English HKSI Paper 7 Topic 1

Malaysian has minor trade relations with Hong Kong. Besides, Malaysian stock market has the smallest market cap among the above options and hence has lesser influence on the global market.

The wording of the question is actually not the most accurate. Arbitrageurs usually hold opposite positions, but this is the best answer among the existing answers.

If the stock market is the leading indicator of the economy, a rising stock market represents continuous expansionary economy.

Novation is the process whereby the clearing house undertakes the credit risk and acts as the counterparty of both buyer and seller. Only the exchange-traded market has this kind of arrangement. There is no clearing house used generally in foreign market, OTC market and fund-raising market. Thus, there is no novation.

The primary market is where new capital is raised and securities are issued for the first time. For example, the government issues a new debt security or a company issues new equity securities to raise funds from the public by listing on the stock market.

The primary market is where new capital is raised and securities are issued for the first time. For example, the government issues a new debt security or a company issues new equity securities to raise funds from the public by listing on the stock market.

The risk of counterparties on the Stock Exchange is extremely low because the clearing house will carry out novation.
Exchange-traded stock option has very low liquidity risk, but still exists, the suggested answer is to exclude this option

Arbitrage means taking risk-free advantage of countervailing prices in different markets. For example, buying an asset at a low price in one market and then selling it at the same time at a higher price in another.

Arbitrage means taking risk-free advantage of countervailing prices in different markets. For example, buying an asset at a low price in one market and then selling it at the same time at a higher price in another.

Financial markets are broadly categorized as being either exchange-traded or OTC.

The primary market is where new capital is raised and securities are issued for the first time. (e.g. new debt security issued by govt. or new equity securities issued by company.) Option III and IV are found in secondary markets.

Exchange-traded markets are those that operate via a centralized exchange, so it has higher liquidity and resilience. “Novation” operates and guarantee every transaction effectively, the credit risk is therefore lowered.

The secondary market is where all subsequent trading takes place so the primary market relies on the existence of a liquid secondary market. Therefore, option C is incorrect.

The OTC foreign exchange and derivatives are traded on OTC markets.

The global foreign exchange market is the biggest such market, and operates globally via a network of telephones and computer screens.

A system of “novation” operates in exchange-traded markets, whereby the exchange clearing house effectively guarantees every transaction. The credit risk is therefore lowered.

A system of “novation” operates in exchange-traded markets, whereby the exchange clearing house effectively guarantees every transaction.

The global foreign exchange market is the biggest such market, and operates globally via a network of telephones and computer screens.

Types of equity securities include: ordinary shares, preference shares, equity warrants.

The market is divided into the short-term debt market, also referred to as the money market, and the
long-term debt market, or capital market. Those with a maturity of up to one year are money market.
Securities.

The asset with a maturity of more than a year are capital market securities (commonly
referred to as bonds).

Types of equity securities include: ordinary shares, preference shares, equity warrants.

Debt securities with a maturity of up to one year are money market securities.

Types of short-term debt securities include: bills of exchange, negotiable certificates of deposit, promissory notes/commercial papers.

Types of long-term debt securities include: government bonds or notes, corporate bonds floating rate notes, mortgage-backed securities.

The borrower of bond need to repay the principal amount at the maturity date and an interest component periodically. Since bond is a kind of debt, bond-holders have higher priority to receive allocated assets when liquidation. Default risk exists in bonds.

Those debt securities with a maturity of up to one year are money market.

Arbitrage means taking risk-free advantage of countervailing prices in different markets. For example, buying an asset at a low price in one market and then selling it at the same time at a higher price in another.

Un-limitation of other markets increases the investments opportunities of arbitragers. It is because they can have more chance for taking risk-free advantage of countervailing prices in different markets.

Arbitrage means taking risk-free advantage of countervailing prices in different markets. For example, buying an asset at a low price in one market and then selling it at the same time at a higher price in another.

Arbitrage means taking risk-free advantage of countervailing prices in different markets. For example, buying an asset at a low price in one market and then selling it at the same time at a higher price in another.

Buying Hang Seng Index components and then short selling it at the same time to obtain risk free profit is generally called arbitrage.

