Question

Describe the role of market makers and why is it important? What are the advantages and disadvantages of margin? Why would someone short a stock?

Define compounding? What is it a building block for investments?

Answer 1

Role of market makers

Market makers ensure liquidity in the market. They are financial instituitions that ensure trading happens without any problem.Market makers are member firms that are usually appointed by the stock exchangs.There are basically two types of market makers :

1. Principal market maker
2. additional market maker

The principal market maker offer to buy and sell qoutes for upto 18 months whereas additional market maker buy and sell qoutes for upto one year from the commencement of initial trading.

Market makers are important in order to maintain liquidity in the stock market.They ensure that there exist enough volume of trading . They help an investor in buying and selling for a specific price.

Examples of market makers are: Deutsche Bank, Morgan Stanley etc

Advantages and disadvantages of margin

Advantages:

• Leverage assets : When we buy securities on margin , we will be able to leverage the value of securities.
• Diversify portfolio : Margin account helps to diversify portfolio without having to sell the original shares of stock.
• Low interest rates : In case of a margin loan , the interest rates will be lower

Disadvantages

• rIncreased Risk : Risk is higher in case of margin trading
• stress : Some investors will not be able to handle the stress due to high fluctuations
• Increases loss : there is a chance to get into loss

Why do you short a stock

Short selling is exercised to make money from stocks whose price is falling. An investor borrow a security and then sell it in the market with an intention to buy back later for lesser price. People short a stock in order to make profit out of it. However the risk is higher.

Compounding

Compounding can be defined as the ability of an asset to generate earnings which are reinvested to make additional earnings. In short compounding refers to generating the earnings from previous earnings. It is the process of increase in the value of an investment due to earning interest on principal and accumulated ineterst.

Compounding is building block for investment

It helps the investment get larger. The longer the period of investment , the more you get from compounding. Compounding is said to create snowball effect in which the original investment along with the income earned grow together.