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2018 S1 ^.^ > FINC2011 Lec 10 Equity Capital Markets > Flashcards

FINC2011 Lec 10 Equity Capital Markets Flashcards

1
Q

What are the 2 types of trading that BROKERS carry out?

A
  1. AGENCY trading: business transacted on behalf of clients.
  2. PRINCIPAL trading: business transacted on the broker’s own account.
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2
Q

What are the 2 tpyes of PRINCIPAL trading?

A
  1. Facilitation: broker takes opposite side of trade to client (i.e. buys shares client wants to sell at a price that cannot be satisfied in the market), brokers makes a loss but important client.
  2. House Trading: buys / sells shares for own investment purposes.
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3
Q

What are the 2 types of FUND MANAGERS?

Fund managers are organisations that invest cash on behalf of their clients.

A
  1. Wholesale: typically invest superannuation contributions sourced from companies.
  2. Retail: obtain cash by selling “units” DIRECTLY to public.
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4
Q

What are the 2 main types of funds?

A
  1. Active: funds used to outperform market index by buying and selling securities to realise capital gains.
  2. Passive: funds used to earn similar return to market index, by adopting a “buy and hold” strategy. (e.g. index funds).
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5
Q

What are the advantages of using fund managers?

A
  1. Economies of scale: lower transaction costs.

2. Knowledge: expectation fund managers more knowledgeable than you.

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6
Q

Fund managers earn profits through MANAGEMENT FEES, which type of fund would have the highest fee and why?

A

Retail Active: more risk, more return, more expenses incurred in investment process.

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7
Q

What are the 2 main types of ORDERS that can be placed on an equity exchange?

A
  1. Limit Order: specifies direction, quantiy, and acceptable price, may enter LOB.
  2. Market Order: specifies direction, quantity, best available price, executed immediately.
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8
Q

How are LIMIT ORDERS executed?

A
  • If there is a MATCH with an existing limit order then trade will be executed.
  • If there is no match as best sell is still higher than best buy, then limit order enters LOB / CLOB.
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9
Q

How is the LOB ranked?

A
  1. Price (highest bid, lowest ask)

2. Time

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10
Q

What happens if a trader placed a buy limit order (e.g. $10.08) much higher than all of the existing sell prices (e.g. Broker 355’s $10.02)?

A

Becuase orders have to be filled in the order they appear in the limit order book, the new order would execute against broker 355’s $10.02, not $10.08.

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11
Q

What happens if a MARKET ORDER involves a larger quantity than is available at the best price.

A

Order might be executed at multiple prices (i.e. “walking the book”).

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12
Q

What is the MARKET IMPACT COST and how is it calculated ($ and %)?

A

The cost incurred bc order was so large that it could push prices up / down.

Market Impact Cost $ = Best price - AVE execution price.

Market Impact Cost % = MIC / best price.

Note: AVE not current price / ending price!

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13
Q

What is the BID ASK SPREAD?

A

Spread = Lowest sell price - Highest buy price.

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14
Q

What is the impact on the price and spread if:

A) roughly same amount of limit / market orders coming in?

B) more market buy orders than limit sell orders? or large market buy that walks the book?

C) more market sell orders than limit buy orders? or large market sell that walks the book?

D) more limit orders than market orders?

A

A) same amount: price bounces between $10.01 - $10.02, spread stable.

B) more market buy: pushes price up, spread widened.

C) more market sell: pushes price down, spread widened.

D) more limit orders: spread narrower.

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15
Q

Why would you not want to put in a large market order that would walk the books?

A
  1. Don’t want to give away info advantage: large market order signals to investors something is going on.
  2. Don’t want to incur market impact cost.
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16
Q

What are some ways the problems with large market orders can be overcome?

A
  1. Off- Market trading: (e.g. ASX “block special crossing”) subject to certain restrictions / min thresholds.
  2. Specialised orders: Time-in-force, Immediate-or-cancel, All-or-nothing, Stop loss, Hidden orders, Iceberg Orders.
  3. Split order up, and wait for new limit orders to replenish between trades.
17
Q

Why would you not use the method of split order up, and wait for new limit orders to replenish between trades?

