investment management certificate unit 1 pdf

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An investmentfonds wikipedia free fund also index tracker is a mutual fund or exchange-traded fund ETF designed to follow certain preset rules so that the fund can track a specified basket johann pfeiffer iforex underlying investments. Index funds may also have rules that screen for social and sustainable criteria. An index fund's rules of construction clearly identify the type of companies suitable for the fund. Additional index funds within these geographic markets may include indexes of companies that include rules based on company characteristics or factors, such as companies that are small, mid-sized, large, small value, large value, small growth, large growth, the level of gross profitability or investment capital, real estate, or indexes based on commodities and fixed-income. Companies are purchased and held within the index fund when they meet the specific index rules or parameters and are sold when they move outside of those rules or parameters. Think of an index fund as an investment utilizing rules-based investing.

Investment management certificate unit 1 pdf online jobs in lahore at home for students without investment

Investment management certificate unit 1 pdf

There are also, of course, important groups of institutional investors which specialise in providing capital and act as financial intermediaries between suppliers and demanders of funds. Many financial services organisations now have diversified operations covering a range of the following activities. Pension funds invest the pension contributions of individuals who subscribe to a pension fund, and of organisations with a company pension fund.

Insurance companies invest premiums paid on insurance policies by policy holders. Life assurance policies, including life-assurance based savings policies, account for substantial assets, which are invested in equities, bonds, property and other assets.

The business of investment trust companies is investing in the stocks and shares of other companies and the government. In other words, they trade in investments. Unit trusts and Open-ended Investment Companies OEICs are similar to investment trusts, in the sense that they invest in stocks and shares of other companies. Venture capital providers are organisations that specialise in raising funds for new business ventures, such as 'management buy-outs' ie purchases of firms by their management staff.

These organisations are therefore providing capital for fairly risky ventures. The capital markets of each country have become internationally integrated. Securities issued in one country can now be traded in capital markets around the world. Securitisation of debt means creating tradable securities which are backed by less liquid assets such as mortgages and other long-term loans.

Various techniques have been developed for companies to manage their financial risk such as swaps and options. These 'derivative' financial instruments may allow transactions to take place 'off-balance sheet' and therefore not easily evident from the company's financial statements. The existence of such transactions may make it more difficult for banks and other would-be lenders to assess the financial risk of a company that is asking to borrow money.

There is much fiercer competition than there used to be between financial institutions for business. For example, building societies have become direct competitors to the retail banks, and foreign banks have also competed in the UK with the big clearing banks.

Banks have made shifts towards more fee-based activities such as selling advice and selling insurance products for commission and away from the traditional transaction-based activities holding deposits, making loans.

Securitisation of debt involves disintermediation. Financial disintermediation is a process whereby ultimate borrowers and lenders by-pass the normal methods of financial intermediation such as depositing money with and borrowing money from banks and find other ways of lending or borrowing funds; or lend and borrow directly with each other, avoiding financial intermediation altogether.

Securitisation of debt provides firms with a method of borrowing from non-banks. Although banks might act as managers of the debt issue, finding lenders who will buy the securitised debt, banks are not doing the lending themselves. Although the money markets largely involve wholesale borrowing and lending by banks, some large companies and the government are also involved in money market operations.

The money markets are essentially shorter term debt markets, with loans being made for a specified period at a specified rate of interest. The money markets operate both as a primary market, in which new financial claims are issued and as a secondary market, where previously issued financial claims are traded. Loans are transacted on extremely 'fine' terms — ie with small margins between lending and borrowing rates — reflecting the economies of scale involved. The emphasis is on liquidity: the efficiency of the money markets can make the financial claims dealt in virtually the equivalent of cash.

Commercial banks make commercial banking transactions with customers. They are distinct from the country's central bank. The term wholesale banks refers to banks which specialise in lending in large amounts to major customers. The clearing banks are involved in both retail and wholesale banking but are commonly regarded as the main retail banks.

These banks operate as brokers, as underwriters and as advisers in corporate actions such as mergers and takeovers. These categories are not mutually exclusive: a single bank may be a retail clearing bank, with wholesale and investment banking operations. Among their liabilities are the balances of the investor members who hold savings accounts with the society.

The distinction between building societies and banks has become increasingly blurred, as the societies have taken to providing a range of services formerly the province mainly of banks, and banks have themselves made inroads into the housing mortgage market. Some building societies now offer cheque book accounts, cash cards and many other facilities that compete directly with the banks. The building society sector has shrunk in size over the last twenty years or so as a number of the major societies have either converted to public limited companies and therefore become banks or have been taken over by banks or other financial institutions.

The Bank is a nationalised corporation, and it has two core purposes: monetary stability and financial stability. Since May , the MPC has had operational responsibility for setting short-term interest rates at the level it considers appropriate in order to meet the Government's inflation target.

When the banking system is short of money, the Bank of England will provide the money the banks need — at a suitable rate of interest. It does this by buying eligible bills and other short-term financial investments from approved financial institutions in exchange for cash.

It does this by selling bills to institutions, so that the short-term money markets obtain interest-bearing bills in place of the cash that they do not want. The process whereby this is done currently is known as open market operations by the Bank.

This simply describes the buying and selling of short-term assets between the Bank and the short-term money market. The Bank acted as lender of last resort to the bank Northern Rock, when the bank became unable to raise enough funds on the wholesale money markets during The City is the largest centre for many international financial markets, such as the currency markets.

The UK has the greatest concentration of foreign banks, numbering around compared with around in the USA, in the world. The banks and building societies form a significant part of the market for financial services. A banking institution could maintain access to a full range of products and product providers by setting up an independent arm. However, few have maintained a wholly independent stance. The universal bank model involves providing financial services of various kinds, including advisory services, in addition to deposit and lending services.

The development of life assurance provision by banks is known as bancassurance or all finanz. The Association of British Insurers ABI defines bancassurers as 'insurance companies that are subsidiaries of banks and building societies and whose primary market is the customer base of the bank or building society'. The UK has a major general insurance and reinsurance market ranging from personal motor insurance to insurance for space satellites. Reinsurance is a process by which a company — for example, a life office writing new business — can sell or pass on the risks on its policies to a third party reinsurer.

This makes the third largest such market in the world, exceeded only by the US and Japan. Lloyds acts as a major reinsurer for life assurance. Lloyds is a long-established market in which underwriting syndicates operate independently. Syndicates are run by managing agents who appoint underwriters to write assess risks on behalf of the syndicate.

Many countries are passing the burden for pensions provision from the state sector to the private sector. Domestically, the UK pensions market is of great importance, and a higher proportion of pension payments are provided by the private sector in the UK than in nearly any other country. Around one quarter of these funds were managed on behalf of overseas clients.

The UK fund management sector offers liquid markets, with the opportunity to trade in large blocks of shares, and a relatively liberalised operating environment combined with protection against abuse. More funds are invested in the London than the ten top European centres combined.

More foreign companies are traded on the London Stock Exchange than on any other exchange. There are a number of aspects favouring London as a major financial centre. Under this system, any recognised bank can provide a full range of banking services, including retail banking services alongside wholesale and investment banking.

However, where it appears that a single bank provides such a range of services in the UK and the USA, this is generally managed by setting up separately capitalised subsidiaries with similar names to the parent company. Spain, France and the Netherlands have banking traditions somewhere between the universal and segmented models.

Equity involvement has been limited, with founding families continuing to play a lead role in firms. In Germany and France as well as Italy, relatively little use has been made of equity finance by firms. Finance for industry in Germany often comes directly from the banks, and stock market liquidity is limited, with investment opportunities being more limited than in other advanced economies. France has a broadly based economy with the Government working closely with industry on major projects.

The stock market of France merged with those in Brussels and Amsterdam in to form Euronext. The financial systems of the smaller Northern European Scandinavian countries have been dominated by a few large domestic banks that have evolved into larger Nordic financial groups through cross-border mergers and acquisitions. US dollar-denominated fixed interest stocks including Eurodollar bonds issued by foreign entities make up around half of total global bond market capitalisation. The size of the US economy and the dominance of the US dollar in international transactions has made the US financial system central to both the US economy and the global economy.

The US banking system is characterised by the large number of deposit-taking banks, which may be either state-chartered or national and federally licensed institutions. Non-depository institutions include securities firms, insurance companies, mutual funds, pension funds and finance companies. This legislation enabled different types of companies operating in the US financial services industry to merge.

For companies in the US, there are broadly two distinct approaches to this form of business. Outside the USA for example, in Japan , non-financial services companies are permitted within the holding company. Then, each company still appears independent, and has its own customers.

The US system is based almost wholly on statute with minimal self-regulation. Within China, Shanghai and Hong Kong are also key centres. China will come to represent an increasingly significant pool of consumers of services as time goes on. In a similar way to India and Malaysia in recent years, China could become a cost-effective focus for service provision in the financial sector. The experience of outsourcing into other emerging markets in recent years shows how security and reliability are key to the expansion of such service provision.

Growth slowed during the s after a bubble in Japanese asset prices. The bond market of Japan is the second largest in the world, and both government and corporate bonds are traded. Accounting standards result in less objectivity than in other jurisdictions, and company information may be less readily available than elsewhere.

Private capital investment remains strong. The Agency is a Japanese governmental organisation that oversees banking, securities and insurance and reports to the Ministry of Finance. Legislation laws introduced by Parliament often gives authority for Government departments to introduce secondary legislation in the form of additional regulations. An argument for public Government provision of services such as healthcare and education postulates that these are merit goods which, if left to private free market transactions, would be consumed in quantities that would be insufficient for the optimisation of social welfare.

For example, if the Government did not provide free or subsidised education, it could be argued, many parents would go without educating their children rather than pay fees for education. The extent to which the Government influences what we do reflects the type of economic system we have.

The economic system of the UK and of the wider European Union to which the UK belongs can be described as that of the mixed economy. Some goods and services — for example, postal services — may be provided by the State. The government may be seen as playing a role in reducing inequalities in the distribution of income and wealth through the tax system.

Its immediate aim is the integration of the economies of the member states. A more long-term aim is political integration. The European Union has a common market combining different aspects, including a free trade area and a customs union. This may be extended into a customs union when there is a free trade area between all member countries of the union, and in addition, there are common external tariffs applying to imports from non-member countries into any part of the union.

In other words, the union promotes free trade among its members but acts as a protectionist bloc against the rest of the world. In addition to free trade among member countries there are also free markets in each of the factors of production. A British citizen has the freedom to work in any other country of the European Union, for example.

A common market will also aim to achieve stronger links between member countries, for example by harmonising government economic policies and by establishing a closer political confederation. In recent years however, UK membership of the EU has restricted the previously unfettered power of Parliament.

Regulations, having the force of law in every member state, may be made under provisions of the Treaty of Rome. Their objective is to obtain uniformity of law throughout the EU. They are formulated by the Commission but must be authorised by the Council of Ministers.

Until a Directive is given effect by a national UK statute, it does not usually affect legal rights and obligations of individuals. A decision may be addressed to a state, person or a company and is immediately binding, but only on the recipient. The Council and the Commission may also make recommendations and deliver opinions, although these are only persuasive in authority.

These variables are linked with inflation in prices generally, and also with exchange rates — the price of the domestic currency in terms of other currencies. That Act states that the Bank of England is expected 'to maintain price stability, and, subject to that, to support the economic policy of HM Government including its objectives for growth and employment'.

This will tend to be followed by financial institutions generally in setting interest rates for different financial instruments. However, a government does not have an unlimited ability to have interest rates set how it wishes. It must take into account what rates the overall market will bear, so that the benchmark rate it chooses can be maintained. The Bank must be careful about the signals it gives to the markets, since the effect of expectations can be significant.

The monthly minutes of the MPC are published. This arrangement is intended to remove the possibility of direct political influence over the interest rate decision. The Bank of England reducing interest rates is an easing of monetary policy. Demand will tend to rise and companies may have improved levels of sales.

Companies will find it cheaper to borrow: their lower interest costs will boost bottom-line profits. Investors will be willing to pay higher prices for gilts government stock because they do not require such a high yield from them as before the interest rate reduction. Those who are dependant on income from cash deposits will be worse off than before. The Bank of England increasing interest rates is a tightening of monetary policy.

Companies will find it more expensive to borrow money and this could eat into profits, on top of any effect from reducing demand. Investors will require a higher return than before and so they will pay less for fixed interest stocks such as gilts.

The Government could try to influence exchange rates by buying or selling currencies through its central bank reserves. However, Government currency reserves are now relatively small and so such a policy might have to be limited in scope. Another way the Government might wish to influence exchange rates is through changes in interest rates: if UK interest rates are raised, this makes sterling a relatively more attractive currency to hold and so the change should exert upward pressure on the value of sterling.

As we have seen, interest rate policy is now determined by the MPC. Interest rate policy is decided in the light of various matters apart from exchange rates, including the inflation rate and the level of house prices. If the UK joined the single European currency, the euro, interest rates would effectively be determined at the European level, by the European Central Bank, instead of at the national level as now.

It would not be possible for interest rates in different eurozone countries to be much out of line at any one time, since differences would encourage money flows to seek the higher rates available in a particular country, and borrowers would seek the best rates available. The forces of supply and demand would lead to an approximate equalisation of rates. These aspects of fiscal policy reflect the three elements in public finance. The government, at a national and local level, spends money to provide goods and services, such as a health service, public education, a police force, roads, public buildings and so on, and to pay its administrative work force.

It may also, perhaps, provide finance to encourage investment by private industry, for example by means of grants. Expenditure must be financed, and the government must have income. Most government income comes from taxation, but some income is obtained from direct charges to users of government services such as National Health Service charges. To the extent that a government's expenditure exceeds its income, it must borrow to make up the difference. Government spending is an injection into the economy, adding to the level of overall demand for goods and services, whereas taxes are a withdrawal.

A government's 'fiscal stance' may be neutral, expansionary or contractionary, according to its overall effect on national income. Expenditure in the economy will increase and so national income will rise, either in real terms, or partly in terms of price levels only: the increase in national income might be real, or simply inflationary. A government might deliberately raise taxation to take inflationary pressures out of the economy The impact of changes in fiscal policy is not always certain, and fiscal policy to pursue one aim eg lower inflation might for a while create barriers to the pursuit of other aims eg employment.

