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
