HKSI Paper 7 (Financial Market) English Free Trial

Company options are issued to enable investors to subscribe for an allocation of ordinary shares deliverable at a specified future date.

Company options are issued to enable investors to subscribe for an allocation of ordinary shares deliverable at a specified future date. Unlike ordinary shares, company options do not provide a dividend. In addition, they are a relatively unreliable source of equity capital for the issuer, because there are no guarantees that option holders will exercise their options to purchase securities.

Clearing and settlement is processed through the Central Clearing and Settlement System (CCASS). This involves stock exchange participants maintaining stock accounts in CCASS.

Types of equity issues are initial public offerings, rights and bonus issues, private placements, dividend reinvestment plans and retained earnings.

. There are two methods of quoting interest rates:
• Nominal interest rates: This refers to quoting interest rates based on the number of periods in a year when interest is calculated. In other words, a nominal interest rate of 10% compounding monthly is different to the interest based on a nominal rate of 10% compounding quarterly, or semi- annually, or annually.
• Effective interest rates: The effective interest rate takes into account different compounding periods in nominal rates and adjusts the nominal rate for comparative purposes.

The main board for companies with proven track records and listing of growth stocks takes place on the Growth Enterprise Market (GEM).

The SEHK and the GEM are wholly owned by a listed entity called the Hong Kong Clearing and Exchanges Limited (HKEx). It oversees the operations of the exchange-traded securities and futures industry in Hong Kong.

In Hong Kong, equity warrants are a popular investment vehicle and they are traded on the SEHK. They are American-style, which means that warrant holders may exercise their right to convert their warrants to the underlying equity securities at any time prior to or on the maturity date.

Convertible notes are a form of hybrid security. They are effectively a combination of debt and equity.

The investor has the option of converting the loan into ordinary shares in the issuing company at a prescribed price at specified times. If the investor chooses not to convert the convertible notes to shares, then the investor can redeem them for cash at maturity in the same way as other debt securities.

An issuer of new equity securities must provide a detailed written prospectus that is approved by the relevant regulatory authority and made available to investors.

A prospectus is a document that describes the company’s financial status, prospects and outlines what the company plans to do with the money raised from the issue.

As the Hong Kong equity market continued to grow, three more exchanges were established – the Far East Stock Exchange in 1969, the Kam Ngan Stock Exchange in 1971 and the Kowloon Stock Exchange in 1972.

The Stock Exchange of Hong Kong Limited was established in 1980 in order to consolidate the four stock exchanges. The four exchanges continued to operate until 1986 when the current Stock Exchange of Hong Kong Limited became fully operational.

The Hong Kong Exchanges and Clearing Ltd (HKEx) is the result of a merger in March 2000 between the Stock Exchange of Hong Kong (SEHK), the Hong Kong Futures Exchange (HKFE) and the Hong Kong Securities Clearing Company Limited (HKSCC).

The primary objective of the HKEx is best summarised by its mission statement:
Our mission is to operate and develop the Hong Kong securities and derivatives markets to meet the highest expectations of market users while delivering attractive returns to our shareholders and contributing to Hong Kong’s aspiration to be the leading international financial centre in Asia.

Fiscal policy deals with taxation and government expenditure.
The purpose of government fiscal policy is generally to encourage consistent economic growth and employment levels by stabilising levels of output and prices.
Fiscal policy influences the economy in two ways:
1) Directly – through changes in the size of the public sector
2) Indirectly – through the response of the private sector to changes in the public sector.

The overall statistical outcome of government fiscal policy is measured by the difference between total expenditure and receipts. If the level of expenditure is greater than receipts, it is described as a budget deficit. When the level of receipts is great than expenditure, it is described as a budget surplus.

The US economy has a significant impact on Hong Kong’s economy because it is a major trading and investment partner, and also because the HKD is linked to the USD. Therefore any changes in the US economy will be reflected in its levels of trade and investment.

Capital gain: Investors can sell their investment at any time. If the selling price exceeds the purchase price, the investor has made a capital gain on the investment. Conversely, if the selling price is lower than the purchase price, the investor has made a capital loss on the investment.

Financial markets are broadly categorised as being either primary or secondary markets and either exchange-traded or over-the-counter (OTC) markets.

This market involves relatively illiquid individual mortgages being consolidated and “repackaged” to form liquid securities, i.e. they are turned into tradable financial assets and traded similarly to shares and bonds. This process is called “securitisation” and the securities created are called “mortgage-backed securities”

Fund managers who perform insurance business are required to adhere to strict guidelines to ensure the financial stability of the insurance industry and also to ensure professionalism and best practice is maintained.

Examples of OTC derivatives include:
• interest rate swaps
• currency swaps
• currency futures and forwards
• forward rate agreements
• interest rate options.

The willingness of consumers to purchase an item is influenced by various factors, such as:
• level of income
• tastes and fashions
• availability of the item
• availability of substitutes
• price of the item.

Price is generally the most important factor. The higher the price for the item, generally the lower the demand will be for it, and vice versa. Demand is therefore inversely related to price.

Financial intermediaries facilitate the flow of funds in the financial system. Banks are financial intermediaries and they have an important role in facilitating the flow of funds in the banking system by performing the following functions:
• Mobilisation of funds: Banks facilitate the mobilisation of both wholesale and retail funds, and by doing so, they allocate funds more efficiently.
• Investment opportunities: Banks enable investors to save money in order to create wealth, and also to alter their investment portfolios so that they can participate in other financial markets.
• Implementation of monetary policy: It is through the banking system that most governments are able to implement monetary policy. This is explained later in this topic.

Financial market risk can be incurred in a number of different ways including:
• Credit risk: The exposure to default or loss as a result of deterioration in a borrower’s ability to honour its obligations.
• Liquidity risk: Exposure to loss resulting from the inability to convert assets (for example: investment securities, receivables, inventories) to an equivalent cash value, or to raise unsecured funding in a timely and cost- effective manner.
• Market risk: Exposure to changes in earnings as a result of fluctuations of market factors (for example: interest rate, exchange rate, share price, etc.).
• Operational risk: This occurs when a company’s operating processes do not comply with prescribed procedures and policies, or contractual obligations. It can be a result of a flaw in design or operation, human error, oversight or indifference. Operational risk can have different forms

In order for financial markets to operate effectively and efficiently, the following infrastructure must be in place:
• freely available (though not necessarily free) information—often referred to as symmetric
• buyers and sellers must be able to freely buy and sell
• buyers and sellers must be confident that payments will be honoured, that is, there must be an effective and transparent regulatory framework.

Derivatives may either be exchange-traded or OTC. They include futures, forwards, swaps or options (or a combination of one or more of these categories).
Types of derivatives
Examples of exchange-traded derivatives include:
• equity futures and options
• equity index futures and options
• interest rate futures.