Chapter 5 Secondary Markets Flashcards
Which exchange has a trading system of electronic with some open outcry
NYSE
Which country has unusual trading structure and how does it work
China - 2 share classes
A-shares are traded on the mainland exchanges and are gradually being opened up to enable
purchase by overseas investors under an approved quota system
H-shares are mainland Chinese
companies listed in Hong Kong and are available to, and popular with, global investors
Difference between brokers and dealers
The broker never actually buys or sells securities – the broker is simply an agent that facilitates the transaction(s) between two parties.
Dealers, in contrast to brokers, actually buy or sell securities. If a client wants to sell shares, a dealer may buy those shares from the client; if another client wants to buy shares, a dealer may sell those shares to the client. Acting as a dealer is often described as dealing as principal, because the dealer is taking a principal position by either buying or selling the securities
Firms, such as investment banks, that are involved in both acting as agent (broking) and as principal (dealing), are often described as broker-dealers.
What are system internalisers (SIs)
Firms, such as investment banks, that are involved in both acting as agent (broking) and as principal
(dealing), are often described as broker-dealers.
They do it in principal, buy from seller and sell to buyer
What are MTFs and who is the operator
Crossing network (matching engine) for equities. Operated by market operator
What are OTFs and who is the operator
Crossing network (matching engine) for bonds and derivatives
What are dark pools and who is the operator
Exchange traded liquidity with OTC confidentiality through hidden orders. Operated by investment firms and private organizations
Difference between quote driven and order driven system
Quote-driven systems – market makers agree to buy and sell at least a set minimum number of
shares at quoted prices. The buying price is the bid and the selling price is the offer. The prime
example of a quote-driven equity trading system is Nasdaq in the US.
- Order-driven systems – the investors (or agents acting on their behalf) indicate how many securities they want to buy or sell, and at what price. The system then simply brings together the buyers and sellers- automatic execution where there is agreed price in order book. Order-driven systems are very common in the equity markets – the NYSE, the TSE
and trading in the shares of the largest companies on the LSE are all examples of order-driven equity
markets.
Role of market makers
The presence of market makers on quote-driven systems provides liquidity that might be lacking on an
order-driven system. Market makers are required to quote two-way prices, resulting in an ability for
trades to be executed. In contrast, an order-driven system can lack liquidity, since transactions can only
be matched against other orders – if there are insufficient orders, trades cannot be matched.
Role of inter-dealer broker (IDB)
An inter-dealer broker (IDB) is an exchange member firm that has registered with the exchange to act
as an agent between dealers (such as market makers). When one dealer trades with another, it often
prefers its identity to remain a secret. This is the key benefit of using an IDB. The IDB is acting as agent
for the dealer but settles any transactions as if it were principal in order to preserve the anonymity of the
dealer. An IDB is not allowed to take principal positions, and it has to be a separate firm, not a division
of another broker-dealer.
Role of broker dealer
Most exchange
members, however, are broker-dealers. This means they have the dual capacity to either arrange deals
(acting as a broker), or to buy and sell shares for themselves (acting as a dealer).
What is meant by latency and co location in context of HFT
HFT work on speed and latency can be an issue. The further the signal has to travel, the longer it takes. Co-location is where the trader gets as close to the exchange as possible to minimize data transmission time.
How does stock lending work
- Temporary transfer of securities with an agreement to return to the lender at a pre agreed time
- No reporting requirement
- Title of security passes to borrower and they receive dividends/coupons
- voting rights lost by lender (unless recalled in good time)
- Benefits of corporate action passed to lender
What is a stock lending agreement
Sets out how the benefits of lent securities will be passed back to the lender e.g. manufactured dividend
What is a securities lending agreement
The terms of the securities loan will be governed by a securities lending agreement, which requires that
the borrower provide the lender with collateral, in the form of cash, government securities, or a letter
of credit of value equal to or greater than the loaned securities. As payment for the loan, the parties
negotiate a fee, quoted as an annualised percentage of the value of the loaned securities. If the agreed
form of collateral is cash, then the fee may be quoted as a rebate, meaning that the lender will earn all of
the interest that accrues on the cash collateral, and will rebate an agreed rate of interest to the borrower.