The purpose of increasing liquidity is to make it easier for market participants to trade. Margin financing makes it easier for buyers to buy securities, hence increase liquidity. Lowering the requirement of lending makes it easier for buyers to buy securities, hence increase liquidity. Short selling allows more sellers to participate in the market, hence increase liquidity. Increasing the margin requirement makes it more difficult for buyers to participate in the market, hence decrease liquidity.

Increased capital flows can facilitate that developed countries provide capital-importing countries with capital and technologies, enhancing productivity and efficiency.

Forward rate agreement is the derivative to bet on the change of interest rates.

All futures are traded in the exchange. Agreements and swaps etc are generally referred to over-the-counter derivatives.

Those debt securities with a maturity of more than a year are capital market securities (commonly
referred to as bonds).

Under the floating rates, market supply and demand determine the value of a currency.

Under the fixed rates, governments and/or their monetary authorities determine a fixed rate of exchange with other currencies.

Under the floating rates, market supply and demand determine the value of a currency.

Derivatives include futures, forwards, swaps and options (or a combination of one or more of these categories). Equity warrants are classified as equity securities.

A highly leveraged institution (“HLI”) is a financial institution that employs high leverage over its asset investment. Hedge funds are currently the best-known examples.

There are three reasons for offshore financial centres (“OFCs”) success: low taxes, less burdensome regulation and supervision, and (in most cases) strict secrecy laws protecting bank clients.

In 2011, the SFC introduced a regulatory framework for the provision of credit rating services in
Hong Kong.

Safeguards for investors and depositors and the power to enforce financial intermediaries to comply with laws and regulations.) should be included in regulation. Without dictation, information affecting liquid markets should not be controlled.

If people do not have confidence in the financial system, they would never lend or invest funds and the financial markets (and ultimately the economy) would stagnate. The number of buyer and seller will decrease as well.

Demand-pull inflation: this results when production cannot keep up with demand for goods and services. Excess demand (i.e. when productivity levels are already maximized) leads to higher
prices in the economy.

Cost-push inflation: this is caused by increases in costs that translate into increases in wages and prices in the economy. Cost-push inflation can also be caused by relatively expensive imports (i.e. imported inflation).

Trough to expansion: this represents economic recovery. Interest rates decrease and investment activity increases.

The willingness of consumers to purchase an item is influenced by various factors while price is generally the most important factor.

Generally, the higher the price for the item, the lower the quantity demanded for it will be, and vice versa. Quantity demanded is therefore inversely related to price. Thus, demand curve is generally shown as negatively sloped curve.

The objective of the producer is to make a profit from the item. Hence, the most important factor, from the producer’s perspective, is the price that can be obtained from selling the item.

The price at which quantity supplied equals quantity demanded at any given time is the “equilibrium” price for that item.

Quantity demanded is inversely related to price. Thus, quantity demanded decreases when the price of the commodity increases. Oppositely, the quantity supplied is positively related to price. Thus, quantity supplied increases when the price increases.

Quantity demanded is inversely related to price. Thus, quantity demanded increases when the price of the commodity decreases. Oppositely, the quantity supplied is positively related to price. Thus, quantity supplied decreases when the price decreases.

The role of intermediaries is to channel the flow of funds between the borrowers and lenders. Therefore, indirect financing, or intermediation, occurs when the needs of borrowers and lenders do not match.

The economic sectors are classified as:

Household sector; Business sector; Government sector; Overseas sector; Finance sector.

Generally, the higher the price for the item, the lower the quantity demanded for it will be, and vice versa. Quantity demanded is therefore inversely related to price.

The objective of the producer is to make a profit from the item. Hence, the higher the price, the more the producer is willing to supply. The quantity supplied is therefore positively related to price.

Household sector consists of the consumers of goods and services. It is also referred to as the retail sector. The household sector spends and invests money, and mainly consists of fund providers (lenders).

Business sector consists of the producers of goods and services. This sector also requires funds to produce goods and services, and the sector is therefore mainly made up of fund seekers (borrowers).