Government planners need to consider how fiscal policy can affect savers, investors and companies. The formal planning of fiscal policy usually follows an annual cycle. In the UK, the most important statement is the Budget, which takes place in the Spring of each year. The Pre-Budget Report formally makes available for scrutiny the Government's overall spending plans.

The institutional framework has the following aims. Innovation policies seek to balance the benefits of intellectual property protection with facilitating the widespread exploitation of new knowledge through, among other things, easing barriers to the widespread dissemination and adoption of ideas. Underpinning this approach is a presumption that, as a whole, the effective operations of markets are a better way of bringing about improvements to business efficiency and the most economically beneficial allocation of capital, knowledge and employment.

Responsibility for the various themes of industrial policy is spread across difference central Government departments, although the Department for Business, Innovation and Skills plays a key role. Another important aspect of international trade is the free movement of capital. Some countries including the UK, since the abolition of exchange controls in have allowed a fairly free flow of capital into and out of the country.

Other countries have been more cautious, mainly for one of the following two reasons. There is often a belief that certain key industries should be owned by residents of the country. Even in the UK, for example, there have been restrictions placed on the total foreign ownership of shares in companies such as British Aerospace and Rolls Royce.

After all, they need capital to come into the country to develop the domestic economy. There is a need, given that such market failures have the potential to occur, to have certain protections in place to ensure that markets are conducted in accordance with principles of fairness and consumers in general are dealt with fairly. The financial crisis of the late s brought into focus the problems of financial instability affecting some banks and other financial sector institutions.

The regulation of conduct across the sector, including issues surrounding advice given to retail consumers, became the responsibility of the Financial Conduct Authority FCA , which was formed out of the FSA legal entity. Clearly, if the Government chooses and Parliament agrees, it can extend statutory regulation to areas previously governed by voluntary codes. For example, mortgage advice and selling, previously governed by the voluntary Mortgage Code, became regulated in General insurance regulation followed in The area of banking can be taken as another example.

Until , banks and building societies followed a voluntary code the Banking Code in their relations with personal customers in the UK. In November , responsibility for the regulation of deposit and payment products transferred to the FSA as financial services regulator. Such claims are financial assets. Loans debt and shares equity represent the two main types of financial security. Many companies have both debt and equity in their financing structure. The term 'equity' means that each share has an equal right to share in profits.

The ordinary shareholders of a company are the owners of the company. However, it is normal for ordinary shares to possess a vote. This means that the holder of any ordinary shares may attend and vote at any meetings held by the company. Whilst the day-to-day control of the company is passed into the hands of the directors and managers, the shareholders must have the right to decide upon the most important issues that affect the business.

Although voting rights may vary for different classes of share, each equity share most typically carries one vote. Companies legally do not have to declare a dividend on ordinary shares, many of them do in order to maintain shareholder loyalty. Companies may pay an interim dividend based on the six-month results, and declare a final dividend based on the year-end results. For public companies, this will not be paid until the shareholders have agreed it at the AGM. Some companies give their shareholders the choice to take their dividend in new shares, rather than cash.

New shares are created, but in a way that there will be no significant impact on the share price. The investors are taxed as if they had taken the cash dividend. Companies may only pay dividends out of post-tax profits — that is, from their distributable reserves.

In any single year, the dividend paid could exceed the profit for that year, because there may be distributable reserves brought forward from earlier years. Not only do shares offer income in the form of dividends, they also offer the possibility of capital growth when the share price rises. Historically, bonds began as very simple negotiable debt instruments, paying a fixed coupon for a specified period, then being redeemed at face value — a 'straight bond'.

In the past, bond markets were seen as being investment vehicles that was safe enough for 'widows and orphans'. They were thought to be dull markets with predictable returns and very little in the way of gains to be made from trading. The bond markets emerged from this shadow during the mids when both interest rates and currencies became substantially more volatile. Bonds have emerged over the past few decades to be much more complex investments, and there are now a significant number of variations on the basic theme.

Whilst it is perhaps easy to be confused by the variety of 'bells and whistles' that have been introduced into the market in recent years, one should always bear in mind that the vast majority of issues are still straight bonds. The reason for this is that investors are wary of buying investments that they do not fully understand. If an issue is too complex, it will be difficult to market.

Bonds are used by a number of issuers as a means of raising finance. Major bond issuers include the following. Negotiability means that it is a piece of paper that can be bought and sold. For certain types of bonds, this is easier than for others. Government bonds tend to be highly liquid, ie very easy to buy or sell, whereas certain corporate bonds are almost illiquid and are usually held to maturity by the initial buyer. However, if the individual has a limited amount of money to invest, it will be very difficult to buy a range of individual equities or bonds without incurring relatively high transaction costs.

Here they pool their money in a large fund, which is managed and invested for them by a fund manager. There are also exchange traded funds ETFs , which are typically designed to track an index. A unit trust differs from investment trusts and OEICs in the way it is set up, as a unit trust is not a company with shares. A key difference between different pooled investments is the way in which the fund is priced.

For unit trusts and OEICs for example , there is a direct relationship between the value of the underlying investments and the value of units. Investment trust shares and also ETFs, however, are priced according to supply and demand in the stock market. Unit trusts are, like OEICs, called open-ended funds as there is no limit to the amount of money which can be invested. Investment trusts, on the other hand, are closed-ended: except when new shares are issued — eg, on launch of the trust — the buyer of investment trust shares is buying them from existing holders of the shares.

A fund manager with a good past performance record may be able to repeat the performance in the future. Derivatives can be used to speculate on future price changes, and risks can be high when derivatives are geared to be very sensitive to price changes. For example, a wheat farmer may sell wheat futures called a short hedge to guarantee him a known fixed price for his wheat.

If the price of wheat falls between when the farmer buys the contract and its maturity date. The farmer will gain on the futures contract if the wheat price falls, and will lose on the futures contract if the wheat price rises.

These gains and losses can respectively be set against the losses and gains that the farmer makes from actually selling his wheat, so that the net effect will be to give him a price that was known in advance. The FTSE index futures contract could be used to hedge against falls in the share price index over future periods. An investment intermediary, such as a collective pooled fund or a pension fund, may use derivative contracts to achieve their objectives. The fund may hold a portfolio of UK shares, and may hedge against a possible fall in the value of its portfolio by selling FTSE index futures.

If the market falls while the contract is held, the value of the share portfolio will most probably fall, but this will be compensated for by gains on the futures contract. Having opened the futures contact by selling it, the fund manager will later buy the futures contract in order to crystallise the gain on the contract. Derivatives contract enable investors to take a position in the price of an asset without actually taking delivery of the underlying asset.

For example, a position can be taken on the price of oil, without participants in the related derivative contract taking physical delivery of oil at any point. Derivatives, including options, can be divided into exchange-traded and over-the-counter OTC types. Exchange-traded derivatives are more standardised and offer greater liquidity than OTC contracts, which are tailor-made to meet the needs of buyers and sellers. Traded options are available on the shares of over 90 major listed UK companies.

As they are traded products, they are standardised in terms of expiry dates, quantity of shares per option contract and so on. Although some FOREX is required for overseas trade, much of it is traded for speculative purposes, where FOREX traders seek to exploit a particular view on interest rate differentials or exchange rate movements.

An investment manager might convert sterling into US dollars, for example, in order to make a purchase of US securities. Prices are advertised on screens and deals are conducted over telephones. The major players are investment banks and specialist currency brokers. This is not a market place where the private investor usually gets directly involved — his currency needs are more often met through specialist money organisations, who themselves have accessed the currency markets through their own specialist broker.

FOREX transactions are described either as spot or forward. Forward is when an exchange rate is agreed today for settlement at some future date, as agreed by the parties. This is a particularly useful way of eliminating risk from transactions requiring currency import and export dealings at some time in the future.

Most currencies are quoted against the US dollar. An effective securities market will have the following characteristics. Electronic order systems should be the most cost-effective. Factors contributing to liquidity are effective and efficient IT and settlement systems, stock availability and stock lending facilities and a diverse membership. We discuss this later in this section.

Sophisticated financial markets also fulfil an important role in the transfer of risk. We have described, for example, how derivatives markets enable investors, entrepreneurs and market participants to hedge risks as well as to speculate on the prices for assets.

Quote-driven markets depend on the existence of market makers who are prepared to offer two-way quotes in shares. Most shares, futures contracts, and standard options contracts are now traded mainly through an orderdriven system. Various order types exist whereby orders may be presented to execute immediately at the prevailing market price, or may be conditional orders depending on price and quantities to match before a trade is achieved. The bid price is the price at which dealers or investors are willing to pay for a stock and the offer price is the selling price at which dealers or other investors are willing to sell.

In a quote-driven market, the spread or turn — the difference between the bid and the offer — enables dealers to make a profit on transactions. Depending on which securities are being traded, dealers may be working for proprietary trading houses, investment banks, commercial banks, or broker-dealers. Traders in financial markets are sometimes categorised broadly into sell-side and buy-side. The purchase cost includes a spread which is the difference between the bid and offer price of the share.

The spread, from which market makers makes their profits, could be 0. A typical charge could be, say, 1. Brokers incur various costs for the resources they employ to fill orders, including costs for market data and order routing systems, exchange memberships and fees, regulatory fees, clearing fees, accounting systems, office space, and staff to manage the trading process.

Stamp Duty on stock registered in Ireland is charged at 0. Buyers putting through relatively large buy orders may need to push the price of the security up in order to make the trade. Sellers who want to put through a large sell order quickly may need to accept a lower price than is immediately available to a seller with a small order. The cost effect of this tendency for fluctuating order sizes to move prices is called the market impact or price impact, and is a significant component of transaction costs for large financial institutions.

Limit orders, which will be filled only if the price is better than the stated limit, provide a way of limiting transaction costs, compared with market orders, which are filled at whatever prices are available when the order is placed. The opportunity cost of using a limit order is that the price may move against the trader before the order is filled. As a rule, a limit order is usually advisable for thinly traded stocks, to avoid the risk of a market order being filled at a possibly very disadvantageous price.

For buy-side traders, transparency enables the trader to gain knowledge of market values and to estimate potential transaction costs. Opacity in markets may be preferred by sell-side dealers because they typically have an informational advantage over the counterparties with whom they trade, such as buyside market participants. Liquidity risk or marketability risk has to do with the ease with which an issue can be sold in the market. Smaller issues especially are subject to this risk.

In certain markets, the volume of trading tends to concentrate in the 'benchmark' stocks, thereby rendering most other issues relatively illiquid. Some bonds become subject to 'seasoning' as the initial liquidity dries up and the bonds are purchased by investors who wish to hold them to maturity. The size of the bid-ask spread relative to the value of a security is an indication of the liquidity of the market in that security. Securities with many daily trades will have more dealers and investors placing orders at any one time, and so it is more likely that the highest bid sell price and the lowest ask buy prices will be closer.

More opaque less transparent markets will typically have larger bid-ask spreads because, in opaque markets, dealers will find it more difficult to judge the level of demand for the stock, and so know the equilibrium price. If a market for a security or securities has many ready and willing buyers and many ready and willing sellers, we can say that the market is deeply liquid. The market for US Treasuries US Federal Government debt is an example of a deeply liquid market, with the large daily volume of transactions and low bid-ask spreads meaning that transaction costs are relatively very low.

However, the level of liquidity for some securities can fluctuate significantly, sometimes in response to wider market sentiments. When the macro-economic environment is relatively benign, liquidity levels may remain relatively high, while in a market downturn when investor sentiment declines, liquidity may dry up — particularly for smaller companies such as those on the Alternative Investment Market AIM , and in order-driven markets where there is no requirement for market makers to maintain two-way quotes at all times —and it may be quite difficult for sellers to find a buyer, particularly for larger orders.

Most companies with a larger capitalisation for example, members of the FTSE Index for UK stocks are widely held by institutions as well as smaller investors, and are followed closely by large numbers of analysts. These larger companies have a relatively large quantity of stocks in public hands and large numbers of potential buyers and sellers at virtually all times, and so markets for such stocks tend to have a deep level of liquidity.

During the late s financial crisis and housing market downturn, liquidity in the markets in mortgage-backed securities dried up because of widespread uncertainty about the value of the securities. Where such securities relied heavily on sub-prime mortgages, the housing market downturn threatened to bring a spate of foreclosures and the prospect of high levels bad mortgage debt that would not be repaid. Investors will generally demand a higher expected return from securities where liquidity is low, because they expect compensation for the risk that they may find it difficult to sell the shares quickly during some periods.

The price may move adversely while the stockholder Is waiting to sell. Thus, liquidity risk — the risk that a lack of liquidity may lead to losses for the investor — will generally be reflected in the price of a security. Firms are better able to take risks and to finance large-scale operations that provide for economies of scale in production if there are willing investors in equities, bringing higher productivity and economic growth.

Governments are able to finance public deficits through markets in which the private sector participates. Through well-developed professional fund markets, individuals are able to enjoy more security in retirement incomes made available through their pension schemes. In well-developed markets, price transparency improves informational efficiency, which describes a situation in which the prices of assets reflect all relevant information about their value.

If all investors have access to good quality and timely information about securities, then the prices of stocks will better reflect their fundamental value. In a well-functioning economy, backed by a legal environment that protects the rule of law and minimises corruption, the highest returns will tend to be earned on the securities if firms whose assets are the most productive.

The LSE is a business enterprise. Its primary objective is to establish and run a market place in securities. The LSE provides the main route in the UK for larger companies to raise funds through the issue of shares equity. It makes it easier for large firms and the government to raise long-term capital, by providing a market place for businesses seeking capital and investors to come together. Companies coming to the market may be launching an initial public offering IPO , or may be coming to the market to obtain further capital, for example for an expansion, through a secondary offering.

This is known as the primary market. Consequently, the exchange must also offer a secondary market trading in second-hand shares, this allows the investor to convert the shares into cash. The Alternative Investment Market AIM , which opened in , is a market where smaller companies which cannot meet the more stringent requirements needed to obtain a full listing on the LSE can raise new capital by issuing shares. Like the Stock Exchange main market, the AIM is also a market in which investors can trade in shares already issued.

This means that they can act as agents on behalf of customers or as principals dealing directly with the customers. Different types of shares, with varying levels of liquidity, trade via different market systems. This is essentially the function which SETS performs.

