MODULE 1: MARKET ORGANIZATION AND STRUCTURE

Market Plumbing

1. The financial system is the network of markets and intermediaries that lets people transfer money, assets, and risk across people, places, and time.
   What is network: A set of connected pieces that work together.
   What is markets: Places or systems where buyers and sellers trade.
   What is intermediaries: Middlemen that help buyers and sellers connect.
   What is assets: Things with economic value, such as stocks, bonds, property, or commodities.
   What is risk: Uncertainty that can hurt or help you.
   Think of it like plumbing for money. One person wants to save for retirement, another wants money today to build a factory, and a farmer wants protection against falling wheat prices. The system connects them.
2. People use the financial system for six reasons: save, borrow, raise equity capital, manage risk, exchange assets immediately, and trade on information.
3. Saving moves money from today to the future. A worker buying an index fund for retirement and Apple parking spare cash in short-term securities are both moving value forward.
4. Borrowing moves money from the future to today. A student loan, a mortgage, and a government bond all give cash now in exchange for promised future cash.
5. Raising equity capital also moves money from the future to today, but the company sells ownership instead of promising fixed repayment.
6. Managing risk means shifting a risk to someone more willing to bear it. A farmer fears wheat prices falling, a food company fears wheat prices rising, and a forward contract can lock the future price for both.
7. Spot trading means exchanging assets for immediate delivery. Volkswagen earning dollars in the United States and paying workers in euros needs the foreign exchange market to swap one currency for another.
8. Information-motivated trading means trading because you think you know something useful about future value. The key is motive: investing moves wealth through time, while information trading tries to earn extra return from insight.
9. The financial system discovers required rates of return by matching savers who supply funds with borrowers and issuers who demand funds.
10. The equilibrium interest rate is the base price of moving money through time. Actual required returns add premiums for risk, maturity, and liquidity.
11. Allocational efficiency means scarce capital goes to the best uses. WeWork is the memory hook: investors funded a glamorous story before the office-leasing economics justified it.

Assets and Markets

1. Assets can be financial assets or physical assets. Financial assets are claims or rights, while physical assets are tangible things. Apple stock is a financial asset; an Apple factory is a physical asset.
2. Securities are financial assets that include debt, equity, and pooled investment vehicle shares.
3. Debt instruments are promises to repay borrowed money. Bonds, notes, bills, certificates of deposit, commercial paper, repurchase agreements, loans, and mortgages all fit the idea.
4. The bond-versus-note label is usually maturity-based, often around ten years, but the exam cares more about the promise to repay than the label.
5. Equities represent ownership. Common shareholders usually vote, receive dividends only if declared, and get the residual assets after other claims are paid.
6. Preferred shares are legally equity but can behave like fixed-income securities when dividends are stable and likely to be paid. Cumulative preferred means missed dividends must be paid before common dividends.
7. Warrants let holders buy a security, usually common stock, at a fixed exercise price before expiry.
8. Public securities are registered for public trading. Private securities are not. A large private bank is still private if its shares are not registered for public trading.
9. Money markets trade debt with one year or less to maturity. Capital markets trade longer-term debt and equity.
10. Traditional investments usually mean public debt, public equity, and funds holding them. Alternative investments include hedge funds, private equity, commodities, real estate, securitized debt, collectibles, and other harder-to-value assets.
11. Spot markets trade for immediate delivery. Forward and futures markets trade for future delivery. Options markets trade rights that may or may not be exercised later.
12. Primary markets are where issuers sell securities and receive funds. Secondary markets are where investors trade those securities with each other.
13. Classification traps matter: a government bond is public but not equity; a single-stock futures contract references equity but is still a derivative contract.

Securities and Contracts

1. Pooled investment vehicles let many investors own a shared portfolio. Mutual funds, closed-end funds, exchange-traded funds, asset-backed securities, and hedge funds all fit the broad idea.
2. Open-ended mutual funds issue and redeem shares directly with investors at net asset value, usually daily.
3. Closed-end funds issue a fixed number of shares, then those shares trade between investors. Their market price can trade at a discount or premium to net asset value.
4. An exchange-traded fund (ETF) trades during the day like a stock, but authorized participants can create or redeem shares, so the price usually stays close to net asset value.
5. Asset-backed securities are backed by pools of assets such as mortgages, credit card debt, or car loans. The 2008 mortgage crisis is the memory hook: the structure was not automatically bad, but weak loans, bad incentives, and optimistic ratings made the package dangerous.
6. Hedge funds are pooled vehicles for qualified investors and usually charge both an asset-based fee and a performance fee. Many use leverage or specialized strategies.
7. Currencies are money issued by monetary authorities. The United States dollar and euro are primary reserve currencies because central banks hold them heavily.
8. Commodities include precious metals, energy products, industrial metals, agricultural products, and carbon credits. Producers can handle delivery; financial traders usually prefer futures because they do not want barrels of oil or tons of wheat.
9. Real assets include tangible assets like real estate, aircraft, machines, and timberland. They are often less liquid because each asset is unique and must be inspected.
10. A derivative is a contract whose value depends on an underlying asset, price, rate, or index.
    What is contract: A binding agreement between parties.
    What is underlying asset: The thing whose price drives the contract value.
    If the contract is based on Apple stock, oil, interest rates, or a stock index, the contract value moves because that underlying thing moves.
11. A contract is physically settled if the actual asset is delivered. It is cash settled if the parties exchange money instead of the asset.
12. A forward contract is a private agreement to trade an underlying asset later at a price set today. It is flexible, but it has counterparty risk and is hard to exit.
13. A futures contract is a standardized forward contract guaranteed by a clearinghouse. The clearinghouse requires margin, marks positions to market daily, and makes it easier for strangers to trade.
14. A swap is an agreement to exchange periodic cash flows. A plain interest rate swap can turn fixed-rate exposure into floating-rate exposure or the other way around.
15. An option gives the holder the right, not the obligation, to buy or sell. A call is the right to buy, a put is the right to sell, and the writer has the obligation if the holder exercises.
16. A credit default swap (CDS) is insurance-like protection against borrower default. American International Group sold huge CDS protection before the 2008 crisis and nearly collapsed when mortgage-linked assets blew up.