Motivations for stock lending for borrower
In securities-driven
transactions, borrowing firms seek specific securities (equities or bonds), perhaps to facilitate their
trading operations
So, the principal reason for borrowing securities is to cover a sale where a seller does not have the
securities sold – a ‘short’ position. Because sellers taking short positions are obliged to deliver the
securities they do not hold, they will have to borrow them.
Motivations for stock lending for lender
. In the cash-driven trades, the lender is able to increase the returns on an underlying
portfolio, by receiving a fee for making its investments available to the borrower
What are the overall benefits of stock lending
- It can increase the liquidity of the securities market by allowing securities to be borrowed
temporarily, thus reducing the potential for failed settlements and the penalties this may incur. - It can provide extra security to lenders through the collateralisation of a loan.
- It can support many trading and investment strategies that otherwise would be extremely difficult
to execute. - It allows investors to earn income by lending their securities on to third parties.
- It facilitates the hedging and arbitraging of price differentials, therefore helping improve market
efficiency.
Risks of stock lending and how to mitigate
The securities on loan, or the collateral, may not be returned on the agreed
date, whether because of settlement delays or liquidity problems in the market concerned or the more
intimidating prospect of counterparty default or legal challenge. Those securities will then need to be
acquired in the market, potentially at a high cost.
- employing detailed credit evaluations on the borrower
- setting limits on the lender’s credit exposure to any individual borrower
- collateralising loan exposures against cash or securities (the lender will decide what quality of
collateral it will accept) - marking exposures and collateral to market (ie, ensuring that exposures and collateral are valued at
current market prices) on a daily basis and making margin calls to bring collateral and exposure into
line, and - employing master legal agreements that set out clear legal parameters that dictate the structure
and process of the lending arrangements, and how the lender will be compensated in the event of
default or systemic crisis.
How do SBLI work and who is normally lender vs borrower
hese stock
borrowing and lending intermediaries (SBLIs) provide a service in separating out the underlying owners
of securities – which are typically large pension funds or insurance companies – from those who would
be borrowers of those securities, typically hedge funds and other asset managers, and liaising with both
sides
Difference between stock lending and repo
Stock lending and sale/repurchase agreements (repos) are similar; however, the key difference is that
a stock lender charges a fee to the borrower, whereas a repo counterparty pays (or receives) a rate of
interest.
LOOK AT PAGE 236
What is the main purpose of stock borrowing from the lender’s point of view?
To increase the portfolio returns
Who is the beneficial owner of stock in a stock loan situation?
The principal trader
When a market maker uses a stock borrowing and lending intermediary to cover a short position by borrowing stock from a fund manager, which of the following best describes the relationship between the SBLI and their counterparties?
Agent with the market maker and agent with the fund manager
The SBLI acts as intermediary with both parties.
In a stock borrowing and lending agreement which of the following is borrower not obligated to pass back to the lender?
Voting rights
For what reason can exchange prohibit a transaction
For any reason
Who can view order book
Members only
What is order priority
Price then time
What is min/max order size
There is none
What is on left and right side of order book
Buy on left, Sell on right
What is shown at top of buy order column
Highest bid price
What is shown at top of sell order column
Lowest sell price
What is not permitted during uncrossing period
Addition, amendment or deletion of orders
Under what circumstance can automatic execution by suspended
If the price of a trade is more than the price tolerance level away from the previous trade price,
an automatic execution is suspended for a period to allow investors time to react to large price changes.
The price tolerance level is typically set at between 5% and 25%, depending upon the exchange and the
share concerned.
Trading will restart with intra day auction
What can members do in opening auction, continuous order book trading, closing auction and housekeeping period
Opening auction - can enter orders but no automatic execution
Continuous order book trading - Automatic execution
Closing auction- can enter orders but no automatic execution
House-keeping period- Can delete but not add new orders. No automatic execution
What happens during a trading halt
The exchange typically reserves the right to prohibit any transaction from being dealt on-exchange
for any reason. This is referred to as a trading halt, and often arises from the suspension of a security’s
listing.
If a security is suspended, permission is required from the exchange before a member firm can affect a
transaction in that security. The length of the trading halt is at the discretion of the exchange. Trades
that have occurred but have not yet settled at the time of suspension are settled as normal.