Prices of securities which trade on SETS are, therefore, purely driven by the buyers and sellers in the market themselves. For such a market to operate efficiently, up-to-date prices at which market makers are willing to trade need to be made available to other market participants. This is the function performed by SEAQ. SETSqx discussed later in this Section combines the market making quote-driven model and the orderdriven model. Clearnet acts as the central counterparty to all SETS trades.

Clearnet such that the buyer buys from LCH. Clearnet and the seller sells to LCH. The limit orders are automatically matched by the electronic order book. If an order is not matched entirely, the unmatched portion will remain on the order book. Orders are prioritised in a strict sequence, with price first, then the time of input with the earlier orders first. Below is an example order book for a SETS security. The SETSqx system combines committed principal quotes with periodic auctions where anonymous limit orders are placed.

Market makers and non-market makers can participate in auctions, these auctions take place at , , and The market makers will provide a ready counterparty to market participants wishing to trade SETSqx shares and bonds in return for being able to make profits from a spread between buying and selling prices. In order to act as a market maker, the relevant firm undertakes an obligation to quote firm, two-way prices in shares for which they register.

Market makers must therefore quote both buying and selling prices two-way prices at which they must deal firm prices up to a predetermined transaction size dependent upon historic volumes. This is the minimum amount of shares a market maker must be prepared to buy, or sell, at their quoted price. The SEAQ system is used to disseminate market maker quotes to all market makers simultaneously. Since at least two market makers are required for a share to trade on SEAQ, the system is referred to as a competing market maker system.

This is termed a cross listing. The term dual listed company DLC describes something different from a cross listing. A DLC involves a corporate structure in which there are two corporations, normally registered in different jurisdictions, which act as a single operating business. The DLC structure involves a legal equalisation agreement and separate stock exchange listings for each of the corporations.

The two corporations will have different sets of shareholders who agree, through the equalisation agreement, to share the risks and rewards of ownership of the operating business in a specified proportion. The arrangement is broadly similar to a joint venture.

The agreement will cover matters such as dividends, corporate governance winding up. The coupon is fixed at the issue date and is paid regularly to the holder of the bond until it is redeemed at maturity when the principal amount is repaid.

Corporate bonds may be sold through an open offer, or in a private placing to a limited number of professional investors. With an open offer, a syndicate of banks with one bank as lead manager will underwrite the issue by buying the bonds and then selling them on to investors.

A bought deal is where the lead bank buys all the bonds and then sells them to the syndicate. Corporate bonds generally trade in over-the-counter OTC markets, with market liquidity being provided by dealers and other market participants. The most important source of financing open to the government is the gilts market.

Holders of gilts can now receive coupon payments gross, unless they opt otherwise. The main investors in gilts are UK pension funds and insurance companies, banks, building societies, overseas investors and private individuals. The accrual convention that is adopted for gilts is not the method used in many other government bond markets. By the accrual method, accrued interest is calculated on the basis of the number of days since the last coupon and the actual number of days in the coupon period.

The DMO controls the issue of gilts into the market place and uses different methods depending upon the circumstances it faces at any time. Currently, the DMO believes that the range of issues in the market is, if anything, too large and may lead to excessive fragmentation of supply and demand.

In order to avoid the problem above, the DMO may issue a tranche of an existing stock. This entails issuing a given amount of nominal value on exactly similar terms to an existing gilt. The DMO refers to this as 'opening up an existing gilt'. The advantages of tranches are that they avoid adding further complexity to the gilt market and increase the liquidity of current issues. When a tranche is issued, it may be identified by the letter 'A' in order to indicate that when the tranche is issued a full coupon may not be paid on the next payment date, to reflect the fact that the gilt has only been in issue for part of the coupon period.

A small tranche may be referred to as a tranchette. However, in they moved to a telephone-driven market supported by market makers. The DMO is the lead regulator in the gilts market. Its objective is to ensure that the gilts market remains solvent, liquid and, above all, fair.

In order to do this, the DMO must have access to the markets. It is the DMO that allows participants to enter the gilts market and, thereafter, it is the DMO that monitors their capital adequacy on a daily basis. Their role is to ensure that two-way quotes exist at all times for all gilts. Market makers are allowed to enter the market by the DMO. Once accepted as a gilt-edged market maker, the firm is obliged to make a market in all conventional gilts.

For index-linked stocks, because the market is less liquid, the DMO has authorised a more limited list of market makers. If a GEMM was to build up a large position in a particular stock and then decide to unwind it, it might be difficult to achieve without revealing to the rest of the market that he was long or short of a stock.

This is obviously a dangerous position and would discourage Gilt-Edged Market Makers from taking substantial positions. IDBs are only accessible to market makers in the gilts market. Equity market makers also have access to Inter— Dealer Brokers. The ability to unwind positions anonymously through the IDBs is also viewed as an important mechanism for ensuring equity market liquidity. The SBLIs borrow stock on behalf of market makers from these dormant positions.

The stock is passed to the market maker who uses it to settle the trade, and in effect, to go short. Eventually, the market maker will be obliged to buy stock to cover the short position, and this stock will then be passed back to the institutional investor. The SBLI charges commission on the trade of around 0.

This commission is split between the intermediaries and the institution. This is a facility available to all market participants and provides them with vital access to stock positions enabling them to go short. The SBLIs also act as a focus for surplus cash, enabling those who are long of funds to deposit money, and market makers who need to borrow money to obtain finance. Broker-dealers have dual capacity, giving them the choice to either act as agents broker on behalf of customers, or to deal for themselves as principal dealer , dealing directly with customers.

Acting as principle involves buying and selling on the firms account. An exchange-traded instrument is one that is packaged in a standardised way, in respect of the contract size and dates for example, facilitating the creation of a liquid market in the instrument, on an exchange.

OTC over the counter markets are decentralised. MTFs are systems where firms provide services similar to those of exchanges by matching client orders. A firm taking proprietary positions with a client is not running an MTF. There has been debate about the requirements to be imposed on MTFs.

The Committee of European Securities Regulators CESR has published standards they expect to be met by MTFs, including notifying the home state regulator of activities, fair and orderly trading, price transparency, clarity of systems and reduction of financial crime.

MTFs may be crossing networks or matching engines that are operated by an investment firm or a market operator. Instruments traded on a MTF may include shares, bonds and derivatives. It aims to ensure this by placing requirements on MTF operators regarding how they organise their markets and the information they give to users.

Equiduct is another MTF. This offers trading anonymity, without prices being displayed on the public order book usually found on exchanges. In the past, stock exchanges have viewed off-exchange trading as their main source of competition. Some exchanges have adapted their technology to handle the need for large orders to be hidden from the market: LSE and Liffe both offer an iceberg facility through which only a small part of a large order is displayed at one time.

Meanwhile, sell-side brokers have been developing algorithms to help them to detect if an order is being traded away from the market. More regulatory attention could be paid to the growing use of dark pools in the future, in case of any systemic risk that they might present. The SI thus executes orders from its clients against its own book or against orders from other clients. An SI is effectively treated like a mini-exchange under MiFID, and is subject to pre-trade and post-trade transparency requirements.

MiFID requires such firms to publish firm quotes in liquid shares for orders below 'standard market size' and to maintain those quotes on a regular and continuous basis during normal business hours. This electronic order-driven trading service offers a select number of gilts and UK corporate bonds. The launch of ORB introduced continuous two-way pricing for trading in UK gilts and retail-size corporate bonds on-exchange. RBS was the first issuer, of 5. The secondary market for retail bonds is fragmented, usually over-the-counter OTC.

In practice, this means that computers are used to enter program trades. Such trades are often made to take advantage of arbitrage opportunities, which seek to exploit small price differences between related financial instruments, such as index futures contracts and the stocks underlying them. Algorithmic trading is a form of trading in which orders are entered to an electronic trading platform based on an algorithm which sets criteria for making the trade based on aspects such as timing, price or quantity.

Generally, orders will be executed without human intervention. Studies have found that over half of equity trading volume on major exchanges results from algorithmic trading. A special type of algorithmic trading is high frequency trading HFT or 'flash' trading, which seeks to respond to information received electronically before other human traders are able to process the information and place trades.

High frequency traders, it is claimed, can make profits at the expense of institutional investors, by creaming off small amounts from each trade. For example, one possible practice is placing an order, then almost instantaneously cancelling it, and then placing an order for the same stock at the next lower price.

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Page iv. Chapter 1. Page 1. Financial markets and institutions. Chapter 2. Page Ethics and investment professionalism. Chapter 3. The regulation of financial markets and institutions. Chapter 4. Legal concepts. Chapter 5. Client advice. Chapter 6. Taxation in the UK. By the end of this Unit, learners should be able to demonstrate:. The detailed content of Syllabus version 11 , which is tested from 1 December , is set out below. The Chapter-Section reference in the right-hand column indicates where in this Study Text each learning outcome is covered.

For example, learning outcome 1. Learning outcome. Demonstrate an understanding of the UK financial services industry, in its European and global context. Demonstrate an understanding of UK and international financial markets. Introduction to financial markets. Explain the functions of the financial services industry in allocating capital within the global economy. Evaluate the role and impact of the main financial institutions. Explain the role of government including economic and industrial policy, regulation, taxation and social welfare.

The role of securities markets in providing liquidity and price transparency. Differentiate between a financial security and a real asset. Identify the key features of: a common equity share, a bond, a derivative contract, a unit in a pooled fund, and a foreign exchange transaction. Types of financial markets. Identify the main dealing systems a nd facilities offered in the UK equities market. Identify the nature of the securities that would be traded on each of the above systems and facilities.

Explain the structure and operation of the primary and secondary UK markets for gilts and corporate bonds. Explain the motivations for and implications of dual listing of a company. Compare and contrast exchange trading and over-the-counter OTC markets. Distinguish between a quote-driven and order-driven market.

Explain the roles of the various participants in the UK equity market. Explain high-frequency trading, its benefits and risks. Settlement procedures in the UK. Explain the clearing and settlement procedures for UK exchange traded securities. The UK Listing Authority and prospectus requirements. Explain the purpose of the requirement for prospectus or listing particulars. Identify the main exemptions from listing particulars. Information disclosure and corporate governance requirements for UK equity.

Explain the purpose of corporate governance regulation and the role of the Financial Reporting Council FRC in promoting good corporate governance. Explain, in outline, the scope and content of corporate governance regulation in the UK. Explain the continuing obligations of LSE listed companies regarding information disclosure and dissemination.

Explain, in outline, the UK company law requirements regarding the calling of general meetings. Distinguish annual general meetings and other types of company meetings. Distinguish between the types of resolution that can be considered at company general meetings. Distinguish between the voting methods used at company meetings.

Explain the role and powers of a proxy. International markets. Explain the structure, features, regulatory and trading environment of international markets, including developed markets and emerging markets. Explain the structure and operation of the primary and secondary markets for Eurobonds. Explain the settlement and clearing procedures overseas, including the role of international central securities depositories, and the different settlement cycles and challenges in managing global assets.

The principal-agent problem: separation of ownership and control. Explain how capital markets allow the beneficial ownership and the control of capital to be separated. Distinguish between beneficial owners principals and the various agents involved in the capital allocation process.

Identify examples of agency costs such as: expropriation, perquisites, self- dealing, and higher cost of capital, which arise when the agency problem is known to exist. Identify the main reasons why it is argued that reducing the agency problem benefits the investment profession and society as a whole. Demonstrate an ability to critically evaluate the outcomes that distinguish between ethical and compliance-driven behaviour.

Ethical and compliance driven behaviour. Describe the need for ethics in the investment industry. Identify the ethical obligations to clients, prospective clients, employers and co-workers. Identify positive and negative behavioural indicators. Critically evaluate the outcomes which may result from behaving ethically — for the industry, individual advisers and consumers. Critically evaluate the outcomes wh ich may result from limiting behaviour to compliance with the rules — for the industry, firm, individual advisers and consumers.

Explain the professional principles and values on which the Code of Ethics is based. Apply the Code to a range of ethical dilemmas. Demonstrate the ability to apply the regulatory advice framework in practice for the consumer. Demonstrate an understanding of where the PRA may also be involved for dual-regulated firms. European Union Directives, Regulations and Guidance. Explain the role and powers of the European Securities and Markets Authority. UK regulation.

Explain the scope of the Regulated Activities Order as amended in terms of: regulated activities, specified investments. Explain the make-up of the Panel on Takeovers and Mergers the takeover panel and how it is financed. Explain the regulatory status of the City Code on Takeovers and Mergers. Explain the main provisions of the City Code including the bid timetable. Explain the purpose and scope of the Trustee Act , the rights and duties of the parties involved, the nature of the trust deed, and the investment powers of trustees.

Explain the significance of the Pensions Act scheme-specific funding requirement, the Pensions Regulator, the Pension Protection Fund. Explain the purpose of a Statement of Investment Principles. The Financial Conduct Authority objectives and high level standards. Identify and distinguish among the blocks of the FCA Handbook. Regulation of investment exchanges. Explain the role of an investment exchange. Explain the need for, and relevance of, investment exchanges needing to be recognised by the FCA.

Explain how the Bank of England regulates clearing houses in the UK. Identify the recognised investment exchanges and clearing houses in the UK. Identify the features of trading systems for derivatives. Identify the main features of the regulation of derivatives. Identify the main features of clearing and settlement for trading on derivatives exchanges, and when trading over-the-counter OTC. Explain the arrangements for market transparency and transaction reporting in the main derivative markets.

FCA Business Standards. Accepting customers for business client categorisation. Financial promotions and other communications with customers including information about the firm. Identifying client needs suitability and appropriateness. Dealing and managing. Investment research. Product disclosure — packaged products. Record keeping and reporting information. Client assets and client money rules.

FCA Supervision and redress. Financial crime. Explain the three stages involved in the money laundering process. Explain the four offence categories under UK money laundering legislation. Explain the offence of insider dealing covered by the CJA Demonstrate an understanding of legal concepts relevant to financial advice.

Explain legal persons and power of attorney. Explain basic law of contract and agency. Explain the types of ownership of property. Explain insolvency and bankruptcy. Explain wills and intestacy. Identify the main types of trusts and their uses. The regulatory advice framework. Demonstrate an understanding of how the retail consumer is served by the financial services industry.

Demonstrate an ability to apply the investment advice process. Demonstrate an understanding of the range of skills required when advising clients. Types and characteristics of investors. Describe and compare different types of investors. Explain how needs differ amongst different types of investors. Explain the main needs of retail clients and how they are prioritised.

