutions

c. is a regulatory authority in US supervising privately negotiated

derivatives industry

d. supervises exchange traded derivatives

Documents

CM101 - D&B - Securities Overview