Investment markets and the Practicalities

Question 1

Explain what an investment/asset market is with examples

Answer 1

Virtual or physical space where buying and selling of assets occurs ex: commodity markets, primary/ secondary bond market, property market, money market, foreign exchange markets

Question 2

Explain market fragmentation

Answer 2

Occurs when a market for a particular asset is conducted in a variety of places. - Provides many different options

Question 3

What does DMA mean

Answer 3

Direct market access

Question 4

What to consider before buying and selling assets

Answer 4

How to access market - what intermediary to use
Where to buy/ access research or advice
Decide when they want to own the asset - determines cash or derivatives markets
What type of market to use primary, secondary,

Question 5

Define cash market

Answer 5

Marketplace where securities purchased are paid for and received at the point of sale

Question 6

Define spot/cash market

Answer 6

Financial instruments are traded for immediate delivery

Question 7

Define derivatives markets

Answer 7

Financial market for financial intruments such as futures or options that are based on the values of their underlying assets

Question 8

Who uses primary and secondary markets

Answer 8

Majority of the time we use secondary markets. Primary markets are created when equities/bonds etc are sold for the first time. ex: IPO usually very small
Secondary markets are transactions in existing securities among investors much bigger and more liquid markets

Question 9

Define an exchange

Answer 9

Central marketplace where securities can be bought and sold, there are rules the securities and issuers must meet to be eligible to trade.

Question 10

What sort of rules are there on an exchnage

Answer 10

Rules and processes around pricing, execution, settlement of trades, provision of information

Question 11

Define and explain OTC markets

Answer 11

Over the counter markets are where deals are agreed directly between buyer and seller, typically bank and client but they do not have trades published.

OTC markets offer different negotiation to agree on transactions and customised products, but investors may have higher risks. ex: counterparty default, non-transparent, alc of info etc. There is always a risk the loss-making the party will be unable to make good its obligations - exposed to the other party’s credit risk. Usually tackled with collateralisation

Question 12

Why do regulators encourage exchanges

Answer 12

Improve transparency and reduce counterparty risk.

Question 13

What is a an example of hybrid exchange and OTC option

Answer 13

Dark Pools are an example of a hybrid marketplace:

Question 14

differnt types of order markets

Answer 14

Quote driven, order-driven markets, broker market

Question 15

What is a quote driven market

Answer 15

A market where the asset buyer or seller will buy or sell from a market maker, who will typically quote a bid-offer price to them

Question 16

Describe what an order driven system is?

Answer 16

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.

Question 17

How do the rules in an order driven system work

Answer 17

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

Question 18

What is the spread

Answer 18

Difference between the bid and offer price

Question 19

Define a broker market

Answer 19

Broker finds a seller and receives a commisision for the service, used when a seller is difficult

Question 20

Define and explain most common order types

Answer 20

Market order - execute the transaction immediately at best market price
Limit order - limited to a specific high price when buying or low price when selling
Stop orders - filled when specific price trades in market
Hidden orders - exposed only to brokers

Question 21

What are the main type of validity of orders

Answer 21

Good till cancelled, good till a date, fill or kill, immediate, good on close/open of market

Question 22

Give examples of trading costs

Answer 22

Brokerage commission, fee charges
Bid offer spreads
Taxes ex: stamp duty

Question 23

How is settlement of a transaction usually reached

Answer 23

There will be clearing instructions telling exchange or broker how to arrange settlement- usually different markets have different spot conventions. Equities typically have T+3 settlement time

Question 24

What is a big risk with overseas investing

Answer 24

Overseas invetsing means investors with domestic liabilities are accepting a mismatch. unless they are negatively correlated with asset returns currency movements will also lead to extra volatility - can hedge the foreign exchange risk but you need to be sure the exposure to the foreign currency is not desirable

Question 25

What are some further problems with overseas investment

Answer 25

Different accounting practices, less information is available, differences in languages, poorer market regulation, time delays because of timing differences

Question 26

What is Algorithmic trading?

Answer 26

The term ‘algorithmic trading’ is often used broadly to refer to automated computerised electronic trading
based on quantitative rules in the form of algorithms.

Question 27

Factors influencing the development of AT?

Answer 27

The continual drive by competitive market participants togain an advantage over other market participants.

Increased market fragmentation - AT allows to find the best real time liquidity

Question 28

What is the aim of High-frequency Algorithmic Trading

Answer 28

The aim of high-frequency algorithmic trading is to make a profit & execute trades as fast as possible

Question 29

What is the aim of execution algorithms

Answer 29

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.

Question 30

What are the two types of AT?

Answer 30

Execution algorithms or high frequency algorithmic trading

Question 31

Differences in trading before and after AT

Answer 31

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.

Question 32

What are two aspects of AT platforms that can be quantatively assessed

Answer 32

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

Question 33

Meaning of white box, grey box, black box

Answer 33

Black box - trade execution (AT style) is hidden
Grey boxes have some external interaction
White boxes logic and workings are visible and have greatest external interaction

Question 34

What does the fine-tuning of an invetsing strategy involve?

Answer 34

Back testing, signing off on it, production, fine tuning, feedback, risk management and monitoring system set up

Question 35

How has the role of traders changed due to AT

Answer 35

Computers now battle other computers - traders are now more strategists and tactians

Question 36

What are the advantages of using AT

Answer 36

Reduces bid offer spread,
Lower transactions costs
Increases liqudity
Arguably improves market efficiency

Question 37

What are the disadvantages of AT

Answer 37

Only available tool to more powerful market participants - making market less fair and more prone to manipulation - pushing market in certain directions
Poorly constructed algorithms can make market moves bigger
Can go wrong

Question 38

Explain fractal analysis

Answer 38

Helps quantify patterns in nature and identify any deviation from these natural patterns

Question 39

Define an equity security

Answer 39

financial instrument that represents an ownership interest in a company

Question 40

What are agency problems

Answer 40

refer to conflicts of interest that arise between two parties in a business relationship, typically between the principal (e.g., shareholders or investors) and the agent (e.g., managers or executives). These issues occur when the agent makes decisions that benefit themselves rather than acting in the best interest of the principal

Question 41

Name types of share

Answer 41

Most are ordinary shares
Preference shares
Callable and puttable shares

Question 42

How does private company raise money from new or existing shareholders

Answer 42

Venture capital investment
Leveraged buyouts
Private investment in public equity

Question 43

What are the costs of buying equity

Answer 43

Commission to stockbroker
Bid offer spread
Stamp duty

Question 44

Define unquoted shares and give their disadvantages

Answer 44

Not listed on stock exchange - privately issued or unquoted shares. They have poor marketability : hard to find a buyer and dealing costs are high
There is less information available about the company so they have uncertain valuation. Also they tend to be higher risk - smaller company

Question 45

Are there advantages to unquoted shares?

Answer 45

High return potential - especially if eventually the company goes public
Lack of information means pricing anaomalies can exist
Better portfolio diversification

Question 46

What is venture capital

Answer 46

Development capital. Form of investment in unquoted companies ex: small companies, longer established companies for next stage of growth, management buy outs, public to private transactions
Venture capital investment shave a high risk

Question 47

Give examples of fixed income markets

Answer 47

Government bonds, corporate bonds, foreign bonds, asset backed securities, property, currency markets, commodity markets. Anything that involves an inital exchange of prinicipal between investor and borrower and not only those where interest payment is fixed.