Chapter 9 Flashcards
Liquid markets
Caused by price transparency
Also have lower transaction costs
Explicit and Implicit costs of transactions
Implicit:
Bid Offer spread - higher spreads more illiquid
Price impact of trade: large orders shift price
Opportunity cost, chance to wait for price to fall
Explicit: Broker fees Stamp duty (0.5%) Takeover panel £1 on >£10k orders FX movements
SETS
Continuous order book execution system for FTSE and liquid AIM shares
Had order driven but market makers to increase liquidity
SETSqx
How many market makers needed?
When do market makers make offers?
When do continuos order book trades be executed?
Hybrid. Continuous order book execution with market maker help
No minimum amount needed
Market makers make offers throughout day from 8-4:35
Central order book execution occurs at 8,9,11,2,4:35
SEAQ
For shares to illiquid for SETS and SETSqx. Quite driven shares
Main UK dealing systems
International Order Book
Order book driven system for international depositary receipts
Main UK dealing systems
European Quotw Service
Quote driven service for European securities
MAin UK dealing systems
Order book for retail bonds (ORB)
Order book driven service for gilts, super national bonds and corporate bonds
What does LCH Clearnet do
Central counterparty (CCP) for all transactions on SETS
Managed default risk for both parties buyer and seller
Dealing (principal)
Vs
Broker (agent)
Or
Dual capacity
Dealing - the firm is taking a position itself. Buy low sell high.
Broker - acting on behalf of the client. Will earn commission not the difference between buy and sell price
Dual capacity - can act as both at discretion
Market makers, what do they do?
Gilt market maker name
Bond market maker name
Create liquidity and a certain buyer and seller
Bond MM - FIMMs
Gilt MM - GEMMs
Inter dealer broker -
Benefit
What they are
How they provide info
What it acts as
Registered with exchange to provide intermediary services for buyer and seller
Anonymous buying and selling
Acts as CCP
Creates Risk-less principal transactions
Explain process of Stock Borrowing and Lending Intermediary:
SBLI
Market maker sells 1000 shares of a security they don’t own
They have T+2 to provide
Contact SBLI
Large institutional investor (pension fund for example) will lend the stock to the market maker for a fee (collateral needed) via the SBLI.
SBLI is the middle man
Quote driven market?
What is it?
Example of market on LSE
Quote driven requires price makers, such as market makers to state their buy and sell price
Prices will show on screen and transactions made over the telephone
Benefit is there is continuous liquidity (always a buyer and seller)
SEAQ is quote driven
Order driven market
What is it?
Any in UK?
Open outcry market?
Order driven markets have no MArket makers or price makers
Simple submit orders and wait for execution
No certainty if liquidity as stock is sold or bought if a price can be matched
Open outcry market is order driven.
None in UK, US NYSE offers this type of trading. London’s Metal Exchange offers open outcry in derivatives.
Hybrid systems (order driven and quote driven)
Explain
Both quote and order driven
SETS is an example
Order Limit Order:
At best order:
Order limit order states both price and how many shares. It will buy up all shares at that price until amount reached. If not available, say only half, it will buy and leave offer on SETS until execution can be made
At Best Order: states amount of shares wanted but not a price. Wants the best price. If want 10,000 shares. 9,000 listed at 210p they will he bought them next 1,000 at best price.
The role of market makers
How many?
When must they provide quotes
What’s the Exchange Market Size?
Provide liquidity
Must be at least two
Must provide quotes in Mandatory Quote Period
The exchange market size is the average shares traded in a day. The market maker just make offers on or above this number
MTFs
Recognised by MiFID? What does this mean?
Benefit
Order or quote driven?
Multi lateral trading facility
Pre and post sale disclosures as well as price transparency
Not recognised by regulator so easy to set up
Order driven
Sits between OTC and exchanges
Dark Pool
What is it?
Benefits?
Execution service for buyers and seller
Large investors can list orders for large quantities without listing a price or who they are.
This aims to reduce impact on price with large orders
Due to lack of transparency, these are considers over the counter
High Frequency Trading
Advantages
Disadvantages
Regulation?
Advantages:
Higher liquidity
Lower commissions in market
Disadvantages:
Higher market volatility = systematic risk
MiFID II ability to:
Slow down flow of orders
Adopt minimum tick sizes
Provide environment to test algorithms.