A

Takes a longer time, and there is a risk that the market may work against you resulting in a larger loss than the market impact cost.

18
Q

Describe the specialised orders:

  1. Time-in-force (TIF)
  2. Immediate-or-cancel (IOC)
  3. All-or-nothing (AON)
  4. Stop loss
  5. Hidden orders
  6. Iceberg Orders.
A
  1. TIF: specifies how long limit order can be active (e.g. day only order)
  2. IOC: Limit order that has be executed immediately, does not enter LOB.
  3. AON: market order that has to be executed in entirety or not at all.
  4. Stop loss: conditional market order triggered if price falls to pre-specified level.
  5. Hidden orders: if cannot be executed, it is added to LOB but not visible to other market participants, loses priority to visible orders (i.e. always bottom even if visible order comes later) to encourage transparency.
  6. Iceberg Orders: partial hidden order, hidden portion executed against first.
19
Q

What is a potential problem with stop losses?

A

TRIGGERS market order does not GUARANTEE PRICE.

Close $8.02, stop loss $8.00, Dow Jones crashes overnight, Open $6.00, executed at this price.

20
Q

Most equity markets are HYBRID markets that combine a continuous limit order market with some other feature.

What are 3 features?

A
  1. Floor Markets
  2. Dealer Markets
  3. Call Auctions
21
Q

What are the advantages and disadvantages of FLOOR MARKETS?

A
  • Transpearancy - can clearly see if someone is buying large quantities
  • Disputes and errors can be resolved quickly.
  • Trading interest is consolidated in 1 location.
  • Substituted by electronic trading systems
22
Q

What are the advantages and disadvantages of DEALER MARKETS? (e.g. FX)

A
  • Liquidity - dealers (intermediary) always willing to act as counterparty.
  • Low transpearency - dealers quote bid / ask prices, investors are price takers.
23
Q

How do CALL AUCTIONS work and what is an advantage?

A

Supply and demand curves constructed, all overlapping trades are then executed at a single price. Negative bid-ask spread as period of time where limit orders can be placed but not executed.

Advantage: facilitates trading in periods of HIGH DEMAND without EXCESSIVE VOLATILITY. (e.g. used to open markets which is high demand time as everyone is responding to overnight info).

24
Q

Why have random opening and closing auctions? / Why not have opening / closing call auctions at set time?

A

Market manipulation (illegal): place extremely large limit order (5000000 shares $1.80) well above yesterday’s closing price ($1.30), signals induce other traders, who might place an order to take advantage of it ($1.81, $1.82…), delete large buy order and instead puts large sell order, now at MUCH better price.

25
Q

Price = PV of future dividends. However, it is evident that the LOB also has an impact on the price. How does the LOB impact pricing? (MARKET MICROSTRUCTURE).

A

Bid-Ask Bounce: market sell order –> market buy order –> market sell order. +33.33% increase in price -25% decline simply due to trading process rather than dividend annoucement, growth rate increase etc.

26
Q

Why do we have MINIMUM PRICE INCREMENTS / TICK SIZES?

A

To prevent ridiculous orders like $0.3999999999. Ithis type of behaviour is allowed then trading would never occur.

27
Q

Why are OPENING HOURS limited instead of 24hrs?

A

Liquidity! Condensing down trade hours ensures there is sufficient liquiditiy for you to trade. Having 24hr market does not increase amount of trading, just spreads it out.

28
Q

When are TRADING HALTS instituted? How does it work.

A

When company releases market sensitive info that could have “a MATERIAL EFFECT on the price”.

Traders can place / cancel orders, but overlapping orders are not executed (negative bid ask spread).

Market resumes after brief opening phase which determines new price.

29
Q

Are trading halts effective?

A

10mins probably not enough time?

30
Q

What is SETTLEMENT and how does it impact the trader?

A

Settlement is the process by which payment is made and shares (ownership) is delivered from seller to buyer.

T+3: trading day + 3 working days for transfer.

Does not affect ability to trade, but can’t take money out of account.

31
Q

What are some RECENT DEVELOPMENTS in trading?

A
  1. Algorithmic trading

2. High frequency trading

2018 S1 ^.^ (24 decks)

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