Chartered Institute for Securities & Investment (CISI) Qualifications Economics and the Financial Markets Environment Syllabus

What is market equilibrium in a supply-and-demand model?

The price and quantity at which the demand curve intersects the supply curve, so quantity demanded equals quantity supplied and there is no tendency to change ($Q_d = Q_s$).

What is the difference between a movement along a demand curve and a shift of the demand curve?

A movement along the curve is caused only by a change in the good's own price (change in quantity demanded). A shift is caused by other factors (income, tastes, prices of related goods), changing demand at every price.

Define price elasticity of demand (PED) and give its formula.

The responsiveness of quantity demanded to a change in price: $$PED = \frac{\%\ \Delta Q_d}{\%\ \Delta P}$$ Demand is elastic if $|PED| > 1$, inelastic if $|PED| < 1$, and unit elastic if $|PED| = 1$.

Distinguish substitute goods from complementary goods.

Substitutes are alternatives where a rise in the price of one increases demand for the other (positive cross elasticity), e.g., tea and coffee. Complements are used together where a rise in one's price reduces demand for the other (negative cross elasticity), e.g., cars and petrol.

What is the difference between absolute advantage and comparative advantage?

Absolute advantage is the ability to produce a good using fewer resources than another producer. Comparative advantage is the ability to produce a good at a lower opportunity cost. Trade is beneficial based on comparative, not absolute, advantage.

What is opportunity cost?

The value of the next best alternative forgone when a choice is made — the benefit you give up by using resources for one purpose rather than another.

According to the theory of comparative advantage, what should each country do?

Specialise in producing the goods in which it has the lowest opportunity cost and trade for the rest, raising total world output and allowing all participating countries to consume beyond their own production possibilities.

Name three common barriers to free trade (protectionism).

Tariffs (taxes on imports), quotas (quantity limits on imports), and subsidies to domestic producers. Others include embargoes and non-tariff/regulatory barriers.

What is the difference between a fixed and a floating exchange rate system?

In a fixed (pegged) system the currency's value is set against another currency or basket and maintained by the central bank through intervention. In a floating system the rate is determined freely by supply and demand in the foreign-exchange market.

What is a managed (dirty) float?

An exchange-rate regime that is broadly market-determined but in which the central bank intervenes occasionally to influence the rate and smooth excessive volatility, rather than holding a fixed peg.

What does Purchasing Power Parity (PPP) theory say about exchange rate determination?

In the long run, exchange rates adjust so that a basket of goods costs the same in different countries; the rate moves to offset inflation differentials. A currency with higher inflation tends to depreciate.

How do interest rate differentials affect exchange rates (interest rate parity intuition)?

Higher domestic interest rates attract foreign capital seeking better returns, increasing demand for the currency and causing it to appreciate, other things equal. Capital flows toward higher real yields.

Distinguish currency appreciation/depreciation from revaluation/devaluation.

Appreciation and depreciation are market-driven rises and falls in a floating currency's value. Revaluation and devaluation are deliberate upward and downward resets of a currency's value by the authorities under a fixed/pegged regime.

What characterises an emerging market economy?

A country transitioning toward developed status with rapid growth and industrialisation, rising incomes, developing but less mature financial markets and institutions, and typically higher risk and volatility than developed markets.

What is the difference between portfolio (capital) flows and foreign direct investment (FDI)?

Portfolio flows are investments in financial assets (shares, bonds) without management control, and are relatively liquid and mobile ('hot money'). FDI involves lasting control/ownership of productive assets (e.g., building a factory or buying a controlling stake) and is longer-term.

Why are large, volatile capital flows a particular risk for emerging markets?

Sudden inflows can overheat the economy and inflate asset bubbles, while sudden 'capital flight' (rapid outflows) can crash the currency, drain reserves, raise borrowing costs and trigger financial crises, because markets are less deep and reserves more limited.

What is the primary role of the International Monetary Fund (IMF)?

To promote global monetary cooperation and exchange-rate/financial stability, monitor economies (surveillance), and provide temporary financial assistance (loans) to member countries facing balance-of-payments difficulties, usually with policy conditions attached.

What is the primary role of the World Bank?

To provide long-term loans, grants and technical assistance to developing countries to fund development projects and reduce poverty (e.g., infrastructure, education, health). It focuses on long-term development, not short-term balance-of-payments support.

What is the primary role of the World Trade Organization (WTO)?

To set and enforce the rules of international trade, provide a forum for trade negotiations, promote trade liberalisation, and resolve trade disputes between member countries.

In one line each, contrast the focus of the IMF, World Bank and WTO.

IMF — monetary/financial stability and short-term balance-of-payments lending; World Bank — long-term development finance and poverty reduction; WTO — rules and dispute resolution for international trade.

What is the difference between the primary market and the secondary market?

The primary market is where new securities are first issued and sold (capital raised goes to the issuer), e.g., an IPO. The secondary market is where existing securities are subsequently traded between investors (no new capital to the issuer), e.g., a stock exchange.

What is an Initial Public Offering (IPO)?

The first sale of a company's shares to the public on the primary market, by which a private company becomes publicly listed and raises new equity capital.

Name the main categories of participants in financial markets.

Issuers (companies/governments raising capital), investors (retail and institutional), and intermediaries/facilitators (brokers, dealers/market makers, investment banks, exchanges, custodians) plus regulators overseeing conduct.

What is the difference between an agency broker and a market maker (dealer)?

An agency broker executes trades on behalf of clients for a commission, taking no position. A market maker (dealer) quotes firm bid and offer prices and trades as principal from its own book, profiting from the bid–offer spread and taking on risk.

What is the difference between a retail investor and an institutional investor?

A retail investor is an individual investing relatively small personal amounts. An institutional investor is an organisation (e.g., pension fund, insurer, mutual fund, hedge fund) investing large pooled sums, with greater resources and market influence.

What is the difference between an order-driven and a quote-driven market?

In an order-driven market buy and sell orders are matched on a central order book by price/time priority (e.g., LSE SETS). In a quote-driven market, market makers post bid/offer quotes and investors trade against those quotes.

What distinguishes exchange-traded markets from over-the-counter (OTC) markets?

Exchanges are centralised, regulated venues trading standardised instruments with transparent prices and a central counterparty. OTC markets are decentralised, with bilateral, often customised contracts negotiated directly between parties, less transparency and higher counterparty risk.

What is a Multilateral Trading Facility (MTF)?

A non-exchange trading venue (introduced under MiFID) that brings together multiple third-party buying and selling interests in financial instruments under non-discretionary rules, competing with traditional exchanges. Example: Cboe Europe / Turquoise.

State the three forms of the Efficient Markets Hypothesis (EMH) and what information each reflects.

Weak form — prices reflect all past price/trading information (so technical analysis cannot give an edge). Semi-strong form — prices reflect all publicly available information (so fundamental analysis of public data cannot give an edge). Strong form — prices reflect all information, public and private/insider.

What is the core implication of the Efficient Markets Hypothesis for investors?

Because prices already reflect available information and adjust quickly to new information, it is not possible to consistently 'beat the market' on a risk-adjusted basis, supporting passive over active management.

Give two behavioural finance critiques of the Efficient Markets Hypothesis.

Investors are not fully rational: biases such as herding, overconfidence, anchoring, and loss aversion drive prices away from fundamentals. Market anomalies and bubbles/crashes (e.g., asset bubbles, momentum effects) suggest prices are not always efficient and arbitrage has limits.