Analyse the main types of investment risk as they affect investors. Explain the role of diversification in mitigating risk. Advice and recommendations. Explain why asset allocation always comes before investment or product selection. Explain the key roles of charges and the financial stability of the provider as criteria within the fund selection process, and the use of past performance. Explain the importance of stability, independence and standing of trustees, fund custodians and auditors in the fund selection process.

Identify benchmarks and other performance measures. Explain the importance of reviews within the financial planning process. Skills required when advising clients. Describe the need for advisers to communicate clearly, assessing and adapting to the differing levels of knowledge and understanding of their clients. Identify and apply suitable investment solutions to suit different needs of retail clients. The objectives of pension funds, life assurance and general insurance. In this first chapter of the Study Text, we look at the place of the financial services industry within the economic system, and at the main institutions and markets within the industry.

Chapter Roundup. Test Your Knowledge. Learning objective. Money is the main medium of exchange in our society. In a barter economy , goods and services are exchanged one for another. If someone works to harvest corn, and is given corn in payment for their labour, this is a barter exchange. The use of money as a medium of exchange creates much flexibility in economic transactions. If the harvester is paid in money instead of corn, he may be able to use that money to buy cooking pots and meat.

He cannot subsist only on corn. Money functions as a medium of exchange because:. The modern monetary economy involves a huge variety of types of transactions involving money. Because money is a recognised medium of exchange among people, it is accepted that debt relationships between people, and claims by one person or institution over another, can be expressed in monetary terms.

The financial services industry covers various activities within our monetary economy. At the national level, we have the economy of the United Kingdom, with its own currency, the pound sterling. The financial services industry also operates within an international framework, resulting from both the multinational nature of many financial services activities and from various international agreements and regulatory influences. The flow of funds in an economy describes the movement of funds or money between one group of people or institutions in the economic system and other groups.

Within each of these three sectors, there are continual movements of funds. As well as movements of funds within each sector, ther e are flows of funds between different sectors of the economy. These flows of funds can be shown in a diagram. Flow of funds ignoring financial intermediation. But reality is not quite so simple, and our analysis of the flow of funds in the UK should also take account of two other main factors. The UK economy is influenced by trade with the foreign sector and flows of capital both from and to it.

An intermediary is a go-between, and a financial intermediary is an institution which links lenders with borrowers , by obtaining deposits from lenders and then re-lending them to borrowers. Such institutions can, for example, provide a link between savers and investors. The role of financial intermediaries such as banks and building societies in an economy is to provide means by which funds can be transferred from surplus units for example, someone with savings to invest in the economy to deficit units for example, someone who wants to borrow money to buy a house.

Financial intermediaries develop the facilities and financial instruments which make lending and borrowing possible. If no financial intermediation takes place, lending and borrowing will be direct. If financial intermediation does take place, the intermediary provides a service to both the surplus unit and the deficit unit.

For example, a person might deposit savings with a bank, and the bank might use its collective deposits of savings to provide a loan to a company. Financial intermediaries might also lend abroad or borrow from abroad, and a fuller version of a diagram depicting the flow of funds is thus as follows. Flow of funds in an open economy, showing the role of financial intermediation.

A financial intermediary is a party bringing together providers and users of finance, either as a broker facilitating a transaction between two other parties, or in their own right, as principal. UK financial intermediaries include the following sectors of the financial services industry:. In spite of competition from building societies, insu rance companies and other financial institutions, banks arguably remain the major financial intermediaries in the UK. The clearing banks are the biggest operators in the retail banking market, although competition from the building societies has grown in the UK.

There is greater competition between different banks overseas banks and the clearing banks especially for business in the wholesale lending market. Financial intermediaries can link lenders with borrowers, by obtaining deposits from lenders and then re- lending them to borrowers. But not all intermed iation takes place between savers and investors. Some institutions act mainly as intermediaries between other institutions. Almost all place part of their funds with other institutions, and a number including finance houses, leasing companies and factoring companies obtain most of their funds by borrowing from other institutions.

Financial intermediaries perform the following functions. Instead of having to find a suitable borrower for their money, lenders can deposit money. Financial intermediaries also provide a ready source of funds for borrowers. By aggregating the deposits of hundreds of small savers, a bank or building society is able to package up the amounts and lend on to several borrowers in the form of larger mortgages.

For example, while many depositors in a building society may want instant access to their funds, the building society can lend these funds to mortgage borrowers over much longer periods, by ensuring that it attracts sufficient funds from depositors over this longer term. By pooling the funds of large numbers of people, some financial institutions are able to give small investors access to professionally managed diversified portfolios covering a varied range of different securities through collective investment products such as unit trusts and investment trusts.

Risk for individuals is reduced by pooling. Since financial intermediaries lend to a large number of individuals and organisations, losses suffered through default by borrowers or capital losses are pooled and borne as costs by the intermediary. Such losses are shared among lenders in general. For most people, risk means the chance that something will go wrong. Taking a risk means doing something that could turn out to be damaging, or could result in a loss.

Individuals can face various risks, such as a risk of physical injury, ill health or death, a risk of damage to property or theft of property, a risk that an investment will lose money, a risk that their bank or other financial institution may fail, and so on. Insurance , of various kinds, offers ways of reducing various risks, by transferring the risk to an insurer who bears risks for many others in exchange for premiums collected from each insured party.

Various financial instruments made available through the financial services industry allow individuals to expose themselves to investment risks that they may wish to run, in the hope of a positive return on their investment.

Businesses , likewise, face various risks. A business may lose customers or key staff, its products may fail, changes in the law may curtail its activities, and so on. A company is owned by its members — that is, its shareholders. However, there are other stakeholders in a company who may stand to lose from the risks that a company is exposed to: these other stakeholder groups that could be affected include providers of debt finance often, banks , employees and directors.

As with individuals, insurance offers a way in which businesses can manage various risks. Financial products offer ways in which individuals and businesses can manage risk. It is not the aim of risk management to eliminate risks entirely. The aims of risk management can be formulated as follows. Risk cannot be totally eliminated, for either individuals or businesses. Indeed, regulators see it as both impossible and undesirable to remove all risk and failure from the financial system.

Exercise: Risk. Set out some reasons why it could be undesirable to remove all risk from the financial system. If there were no risk in the financial system, companies would not be able to raise finance through the system for risky ventures such as developing new medicines or investing in innovative technologies.

People may wish to take risks with money that they can afford to lose, to give the possible prospect of high returns if an investment turns out well. Many of the things that people would like to do, such as buy their own home, are subject to market forces that inevitably involve risks: house prices might fall, so that someone with a mortgage might find that the house comes to be worth less than the mortgage loan on the house. Removing all risk from transactions could mean that excessive resources are spent on bureaucracy to regulate institutions and markets.

The capital markets and the money markets are types of market for dealing in capital. What do we mean by long-term and short-term capital? Banks can be approached directly by individuals retail business and businesses for medium-term and long-term loans as well as short-term loans or overdrafts.

The major clearing banks, many investment banks and foreign banks operating in the UK are often willing to lend medium-term capital, especially to well established businesses. The gilt-edged market is a further major capital market in the UK. Trade in second-hand gilts will continue until the debt eventually matures and the government redeems the stock.

The primary gilts market is the market for the sale of new gilt issues. There is an active secondary market in second-hand gilts with existing holders selling their holdings of gilts to other investors in the gilts market. Providers of capital include private individuals in the retail sector.

There are also, of course, important groups of institutional investors which specialise in providing capital and act as financial intermediaries between suppliers and demanders of funds. Many financial services organisations now have diversified operations covering a range of the following activities.

Pension funds invest the pension contributions of individuals who subscribe to a pension fund, and of organisations with a company pension fund. Insurance companies invest premiums paid on insurance policies by policy holders. Life assurance policies, including life-assurance based savings policies, account for substantial assets, which are invested in equities, bonds, property and other assets.

The business of investment trust companies is investing in the stocks and shares of other companies and the government. In other words, they trade in investments. Unit trusts and Open-ended Investment Companies OEICs are similar to investment trusts, in the sense that they invest in stocks and shares of other companies. Venture capital providers are organisations that specialise in raising funds for new business ventures, such as ' management buy-outs ' ie purchases of firms by their management staff.

These organisations are therefore providing capital for fairly risky ventures. The role of financial intermediaries in capital markets is illustrated in the following diagram. Recent years have seen great changes in the capital markets of the world.

The capital markets of each country have become internationally integrated. Securities issued in one country can now be traded in capital markets around the world. Securitisation of debt means creating tradable securities which are backed by less liquid assets such as mortgages and other long-term loans.

Various techniques have been developed for companies to manage their financial risk such as swaps and options. These ' derivative ' financial instruments may allow transactions to take place 'off-balance sheet' and therefore not easily evident from the company's financial statements.

The existence of such transactions may make it more difficult for banks and other would-be lenders to assess the financial risk of a company that is asking to borrow money. There is much fiercer competition than there used to be between financial institutions for business.

For example, building societies have become direct competitors to the retail banks, and foreign banks have also competed in the UK with the big clearing banks. Banks have made shifts towards more fee-based activities such as selling advice and selling insurance products for commission and away from the traditional transaction-based activities holding deposits, making loans.

Securitisation of debt involves disintermediation. Financial disintermediation is a process whereby ultimate borrowers and lenders by-pass the normal methods of financial intermediation such as depositing money with and borrowing money from banks and find other ways of lending or borrowing funds; or lend and borrow directly with each other, avoiding financial intermediation altogether. Securitisation of debt provides firms with a method of borrowing from non-banks.

Although banks might act as managers of the debt issue, finding lenders who will buy the securitised debt, banks are not doing the lending themselves. The UK money markets are operated by the banks and other financial institutions. Although the money markets largely involve wholesale borrowing and lending by banks, some large companies and the government are also involved in money market operations.

The money markets are essentially shorter term debt markets, with loans being made for a specified period at a specified rate of interest. The money markets operate both as a primary market , in which new financial claims are issued and as a secondary market , where previously issued financial claims are traded.

Loans are transacted on extremely ' fine ' terms — ie with small margins between lending and borrowing rates — reflecting the economies of scale involved. The emphasis is on liquidity: the efficiency of the money markets can make the financial claims dealt in virtually the equivalent of cash. There are different types of banks which operate within a banking system, and you will probably have come across a number of terms which describe them.

Commercial banks make commercial banking transactions with customers. They are distinct from the country ' s central bank. The term wholesale banks refers to banks which specialise in lending in large amounts to major customers. The clearing banks are involved in both retail and wholesale banking but are commonly regarded as the main retail banks. These banks operate as brokers, as underwriters and as advisers in corporate actions such as mergers and takeovers.

These categories are not mutually exclusive: a single bank may be a retail clearing bank, with wholesale and investment banking operations. The building societies of the UK are mutual organisations whose main assets are mortgages of their members.

Among their liabilities are the balances of the investor members who hold savings accounts with the society. The distinction between building societies and banks has become increasingly blurred, as the societies have taken to providing a range of services formerly the province mainly of banks, and banks have themselves made inroads into the housing mortgage market. Some building societies now offer cheque book accounts, cash cards and many other facilities that compete directly with the banks.

The building society sector has shrunk in size over the last twenty years or so as a number of the major societies have either converted to public limited companies and therefore become banks or have been taken over by banks or other financial institutions.

A central bank is a bank which acts on behalf of the government. The Bank is a nationalised corporation, and it has two core purposes : monetary stability and financial stability. Functions of the Bank. Since May , the MPC has had operational responsibility for setting short-term interest rates at the level it considers appropriate in order to meet the Government ' s inflation target.

When the banking system is short of money, the Bank of England will provide the money the banks need — at a suitable rate of interest. In the UK, the short-term money market provides a link between the banking system and the government Bank of England whereby the Bank of England lends money to the banking system, when banks which need cash cannot get it from anywhere else.

It does this by buying eligible bills and other short-term financial investments from approved financial institutions in exchange for cash. It does this by selling bills to institutions, so that the short-term money markets obtain interest-bearing bills in place of the cash that they do not want.

The process whereby this is done currently is known as open market operations by the Bank. This simply describes the buying and selling of short-term assets between the Bank and the short-term money market. The Bank acted as lender of last resort to the bank Northern Rock, when the bank became unable to raise enough funds on the wholesale money markets during

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The spread, from which market makers makes their profits, could be 0. A typical charge could be, say, 1. Brokers incur various costs for the resources they employ to fill orders, including costs for market data and order routing systems, exchange memberships and fees, regulatory fees, clearing fees, accounting systems, office space, and staff to manage the trading process.

Stamp Duty on stock registered in Ireland is charged at 0. Buyers putting through relatively large buy orders may need to push the price of the security up in order to make the trade. Sellers who want to put through a large sell order quickly may need to accept a lower price than is immediately available to a seller with a small order. The cost effect of this tendency for fluctuating order sizes to move prices is called the market impact or price impact, and is a significant component of transaction costs for large financial institutions.

Limit orders, which will be filled only if the price is better than the stated limit, provide a way of limiting transaction costs, compared with market orders, which are filled at whatever prices are available when the order is placed. The opportunity cost of using a limit order is that the price may move against the trader before the order is filled.

As a rule, a limit order is usually advisable for thinly traded stocks, to avoid the risk of a market order being filled at a possibly very disadvantageous price. For buy-side traders, transparency enables the trader to gain knowledge of market values and to estimate potential transaction costs. Opacity in markets may be preferred by sell-side dealers because they typically have an informational advantage over the counterparties with whom they trade, such as buyside market participants.

Liquidity risk or marketability risk has to do with the ease with which an issue can be sold in the market. Smaller issues especially are subject to this risk. In certain markets, the volume of trading tends to concentrate in the 'benchmark' stocks, thereby rendering most other issues relatively illiquid.

Some bonds become subject to 'seasoning' as the initial liquidity dries up and the bonds are purchased by investors who wish to hold them to maturity. The size of the bid-ask spread relative to the value of a security is an indication of the liquidity of the market in that security. Securities with many daily trades will have more dealers and investors placing orders at any one time, and so it is more likely that the highest bid sell price and the lowest ask buy prices will be closer.