Whether a government is a fund seeker or a fund provider depends on its overall budgeting position – if in surplus, it is a fund provider.

Whether a government is a fund seeker or a fund provider depends on its overall budgeting position – if in deficit, it is a fund seeker.

A government requires funds to meet its economic, political and social objectives (such as provision of hospitals, schools and roads), and is primarily a fund seeker.

If interest rate increases, debt securities are perceived as a less attractive investment option and investors may look to other markets for better return or lessen their exposure to debt securities.

Under globalization, most economies do not exist in isolation, but as part of the global economy, relying on other countries for trade – that is, imports and exports – to borrow and lend funds and to develop domestic infrastructure by establishing new businesses in the domestic economy.

A disadvantage of this mobility, however, is that it can encourage speculative capital inflows and outflows, and cause economic and financial instability not only to individual countries, but also to entire regions; and additionally, it may also have global implications.

Some investors can find investments which takes place in other places and thus the rate of return can be enhanced.

Up to 1997, companies in the worst-hit countries had borrowed large amounts as their economies boomed, and many of these loans were in US dollars because of the lower interest rate. The exchange rates of local currencies were pegged to the US dollar, and so these companies had no fears of having to earn money in the local currency to pay back loans in US dollars. From the middle of 1995 the US dollar started to rise against most of the world’s currencies. Many Asian economies, prior to the currency crisis, tried to shadow the US dollar through central bank intervention and thus their exports became more expensive and less competitive. Inevitably, Asian countries did devalue, and stock markets plunged because it was clear many companies would have difficulty repaying US dollar loans.

There are some well-known lessons to be learnt from the Asian financial crisis:(1)A strong, well-regulated and transparent financial sector is important to a sustainable policy framework;
(2)It is necessary to establish an effective mechanism of economic and financial surveillance to identify potential risk;(3)Careful debt management is required to sustain both governments and corporations. Their policies and strategies must be designed to enable them to meet their debt obligations;(4)Good corporate governance is a requirement of corporate sector health, which in turn can provide the foundation of a healthy financial sector.

The subprime crisis case highlights the following lessons:(1)Credit ratings for different types of obligation should be clearly distinguished, and investors should not solely rely on ratings to make their investment decisions;(2)Appropriate policy should strike a balance between improving consumer protection and maintaining the viability of the securitization model;(3)Policymakers should resist pressure for bailouts in order to reduce the danger of reinforcing speculative or fraudulent behaviour.
A moral hazard may occur where the actions of one party may change to the detriment of another after a financial transaction has taken place. The subprime crisis consists of lots of Breach of contract, so the government should be aware of moral hazard.

Often news is pre-empted in the market (i.e. market expectations) and as a result the expected impact has already been factored into the prices of securities. Therefore, the prices of stocks decrease when the market expects that the economy is likely to shrink in the short term.

The BIS fulfils this mission by:(1)promoting discussion and facilitating collaboration among central banks;(2)supporting dialogue with other authorities that are responsible for promoting financial stability;(3)conducting research on policy issues confronting central banks and financial supervisory authorities;(4)acting as a prime counterparty for central banks in their financial transactions; and(5)serving as an agent or trustee in connection with international financial operations.

Intermediaries will satisfy the exact requirements of lenders and borrowers, so that the credit risk will be lowered. The effective financing encourages international trades. Intermediaries also facilitates the efficient allocation of resources, i.e. funds may be rapidly and easily moved to where they are needed most. Thus, the mobility is enhanced.

The question is imperfect as it depends on the growth speed of demand and supply. If the growth rate of demand exceeds the growth rate of supply, the price will rise; otherwise, the price will fall. However, since there is no such information, the answer is estimated to be I, III according to the pattern of the examination.

The Hang Seng China Enterprises Index reflects the overall performance of Mainland Chinese companies listed in Hong Kong, so it has a close relationship with enterprises related to Mainland China. Monetary policy affects the supply and cost of CNY, which in turn affects the value of the currency. Therefore, the exchange rate of CNY against the Hong Kong dollar will also change. The Hang Seng Index covers many stocks that are related to China and not related to China. As for the fourth answer, since the Hong Kong dollar and the US dollar have a linked exchange rate system, the currency value of the Hong Kong dollar is directly related to the US dollar, so the Hong Kong dollar interest rate will also follow the rise and fall of the US dollar interest rate, not CNY. Therefore, Hong Kong dollar interest rate has the slightest relationship with Mainland China’s monetary policy.

