Trading and Financial Markets Overview

A comprehensive set of question-and-answer flashcards covering motivations for trading, types of financial markets and instruments, and key concepts in derivatives and risk management.

What are the three main reasons people choose to trade?

To earn a profit through speculation, to manage or hedge risk, and for the personal challenge or enjoyment of trading.

What is the primary goal of a speculator in a financial market?

To anticipate price movements and profit by buying low and selling high.

Who are hedgers and why do they trade?

Hedgers trade to protect the value of an asset they already own—such as a farmer selling crops ahead of harvest—to reduce risk.

What is a financial market?

A venue, physical or electronic, where financial assets like stocks, bonds, currencies, and commodities are bought and sold.

How do exchange-traded markets differ from over-the-counter (OTC) markets?

Exchange-traded markets operate through centralized exchanges with standardized rules, while OTC markets are decentralized networks where dealers quote prices and match buyers and sellers.

Name three major centralized stock exchanges.

The New York Stock Exchange (NYSE), London Stock Exchange (LSE), and Tokyo Stock Exchange (TSE).

In an OTC market, what role do dealers play?

Dealers act as market makers, quoting buy and sell prices and linking buyers with sellers.

What asset class is traded in the foreign exchange (Forex) market?

Currencies such as the euro, the U.S. dollar, and many others.

Why does the Forex market operate 24 hours a day, five days a week?

Because global participants in different time zones create continuous demand and supply for currencies from Monday through Friday.

List three common reasons foreign exchange transactions occur.

International trade, tourism, and borrowing/lending or speculation.

How is the price of a freely floating currency determined?

By the forces of supply and demand for that currency in the market.

What economic lesson is illustrated by Zimbabwe’s excessive money printing?

Excess supply of money causes hyperinflation and severe currency devaluation.

What financial assets are bought and sold in the equity market?

Shares (stocks) representing ownership in companies.

How does a company’s expected profitability affect its share price?

If the firm is profitable and expected to grow, demand for its shares rises and the price increases; if not, the share price tends to fall.

What are commodities, and give two examples from each of the three main commodity sectors.

Commodities are raw materials. Agricultural: corn, soybeans; Energy: crude oil, natural gas; Metal: gold, copper.

Who are the main issuers of bonds in the fixed-income market?

Governments, semi-government bodies such as municipalities, and corporations.

When you buy a bond, what are you essentially doing?

Lending money to the issuer in exchange for periodic interest and repayment of principal at maturity.

What is a derivative?

A financial contract whose value is derived from an underlying asset.

Differentiate between commodity derivatives and financial derivatives.

Commodity derivatives derive value from physical commodities (e.g., oil), while financial derivatives derive value from financial instruments like stocks or indices.

Define a futures contract.

A standardized agreement to buy or sell an asset at a predetermined price on a specified future date.

What rights does an options contract confer to the holder?

The right, but not the obligation, to buy (call) or sell (put) the underlying asset at a specified price.

What is a Contract for Difference (CFD) primarily used for?

As a speculative instrument to profit from price changes in an underlying asset without owning it.

List two advantages of financial derivatives.

They allow margin trading (leverage) and enable traders to go long or short; some derivatives may also receive favorable tax treatment.

Why must margin trading be used cautiously?

Because leverage magnifies both potential gains and potential losses.

What does “going long” mean in trading?

Taking a position that profits if the asset’s price rises; buying first and selling later.

What does “going short” mean in trading?

Taking a position that profits if the asset’s price falls; selling first and buying back later.

In trading terminology, what does the phrase “buy low, sell high” refer to?

The core strategy of a speculator aiming to profit from price movements.

Why might someone trade purely for the challenge?

Some individuals find the analytical and psychological aspects of trading intellectually stimulating and enjoyable.

Which market is considered the largest in the world by daily volume?

The foreign exchange (Forex) market, with average daily volume exceeding five million dollars per day.

What evidence of ownership does a share provide?

A share certifies ownership in a company and entitles the holder to a portion of its profits.