What is a limit order
Has volume and price - partial execution allowed
What is a iceberg order
Type of limit order
They enable a market participant with a
particularly large order to partially hide the size of their order from the market and reduce the
market impact that the large order might otherwise have. The term comes from the fact that just the
top part of the order is on view (the peak of the iceberg); the rest is hidden (the bulk of the iceberg
is below the water). Once the top part of the order is executed, the system automatically brings the
next tranche of the iceberg order on to the order book. This process continues until the whole of the
iceberg order has been executed, or the time limit for the order expires.
What is a market order
No price, just volume executed at best price
What is a execute and eliminate order
Price and volume. If partially filled, remainder cancelled
What is a fill or kill order
Price and volume. No partial fill, all of volume or nothing. Immediate execution required
What is a all or none order
Like fill or kill but can remain on order book for a day
What is CCP role in novation and what are benefits
Novation makes clearing house the central party- buys from seller and sells to buyer
- Reduced counterparty risk
- Providing total anonymity
- Reduced admin
- Improved prices
-Facilitating netting of transactions
State costs of trading
- Brokers commission
-Account fees - Exchange fees
Difference between price-weighted and capitalization-weighted indices
Price weighted assume equal number of shares in each constituent stock. Highest share price has highest influence. need to adjust for splits and consolidation
Market-value weighted assumes proportionate value investment in each stock. Highest market cap has highest influence
FTSE All-share composition
Representing 98-99% of UK market cap
Dow Jones Industrial average composition
30
Nasdaq composition
Over 3,200
Japan index name and composition
Nikkei - 225
Hong Kong/China index name and composition
Hang seng - 50 (variable)
Europe index name and composition
Eurofirst 300
germany index name and composition
DAX - 30
France index name and composition
CAC - 40
MSCI composition
1700
STOXX composition
600
DJIA Dow divisor role and formula
Adjustment that ensures that such events (splits etc) do not alter numerical value of DJIA
DJIA= sum of price of constituent stocks/ Dow divisor
What does price return measure
measures the price performance and, therefore, disregards income from
dividends
What does total return measure
(also sometimes called ‘gross’), which measures the performance of both price return
and dividend reinvestment,
What does net total return measure
which accounts for dividend reinvestment after the deduction of a withholding tax.
Difference between free-float and market cap
Free float, also known as public float, refers to the shares of a company that can be publicly traded and are not restricted (i.e., held by insiders). In other words, the term is used to describe the number of shares that is available to the public for trading in the secondary market.
Market capitalization, sometimes referred to as market cap, is the total value of a publicly traded company’s outstanding common shares owned by stockholders. Market capitalization is equal to the market price per common share multiplied by the number of common shares outstanding
Who are the four major groups of participants that facilitate deals in
the government bond markets:
- The government’s issuing agency.
- Primary dealers – such as gilt-edged market makers (GEMMs) in the UK.
- Broker-dealers.
- Inter-dealer brokers.
Who oversees dealing of gilts and what do they do
DMO issues the gilts
Once issued, the secondary market for dealing gilts is overseen by DMO and LSE
Who chooses GEMMS then who oversees them
It is the DMO that enables certain LSE member firms to act as primary dealers, known as gilt-edged
market makers or simply GEMMs. (DMO vets them)
The DMO then leaves it to the LSE to prescribe rules that apply when
dealing takes place.
Eurozone bond issuing agency
Federal governments
How are german gov securities issued
The German federal government usually places single issues by auction.
Only credit institutions
domiciled in an EU member state can be members of the auction group and participate directly in these
auctions.
The Bund uses a multiple price auction procedure
What are BTFs
French government securities
How are french gov securities issued
The principal method of issuing French government securities is the bid price system where participants
compete in the auction, on an equal footing, through a transparent system of open bidding according
to a planned issuance programme.
