Exam Focus Flashcards
Describe the consensus viewpoint (nous =perspective) in investment markets
Consensus narrative is to see the market price as mostly the combined wisdom of the market. They consider that the Efficient Markets Hypothesis holds.
Because of this, they believe Markets are a zero-sum game whereby half lose and half win, posing the question is there any money to be made? These are the consensus base narratives and consensus investors carry out analysis only in this sphere as they are potentially frightened of any other approaches
Consider market to be random and in line with EMH, CAPM
Emphasis persistence and stability
Describe the competitive viewpoint of investment markets
Competitive investors see the market price as reflecting the combined ignorance of the market. They do not believe in EMH - have the view that people cannot know everything.
They consider that leaning on the EMH may be those who failed to outperform the market.
Market is a zero-sum game - winners and losers and are not evenly distributed
Their aim is to be in small number of winners.
The competitive investors narrative is constantly evolving, they form their own unique narrative which gives them a competitive edge.
They look for cause an effects in markets
They persist but put emphasis more on vitality - ability to start again
How to create narrative with a competitive edge
Better understanding than average of the non-Logos behaviour of other investors
Deep narrative - more capabilities for Logos
Recognition of deficiencies in current consensus
Allowance for the expected behaviour of investors adhering to EMH and CAPM
Recognition and understanding of likely behaviour of the bigger players in the market - winning and losing player
Give an example to emphasise importance of deep narratives
Ex: financial crash 07/08 closing the banks. Some argued banks are essential to the economy, others that banks are parasites to be let go bankrupt. This is an example of two shallow narratives contradicting each other. Both arguments would have resulted in a poor outcome, a deeper understanding could have been to consider a middle ground - perhaps removing some of the banks but leaving some for the economy to function would have been a better solution.
What is a narrative
Narrative means story and refers to the big picture or the mental frameworks in which analyses are carried out.
Narratives dominate and limit any analysis
We must also understand the limits to our narrative - this could be because of bias or lack of information, our ego etc
A narrative has to be deep and bright enough to show the full story without bias. - no taking sides. Disagreements often arise due to no middle ground between people’s extreme narratives. If a narrative is too shallow it gives way to persuasive but erroneous speech prevailing over reason and logic.
A simple narrative always has an opposite simple narrative contradicting it.
What’s an analysis
The analysis is within the narrative. The analysis part is within the context of the world where the investor works, does calculations, takes actions etc. To analyse means to examine (something) methodically and in detail, typically in order to explain and interpret it. The narrative (bigger picture) will dominate and limit the analysis. Example of the investment manager job being within an outside market narrative.
List the main participants in financial markets
Individuals/ Households
Groupings of individuals
Companies
Financial organisations
Non financial organisations ex: government and regulatory bodies, charities
Financial Intermediaries - Brokers, Dealers, Market makers
Exchanges
Online trading platforms
Professional investment decision makers - analysts and traders/ strategists
Investment management companies
Consultants and advisors
What is the role very briefly of financial intermediaries in the investment industry?
Financial Intermediaries - Brokers (agents hired to find the other side of a desired deal), Dealers, Market makers (quote two way bid offer prices and will buy or sell at respective price) Have little or no responsibility for positions thereafter whereas a trader would
What is the role very briefly of financial organisations in the investment industry?
Financial organisations - bank investment managers, insurers, hedge funds. Create new instruments depending on the risks and cash flows of other instruments
What is the role very briefly of exchanges and Online trading platforms in the investment industry?
Exchanges - places where trades can be arranged/ executed. Regulate
Online trading platforms - Alternative trading systems trading platforms function like exchanges but do not exercise regulatory authority over users except conduct of trading on the system
Dark pools - online platform that don’t show all clients orders on the system
Describe briefly the back, middle and front office roles
Back office - task driven,
Middle office - judgement and strategy and risk management,
Front office - direct involvement making decisions
What factors should you consider as regards to the practicalities of buying and selling assets?