The World Bank help each developing country onto a path of stable, sustainable and equitable growth. Option A is the function of The BIS while option C and option D are the functions of The IMF.

The WTO is an international organization dealing with the global rules of trade between nations. Its main function is to ensure that trade flows as smoothly, predictably and freely as possible.

Money plays an important role in the financial system. Money acts as a
-means of storing wealth
– medium of exchange
-unit against which to value other goods and services.

In order to fulfil its functions, money needs to be durable, storable and portable.

M1 consists of all notes and coins in circulation and customers’ demand deposits placed with licensed banks (the authorized institutions in Hong Kong under the Banking Ordinance). It is collectively known as “narrow money”.

M3 consists of M2 plus deposits in other financial institutions. It is collectively termed “broad money”.

M1 consists of all notes and coins in circulation and customers’ demand deposits placed with licensed banks (the authorized institutions in Hong Kong under the Banking Ordinance).Option III and option IV are classified as M2.

M1 consists of all notes and coins in circulation and customers’ demand deposits placed with licensed banks. Meanwhile, M2 consists of M1 and M3 consists of M2.

M2 consists of savings and time (term) deposit accounts with licensed banks while M3 consists of M2.

M3 consists of M2 plus deposits in other financial institutions. It is collectively termed “broad money”.

Money plays an important role in the financial system. Money acts as a
– means of storing wealth
– medium of exchange
– unit against which to value other goods and services.

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:
1.Mobilization of funds
2.Investment opportunities
3.Implementation of monetary policy

The BIS offers a range of financial services specifically designed to assist central banks in the management of their foreign exchange.

In Hong Kong, Hong Kong Monetary Authority plays a role as central bank. Meanwhile, the BIS offers a range of financial services specifically designed to assist central banks in the management of their foreign exchange.

Central banks are generally the authorities responsible for regulating the monetary and banking systems, and the money supply. Hong Kong Monetary Authority also responsible for such matters in Hong Kong.

Although central banks do not dictate interest and exchange rates per se, the actions they take in foreign exchange and domestic fixed income markets, particularly in the sale and purchase of government bonds, have a profound effect on financial markets.

Duties of central banks: 1) Conduct the nation’s monetary policy.2) Maintain the stability of the financial system.3) Supervise and regulate banking institutions.4) Provide financial services to certain institutions, government and public.

Financial intermediaries may perform the function of “market makers”, who quote two-way prices in the market – that is, they quote a bid and an ask, so that they encourage securities trading and thus increase liquidity in the market.

Intermediation transfers risk to intermediaries but additional cost to borrowers and investors. Intermediaries channel funds from where there is a surplus to where there is a deficit, this improves the efficiency of the allocation.

The main advantage of intermediation is the transfer of risk from borrowers and lenders to intermediaries. This lowers the credit risk

Intermediation (indirect financing) involves third parties, financial institutions or intermediaries, acting as a link between fund providers (lenders) and fund seekers (borrowers).

Intermediation transfers risk to intermediaries but additional cost to borrowers and investors.

The main disadvantage of intermediation is the additional cost that is passed on to borrowers and investors in the form of higher interest costs, fees, brokerage or commission. Disintermediation or direct financing may be less costly.

Intermediation transfers risk to intermediaries but additional cost to borrowers and investors.

Efficient financial markets have:
1. freely available information
2.able to buy and sell freely;
3.people must be confident that payments will be honoured
4.operate with high standards of honesty, integrity and credibility.

Under an effective financial market, there must be an efficient payment and settlement system. Thus, buyers and sellers cannot trade without cost.

Liquidity are measured by:
Depth: volume of buyers and sellers
Spread: difference between bid and ask prices
Immediacy: time taken to effect the transaction
Resilience: the speed at which prices respond to disruptions caused by large transactions

liquidity means the ease with which an investment can be converted into cash with little or no loss of capital value during the conversion, and with minimum delay.

