Introduction to Financial Markets – Core Concepts

Key Q&A flashcards covering the essential concepts, instruments, markets, risks, and calculations from SAIFM’s Introduction to Financial Markets module.

What is the primary economic function of the financial system?

To channel funds from surplus economic units (net savers) to deficit economic units (net spenders) and allocate resources to their most efficient use.

Name the four elements of the financial system.

1) Lenders & borrowers 2) Financial institutions 3) Financial instruments 4) Financial markets

Which two modules are compulsory in the SAIFM Registered Persons Examination (RPE)?

1) Regulation & Ethics of the SA Financial Markets 2) Introduction to the Financial Markets

Define a money-market instrument.

A short-term debt security (original maturity ≤ 1 year) issued in the money market, typically used for liquidity and cash-flow management.

What is a treasury bill (T-bill)?

A short-term, risk-free, discount security issued by the National Treasury, usually with 91-, 182-, 273- or 364-day maturities.

Explain the core difference between primary and secondary markets.

Primary market = new issue of securities where issuers raise capital; Secondary market = trading of previously-issued securities among investors.

What are the three major yield-curve shapes?

1) Normal (upward sloping) 2) Inverted (downward sloping) 3) Flat / Humped (transition curves)

Define ‘beta’ in the Capital Asset Pricing Model (CAPM).

A measure of a security’s systematic risk, i.e. its sensitivity to movements in the market portfolio; market beta = 1.

In portfolio theory, what is the efficient frontier?

The set of portfolios offering the highest expected return for each level of risk (or the lowest risk for each level of return).

Give two assumptions of the CAPM.

Investors can (1) borrow/lend unlimited amounts at the risk-free rate, and (2) hold diversified, mean-variance-efficient portfolios.

What is a forward exchange contract?

An OTC agreement to buy or sell a specified amount of currency at a fixed rate on a future date, eliminating FX rate uncertainty.

Differentiate between exchange-traded futures and OTC forwards.

Futures are standardised, exchange-traded, margined and CCP-cleared; forwards are custom-tailored, OTC, and involve bilateral credit risk.

What role does Strate play in the SA financial markets?

It is the licensed central securities depository (CSD) and clearing house that provides electronic custody, clearing and settlement of securities.

List three types of preference shares.

1) Cumulative 2) Redeemable 3) Convertible (others include participating and non-cumulative).

Define ‘repurchase agreement’ (repo).

A short-term collateralised loan where one party sells securities and agrees to repurchase them later at a set price.

What is meant by ‘liquidity’ in a financial market?

The ability to buy or sell a security quickly at low cost with minimal price impact.

Give the formula for simple interest.

Interest = Principal × Rate × Time (I = PV × r × t)

How is the holding-period return (HPR) calculated?

HPR = (Ending price – Beginning price + Cash flow received) / Beginning price.

State two tests of the Efficient Market Hypothesis (EMH).

Weak-form (prices reflect past data) and semi-strong-form (prices reflect all public info).

What are the four G-20 reforms for OTC derivatives?

1) Central clearing 2) Higher capital & margin for non-cleared trades 3) Trading on organised platforms 4) Reporting to trade repositories.

Name two South African interest-rate benchmarks undergoing reform.

JIBAR (Johannesburg Interbank Average Rate) and Sabor (to be replaced by ZARONIA).

Explain ‘duration’ with regard to bonds.

A measure (in years) of a bond’s price sensitivity to changes in interest rates; higher duration => greater price volatility.

What is a collective investment scheme (CIS)?

A vehicle that pools investors’ funds to invest collectively in a diversified portfolio, e.g. unit trusts and ETFs, regulated under the CIS Act.

Define ‘securitisation’.

Packaging illiquid assets (e.g., mortgages) into marketable securities that are sold to investors, with cash flows backed by the asset pool.

What is the purpose of margin on futures exchanges?

To act as good-faith collateral; initial margin starts the position, variation margin covers daily marked-to-market losses.

Describe ‘diversifiable’ versus ‘systematic’ risk.

Diversifiable (unsystematic) risk can be mitigated via diversification; systematic risk is market-wide and cannot be diversified away.

Give two advantages of ETFs for investors.

1) Low-cost access to diversified index exposure 2) Ability to trade intra-day like ordinary shares.

What is a callable bond?

A bond that the issuer may redeem before maturity at specified call dates and prices, allowing refinancing if rates fall.

How does a currency swap differ from an FX swap?

Currency swap exchanges principal & interest in different currencies over years; FX swap is typically < 1 year and exchanges principal only.

State two main taxes that affect SA investors.

Capital Gains Tax (CGT) and Dividends Tax (plus Income Tax on interest and Securities Transfer Tax on share purchases).

What is the JSE’s AltX board designed for?

To facilitate capital raising and trading for small-to-medium, high-growth companies under lighter listing requirements.

Define ‘initial public offering’ (IPO).

The first sale of shares by a private company to the public, creating a new listing on a stock exchange.

Why do portfolio managers rebalance portfolios?

To realign asset weights with the strategic asset allocation after market movements or changes in risk/return expectations.

What is ‘basis risk’ in hedging?

The risk that the hedge instrument’s price does not move perfectly in line with the underlying exposure, leaving residual risk.

Explain ‘value-at-risk’ (VaR).

An estimate of the maximum loss over a specified period at a given confidence level (e.g., 5% chance of exceeding R10 m loss in 1 day).

What is the main difference between income and growth investment objectives?

Income objectives target regular cash flows (dividends/interest) with lower risk, whereas growth objectives target capital appreciation.

List three costs typically incurred when trading shares on the JSE.

Brokerage commission, Strate settlement fee, and Securities Transfer Tax (0.25% on purchases).