- Using an intermediary - some offer advice on related assets and investments. Uuslaly you would go through a broker or electronic trading platform. The intermediary sends buy/sell order to a broker who in turn transmits it to the
exchange - How long they want to own asset and when - immediate delivery is cash market
- Primary or secondary market
- Exchanage vs over the counter
- trends in the market, new concepts, market psychology and behavioural aspects. Technical analysis
Do people usually use secondary or primary markets
the majority of cases the secondary markets are where transactions take place in existing securities. It’s a much more liquid environment.
What is a quote driven market
Asset buyer or seller will buy or sell from a market maker who will typically quote a bid-offer price to them. This bid-offer price is the price at which the market maker is prepared to buy or sell a given quantity of securities. The bid price is how much they are willing to pay. The offer price is the selling price the market maker is willing to accept from a party.
Most trading is done in quote driven markets except equities
How does it practically work in quote driven market - what are the actions
How it works: The market maker may specify a maximum size of order they will do at the named price. If a party wants to buy they pay the offer price which is usually the higher of the two. If the party wants to sell to the market maker they sell at the bid price. The bid-offer spread is the difference between the bid and offer price and it’s the market maker’s product assuming the opposite trade is at the same price.
What is an order driven system
In an order driven system there is a rules based matching system in place used to execute traders based on orders submitted to the system. Buyers enter buy orders in an order queue and sellers do likewise. If a buy order specifies a price that is higher than the lowest sell order price in the system a trade is executed.
What are the rules regarding pricing of trades and when orders have the same prices
There are different rules for what price a trade is executed at. Ex: discriminatory pricing rule where price is determined often by the order that arrived into their queue first.
When multiple orders have the same price order of precedence is determined by:
Order displayed go before hidden orders
Earliest order goes first
These rankings ensure liquidity goes up as traders are encouraged to price aggressively, display their order and trade earlier
What des term AT usually refer to?
AT or automated trading is often a term used broadly to refer to the automated computerised electronic trading based on quantitative rules in the form of algorithms. Two distinct uses of AT exist. One is for dealing and execution only - these algorithms are usually called execution algorithms or just algorithmic trading. Secondly they can be used for trading with an aim of making trading profits referred to as high frequency algorithmic trading or quantitative trading.
Factors influencing the development of AT?
Development of technology
Increased market fragmentation - AT allows to find the best real time liquidity
In an order driven market you can trade simultaneously with AT
Means of survival in a competitive environment
Define market fragmentation
Market fragmentation is a situation in which there are many different types of customers for a particular product or service or many different companies providing a particular product or service.
What are the aims of AT platforms?
Two distinct uses of AT exist- execution algorithms and high frequency algorithmic trading.
The aim of high frequency algorithmic trading is to make a profit and to use algorithms to make decisions based on how, when and what to trade to do that.
In terms of execution algorithms the main aim is to reduce the costs and risks associated with dealing and execution of trades. Algorithms used minimise market impact achieving an execution price as close to the market price as possible. Also often AT is used to disguise/ hide deals from other market participants ex: Placing trades to match the expected volume pattern during a trading day or just to palace trades evenly over time.
Differences in trading before and after AT
Automation in executing trades - computers fighting other computers
The role of trader has changed to more tactician
Investment in technology for investment
Volatility in the market also - powerful market participants bullying the market
Over time however as it becomes a more integrated part of the trading world, AT overall has increased liquidity in the market.