More opaque less transparent markets will typically have larger bid-ask spreads because, in opaque markets, dealers will find it more difficult to judge the level of demand for the stock, and so know the equilibrium price. If a market for a security or securities has many ready and willing buyers and many ready and willing sellers, we can say that the market is deeply liquid. The market for US Treasuries US Federal Government debt is an example of a deeply liquid market, with the large daily volume of transactions and low bid-ask spreads meaning that transaction costs are relatively very low.

However, the level of liquidity for some securities can fluctuate significantly, sometimes in response to wider market sentiments. When the macro-economic environment is relatively benign, liquidity levels may remain relatively high, while in a market downturn when investor sentiment declines, liquidity may dry up — particularly for smaller companies such as those on the Alternative Investment Market AIM , and in order-driven markets where there is no requirement for market makers to maintain two-way quotes at all times —and it may be quite difficult for sellers to find a buyer, particularly for larger orders.

Most companies with a larger capitalisation for example, members of the FTSE Index for UK stocks are widely held by institutions as well as smaller investors, and are followed closely by large numbers of analysts. These larger companies have a relatively large quantity of stocks in public hands and large numbers of potential buyers and sellers at virtually all times, and so markets for such stocks tend to have a deep level of liquidity.

During the late s financial crisis and housing market downturn, liquidity in the markets in mortgage-backed securities dried up because of widespread uncertainty about the value of the securities. Where such securities relied heavily on sub-prime mortgages, the housing market downturn threatened to bring a spate of foreclosures and the prospect of high levels bad mortgage debt that would not be repaid.

Investors will generally demand a higher expected return from securities where liquidity is low, because they expect compensation for the risk that they may find it difficult to sell the shares quickly during some periods. The price may move adversely while the stockholder Is waiting to sell. Thus, liquidity risk — the risk that a lack of liquidity may lead to losses for the investor — will generally be reflected in the price of a security. Firms are better able to take risks and to finance large-scale operations that provide for economies of scale in production if there are willing investors in equities, bringing higher productivity and economic growth.

Governments are able to finance public deficits through markets in which the private sector participates. Through well-developed professional fund markets, individuals are able to enjoy more security in retirement incomes made available through their pension schemes. In well-developed markets, price transparency improves informational efficiency, which describes a situation in which the prices of assets reflect all relevant information about their value.

If all investors have access to good quality and timely information about securities, then the prices of stocks will better reflect their fundamental value. In a well-functioning economy, backed by a legal environment that protects the rule of law and minimises corruption, the highest returns will tend to be earned on the securities if firms whose assets are the most productive. The LSE is a business enterprise. Its primary objective is to establish and run a market place in securities.

The LSE provides the main route in the UK for larger companies to raise funds through the issue of shares equity. It makes it easier for large firms and the government to raise long-term capital, by providing a market place for businesses seeking capital and investors to come together. Companies coming to the market may be launching an initial public offering IPO , or may be coming to the market to obtain further capital, for example for an expansion, through a secondary offering.

This is known as the primary market. Consequently, the exchange must also offer a secondary market trading in second-hand shares, this allows the investor to convert the shares into cash. The Alternative Investment Market AIM , which opened in , is a market where smaller companies which cannot meet the more stringent requirements needed to obtain a full listing on the LSE can raise new capital by issuing shares.

Like the Stock Exchange main market, the AIM is also a market in which investors can trade in shares already issued. This means that they can act as agents on behalf of customers or as principals dealing directly with the customers. Different types of shares, with varying levels of liquidity, trade via different market systems.

This is essentially the function which SETS performs. Prices of securities which trade on SETS are, therefore, purely driven by the buyers and sellers in the market themselves. For such a market to operate efficiently, up-to-date prices at which market makers are willing to trade need to be made available to other market participants. This is the function performed by SEAQ. SETSqx discussed later in this Section combines the market making quote-driven model and the orderdriven model.

Clearnet acts as the central counterparty to all SETS trades. Clearnet such that the buyer buys from LCH. Clearnet and the seller sells to LCH. The limit orders are automatically matched by the electronic order book. If an order is not matched entirely, the unmatched portion will remain on the order book. Orders are prioritised in a strict sequence, with price first, then the time of input with the earlier orders first. Below is an example order book for a SETS security. The SETSqx system combines committed principal quotes with periodic auctions where anonymous limit orders are placed.

Market makers and non-market makers can participate in auctions, these auctions take place at , , and The market makers will provide a ready counterparty to market participants wishing to trade SETSqx shares and bonds in return for being able to make profits from a spread between buying and selling prices.

In order to act as a market maker, the relevant firm undertakes an obligation to quote firm, two-way prices in shares for which they register. Market makers must therefore quote both buying and selling prices two-way prices at which they must deal firm prices up to a predetermined transaction size dependent upon historic volumes. This is the minimum amount of shares a market maker must be prepared to buy, or sell, at their quoted price.

The SEAQ system is used to disseminate market maker quotes to all market makers simultaneously. Since at least two market makers are required for a share to trade on SEAQ, the system is referred to as a competing market maker system. This is termed a cross listing. The term dual listed company DLC describes something different from a cross listing. A DLC involves a corporate structure in which there are two corporations, normally registered in different jurisdictions, which act as a single operating business.

The DLC structure involves a legal equalisation agreement and separate stock exchange listings for each of the corporations. The two corporations will have different sets of shareholders who agree, through the equalisation agreement, to share the risks and rewards of ownership of the operating business in a specified proportion. The arrangement is broadly similar to a joint venture.

The agreement will cover matters such as dividends, corporate governance winding up. The coupon is fixed at the issue date and is paid regularly to the holder of the bond until it is redeemed at maturity when the principal amount is repaid. Corporate bonds may be sold through an open offer, or in a private placing to a limited number of professional investors.

With an open offer, a syndicate of banks with one bank as lead manager will underwrite the issue by buying the bonds and then selling them on to investors. A bought deal is where the lead bank buys all the bonds and then sells them to the syndicate. Corporate bonds generally trade in over-the-counter OTC markets, with market liquidity being provided by dealers and other market participants.

The most important source of financing open to the government is the gilts market. Holders of gilts can now receive coupon payments gross, unless they opt otherwise. The main investors in gilts are UK pension funds and insurance companies, banks, building societies, overseas investors and private individuals. The accrual convention that is adopted for gilts is not the method used in many other government bond markets. By the accrual method, accrued interest is calculated on the basis of the number of days since the last coupon and the actual number of days in the coupon period.

The DMO controls the issue of gilts into the market place and uses different methods depending upon the circumstances it faces at any time. Currently, the DMO believes that the range of issues in the market is, if anything, too large and may lead to excessive fragmentation of supply and demand. In order to avoid the problem above, the DMO may issue a tranche of an existing stock. This entails issuing a given amount of nominal value on exactly similar terms to an existing gilt.

The DMO refers to this as 'opening up an existing gilt'. The advantages of tranches are that they avoid adding further complexity to the gilt market and increase the liquidity of current issues. When a tranche is issued, it may be identified by the letter 'A' in order to indicate that when the tranche is issued a full coupon may not be paid on the next payment date, to reflect the fact that the gilt has only been in issue for part of the coupon period.

A small tranche may be referred to as a tranchette. However, in they moved to a telephone-driven market supported by market makers. The DMO is the lead regulator in the gilts market. Its objective is to ensure that the gilts market remains solvent, liquid and, above all, fair. In order to do this, the DMO must have access to the markets.

It is the DMO that allows participants to enter the gilts market and, thereafter, it is the DMO that monitors their capital adequacy on a daily basis. Their role is to ensure that two-way quotes exist at all times for all gilts. Market makers are allowed to enter the market by the DMO. Once accepted as a gilt-edged market maker, the firm is obliged to make a market in all conventional gilts. For index-linked stocks, because the market is less liquid, the DMO has authorised a more limited list of market makers.

If a GEMM was to build up a large position in a particular stock and then decide to unwind it, it might be difficult to achieve without revealing to the rest of the market that he was long or short of a stock. This is obviously a dangerous position and would discourage Gilt-Edged Market Makers from taking substantial positions.

IDBs are only accessible to market makers in the gilts market. Equity market makers also have access to Inter— Dealer Brokers. The ability to unwind positions anonymously through the IDBs is also viewed as an important mechanism for ensuring equity market liquidity. The SBLIs borrow stock on behalf of market makers from these dormant positions. The stock is passed to the market maker who uses it to settle the trade, and in effect, to go short. Eventually, the market maker will be obliged to buy stock to cover the short position, and this stock will then be passed back to the institutional investor.

The SBLI charges commission on the trade of around 0. This commission is split between the intermediaries and the institution. This is a facility available to all market participants and provides them with vital access to stock positions enabling them to go short. The SBLIs also act as a focus for surplus cash, enabling those who are long of funds to deposit money, and market makers who need to borrow money to obtain finance.

Broker-dealers have dual capacity, giving them the choice to either act as agents broker on behalf of customers, or to deal for themselves as principal dealer , dealing directly with customers. Acting as principle involves buying and selling on the firms account. An exchange-traded instrument is one that is packaged in a standardised way, in respect of the contract size and dates for example, facilitating the creation of a liquid market in the instrument, on an exchange.

OTC over the counter markets are decentralised. MTFs are systems where firms provide services similar to those of exchanges by matching client orders. A firm taking proprietary positions with a client is not running an MTF. There has been debate about the requirements to be imposed on MTFs. The Committee of European Securities Regulators CESR has published standards they expect to be met by MTFs, including notifying the home state regulator of activities, fair and orderly trading, price transparency, clarity of systems and reduction of financial crime.

MTFs may be crossing networks or matching engines that are operated by an investment firm or a market operator. Instruments traded on a MTF may include shares, bonds and derivatives. It aims to ensure this by placing requirements on MTF operators regarding how they organise their markets and the information they give to users. Equiduct is another MTF. This offers trading anonymity, without prices being displayed on the public order book usually found on exchanges.

In the past, stock exchanges have viewed off-exchange trading as their main source of competition. Some exchanges have adapted their technology to handle the need for large orders to be hidden from the market: LSE and Liffe both offer an iceberg facility through which only a small part of a large order is displayed at one time. Meanwhile, sell-side brokers have been developing algorithms to help them to detect if an order is being traded away from the market.

More regulatory attention could be paid to the growing use of dark pools in the future, in case of any systemic risk that they might present. The SI thus executes orders from its clients against its own book or against orders from other clients. An SI is effectively treated like a mini-exchange under MiFID, and is subject to pre-trade and post-trade transparency requirements. MiFID requires such firms to publish firm quotes in liquid shares for orders below 'standard market size' and to maintain those quotes on a regular and continuous basis during normal business hours.

This electronic order-driven trading service offers a select number of gilts and UK corporate bonds. The launch of ORB introduced continuous two-way pricing for trading in UK gilts and retail-size corporate bonds on-exchange. RBS was the first issuer, of 5. The secondary market for retail bonds is fragmented, usually over-the-counter OTC. In practice, this means that computers are used to enter program trades. Such trades are often made to take advantage of arbitrage opportunities, which seek to exploit small price differences between related financial instruments, such as index futures contracts and the stocks underlying them.

Algorithmic trading is a form of trading in which orders are entered to an electronic trading platform based on an algorithm which sets criteria for making the trade based on aspects such as timing, price or quantity. Generally, orders will be executed without human intervention. Studies have found that over half of equity trading volume on major exchanges results from algorithmic trading. A special type of algorithmic trading is high frequency trading HFT or 'flash' trading, which seeks to respond to information received electronically before other human traders are able to process the information and place trades.

High frequency traders, it is claimed, can make profits at the expense of institutional investors, by creaming off small amounts from each trade. For example, one possible practice is placing an order, then almost instantaneously cancelling it, and then placing an order for the same stock at the next lower price. By flashing orders quickly, traders may be trying to ascertain where other investors want to buy and sell stocks, and may thus be squeezing slightly better prices from investors.

Exchange Traded Funds ETFs have come to be used by high frequency traders as part of complex arbitrage strategies. Such strategies can benefit traders who can place themselves to take advantage of them when they work as intended, but there is the risk that the predominance of HFT can precipitate extreme market volatility which can affect market participants widely.

A further risk arises from the possibility of technical problems in this form of automated trading. The Foresight report was able to find no clear evidence that HFT increased market volatility, although HFT had the potential to increase market illiquidity periodically. The report finds that there is widespread concern among larger institutional investors that HFT is the cause of market manipulation.

The Report found no direct evidence of HFT leading to increased market abuse, although there has been little research that would shed light on this issue. The Report noted that the nature of market making has changed, with high frequency traders now providing the bulk of such activity in both futures and equities.

However, unlike designated specialists, high frequency traders typically operate with little capital, hold small inventory positions and have no obligations to provide liquidity during periods of market stress. These factors, together with the ultra-fast speed of trading, create the potential for periodic illiquidity, such as the US Flash Crash. Settlement in sterling or euros is made on a Delivery versus Payment DVP basis, where both parties are ready to settle with each other at the same time, known as real time gross settlement.

The ability to have special settlement periods, up to business days after the day of the trade, gives flexibility to investors. This means that any purchaser of the shares is entitled to expect to receive the next dividend. As a share approaches its dividend payment date, a company sets a books closed date also known as the 'record date' or the 'on register date'. The company pays the next dividend to all shareholders who are on the register of shareholders, on the books closed date.

The books closed date will be some time before the dividend payment date to make administration easy for the company. If a shareholder buys a share cum dividend and fails to have his name entered on the register of shareholders by the books closed date, the company will send the dividend cheque to the previous shareholder.

The new shareholder does not lose the dividend, since they are legally entitled to it, but the mechanics of arranging for the old shareholder to remit the dividend to the new shareholder are cumbersome and time consuming. In order to avoid this problem, the Stock Exchange has developed a system whereby shares will commence trading ex-dividend on the Stock Exchange two business days prior to the books closed date.

A purchaser of the share ex-dividend is not entitled to receive the next dividend as it belongs to the seller of the share. It is possible, by agreement, to carry out a transaction ex-dividend before the official ex-dividend date. This is only permitted by the Exchange for ten business days before the normal ex-div date. The idea is that shareholders who buy the shares cum dividend will be able to get on the register of shareholders in time to receive the dividend.

Those who buy the shares ex-dividend will not be entered on the register by the books closed date. This means that the appropriate person always receives the dividend from the company. Parties may agree bilaterally to trade a share ex-dividend in the 'special ex-dividend' period, which covers 10 business days up to the ex-dividend date.

