Chapter 5: Secondary Markets Flashcards
Participants of exchanges (broker dealers):
- Broker/dealers - Firms such as IBs that act as agent (broking) and principal (dealing) in transactions.
- Brokers- arrange deals/advise clients in return for commision
- Dealers - buy or sell securities with customers=called principal as dealers can take positions onto their own book when buying/selling to clients
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Alternative trading systems (ATSs)
When an investment firm (ususally IBs) match customers’ sell trades with other customers buy trades and settle transactions that way.
3 types of trading venue according to MiFID
- Regulated markets - exchanges
- Multilateral trading facilities (MTFs) - managed by a market operator and match buy/sell orders from multiple clients to execute trades
- Systematic internalisers - firms that on an organised, frequent, systematic and substantial basis that deals on it’s own account outside of a trading venue.
OTC marrkets
Over The Counter - buying and selling securities outside of a designated exchanged and is typically dealers trading directly with one another.
Dark pools
= trading systems where stocks are traded without the order price being shown until after the trade executes. AKA dark liquidity.
These allow for large trades that cannot be seen by the public on the market and increase annonymity.
A form of ATS - and a form of an MTF in EU.
Emerging market – examples
- Stock exchange of Thailand (SET)
- China - saw rapid development and growth of its mkts - Shangha SE (SSE) 3rd largest in the world and shenzhen SE (SZSE) is the 5th largest
Quote and order driven systems
- Quote - market makers provide a buy and a sell price (bid/offer) e.g. NASDAQ
- Order - investors place buy or sell orders with a specified price and volume of shares and the system will match a buyer and a seller willing to exchange the same quantity of shares at the same price. e.g. LSE, NYSE
Quote driven systems are more liquid than order driven as market makers provide two way prices which make trades more likely to execute. Order driven can mean if there are low trade volumes it is unlikely to match trades so liquiditiy is poor.
SETSqx has both order and quote driven
Market participants
- Principal=buying shares into it’s own book and selling from it’s own inventory. It hopes the share prices will increase so it can sell for a profit. AKA dealers
- Agent = arranging deals on behalf of clients and charges commission. AKA broker
- Broker/dealer - does both
- Market maker = provides bid/offers which provides liquidity. To become a MM a firm must apply to an exchange wit hthe securities it wants to deal in and provide bid/offer spread to the exchange over the course of the trading day
Inter-dealer broker (IDB) - can they take principal positions?
Acts as an agent/intermediary between dealers (such as a market maker). Provides anonymity to both dealers by settling the trades like it is acting as a principal.
Cannot take principal positions and has to be a dedicated firm, not a division of another broker/dealer
Algorithmic trading - benefits
Computer systems buy/sell shares by analysing market data and responding to it by making trades to make profit
1. Removes emotion from trading - reduces risk of irrational decisions if the trader has had a shitter
2. Preserves discipline - startergy is maintained regardless of mkt volatility
3. Speed - executes much quicker than a person trading
4. Accuracy - removes the risk of innaccurate trade details being manually entered when trading
5. Cheaper - don’t need to pay trading staff
However glitches or system errors can be VERY expensive
High frequency trading (HFT)
Uses powerful computers and algorithms to place orders. They respond rapidly to market movements and becasue HFT computers are normally located close to the exchange, orders will arrive faster than others.
They execute loads of very small trades with small profits but in huge quantities.
Exchanges assume that the proportion of HFT compared to other methods is 50% or more.
Criticisms of HFT
- ‘Vultures’ exploiting their superior HFT positions to manipulate prices
- Flashcrash of 1/5/2010 - 600 points wiped off the DJIA in 5 mins. HFTs started to aggressively sell which caused a positive feedback loop, decreasing the price.
- Creates systematic risks - if one exchange has negative price movements HFT algorithms will drive prices down on other exchanges to try and benefit from arbitrage, spreading the price volatility to other exchanges
- many of the stratergies can be considered as market manipulation
- Latency (time taken to interact with the mkt) is much quicker for HFT so they can act on information quicker than othe traders.
Prime broker services - 7 services - who are they provided too
=A collection of services IBs provide to hedge funds. Typical services are:
* Securities lending/borrowing
* Levergaed trade execution
* Cash management
* Core settlement - ensure trade settlements occur properly - ie buyer recieves shares, seller recieves cash.
* custody
* Rehypothecation - the prime broker will use assets posted as collateral by the hedge fund for it’s own benfit i.e. to obtain cheap funds.
* Access to OTC mkts.
The typical IB services are also expected to be offered like research and invitiations to deal presentations.
Order book
Lists buy and sell orders. Buy orders are arranged by largest price at teh top of the book and then the time they were entered. Sell orders are arranged with the lowest price at the top of the book.
It allows buy and sell orders to match at the best possible price
Opening auctions and automatic execution
Opening price is decided using an auction process where exchange members enter orders in the period leading up to the auction. The auction uses an Uncrossing algorithm which executes over lapping orders that maximise the number of shares sold for the price which in turn calculates the opening price.
The automatic execution process can be interrupted if a trade price exceeds the preset limit (between 5% and 25% change in price in a set time) to allow investors to react to vast price swings.
Viewing the order book - who can view it and who can interact with it.
Any market participant can view an exchange’s order book however, you must be a member of the exchange to interact with the book (fill orders).