Intermediaries and Positions

1. Financial intermediaries connect buyers, sellers, borrowers, lenders, and risk-takers more cheaply than they could connect alone.
2. Brokers are agents: they arrange trades for clients and charge commissions. Dealers are principals: they trade from inventory, buy at the bid, sell at the ask, and earn the spread.
3. Broker-dealers have a conflict because agency duty wants the best client price, while dealer profit improves when buying cheaply from clients or selling expensively to clients.
4. Exchanges provide trading venues and often regulate members and listed issuers. Alternative trading systems are exchange-like venues; dark pools hide order information so large investors reduce market impact.
5. Arbitrageurs buy the relatively cheap instrument and sell the relatively expensive related instrument. Dealers move liquidity through time; arbitrageurs move liquidity across markets.
6. Clearinghouses reduce counterparty risk by standing between buyers and sellers. Depositories hold securities and help settle trades. Securitizers pool assets like loans and issue new securities backed by the pool.
7. Banks, insurance companies, mutual funds, and hedge funds also intermediate: banks borrow and lend, insurers pool risks, and funds pool investor capital.
8. A long position benefits when the asset price rises. A normal long stock position has limited loss and large upside.
9. A short position benefits when the asset price falls. The gain is capped because price cannot fall below zero, but the loss can be unlimited because price can keep rising.
10. Shorting stock means borrowing shares, selling them, and later buying them back to return them. Shorting an option means writing a new contract and taking on the obligation.
11. Margin means using borrowed money or collateral to support a position, which magnifies gains and losses.
    What is borrowed money: Money supplied by the broker or lender.
    What is collateral: Assets pledged to protect the lender if you fail to pay.
    Why is magnifies used: A smaller equity base absorbs the price movement of a larger position.
12. The leverage ratio is position value divided by investor equity.

1. If initial margin is 40 percent, the maximum leverage ratio is 2.5.

1. A margin call happens when investor equity falls below maintenance margin. For a long margin purchase, set equity divided by current price equal to maintenance margin.

Orders, Issuance, Trading, and Regulation

1. Every order says what to trade, how much to trade, and whether to buy or sell. Execution instructions say how to trade, validity instructions say when the order may trade, and clearing instructions say how settlement happens.
2. The bid is the highest price a buyer will pay, and the ask is the lowest price a seller will accept. You sell at the bid and buy at the ask; the bid-ask spread is an implicit trading cost.
3. A market order gives speed with price uncertainty. A limit order gives price protection with execution uncertainty. A limit price is a guardrail, not a target, because the order can trade at a better price.
4. Standing limit orders make the market. Market orders and marketable limit orders take the market. Hidden and iceberg orders hide size so large traders do not move prices against themselves.
5. Validity instructions are exam bait: all-or-nothing (AON) requires full size, immediate-or-cancel (IOC) trades now and cancels the rest, fill-or-kill (FOK) requires full size immediately, and good-till-canceled (GTC) stays active until filled, canceled, or expired by broker rules.
6. Primary issuance, secondary trading, market structure, and regulation all serve one idea: trust makes markets cheaper. Underwritten offerings shift unsold-issue risk to investment banks; best-efforts offerings do not. IPO underpricing creates first-day pops but may leave money on the table. Rights offerings protect existing owners if they exercise or sell rights. Quote-driven markets use dealers, order-driven markets match orders by rules, and brokered markets search for hard-to-trade counterparties. Good systems are complete, liquid, transparent, operationally efficient, informationally efficient, and reliably settled. Regulation controls fraud, agency problems, unfairness, weak standards, undercapitalized firms, and unfunded long-term promises. Enron is the simple memory hook: once trust in the numbers dies, markets stop being cheap.