Effective financial markets require freely available (though not necessarily free) information and operate with high standards of honesty, integrity and credibility. No one will otherwise have the confidence to borrow and lend funds.

Financial markets are broadly categorized as being either primary or secondary.

Peak to contraction: this is a decrease in economic growth, marked by a decrease in business investment and industrial production. For example, the Asian financial crisis in 1997–1998 constituted a period of peak to contraction in Hong Kong.

Trough to expansion: this represents economic recovery. Interest rates decrease and investment activity increases.

Trough to expansion: this represents economic recovery.

Peak to contraction: this is a decrease in economic growth, marked by a decrease in business investment and industrial production.

Large quantities of data available virtually in real-time makes businesses can now address and resolve economic imbalances far more rapidly than in the past. Deregulation improve efficiency. Innovation in financial markets prevent credit failures.

Under innovative modern technology, large amounts of funds may be quickly and easily mobilized, the accessibility is increased and thus transparency increases and chance of arbitrage decreases. Thus, financial service providers need to find new products that can provide higher returns.

Arbitrage means taking risk-free advantage of countervailing prices in different markets. For example, buying an asset at a low price in one market and then selling it at the same time at a higher price in another.

Excess demand (i.e. when productivity levels are already maximized) leads to higher
prices in the economy.

Peak to contraction: this is a decrease in economic growth, marked by a decrease in business investment and industrial production.

Lenders refer to people who lend money to financial institutions or borrowers. Intermediation may not be able to reduce lenders’ costs, because direct financing may be more profitable and not necessarily has costs. However, there will be credit risks for direct financing for not every borrower repays the outstanding amounts totally and as scheduled. Alternatively, through intermediation, the intermediary will bear the credit risk of the borrower, so the lender can rest assured they can recover the loan and recover it more easily.

Often news is pre-empted in the market (i.e. market expectations) and as a result the expected impact has already been factored into the prices of securities. Therefore, An economic downturn which has been already expected will not result in stock price decline.

Deflation refers to negative inflation that occurs in an environment where the general level of prices in the economy is actually falling while the value of money is rising. This is distinct from the concept of disinflation, which refers to a fall in the inflation rate.

Inflation refers to the tendency for prices to continue to rise over a period of time, resulting in a decrease in the purchasing power of money – more money is needed to purchase the same value of goods and services.

Technology effectively smoothen out time differences and enables information on markets and securities to be more readily accessible, limiting arbitrage opportunities.

An example of the destabilizing effects of the mobility of funds was the Asian financial crisis in 1997–98. This regional crisis was brought about by massive short-term speculative capital flows, causing currency devaluations and economic instability in the region.

Technology has also facilitated the switch to electronic trading for interbank spot foreign exchange transactions. This has markedly reduced the trading volumes required to maintain an effective market.

Technology effectively smoothen out time differences and enables information on markets and securities to be more readily accessible, limiting arbitrage opportunities.

Economic imbalances are now more likely to be readily contained as a result of a number of factors, including increased access to real-time information, deregulation and innovation in financial and product markets. Consequently, cyclical episodes overall tend to be less severe than in the past.

These financial products enable risk to be spread more effectively to those who are willing, and presumably able, to bear it.

The interrelationship of globalization and technology means that large amounts of funds may be quickly and easily mobilized on a global scale, via computer and telecommunication networks.

Higher mobility does not represent higher return and globalization encourages the development of local economies.

The future deflation means low inflation and deflation and the government is likely to cut interest rates. If the interest rate will be cut in future, the future bond yields will decline and the bond price will rise. Therefore, it is the best way to buy bonds today.

Price of the goods and services affects supply and demand. Level of income and Preferences and trends affect demand. Thus, these four options will affect supply and demand curve.

Commercial papers are kind of short-term debt securities.

High inflation leads to an increase in interest rate and the borrowing cost of companies increases. Therefore, the profit of the companies is affected by the increasing cost.

If the market expects higher inflation in the future, interest rates will also increase. If the market expects lower inflation in the future, interest rates will be lower.