Who issues government bonds in US and how is it done
The Treasury Department conducts auctions and direct sales of US Government securities
It conducts auctions on regular basis and appoints primary dealers
Who issues government bonds in japan and how is it done
Japanese Government bonds (JGBs) are issued by the Ministry of Finance (MoF) and, as the name
implies, they are the bonds issued by the government
what is ORB
Order book for retail bonds-LSE platform for gov and corp bonds
How can Dealer to Dealer method of trading bonds occur
- Direct telephone contact
- Indirect via an IDB voice-broking the deal
- Via an electronic market, known as an electronic trading platform, such as
MTS Cash or BrokerTec or eSpeed
How does request for quote system work
investor puts in 1 request and system shoots off multiple messages to dealers simultaneously. Investor receives multiple quotes
How can Dealer to Customer method of trading bonds occur
TradeWeb,
MTS BondVision
What are the main requirements for a company’s shares to be admitted to AIM (UK Alternative Investment Market)
- No restriction on transferability of shares
- AIM company appoints 2 experts to assist: Nominated advisor and broker
What rules does LSE impose on AIM
The broker and advisor can be the same firm
If a company ceases, at any time, to have a broker or advisor then the firm’s shares are suspended from trading
If the company is without a broker or advisor for a period of 1 month, it is removed from AIM
What is Ftse 100
Weighted arithmetic index of stock prices
What is a circuit breaker
It is an automated suspension of trading where prices have moved more than a predetermined amount
On an exchange’s order-driven platform, during which of the periods is a member firm not permitted to delete orders
Closing algorithm
A company aims to reduce its free float without cancelling any of its shares. All other things being equal, what would the effect of this be on the company’s market capitalisation?
The market capitalisation would not be affected
Which of the following is primarily known for utilising quote driven systems?
Nasdaq
To whom must primary dealers in the government bond market quote firm two-way prices?
Customers on demand
Which of the following is least likely to be a benefit of using a central counterparty for exchange traded transactions?
Lower margin costs
The CCP typically charges a flat fee to both parties for fulfilling its role and requires margin payments to reduce its potential loss, should one party default. All the others are considered benefits.
What is netting
Facilitating netting of transactions – because all the trades are with a single CCP, receipts and
payments for transactions in the same share that settle on the same day can be netted against each
other.
When an exchange calls a trading halt in an order driven security due to a disorderly market, which of the following is true?
- Automatic execution ceases, but trading outside the order book is permitted
GEMMs on the London Stock Exchange need to be vetted and registered by which of the following
DMO
what is the role of DMO and LSE for GEmms
DMO vets
LSE oversees after
An inter-dealer broker (IDB) can deal with which of the following?
Market maker acting as principal
IIMarket maker acting as an agent
IIIStock borrowing and lending intermediary
IVBroker dealer
What is the uncrossing period
The uncrossing price is calculated as the price at which the maximum VOLUME of shares can be uncrossed.
A buy order matches a sell order 10 mins before a trading halt was imposed by the exchange. What will happen to this order?
The order will proceed straight to the settlement system as normal
A company traded on the UK’s Alternative Investment Market (AIM) has a nominated adviser and a corporate broker. If the company should lose any of these which of the following will occur?
A
The company’s shares will be instantly suspended from trading activities
Which of the following are permitted at the end of the closing auction after the matching algorithm has completed the uncrossing?
Once the order book closes (after the uncrossing), no orders may be input but limit orders may still be deleted.
A broker-dealer is a member firm that:
Broker-dealer broken down:
Broker - the firm buys and sells as an agent
Dealer - the firms buys and sells as principal
What is the purpose of the London Stock Exchange’s central counterparty service?
To reduce default risk through margin
If a limit order is entered into an order book during the opening auction call period, what price will it be executed at:
The uncrossing price
Which of the following is true of Gilt trading?
Only broker-dealers and GEMMs are permitted to deal in principal
Which of the following BEST highlights a problem with order-driven markets?
No guarantee of execution
Which of the following monitors compliance with the requirements for authorised firms to report their transactions?
FCA Transaction Monitoring Unit
What is the BIGGEST advantage to the investors of using a central counterparty service (CCP)?
The biggest advantage to the investor is the management of credit risk exposure through the process of novation. Netting-off transactions is an advantage provided by CCPs, but this is more an administrative advantage, so would benefit the firms more than the investors.
If a trader is using a decentralised dealer market, which of the following are they most likely trading?
Corporate bonds
There are no buy orders on the order book for a particular security. What is disseminated as the best bid price?
0
What is the minimum number of market makers a stock may have on a hybrid system of an exchange?
0
On an electronic order book, the best offer price is:
The lowest priced sell order
On an electronic order book, the bid offer price is:
Note: the best bid price is the highest priced buy order.