High Frequency Trading Strategies (4)
Market Making -
Ticker tape trading -
Event arbitrage -
Statistical arbitrage -
Market making - algorithm is programmed to buy and sell closely around current price
Ticker tape trading - algorithm is programmed to analyse information being released at the moment of release. For example, if a large order is being placed. It will act on information
Event arbitrage - acts on recurring events before humans can act/notice them
Statistical arbitrage - programmed to identify price discrepancies among assets and trading on mispricing
BOND MARKET
GEMMs - Gild edged market makers
Who regulated them
Who do they register with?
What do they do?
GEMMs are market makers for government gilts
They buy government gilts and sell on the market to brokers. Not oblifged to offer to other GEMMs
Register with DMO, Debt Managwment office
Regulated by FCA
BOND MARKET
Broker Dealer:
What do they do?
Trade gilts as agent or principal
They have dual capacity
BOND MARKET
Inter Broker Dealer (IBD)
What are they what do they do?
Act as intermediary between LSE firms to offset positions for gilts
Use GEMMs and Equity MM and act as middle man
Why do the government issue gilts?
To fund public sector net cash requirement
PSNCR
Issuance of Gilts: Primary Issuance
Who manages gov debt
What % are index linked gilts (ILGs)
Methods of issuing gilts?
DMO manages government debt headed by treasury
15% are index linked
Auction gilts or Tap method (slower release)
Gilts settled T+ what?
T+1
Can retail clients buy gilts?
Yes, but through a broker
Where can investors buy gilts?
Through DMO auction or on LSE
Where are most gilts traded?
Through e trading between member firms.
GEMMs provide liquidity but majority done on the above
What is a private placing on corporate bonds
A select few of professional clients are offered bonds
Corporate Bond Underwriting?
Where the bank ensures the issuer of bonds will have a certain amount sold. Even if the underwriter (usually The bank has to buy some if not all the bonds themselves)
What is a Bought Deal in an open offer of corporate bonds?
Where the lead bank buys all the bonds and sells to the rest of the syndicate (banks)
What is a fixed price re offering with corporate bonds
Where lead bank and syndicate buy the bonds and sell them at a fixed price for a period of time to the market
What can have the longer maturity, gilts or corporate bonds
Corporate bonds, maturities of up to 100 years
What’s a Eurobond?
Where the denomination of the bond is different from that in the issuing country
Dollar bond in London
Where are Eurobonds held
Examples
International central securities depositories (ICSDs)
Examples are euroclear and Clearstream
This is called immobilisation
Two main types of issuance for Eurobonds!
Bought deal? Where lead bank sells all bonds to syndicates
Fixed price re offer - where lead and syndicate bugs all bonds and then sells for fixed price for fixed period
Eurobonds are most commonly traded where
OTC
BUT, exchanged becoming more popular
Who regulated international bond market?
ICMA, international capital market association
Settlement of European bonds is reported to where and is T+ ?
Reported to ICMA and is T+1
Settlement then is T+2
Outcry derivatives is what?
Face to face, ‘crying out’ shouting orders.
This still occurs on MYMEX and LME.
Derivatives is mainly exchanged how?
Through screen based exchange on Universal Trading Platform created by ICE Futures Europe
Are OTC Derivative trades subject to MiFID pre and post trade rules
No but there are reports required
Why are OTC derivatives good and what are they
Over counter trades between to eligible counter parties done by telephone or on screen based
Guarantor not involved (LCH Clearnet or ICE Clear Europe) so credit worthiness is important!
Good because they are flexible and can he change for hedge purposes
Who oversees Derivatives market?
ISDA, international swaps and derivatives association
Regulation of the derivatives market is done by whom!
European Markets Infrastructure Regulatiojn
CREST settlement time for:
Corporate Bonds + Equities
Gilts
T+2
T+1
Explain initial markets in relation to Clearing Houses
initial margins is a good will payment from members of clearing house
Reduces risk of the clearing house
If a member defaults it can use the initial margin to cover shortfall
Prices are always changing and the risk of the CH is always changing so members may receive margin bills to cover this
Explain variable margin in the case of clearing houses
Variable margin is profit and loss on derivative
Losers pay clearing house and clearing house send that winners
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