Notes 2 Flashcards
What is an investment/asset market?
-virtual/physical place
- individuals buy/sell assets
Changes in the investment market
Rapid technological evolution - use electronic trading platforms now
- Increase in market fragmentation ( especially in equities)
- both of these led to rapid growth in algorithm trading
Intermediary
- definition
- why use
- who is it
- party needs to do what
-some investors can buy/sell directly.
- most need intermediary.
- buying/selling directly is limited to certain market participants.
eg members of an exhange - trader with Direct Market Access (DMA) platform.
- some want advice - online - poor
purchased through an intermediary/ specialist researcher. - broker/agent/online trading platform - used to electronically submit buy/sell order to the broker who in turns transmits it to the exchange.
- party wanting to buy/sell need to set up some kind of account with the intermediary for the settlement process.
Market Fragmentation
this is when a market for a particular asset is conducted in a variety of places
things the party has to decide when buying/selling asset
- when want to own/dispose the asset
- if immediately - cash or spot markets to be used?
- if future - derivative markets used
what and explain are the main types of markets where are assets are bought or sold,
Primary - equity/bonds/other securities sold for the first time . EG IPO (initial public offering for equities)
Secondary Markets - refers to a transaction in existing securities amongst investors.
Investor typically use secondary markets - bigger & more liquid.
what are the two distinct marketplaces and explain
Exchange traded market -
Over the counter (OTC)
Eg equities - often traded on exchanged
Eg Currencies - over the counter
exchange traded
exchange - refers to a central marketplace where securities are available to buy or sell.
- specify the rules - issuer of security and security must meet to be eligible for trading on the exchange.
-specify rules and procedures that dealer must comply with.
- regulated - ensure trading conducted in appropriate manner
-has rules and processes around pricing, execution, settlement of trades, and the provision of information - company wish to list - fulfil certain conditions - eg minimum profit level over a number of years
- when listed, comply with various disclosure rules ( eg provide financial information in a prescribed manner)
Over the Coutner, difference between exchange, risks
deals are agreed directly between buyer and seller. eg bank and client
conducted by phone or through dealer electronic trading platform
- trades not published (biggest difference)
- offer different types of negotiation to agree transactions and customised products
- increased risk - counterparty default, non transparent, potentially riskier products and lack of info
- each party exposed to credit risk
- price moves - one suffer gain, other suffer loss
- mitigated through collaterisation ( suffer loss required to provide collateral to cover their loss making position with their counterpart.
Derivative markets
increased the no. of products offered.
- focus on standardised derivatives, high levels of supply/demand + liquidity.
Hybrid between exchange trading and OTC
- unregulated marketplaces
have some charactsrtis of exchange
-users must comply with the rules of that marketplaces own.
Eg Dark Pools
What are three types of Market Structure
- quote driven markets
- order driven markets
- broker market - broker hired to find seller of asset, receive commission, used when finding a seller is difficult. (i.e poor quote driven systems or no order driven systems with adequate liquidity)
- commission - profit - using their expert knowledge of the market and client network
Quote Driven MArkets
- buyer/seller sell from market maker
- quote a bid offer price to them
- price at which the market maker is prepared to buy or sell a given qty of securtities.
- specify the max size of order for that price
- if buy - pay the offer price
if sell - sell at bid price quoted
(difference in price - called spread- profit made) - size of spread - indicate liquidity
- most trading (apart from equities) conducted in quote driven markets
Order Driven Markets
Rule based matching system - used to execate trades based on orders submitted to the system
- buyers enter buy order in order queue (particular qty at particular price)
- sellers do the same
- buy order specifies a price that is higher than the lowest sell order price - trade excuted
- if sell order price lower than the highest bug order - trade
- give priority to the highest priced buy order, lowest price sell,
- multiple same prices - preference to displayed, earlier orders
- can be run by exchanges or by brokerages
- referred to as alternative trading system
Order driven markers
- buyer/seller see the order book
- decide for themselves if want to trade with an existing displays order or enter their own order
- advantage : always trade at the bid or offer price
What are the types of Buy/Sell Orders
Market Order - execute transaction immediately, at best market price
Limit order -execute transaction immediately, limited to a specific high price when buying or a specific low price when selling
stop orders- an order to be filed immediately when specific price trades in the market.
hidden orders - orders exposed only to brokers which cannott be disclosed to other traders
order validity
good till cancelled - an order is valid until it is cancelled
good till xxx date, an order valid until specific date/time
Fill or Kill: has to be transaction immeediately in full or is cancelled
Immediate or Cancel : transaction imeddaitely in full or part, any unfilled parts of the order are canceled.
Good on close - can be only be filled at the close of the market
Good on open - can only be filled at the open of the market
Trading Costs
Brokerage commission
bid offer spreads
taxes eg stamp duty
Market participants May receive commission rebates in return for providing liquidity in some alternative trading system. eg dark pools
- market not liquid - buying/selling move market - referred to as liquid cost
delays
Soft commission
commission paid cover more than the excecution fee
what happens after the buying or selling transaction is carried out, typical settlement time
- accompanied by a set of clearing instructions
- tell exchange/broker how to arrange the settlement of the transaction.
Asset markets - referred to as cash or spot markets - settled in cash and on the day at which the trade is settled.
Equities have T+3 settlement time.
Bonds/currencies - shorter
proof of ownership
- electronic form
- custodian may be appointed - manage security ownership on behalf of investor.
- take care of other practical approaches - eg voting shares
What makes a market efficient
openness and transparency
Foreign Asset Investment
Investors with domestic liabilities are accepting a mis-match.