For corporate bonds, there is a special exdividend period of five business days. For gilts, there is no special ex- period. The LSE publishes rules governing the trading in securities in the secondary markets, and to some extent in the primary markets.

There are two levels of entry into the stock market, namely through the Official List and traded on the main market, or through the Alternative Investment Market AIM. These detail the requirements that a company must meet prior to being admitted to the Full List. A company must be a plc in order to offer its shares to the public. In addition to the requirements, the company will be required to pay a fee.

Its main business activity must have been continuous over the whole three-year period. In addition, there should be three years of audited accounts. This requirement is waived for innovative high growth companies, investment companies and in certain other situations. For a standard listing, there is no trading history requirement. The lower the free float, the fewer shares are available in the market, potentially leading to higher share price volatility.

For a standard listing, there is no minimum for the proportion of shares in public hands. Interim reports must be published within two months of the half-year end. If price-sensitive information is inadvertently released to analysts or journalists, a company must take immediate steps to provide the information to the whole market.

A company should correct their public forecasts as soon as it becomes aware that the outcome is significantly different. However, companies are not obliged to tell analysts their forecasts are wrong. Documentation in its final form must be submitted 48 hours prior to the hearing the 'hour rule'. Companies are obliged to produce and include in that documentation a statement by the directors confirming that the working capital of the business will be adequate.

This letter must be submitted and approved by the sponsor. This contains detailed information and a report given by the company's accountants on the information produced. The level of detail and the requirement for verification makes a prospectus under the listing rules much more expensive to produce than an ordinary prospectus produced by an unlisted company issuing shares. Thus smaller, fast-growing companies may obtain access to the market at a lower cost and with less regulatory burden.

Should the company lose its NOMAD, it must appoint a new one otherwise the listing will be suspended. For AIM companies, there is no minimum level of free float shares available for purchase by the public , no minimum market value for their securities and no minimum trading history. However, they must produce a prospectus, which is considerably less detailed than for a full listing, and is known as an Admission Document. This document gives details of the company, its shares, financial information, management and future prospects.

The prospectus is not examined by the Stock Exchange and investors must make their own judgements as to its contents. The cost of raising finance is lower than on the AIM market. ISDX describes itself as a London-based stock exchange providing UK and international companies with access to European capital through a range of fully listed and growth markets.

The Directive requires that a prospectus is produced when there is a public offer of securities or where securities are admitted to trading on an EU regulated market. The Directive specifies the content of prospectuses and requires that they are approved by the relevant competent authority — in the UK, the FCA. These requirements are designed to increase protection of investors by ensuring the quality of prospectuses and to enhance international market efficiency through the issue of single approved prospectuses for use throughout the EEA.

Investors must be given 'essential and appropriately structured' information for them to understand the nature of the risks posed by the issuer. If the competent authority in the relevant member state approves the prospectus, it will be accepted throughout the EEA. The overall position is that a prospectus is required in the case of an offer of transferable securities to the public in the EEA, unless an exemption applies. Following July amendments to the Prospectus Directive, the main exemptions from the requirement to publish a prospectus are currently follows.

The Model Code also governs the approval process and disclosure of such dealings at all times: clearance to deal must be sought from a designated director. The Code is intended to ensure that shareholder-directors demonstrate to other shareholders that they will not abuse their position for unfair advantage. No trades should be undertaken in a listed company by its directors and senior executives in specified close periods before the announcement of results.

The rules require those who discharge managerial responsibilities to make notifications to the issuer and the market via a Regulatory Information Service. The holdings involved include holdings of authorised unit trusts and open-ended investment companies, of EEA qualifying investment managers, and of registered US investment managers.

EEA issuers ie, companies issuing securities incorporated and with their registered office in another EEA Member State are instead required to comply with their home State's requirements. There is no longer a requirement for a public company to keep a register of interests in shares as s CA was repealed when the EU Transparency Directive was implemented in The company must keep a register of the information received from such investigations.

DTR 5. Institutional shareholders have abandoned their traditional 'back seat' role and show an increasingly proactive approach to holding directors of the company to account. The change in attitude has been fuelled by some notable corporate failures and the perception that directors may be improving their own pay and conditions at the expense of the shareholders. The code acknowledges that corporate governance is the system by which companies are directed and controlled.

Boards of directors are responsible for the governance of their companies. In its review of the Code following the financial crisis of the late s, the Financial Reporting Council considered that the impact of shareholders in monitoring the Code could and should be enhanced by better interaction between the boards of listed companies and their shareholders.

The way this operates is widely supported by companies and investors as allowing flexibility while ensuring sufficient information for investors to come to their own conclusions. The Main Principles of the Code are as follows. Section A: Leadership Every company should be headed by an effective board, which is collectively responsible for the longterm success of the company.

No one individual should have unfettered powers of decision. The chairman is responsible for leadership of the board and ensuring its effectiveness on all aspects of its role. As part of their role as members of a unitary board, non-executive directors should constructively challenge and help develop proposals on strategy.

Section B: Effectiveness The board and its committees should have the appropriate balance of skills, experience, independence and knowledge of the company to enable them to discharge their duties and responsibilities effectively.

There should be a formal, rigorous and transparent procedure for the appointment of new directors. All directors should be able to allocate sufficient time to discharge their responsibilities effectively. All directors should receive induction on joining the board and should regularly update and refresh their skills and knowledge. The board should be supplied with timely information to enable it to discharge its duties.

The board should undertake a rigorous formal annual evaluation of its own performance and that of its committees and individual directors. All directors should be submitted for re-election at regular intervals, subject to continued satisfactory performance. The board is responsible for determining the nature and extent of the significant risks it is willing to take in achieving its strategic objectives.

The board should maintain sound risk management and internal control systems. Section D: Remuneration Levels of remuneration should be sufficient to attract, retain and motivate directors of the quality required to run the company successfully, but a company should avoid paying more than is necessary for this purpose. No director should be involved in deciding his or her own remuneration. Section E: Relations with shareholders There should be a dialogue with shareholders based on the mutual understanding of objectives.

The board as a whole has responsibility for ensuring that a satisfactory dialogue with shareholders takes place. The board should use the AGM to communicate with investors and to encourage their participation. It has the aim of making shareholders more active and engaged in corporate governance. Companies should maintain consistent procedures to determine what information is price-sensitive and should therefore be released.

If price-sensitive information is inadvertently released to analysts, journalists or others, the company should take immediate steps to publicise the information to the whole market. DTR provides that an issuer may delay the public disclosure of inside information, such as not to prejudice its legitimate interests, provided that the public would not be likely to be misled and the issuer is able to ensure the confidentiality of the information.

For example, public disclosure of information may be delayed for a limited period if the firm's financial viability in 'grave and imminent danger' to avoid undermining negotiations to ensure the firm's long-term financial recovery. The members of a company in general meeting can exercise control over the directors, although only to a limited extent.

The company may remove directors from office by ordinary resolution s The removal by CA of the requirement for private companies to hold an AGM see below enables private companies to make many decisions by written resolution, although the company will still need to hold meetings to dismiss a director or to remove an auditor before the end of his term of office.

The shareholders and directors also still have the power to call a meeting. If no quorum is present, the meeting is adjourned. The court, on the application of a director or a member entitled to vote, may order that a meeting shall be held and may give instructions for that purpose including fixing a quorum of one s CA This is a method of last resort to resolve a deadlock such as the refusal of one member out of two to attend and provide a quorum at a general meeting.

The directors of a public company must convene a general meeting if the net assets fall to half or less of the amount of its called-up share capital s CA For public companies at least, it is a statutorily protected way for members to have a regular assessment and discussion of their company and its management. A listed company must, under the CA rules, hold their AGM within six months of the end of their financial year.

If a company wishes to amend or replace their Articles of Association, the new Articles will need to be filed at Companies House with a written resolution. One of the basic principles of company law is that the powers which are delegated to the directors under the articles are given to them as a collective body.

The board meeting is the proper place for the exercise of those powers. The directors can unanimously assent on issues without meeting by a signed resolution procedure. Any resolution signed by all the directors entitled to attend a board meeting will be valid, as if it had been decided at a board meeting. This does not apply to AGMs of a public company, where unanimity is required. A resolution is passed when the pre-determined majority is reached, or it fails if the necessary majority is not obtained.

This is not necessary for an ordinary resolution if it is routine business. Some ordinary resolutions, particularly those relating to share capital, have to be delivered for filing but many do not. A special resolution is required for major changes in the company such as the following. This is an important distinction between special resolutions and ordinary resolutions. Copies of a written resolution proposed by directors must be sent to each member eligible to vote by hard copy, electronically or by a website.

Alternatively, the same copy may be sent to each member in turn. The company may appeal to the court not to circulate the 1, word statement by the members if the rights provided to the members are being abused by them. A public company can no longer pass a written resolution. They must also keep copies of all resolutions of members passed other than at general meetings.

These records must be kept for 10 years and need to be available for inspection by members on request. When sending out proxy forms, companies usually suggest the names of directors of the company who can be appointed by the member to act as a proxy, voting as they see fit unless otherwise instructed. The maximum period of time before a meeting that a company may specify for the deposit or revocation of a proxy is 48 hours.

There are two different types of proxy. A proxy is valid for the meeting and any adjournment. See below on voting methods. Thus, following CA changes, proxies may exercise all the powers the member would have if they were present in person s 1.

A declaration by the chairman that the resolution is carried on a show of hands is all that is required for a resolution to be passed: but this does not apply if a poll is called for. The number of votes for or against on a show of hands need not be counted. In a poll, the votes will reflect the number of shares held. There is a common law duty on the chairman to demand a poll on a vote if he considers that the outcome would be different from that reached on a show of hands. Many companies — particularly quoted companies — count all votes on a poll as a matter of practice.

Some companies still allow meeting participants — whether members attending in person or by proxy — to demonstrate their feelings on a resolution through a show of hands. In general, on a show of hands, each member present is entitled to one vote. In the case of a proxy however, on a show of hands, a proxy will have one vote for and one vote against the resolution, if the proxy has been appointed by multiple members some of whom have instructed the proxy to vote for and some of whom have instructed the proxy to vote against the resolution s 2 CA , as amended.

If members want an independent scrutiny of a poll, they must make their request up to one week after the meeting. Below is a summary of the major foreign government bonds and their key features. The French government also has an inflation-linked bond, the OATi. This receipt is in bearer form and denominated in dollars. It is possible to trade ADRs in what is known as pre-release form.

Here, the holding bank releases the receipt to the dealer prior to the deposit of shares in its vaults. The dealer may then sell the ADRs in the market. However, the cash raised through this trade must then be lodged with a holding bank as collateral for the deal.

This situation may exist for a maximum of three months, at the end of which the broker must purchase shares in the cash market and deposit them with the holding bank which then releases the collateral. ADRs, whilst being designated for the American market, also trade in London. These securities are traded through the International Order Book.

In line with the domestic American markets, settlement for ADRs takes place in three business days. Dividends are received by the bank which holds the shares. They are then converted into dollars and paid to the holders. The holder of the ADR has the right to vote at the company's meeting in the same way as an ordinary shareholder.

The only right which they do not possess is that of participation in rights or bonus issues. In the case of such an issue, the bank holding the shares will sell the bonus shares or rights nil paid and distribute the cash proceeds to the ADR holders. It is a term used to describe a security primarily used to raise dollar-denominated capital either in the US or European markets.

The NYSE was established in and is an order-driven floor dealing market. Trading on the NYSE revolves around specialists who receive and match orders via a limit order book. Specialists will also act as market makers where an order cannot be matched via the order book to ensure continuous liquidity in a stock. Exchange member firms input orders in a similar way to SETS and these reach specialists via the trading post, where the security is traded. The user, who may be an investor or a broker, receives a confirmation report of the transaction in real time as soon as the order is executed.

This size is evident in both the quantity of issuance in the primary market and volumes of activity in the secondary market. This is due to the UK reforms that have been designed to bring the two markets into line. Indeed, the general direction of all government bond markets has been towards greater 'fungibility' or similarity, with the US being seen as the role model.

The key player in the market is the Federal Reserve the 'Fed'. The US Treasury is part of government and responsible for the issuance of debt in order to fund the deficit. Central to the operation of the market are the primary dealers. These firms are the market makers. They are authorised to conduct trades by the Fed and are obliged to make markets in all issues. As with the UK, there are inter-dealer brokers IDBs to facilitate the taking and unwinding of large positions.

There are no money brokers, but there is a full repo market. While the stocks are listed on the New York Stock Exchange, the market is effectively an over-the-counter market. The market operates to locally, but is perhaps the most truly global market.

The market has deep liquidity across the maturity range. There are three main types of instrument issued. Issuance takes place on a regular calendar with weekly issues of three or six-month Treasury bills, monthly issues of one-year bills and two and five-year notes, and quarterly issues in set cycles of longer dated stocks.

The competitive auction in the US is basically the system that was introduced into the UK in The principal differences are that, in the US, the primary dealers are obliged to bid for stock and bids are on a yield basis rather than price in the UK. In part, this has been forced upon them by the highly fragmented nature of the domestic banking market. Equally, however, investors are willing to hold corporate debt as part of their portfolios in a way in which UK investors are not.

Under rule A, corporates are allowed to issue bonds into the private placement market without seeking full SEC registration. This access to the market is not restricted to overseas issuers, and the market is dominated by US domestic issuers who have chosen not to enter the public market. Prior to the emergence of the Eurodollar market and to a limited extent after this , there has been substantial interest from non-US firms in raising dollar finance. A Yankee bond is a dollar-denominated bond issued in the US by an overseas borrower.

Given that Eurodollar bonds may not be sold into the US markets until they have seasoned a period of 40 days , there is still a divide between the Euromarket and the domestic market. Within this, there tends to be a strong focus on the 'benchmark' bond. This has in the past caused wide discrepancies between the benchmark and other 'side issues'. The terms of the issue are set by the Ministry of Finance having taken soundings in the market from the syndicate.

However, any issues that are deliverable into the JGB future will possess a fair degree of liquidity. Settlement is conducted through book entry systems. In the form of 'quasigovernment' there are the agencies and municipal stocks. International borrowers are able to access the domestic pool of savings through the issue of Samurai publicly issued yen bonds and Shibosai yen bonds issued via private placement. It operates a computerised order book known as the NSC.

