Question

1. What are the three main types of Securities traded on public markets? Briefly describe each.

2. Briefly explain how CDO tranches work and why they are used.

3. Briefly explain going ‘short’ in market trading.

Answer 1

1. i) Equity securities- share of ownership of company is traded.

ii.) Debt securities-also called Bonds, these traded securities are debt owed by a company or country.

iii.) Derivative securities-these complex securities derive their value from an underlying asset whoch could be a stock/debt or any marketable security.

2. Collaterized Debt Obligations (CDO) are asset backed credit products which creates tiered cash flows. The asset could be mortgages which are rated investment grade (prime loans) or sub-investment grade (sub-prime). CDO can a mix of both grades.These credit products are purchased by pension funds, investment banks and hedge funds. These products offer a higher return than Treasury bonds although they are riskier as there is possibility of the asset's price to decline.

3. When an investor borrows a security, sells it and purchases it back at lower price such a trade is called short selling. Such a strategy helps the investor to benefit from the price drop in the asset's price.