Financial management revision question and answer

CPA-Financial-Management-Section-3 Revision kit

In relation to the stock exchange”
(i) Explain the role of the following members:
• Floor brokers
• Market makers
• Underwriters
(ii) Explain the meaning of the following terms:
• Bull and bear markets
• Bid-ask spread
• Short selling
ANSWER
(b) Floor brokers – act on behalf of individuals
(i) Client who are willing to buy or sell some of their shares or debentures through floor/stock brokers:
• Stock brokers acting on behalf of client will deal with one of the market makers to buy or sell the shares.
• Market makers may act as shareholders too, dealing directly with individual investors.
• Stock brokers earn a commission for their service payable the client.

(ii) Market makers are dealers in the shares of the selected companies whose responsibility is to “make a market” in the shares of those companies. It is noteworthy that a market maker:
• Must be a member of the stock exchange
• Must announce which company‟s shares they are prepared to market
• Must undertake to make a two way prices in the securities for which they are registered as market makers under any trading conditions.
• Must decide the share price
• Brings “new” companies to the market.
• Earns a profit being the difference of selling and buying price.
(iii) •Underwriter is an investment banker who performs the insurance function of bearing the risk of adverse price fluctuating during the period in which a new issue of security is being distributed.
• The underwriter underwrites the risk of under-subscription of a company‟s
shares during a primary issue.

• He ensures that the company gets the targeted funds sometimes having to take up the shortfall in demand.
i)Bull and bear markets
A bull market is a market characterized rising prices, encouraging people to buy now in the hope of making a profit when they sell later after prices have climbed up.

A bear market is characterized falling prices encouraging bears to sell now in order to avoid future losses when prices would have fallen.

(ii) Bid ask spread
Is the difference between the offer price and the buying price of a share.

(iii) Short selling
– Is the act of selling a share which one does not already possess.
– The dealer could “borrow” the shares, sell them when prices are high and in anticipation of decline in prices, the shares will be bought back at lower prices and refunded to the “lender”

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