1 - The Trading Process

Question 1

What is the basic function of the market?

Answer 1

To bring together buyers and sellers

Question 2

Capital market necessary for:

Answer 2

Economic growth and development

Companies need capital to fund projects

Secondary market

Question 3

Price Discovery:

Answer 3

process of determining the price for an asset through the interaction of buyers and sellers

Question 4

Investing linked to:

Answer 4

rationale to buy or sell

to exploit undervaluation

Question 5

Trade Decision:

Answer 5

concerns how to execute the investment decision, in which markets, at what prices and times, and through which agents

• acquisition of information
• routing of the order
• execution of the trade
• confirmation, clearance and settlement

Question 6

Buy Side:

Answer 6

people and institutions who use financial services

Question 7

Sell Side:

Answer 7

those who provide financial services

Question 8

Examples of Utilitarian Traders

Answer 8

Investors
Borrowers
Asset exchangers

Question 9

Examples of profit motivated traders

Answer 9

Speculators

Arbitrageurs

Question 10

Real Assets:

Answer 10

represent ownership of tangible things

Question 11

Financial Assets:

Answer 11

are instruments that represent ownership of real assets and cash flow they produce

Question 12

Derivative contracts:

Answer 12

derive their values from other instruments values

Question 13

Orders:

Answer 13

instructions to trade, given to brokers and/or exchanges

Question 14

Limit order:

Answer 14

instructs broker to trade at best price available but do not violate limit price condition

• do not buy at a price above the limit price
• do not sell at a price less than the limit price

Question 15

Limit orders may not execute.

Answer 15

Standing limit orders supply liquidity by allowing others to trade when they want

Question 16

Market orders:

Answer 16

buy/sell orders that are to be executed immediately at the market price

Question 17

Properties or market order:

Answer 17

• Consumption of liquidity
• Have market impact when brokers move prices to find liquidity
• Execution near certain but execution maybe uncertain

Question 18

Stop orders:

Answer 18

price contingent orders

• activate when their price contingency is met
• almost always market orders
• typically are use to close losing positions

Question 19

Duration orders:

Answer 19

• Day order
• Good till canceled order
• Fill or kill order
• Immediate or cancel orders

Question 20

Bargaining:

Answer 20

negotiation process over contract terms (e.g price & quantity) that occurs between a buyer and a seller
- useful when dealing in large sizes

Question 21

Auction:

Answer 21

competitive market process involving multiple buyers, multiple sellers, or both
- useful and cost effective method for pricing a security with an unknown value

Question 22

Walrasian auction:

Answer 22

simultaneous auction where each buyer submits to the auction his demand and each sellers submits his supply for a given security at every possible price
- e.g. opening and closing auctions on ASX

Question 23

Dutch (english) auction:

Answer 23

descending (ascending) auction

Question 24

First-Price sealed- bid auctions:

Answer 24

Have all bidders simultaneously submit sealed bids

• Winner is one who submits highest bid
• Winner facers ‘winner’s curse’ problem if value is unknown

Question 25

Continuous double auctions - NYSE, ASX

Answer 25

• Buyers submit bids (max buy prices) and sellers submit offers (min sell price)
• Bids and offers are ranked by their price levels
• Transaction occurs when the highest bid and lowest offer match

Question 26

Development in Markets

Answer 26

Late 90s and early 2000s saw most world stock exchanges demutualize and go public
- Profit motives led to need for growth and subsequently mergers

Question 27

Past decade development:

Answer 27

• Numerous new entrants in market: Alternative Trading Systems
• Markets have become fragmented: Chi-X in Australia
• New types of traders focusing on speed and technology
• Innovation in the way trading is done