What are two aspects of AT platforms that can be quantatively assessed
For execution algorithms the implementation shortfall is measureable - difference in value fo a notional portfolio with trades executed at observed market price at time of deal and value of actual protfolio after execution of the actual trade - the lower the better
Latency also - quant measurement, time difference between stimulus and repsonse (order generation by algorithm and response) - Want first mover advantage and low latency
State the quantity theory of money
It states that, M × V = P × Q, where:
M = the amount of money in an economy
V = the velocity of money – the number of times money
circulates the economy over a specified period
P = the average price level of goods, services and assets
Q = the volume of goods, services and assets produced/ Transacted
What does the Quantity theory of money tell us
Primary research areas for the branch of economics referred to as monetary economics is the quantity theory of money
According to the Quantity Theory of Money, if the money supply doubled, it would not necessarily make people better off unless an increase in the volume of goods, services and assets accompanied it. - likely lead to a doubling of prices and still the same amount of stuff to buy. This will bring rising inflation level (as the buying capacity of one unit of currency decreases.); inflation is a measure of the rate of rising prices of goods and services in an economy.
Define QE and QT
QE is At its heart this is a form of monetary policy in which a central bank purchases securities to achieve the desired outcome of boosting the money supply and liquidity in the market.
QT A pretty key monetary policy at the moment is QT. At its heart this is a form of monetary policy in which a central bank sells securities in particular sells bonds or lets them mature to achieve the desired outcome - reducing liquidity int he market
What is the current climate to QE or QT?
The current climate in the US market and globally is for a period of QT to happen. The Federal Reserve’s balance-sheet has been shrinking since July and will continue this trend until the middle of 2023 In Europe there has also been an expectation of QT for months. The Bank of England held its first gilt auction on November 1st but the ECB is yet to let go of a bond - It is expected that the key principles of quantitative tightening are laid out for the ECB this month.
In general, QT is in response to QE which pumped alot of liquidity into system. There is too much hence reducing a little has no massive impact. Less of an extreme impact that QE. However as further liquidity removal occurs, could effect on multiple markets.
What is the impact of QE on Asset Prices
Assets price inflation
Central bank purchases will push up (bond) prices in those (bond ) markets
Asset prices increase in other markets too as (bond) sellers will look to buy toher assets to replace them, etc etc this continues recursively
Speculation further adds to inflation of prices
What is the impact of QE on Wealth and economic inequity
Asset owners have wealth increases
No assets no gains - will be worse off having no participation
Increase in inequality
What is the impact of QE on hedge funds
Inflation will make it harder to see what stocks are overvalued/ undervalued - the stock price of companies with weak fundamentals could increase for a sustained period of time
Investors will grow in numbers as more people have money to invest in assets
Investors become more wealthy
What is the impact of QE on economic growth
Increases due to the wealth effect
People with wealth gains have higher purchasing power - spend more so economic activity is creased
Should mean increased employment
Most impact will be in areas with higher concentration fo asset owners
Those without assets will gain from the creation fo jobs- Money trickles down
Not massive growth
What is the impact of QE on interest rates
It lowers the interest rates on savings and loans. And that stimulates spending in the economy.
Increasing the supply of money lowers interest rates further and provides liquidity to the banking system
On most fundamental level it is because interest rate is price for money
What is the impact of QE on Price inflation
Retail inflation rates stay low - Less wealthy people will not see any significant gains from QE
Ratil price inflation may turn to deflation as relatively less well off are worse off - demand for normal baket of goods falls
Ex: House prices going up so need to save and dont spend as much on groceries
What is the impact of QE on bank lending
Banks have more cash from selling bonds to central banks - cna lend more
They will only lend to those that can repay (those with greater level of assets)
Low interest rates have a detrimental impact of banks lending margins, dampens overall willingness to lend
What are the risks arising from QE
Likely lead to significant bubbles in asset markets
Low interest rates mean that future equity earnings will be discounted using very low interest rates.
As these move towards zero, theoretical equity prices move to infinity. - overvalued
QE is also likely to impact corporate finance decisions, meaning otherwise poor projects will get finance as they show profitability using the low interest rates,
Idea of TINA – ‘There Is No Alternative’ . The idea was that the investor needed to invest, and the least overvalued alternative was equities.
What does QE impact in terms of corporate finance
Quantitative easing to push money into areas such as corporate bonds, thereby lowering corporations’ borrowing costs and, it hoped, sparking the productive use of capital.