In , plans were announced to move towards a more independent central bank in line with the obligations of the Maastricht Treaty. This commitment made the French market the most efficient bond market within the first wave of European Economic and Monetary Union EMU , with a transparent, liquid and technologically strong market.

The development of MATIF the French financial futures market, now part of Euronext and the trading of the 'Notional' future into the French long bond were also a vital component in the reform of the market. The French Government issues the following types of bond, each with a different maturity. New issues are made on a sixmonthly basis and, in between these new issues, existing issues are reopened on a monthly basis.

They are issued with maturities of between 6 and 30 years. OAT strips are permitted. All French Government issues are now in book entry form with no physical delivery. Over half the market is made up of debt issues from the public corporations. These stocks are not, for the most part, guaranteed by the Government, but the corporations concerned do possess strong credit ratings.

They have established their own market structure in order to facilitate trading in their stocks. All issues are by way of a placing through a syndicate of mainly local banks. Clearing, settlement and custody take place through Clearstream. Unlike the UK, Germany has a strong corporate debt market and a relatively weak equity market. The bulk of finance for industry is provided through the banks, either as lenders or shareholders, with debt securities other than Eurobonds being less significant.

Within the context of debt issuance, it is the banks that issue bonds and then lend on the money to the corporate sector. The German financial markets have undergone a process of liberalisation and modernisation. These have gradually removed the residual capital controls and allowed the development of a market in futures and options. With the adoption of the Euro, the German bond market emerged as the benchmark for Government bonds of the Eurozone. The bulk of the banking sector bond issuance comes in the form of Pfandbriefe.

These are effectively bonds collateralised against portfolios of loans. Offenliche Pfandbriefe are backed by loans to the public sector and Hypotheken Pfandbriefe are backed by mortgages. Special bonds have been issued to fund the reunification process and are referred to as unity bonds. This now matches to the Eurobond three-day settlement period, allowing Government or bank bonds held outside Germany to settle via Euroclear and Clearstream.

In many of these markets, bond and equity trading is OTC and is restricted to locally registered participants. Settlement systems in such markets tend to be run by central banks with no counterparty guarantees. In addition, non-electronic settlement systems and physical delivery are not uncommon. These characteristics make participation both difficult and risky for the UK investor.

Companies issuing debt in the Eurobond market have their securities traded all around the world and are not limited to one domestic market place. The market only accepts highly rated companies, since Eurobonds themselves are unsecured debt. As such, a better name for it might be an 'international bond'. As mentioned above, Eurobonds frequently carry no security other than the high name and credit rating of the issuer. Another important feature of bonds issued in this market is that, for the most part, they are issued in bearer form, with no formal register of ownership held by the company.

For a number of pragmatic reasons, the clearing houses in the Euromarkets do maintain a form of register of ownership, but this register is not normally open either to government or tax authorities. Combined with the feature of being bearer documents, a vital aspect of the Eurobond is that, unlike most government bonds, it does not attract withholding tax.

Eurobonds pay coupons gross and usually annually. Most Eurobonds are issued in bullet form, redeemed at one specified date in the future. However, a number of issues have alternative redemption patterns. Some bonds are redeemed over a number of years with a proportion of the issue being redeemed each year.

Whilst Eurobonds are not issued in registered form, each will have an identifying number. A drawing of numbers is made every year from the pool of bonds in issue, the numbers drawn are published and the bonds are called in and redeemed.

This redemption process is known as a drawing on a Eurobond. The market is telephone driven and the houses are based in London. The market is regulated by the International Capital Market Association ICMA which operates rules regulating the conduct of dealers in the market place. Settlement is conducted for the market by two independent clearing houses, Euroclear and Clearstream.

These clearing houses immobilise the stocks in their vaults and then operate electronic registers of ownership. Settlement in the Eurobond market is based on a three business day settlement system. Once again, the important feature about the registers maintained by the two clearing houses is that they are not normally available to any governmental authority, thereby preserving the bearer nature of the documents. A traditional method of issuing a Eurobond is for an issuer to appoint a lead manager and award them the mandate.

The mandate gives the lead manager the power and responsibility to issue the bond on the issuer's behalf. The lead manager may then create a management group of other Eurobond houses. Each house then receives a portion of the deal and places it with its client base. The lead manager may elect to run the entire book alone, and miss out the other members of the management group. In normal issues, the lead manager has the ability to amend the terms of the issue as market conditions dictate.

It is also common for the lead manager to place the entire deal themselves in these circumstances without forming a syndicate. The clearing banks are involved in both retail and wholesale banking but are commonly regarded as the main retail banks. These banks operate as brokers, as underwriters and as advisers in corporate actions such as mergers and takeovers. These categories are not mutually exclusive: a single bank may be a retail clearing bank, with wholesale and investment banking operations.

The building societies of the UK are mutual organisations whose main assets are mortgages of their members. Among their liabilities are the balances of the investor members who hold savings accounts with the society. The distinction between building societies and banks has become increasingly blurred, as the societies have taken to providing a range of services formerly the province mainly of banks, and banks have themselves made inroads into the housing mortgage market.

Some building societies now offer cheque book accounts, cash cards and many other facilities that compete directly with the banks. The building society sector has shrunk in size over the last twenty years or so as a number of the major societies have either converted to public limited companies and therefore become banks or have been taken over by banks or other financial institutions. A central bank is a bank which acts on behalf of the government.

The Bank is a nationalised corporation, and it has two core purposes : monetary stability and financial stability. Functions of the Bank. Since May , the MPC has had operational responsibility for setting short-term interest rates at the level it considers appropriate in order to meet the Government ' s inflation target.

When the banking system is short of money, the Bank of England will provide the money the banks need — at a suitable rate of interest. In the UK, the short-term money market provides a link between the banking system and the government Bank of England whereby the Bank of England lends money to the banking system, when banks which need cash cannot get it from anywhere else.

It does this by buying eligible bills and other short-term financial investments from approved financial institutions in exchange for cash. It does this by selling bills to institutions, so that the short-term money markets obtain interest-bearing bills in place of the cash that they do not want. The process whereby this is done currently is known as open market operations by the Bank. This simply describes the buying and selling of short-term assets between the Bank and the short-term money market.

The Bank acted as lender of last resort to the bank Northern Rock, when the bank became unable to raise enough funds on the wholesale money markets during The financial services industry is a key sector of the UK economy.

The City is the largest centre for many international financial markets, such as the currency markets. The UK has the greatest concentration of foreign banks, numbering around compared with around in the USA, in the world. The assets of UK-owned banks,. The banks and building societies form a significant pa rt of the market for financial services.

A banking institution could maintain access to a full range of products and product providers by setting up an independent arm. However, few have maintained a who lly independent stance. The universal bank model involves providing financial services of various kinds, including advisory services, in addition to deposit and lending services. UK life insurance companies sell various products within the UK retail market, including collective investment schemes such as unit trusts, OEICs and investment trusts, pension products and individual life insurance.

The development of life assurance provision by banks is known as bancassurance or all finanz. The Association of British Insurers ABI defines bancassurers as 'insurance companies that are subsidiaries of banks and building societies and whose primary market is the customer base of the bank or building society'. The UK has a major general insurance and reinsurance market ranging from personal motor insurance to insurance for space satellites.

Reinsurance is a process by which a company — for example, a life office writing new business — can sell or pass on the risks on its policies to a third party reinsurer. This makes the third largest such market in the world, exceeded only by the US and Japan. Lloyds acts as a major reinsurer for life assurance. Lloyds is a long-established market in which underwriting syndicates operate independently. Syndicates are run by managing agents who appoint underwriters to write assess risks on behalf of the syndicate.

With a rapidly ageing population, there is a pensions crisis worldwide. Many countries are passing the burden for pensions provision from the state sector to the private sector. Domestically, the UK pensions market is of great importance, and a higher proportion of pension payments are provided by the private sector in the UK than in nearly any other country. Collective funds such as unit trusts and investment trusts need to be managed.

Around one quarter of these funds were managed on behalf of overseas clients. The UK fund management sector offers liquid markets, with the opportunity to trade in large blocks of shares, and a relatively liberalised operating environment combined with protection against abuse. More funds are invest ed in the London than the ten top European centres combined. As well as having a substantial domestic market in equities company shares and bonds interest-bearing securities , the UK is a major international centre for trading in Eurobond markets, which are the markets.

More foreign companies are traded on the London Stock Exchange than on any other exchange. At the time of the introduction of the euro as a common European currency, it was suggested by many that London could lose its strong position as a lead ing world financial centre and might lose out to competing European centres such as Frankfurt. There are a number of aspects favouring London as a major financial centre.

Germany , which has a large banking and insurance sector, and Switzerland both carry a tradition of the universal bank. Under this system, any recognised bank can provide a full range of banking services, including retail banking services alongside wholesale and investment banking. However, where it appears that a single bank provides such a range of services in the UK and the USA, this is generally managed by setting up separately capitalised subsidiaries with similar names to the parent company.

Spain , France and the Netherlands have banking traditions somewhere between the universal and segmented models. Equity involvement has been limited, with founding families continuing to play a lead role in firms. In Germany and France as well as Italy, relatively little use has been made of equity finance by firms. Finance for industry in Germany often comes directly from the banks, and stock market liquidity is limited, with investment opportunities being more limited than in other advanced economies.

France has a broadly based economy with the Government working closely with industry on major projects. The stock market of France merged with those in Brussels and Amsterdam in to form Euronext. The financial systems of the smaller Northern European Scandinavian countries have been dominated by a few large domestic banks that have evolved into larger Nordic financial groups through cross-border mergers and acquisitions.

US dollar-denominated fixed interest stocks including Eurodollar bonds issued by foreign entities make up around half of total global bond market capitalisation. The size of the US economy and the dominance of the US dollar in international transactions has made the US financial system central to both the US economy and the global economy. The US banking system is characterised by the large number of deposit-taking banks, which may be either state-chartered or national and federally licensed institutions.

Non-depository institutions include securities firms, insurance companies, mutual funds, pension funds and finance companies. This legislation enabled different types of companies operating in the US financial services industry to merge. For companies in the US, there are broadly two distinct approaches to this form of business. Outside the USA for example, in Japan , non-financial services companies are permitted within the holding company.

Then, each company still appears independent, and has its own customers. The US system is based almost wholly on statute with minimal self-regulation. Ranking after London and New York, the third and four th largest financial centres are found in Asia — being Tokyo and Singapore respectively. Within China, Shanghai and Hong Kong are also key centres.

With a population of around 1. China will come to represent an increasingly significant pool of consumers of services as time goes on. In a similar way to India and Malaysia in recent years, China could become a cost-effective focus for service provision in the financial sector. The experience of outsourcing into other emerging markets in recent years shows how security and reliability are key to the expansion of such service provision.

Growth slowed during the s after a bubble in Japanese asset prices. The economy is technologically. The bond market of Japan is the second largest in the world, and both government and corporate bonds are traded. Accounting standards result in less objectivity than in other jurisdictions, and company information may be less readily available than elsewhere.

Private capital investment remains strong. The Agency is a Japanese governmental organisation that oversees banking, securities and insurance and reports to the Ministry of Finance. Legislation laws introduced by Parliament often gives authority for Government departments to introduce secondary legislation in the form of additional regulations.

An argument for public Government provision of services such as healthcare and education postulates that these are merit goods which, if left to private free market transactions, would be consumed in quantities that would be insufficient for the optimisation of social welfare. For example, if the Government did not provide free or subsidised education, it could be argued, many parents would go without educating their children rather than pay fees for education.

The extent to which the Government influences what we do reflects the type of economic system we have. The economic system of the UK and of the wider European Union to which the UK belongs can be described as that of the mixed economy.

Some goods and services — for example, postal services — may be provided by the State. The government may be seen as playing a role in reducing inequalities in the distribution of income and wealth through the tax system. Its immediate aim is the integration of the economies of the member states.

A more long-term aim is political integrat ion. The European Union has a common market combining different aspects, including a free trade area and a customs union. This may be extended into a customs union when there is a free trade area between all member countries of the union, and in addition, there are common external tariffs applying to imports from non-member countries into any part of the union.

In other words, the union promotes free trade among its members but acts as a protectionist bloc against the rest of the world. In addition to free trade among member countries there are also free markets in each of the factors of production. A British citizen has the freedom to work in any other country of the. European Union, for example. A common market will also aim to achieve stronger links between.

UK Statute law is made by Parliament or in exercise of law-making powers delegated by Parliament. In recent years however, UK membership of the EU has restricted the previously unfettered power of Parliament. Regulations, having the force of law in every member state, may be made under provisions of the Treaty of Rome. EU legislation takes the following three forms. Their objective is to obtain uniformity of law throughout the EU.

They are formulated by the Commission but must be authorised by the Council of Ministers. Until a Directive is given effect by a national UK statute, it does not usually affect legal rights and obligations of individuals. A decision may be addressed to a state, person or a company and is immediately binding, but only on the recipient.

The Council and the Commission may also make recommendations and deliver opinions, although these are only persuasive in authority. Monetary policy is the area of government economic policy making that is concerned with changes in the amount of money in circulation — the money supply — and with changes in the price of money — interest rates.

These variables are linked with inflation in prices generally, and also with exchange rates — the price of the domestic currency in terms of other currencies. Since , the most important aspect of monetary policy in the UK has been the influence over interest rates exerted by the Bank of England , the central bank of the UK.

That Act states that the Bank of England is expected 'to maintain price st ability, and, subject to that, to support the economic policy of HM Government including its objectives for growth and employment'. This will tend to be followed by financial in stitutions generally in setting interest rates for different financial instruments.

However, a government does not have an unlimited ability to have interest rates set how it wishes. It must take into account what rates the overall market will bear, so that the benchmark rate it chooses can be maintained. The Bank must be careful about the signals it gives to the markets, since the effect of expectations can be significant. The monthly minutes of the MPC are published.

This arrangement is intended to remove the possibility of direct political influence over the interest rate decision. The Bank of England reducing interest rates is an easing of monetary policy. Demand will tend to rise and companies may have improved levels of sales.