- unless negatively correlated with asset returns, currency movements will also lead to extra volatility of total returns.
- wholly/partially overcome by hedging the foreign exchange risk.
- if foreign currency exposure is desirable, then hedging programme may be unhelpful.
Problem with Foreign Asset Investments
- cost of increased expertise required, may appoint overseas custodian..
- costs further increase, by additional administrative procedures (accounting for foregin currencies)
-Taxation varies from country to country . ( may or may not be possible to recover withholding taxes imposed on overseas investments, issue for pension funds)
- different accounting practises
- less info available than in home market, presented in form difficult to integrate with local data format.
- difference in languages - although many of the larger overseas companies publish accounts in English
Algorithm Trading influences
- Continuous drive by market participants to gain an advantage over other market participants.
- Increased Market Fragmentation, increased trading venues, liquidity split over multiple venues.
- Development of Rule Based Trading, allows execution of more than one trade silmulatenously on order driven markets. Eg ITGs QuantEX System.
- Development of exection management systems, allows access to algorithms,
Algorithm trading used by who ?
Large hedge funds and proprietary traders, brokers.
Def of Algorithm trading
Automated computerised electronic trading based on quantitive rules in the form of algorithms
Two uses of Algorithm trading
- Dealing & Execution - algorithms referred to as execution algorithms.
- Trading with the aims of making trading profits, referred to as high frequency Algorithm trading/ quantitive trading
Aim of Algorithm trading
- reduce costs and risks with dealing and excution of trades
- minimise market impact : help achieve an execution price as close to the market price as possible.
- Disguise deals to stop market participants benefiting from any knowledge about another participants desired trades.
- Make profits
Methods of Algorithm trading
- Various Methods exist
-Place trades so as to match the expected volume pattern during trading day
- Place trades evenly over time.
- Can be set up as black boxes, grey boxes or white boxes.
-
What are black, grey and white boxes
Black - hidden workings
Grey - facilliate some external interaction
White- logic + workings clearly visible (have greater external interaction)
Aim of high frequency Algorithm trading
- track high frequency data, use algorithm to make decision on how to trade/when or what to trade
Development of Algorithmic Trading
- created by astute market participants
- spot market behaviour, believe can take advantage of by a profitable trading straregty .
- Once strategy decided, needs to be back testes, signed off, put into production, fine tune and feedback risk management, monitor system to manage it.
- first mover advantage (first market access)
- significant ongoing investment in technology and research to stay competitive)
- danger of market participants reverse engineering another market participants algorithm.
Uses of Algorithm Trading
- Assess and spot liqudity in market, for execute deals + price large deals. (Algorithm give good estimate of th likely market impact of the deal at that time)
- Make money - identify patterns or information lags
Advantages + Disadvantage of Algorithm trading
- Redice bid offer spreads
-lower transaction costs
-increase liquidity - improve market efficiency
- only available to the most powerful market participants, gains advantage.
make market unfair, prone to manipulation and abuse. - poorly designed, might make market moves bigger, risk of going work
- significant challenge: latency - time difference between stimulus and response, between order generation + execution .
Low latency - need to gain first mover advantage, invest lots of money to improve the speed in IT and telecommunications
important aspects of equity markets
- equity security represents part ownership of a company.
- entitles to a share in the dividends,
- proportional voting right at general meetings of company,
Advantage and Disadvantage of Ownership and management separated
- no disruption to the running of the company as ownership changes
- agency problem - interests are not fully aligned,
Main types of equities securities
- ordinary shares.
-Preference shares: cumulative preference shares, participating preference shares, non participating preference shares..
- Cullable and Puttable ordinary shares.
Private company
- how raise money
- advantages
- raise money from new or existing shareholders - Eg venture capital investments .
- advantages: volatile industries : not subject to shorter term performance measures and reporting
Which is the most volatile of the asset classes
equity
characteristics of equities
cashflows should be real
dividends usually increase in line with companies profits.
Problems with ownership being in electronic form
counterparty risk - electronic share certificate lodged in the name of their broker or custodian, and if custodian goes bankrupt.
Unquoted Shares - Privately issued shares
not listed on stock exchange
Disadvantage of Unquoted Shares
-1.poor marketability - not listed on stock exchange
- shares unmarketable
- difficult in finding buyer
- when find buyer, dealing costs much higher than with quoted shares
- Lack of Info - less public available info
- Uncertain valuation - lack of regular market and limited publically info - difficult to put fair price on unquotes shares.
- Risk - tend to smaller, much risker
Advantages of Unquoted Shares
1- potential for higher returns, higher risk , higher return
- Expect signicatn return if the company decides to go public at some time in the future.
- Lack of information - pricing anomalies can exist , investor with good info can take advantage
- Obain better overall diversification of portfolio
Venture Capital
investment into unquoted companies
- small companies : early stage in growth
- longer established companies, raise capital for next stage of their growth
- management buy out or buy ins
how can invest in venture capital ?
some features of VC?
establish own venture capital fund,
- or invest in a specialist venture capital company
- very high risk
- expect a large no. to fail.
- those that do succeed, expect to produce a very high return
- internal rate of return 15% to 20% a year to investors.
important aspects of fixed income markets
- bonds, loans, debt and other instruments
- involve an initial exchange of principal between investor and the borrower
interrest payments fixed,
difference between equity security - ownership of a company
-
Different fixed income markets
- government bonds
- corporate bonds
foreign bonds
asset back securities
repos
other investment markets
property markets
currency markets
commodity markets