When there are overheating in the economy and inflation, it is likely that the government would institute a contractionary monetary policy by increasing short-term interest rates and discouraging spending.

Increase the interest rate is a kind of monetary policy instead of political factor. In general, monetary policy is used to influence the supply and the cost of money.

The introduction of the Government Bond cannot be classified as political factor.

Hong Kong has adopted a linked exchange rate regime, which is a variant of the fixed rate regime where the Hong Kong dollar is linked to the US dollar.

Arbitrage means the ability to exploit price differences between various markets and securities and make risk-free profits at more or less the same time. Since there is time zone difference between Hong Kong stock market and American stock market, Mr. Liao can’t make the arbitrage trading.

“Depth” reflects how easy or difficult it is for a price to be moved by small volumes. The number of buyers and sellers on different prices affects the changes of prices on small volumes.

Contraction to trough: this is usually characterized by a fall in inflation and private consumption expenditure (household spending) and an increase in unemployment. For example, SARS caused the economy moving from contraction to trough in 2003-2004.

The price paid for purchasing an option is referred to as the option premium, and is paid to the option seller. The option buyer obtain the leverage after the option premium payment. Securities margin financing is the process of securities being used as collateral to facilitate the purchase of additional exchange-traded securities. It is also a kind of leverage.

The primary market is where new capital is raised and securities are issued for the first time. For example, the government issues a new debt security or a company issues new equity securities to raise funds from the public by listing on the stock market.

The primary market is where new capital is raised and securities are issued for the first time. For example, the government issues a new debt security or a company issues new equity securities to raise funds from the public by listing on the stock market.

There are three reasons for their success: low taxes, less burdensome regulation and supervision, and (in most cases) strict secrecy laws protecting bank clients.

Finance sector includes the financial intermediaries and institutions that facilitate the transfer of funds between fund providers and seekers, and is therefore both provider and seeker.

Business sector consists of the producers of goods and services. Businesses require funds to produce goods and services, and the sector is therefore mainly made up of fund seekers (borrowers).

Intermediaries are compensated for assuming the risk involved by receiving a fee (brokerage or commission) or by charging higher rates to borrowers than they pay to lenders.

Under Globalization, investment is being unrestricted by national borders. Capital-exporting countries can earn higher return by providing services to capital-importing countries. International capital flows grew but it’s getting instable.

According to the International Monetary Fund(“IMF”),The net capital flows to emerging market economies have demonstrated higher volatility than those to advanced economies, and a stronger correlation to changes in global financing conditions.

Supranational organizations and multilateral agencies include:
The IMF； The Bank for International Settlements (“BIS”)； The World Bank
；The Organisation for Economic Co-operation and Development (“OECD”)； The World Trade Organization (“WTO”).

The main purpose of the IMF is to provide a forum for cooperation on international monetary problems; to promote exchange rate stability; to lend countries foreign exchange when needed; and to facilitate the growth of international trade.

The main purpose of the IMF is to provide a forum for cooperation on international monetary problems; to promote exchange rate stability; to lend countries foreign exchange when needed; and to facilitate the growth of international trade.

Bank for International Settlements is perceived as a bank for central banks in the international financial market.

The BIS is an organization that promotes international cooperation among central banks and other agencies to achieve monetary and financial stability. Maintenance of exchange rate stability is one of the missions of IMF.

The ease with which an investment can be converted into cash with little or no loss of capital value during the conversion, and with minimum delay. It is difficult for real estates to trade in short time.

Fixed-income securities generally involve regular interest repayments throughout the life of the loan, and repayment of the principal (face value) amount at maturity together with the final interest instalment. Preference shareholders have priority for dividend payments over ordinary shareholders. Floating rate debt securities, short term notes and bonds will distribute coupon regularly.

The secondary market is where all subsequent trading takes place.

A liquid market is one with a significant number of active buyers and sellers, so that when a specific transaction is made it does not disturb market prices very much.

Expansion to peak: this represents overall economic growth. Household and business spending increases, inflation starts to grow, output is maximized and the unemployment rate is low.