Companies will find it cheaper to borrow: their lower interest costs will boost bottom-line profits. Investors will be willing to pay higher prices for gilts government stock because they do not require such a high yield from them as before the interest rate reduction. Those who are dependant on income from cash deposits will be worse off than before. The Bank of England increasing interest rates is a tightening of monetary policy. Companies will find it more expensive to borrow money and this could eat into profits, on top of any effect from reducing demand.

Investors will require a higher return than before and so they will pay less for fixed interest stocks such as gilts. The exchange rate of the national currency pounds sterling against other major currencies such as the US dollar, the euro and the Japanese yen is another possible focus of economic policy. The Government could try to influence exchange rates by buying or selling currencies through its central bank reserves.

However, Government currency reserves are now relatively small and so such a policy might have to be limited in scope. Another way the Government might wish to influence exchange rates is through changes in interest rates :. As we have seen, interest rate policy is now determined by the MPC. Interest rate policy is decided in the light of various matters apart from exchange rates, including the inflation rate and the level of house prices. If the UK joined the single European currency , the euro , interest rates would effectively be determined at.

It would not be possible for interest rates in different eurozone countries to be much out of line at any one time, since differences would encourage money flows to seek the high er rates available in a particular country, and borrowers would seek the best rates available. The forces of supply and demand would lead to an approximate equalisation of rates. A government's fiscal policy concerns its plans for spending, taxation and borrowing.

These aspects of fiscal policy reflect the three elements in public finance. The government, at a national and local level, spends money to provide goods and services, such as a health service, public education, a police force, roads, public buildings and so on, and to pay its administrative work force. It may also, perhaps, provide finance to encourage investment by private industry, for example by means of grants. Expenditure must be financed, and the government must have income.

Most government income comes from taxation, but some income is obtained from direct charges to users of government services such as National Health Service charges. To the extent that a government ' s expenditure exceeds its income, it must borrow to make up the difference. Government spending is an injection into the economy, adding to the level of overall demand for goods and services, whereas taxes are a withdrawal. A government ' s ' fiscal stance ' may be neutral, expansionary or contractionary , according to its overall.

Expenditure in the economy will increase and so national income will rise, either in real terms, or partly in terms of price levels only: the increase in national income might be real, or simply inflationary. A government might deliberately raise taxation to take inflationary pressures out of the economy.

The impact of changes in fiscal policy is not always certain, and fiscal policy to pursue one aim eg lower inflation might for a while create barriers to the pursuit of other aims eg employment. Government planners need to consider how fiscal policy can affect savers, investors and companies. Companies will be affected by tax rules on dividends and profits, and they may take these rules into account when deciding on dividend policy or on whether to raise finance through debt loans or equities by issuing shares.

The formal planning of fiscal policy usually follows an annual cycle. In the UK, the most important statement is the Budget , which takes place in the Spring of each year. The Pre-Budget Report formally makes available for scrutiny the Government's overall spending plans. While macroeconomic policy-making is concerned with the economy as a while, industrial policy is focused on particular sectors of the economy.

The institutional framework has the following aims. Other aspects of UK policy concentrate on the advance and commercial application of scientific knowledge, and investment in physical infrastructure, education and health. Innovation policies seek to balance the benefits of intellectual property protection with facilitating the widespread exploitation of new knowledge through, among other things, easing barriers to the widespread dissemination and adoption of ideas.

Underpinning this approach is a presumption that, as a whole, the effective operations of markets are a better way of bringing about improvements to busin ess efficiency and the most economically beneficial allocation of capital, knowledge and employment. Responsibility for the various themes of industrial policy is spread across difference central Government departments, although the Department for Business, Innovation and Skills plays a key role.

The UK works with the European Commission and othe r EU Member States to address from the European perspective issues that are confronting all industrialised countries — the challenges laid down by globalisation, including for example the intense compet ition from growing economies like China and India,.

Actions under the EU Policy agenda. Free international trade is generally associated with the free movement of goods and services between countries. Another important aspect of international trade is the free movement of capital. Some countries including the UK, since the abolition of exchange controls in have allowed a fairly free flow of capital into and out of the country. Other countries have been more cautious, mainly for one of the following two reasons. There is often a belief that certain key industries should be owned by residents of the country.

Even in the UK, for example, there have been restrictions placed on the total foreign ownership of shares in companies such as British Aerospace and Rolls Royce. After all, they need capital to come into the country to develop the domestic economy.

While it is widely accepted that the market mechanism enables prosperity, there are aspects of unbridled free markets that can lead to exploitation, abuse of information and dishonest dealing to the detriment of the overall welfare. There is a need, given that such market failures have the potential to occur, to have certain protections in place to ensure that markets are conducted in accordance with principles of fairness and consumers in general are dealt with fairly.

The Financial Services. Act FSA was brought in to replace the system of self-regulation which had previously prevailed in the UK financial sector. The financial crisis of the late s brought into focus the problems of financial instability affecting some banks and other financial sector instituti ons. The regulation of conduct across the sector, including issues surrounding advice given to retail consumers, became the responsibility of the Financial Conduct Authority FCA , which was formed out of the FSA legal entity.

In some areas and at some times, financial services providers have been subject to voluntary codes , which an industry sector develops itself, rather than rules imposed through the law statutory rules. Clearly, if the Government chooses and Parliament agrees, it can extend statutory regulation to areas previously governed by voluntary codes.

For example, mortgage advice and selling , previously governed by the voluntary Mortgage Code, became regulated in General insurance regulation followed in. The area of banking can be taken as another example. Until , banks and building societies followed a voluntary code the Banking Code in their relations with personal customers in the UK. In November , responsibility for the regulation of deposit and payment products transferred to the FSA as financial services regulator.

Learning objectives. An asset is an item that has value. Such claims are financial assets. Loans debt and shares equity represent the two main types of financial security. Many companies have both debt and equity in their financing structure. Ordinary shares are often referred to as equity shares , or simply equities. The term 'equity' means that each share has an equal right to share in profits.

The ordinary shareholders of a company are the owners of the company. However, it is normal for. This means that the holder of any ordinary shares may attend and vote. Whilst the day-to-day control of the company is passed into the. Although voting rights may vary for different classes of share, each equity share most typically carries one vote.

Companies legally do not have to declare a dividend on ordinary shares, many of them do in order to maintain shareholder loyalty. Companies may pay an interim dividend based on the six-month results, and declare a final dividend based on the year-end results. For public companies, this will not be paid until the shareholders have agreed it at the AGM. Some comp anies give their shareholders the choice to take their dividend in new shares, rather than cash.

New shares are created, but in a way that there will be no significant impact on the share price. The investors are taxed as if they had taken the cash dividend. Companies may only pay dividends out of post-tax profits — that is, from their distributable reserves. In any single year, the dividend paid could exceed the profit for that year, because there may be distributable reserves brought forward from earlier years. Not only do shares offer income in the form of dividends, they also offer the possibility of capital growth when the share price rises.

The term ' bonds ' is used to encompass the asset class of fixed income securities. A bond may be defined as a negotiable debt instrument for a fixed principal amount issued by a borrower. Historically, bonds began as very simple negotiable debt instruments, paying a fixed coupon for a specified period, then being redeemed at face value — a 'straight bond'.

In the past, bond markets were seen as being investment vehicles that was safe enough for 'widows and orphans'. They were thought to be dull markets with predictable returns and very little in the way of gains to be made from trading. The bond markets emerged from this shadow during the mids when both interest rates and currencies became substantially more volatile. Bonds have emerged over the past few decades to be much more complex investments, and there are now a significant number of variations on the basic theme.

Whilst it is perhaps easy to be confused by the variety of 'bells and whistles' that have been introduced into the market in recent years, one should always bear in mind that the vast majority of issues are still straight bonds. The reason for this is that investors are wary of buying investments that they do not fully understand. If an issue is too complex, it will be difficult to market. Bonds are used by a number of issuers as a means of raising finance. Major bond issuers include the following.

Regardless of who the issuer is, there are a number of general characteristics that any bond is likely to have which we will examine next. Negotiability means that it is a piece of paper that can be bought and sold. For certain types of bonds, this. Government bonds tend to be highly liquid, ie very easy to buy or sell, whereas. In order to minimise the risk involved in investment, it is often a good idea for the investor to spread invested money over a range of instruments, thereby diversifying risk.

However, if the individual has a limited amount of money to invest, it will be very difficult to buy a range of individual equities or bonds without incurring relatively high transaction costs. Here they pool their money in a large fund, which is managed and invested for them by a fund manager. There are also exchange traded funds ETFs , which are typically designed to track an index.

A unit trust differs from investment trusts and OEICs in the way it is set up, as a unit trust is not a. A key difference between different pooled investments is the way in which the fund. For unit trusts and OEICs for example , there is a direct relationship between the value of the. Investment trust shares and also ETFs, however, are priced according to supply and demand in the stock.

Unit trusts are, like OEICs, called open-ended funds as there is no limit to the amount of money which can be invested. Investment trusts, on the other hand, are closed-ended : except when new shares are issued — eg, on launch of the trust — the buyer of investment trust shares is buying them from existing holders of the shares.

Advantages of collective investments. A fund manager with a good past performance record may be able to repeat the performance in the future. Disadvantages of collective investments. Derivative contracts is a term encompassing contracts such as futures, options and swaps which derive their value from the movement, up or down, in the price of an underlying asset.

Derivatives can be used to speculate on future price changes, and risks can be high when derivatives are geared to be very sensitive to price changes. For example, a wheat farmer may sell wheat futures called a short hedge to guarantee him a known fixed price for his wheat. If the price of wheat falls between when the farmer buys the contract and its maturity date. The farmer will gain on the futures contract if the wheat price falls, and will lose on the futures contract if the wheat price rises.

These gains and losses can respectively be set against the losses and gains that the farmer makes from actually selling his wheat, so that the net effect will be to give him a price that was known in advance. The FTSE index futures contract could be used to hedge against falls in the share price index over future periods. An investment intermediary, such as a collective pooled fund or a pension fund, may use derivative contracts to achieve their objectives.

The fund may hold a portfolio of UK shares, and may hedge against a possible fall in the value of its portfolio by selling FTSE index futures. If the market falls while the contract is held, the value of the share portfolio will most probably fall, but this will be compensated for by gains on the futures contract.

Having opened the futures contact by selling it, the fund manager will later buy the futures contract in order to crystallise the gain on the contract. Derivatives contract enable investors to take a position in the price of an asset without actually taking delivery of the underlying asset. For example, a position can be taken on the price of oil, without participants in the related derivative contract taking physical delivery of oil at any point.

Derivatives, including options, can be divided into exchange-traded and over-the-counter OTC types. Exchange-traded derivatives are more standardised and offer greater liquidity than OTC contracts, which are tailor-made to meet the needs of buyers and sellers. Traded options are available on the shares of over 90 major listed UK companies. As they are traded products, they are standardised in terms of expiry dates, quantity of shares per option contract and so on.

Currency or foreign exchange trading or FOREX as it is commonly known is the dealing of the currencies of various countries. Although some FOREX is required for overseas trade, much of it is traded for speculative purposes, where FOREX trader s seek to exploit a particular view on interest rate differentials or exchange rate movements. An investment manager might convert sterling into US dollars, for example, in order to make a purchase of US securities.

Prices are advertised on screens and deals are conducted over telephones. The major players are investment banks and specialist currency brokers. This is not a market place where the private investor usually gets directly involved — his currency needs are more often met through specialist money organisations, who themselves have accessed the currency markets through their own specialist broker.

FOREX transactions are described either as spot or forward. Forward is when an exchange rate is agreed today for settlement at some future date, as agreed by the parties. This is a particularly useful way of eliminating risk from transactions requiring currency import and export dealings at some time in the future.

Most currencies are quoted against the US dollar. An effective securities market will have the following characteristics. Electronic order systems should be the most cost-effective. Factors contributing to liquidity are effective and efficient IT and settlement system s, stock availability and stock lending facilities and a diverse membership.

We discuss this later in this section. Sophisticated financial markets also fulfil an important role in the transfer of risk. We have described, for example, how derivatives markets enable investors, entr epreneurs and market participants to hedge risks as well as to speculate on the prices for assets. Quote-driven markets depend on the existence of market makers who are prepared to offer two-way quotes in shares.

Most shares, futures contracts, and standard options contracts are now traded mainly through an order- driven system. Large orders can present a problem, as the broker or the system may struggle to find a. Various order types exist whereby orders may be presented to execute immediately at the prevailing market price, or may be conditional orders depending on price and quantities to match before a trade is achieved.

The bid price is the price at which dealers or investors are willing to pay for a stock and the offer price is the selling price at which dealers or other investors are willing to sell. In a quote-driven market, the spread or turn — the difference between the bid and the offer — enables dealers to make a profit on transactions.

Depending on which securities are being traded, dealers may be working for proprietary trading houses, investment banks, commercial banks, or broker-dealers. Traders in financial markets are sometimes categorised broadly into sell-side and buy-side. The typical costs of a share transaction for a UK investor can be broken down as follows. The purchase cost includes a spread which is the difference between the bid and offer price of the share.

The spread, from which market makers makes their profits, could be 0. A typical charge could be, say, 1. Brokers incur various costs for the resources they employ to fill orders, including costs for market data and order routing systems, exchange memberships and fees, regulatory fees, clearing fees, accounting systems, office space, and staff to manage the trading process. Stamp Duty on stock registered in Ireland is charged at. Cost of purchase. Shares Brokerage commission 1.

Cost of sale. Market participants will typically want to make timely trades, often responding quickly to new information about a security or about the wider market, and will typically buy at higher prices than the prices at which they are able to sell, overall. Buyers putting through relatively large buy orders may need to push the price of the security up in order to make the trade. Selle rs who want to put through a large sell order quickly may need to accept a lower price than is immediately available to a seller with a small order.

The cost effect of this tendency for fluctuating order sizes to move prices is called the market impact or price impact , and is a significant component of transaction costs for large financial institutions. Limit orders , which will be filled only if the price is better than the stated limit, provide a way of limiting transaction costs, compared with market orders , which are filled at whatever prices are available when the order is placed.

The opportunity cost of using a limit order is that the price may move against the trader before the order is filled. As a rule, a limit order is usually advisable for thinly traded stocks, to avoid the risk of a market order being filled at a possibly very disadvantageous price. Transparent markets are markets in which data is available to participants on quotes and in real-time pre- trade transparency and on trades once they occur post-trade transparency.

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