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Investments > Notes 2 > Flashcards

Notes 2 Flashcards

1
Q

What is an investment/asset market?

A

-virtual/physical place
- individuals buy/sell assets

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2
Q

Changes in the investment market

A

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
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3
Q

Intermediary

  • definition
  • why use
  • who is it
  • party needs to do what
A

-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.
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3
Q

Market Fragmentation

A

this is when a market for a particular asset is conducted in a variety of places

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4
Q

things the party has to decide when buying/selling asset

A
  • when want to own/dispose the asset
  • if immediately - cash or spot markets to be used?
  • if future - derivative markets used
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5
Q

what and explain are the main types of markets where are assets are bought or sold,

A

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.

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6
Q

what are the two distinct marketplaces and explain

A

Exchange traded market -

Over the counter (OTC)

Eg equities - often traded on exchanged

Eg Currencies - over the counter

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7
Q

exchange traded

A

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)
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8
Q

Over the Coutner, difference between exchange, risks

A

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.
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9
Q

Derivative markets

A

increased the no. of products offered.

  • focus on standardised derivatives, high levels of supply/demand + liquidity.
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10
Q

Hybrid between exchange trading and OTC

A
  • unregulated marketplaces
    have some charactsrtis of exchange
    -users must comply with the rules of that marketplaces own.
    Eg Dark Pools
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11
Q

What are three types of Market Structure

A
  • 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
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12
Q

Quote Driven MArkets

A
  • 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
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13
Q

Order Driven Markets

A

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
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14
Q

Order driven markers

A
  • 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
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15
Q

What are the types of Buy/Sell Orders

A

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

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16
Q

order validity

A

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

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17
Q

Trading Costs

A

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

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18
Q

Soft commission

A

commission paid cover more than the excecution fee

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19
Q

what happens after the buying or selling transaction is carried out, typical settlement time

A
  • 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

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20
Q

proof of ownership

A
  • electronic form
  • custodian may be appointed - manage security ownership on behalf of investor.
  • take care of other practical approaches - eg voting shares
21
Q

What makes a market efficient

A

openness and transparency

22
Q

Foreign Asset Investment

A

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.
23
Q

Problem with Foreign Asset Investments

A
  • 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
24
Q

Algorithm Trading influences

A
  • 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,
25
Q

Algorithm trading used by who ?

A

Large hedge funds and proprietary traders, brokers.

26
Q

Def of Algorithm trading

A

Automated computerised electronic trading based on quantitive rules in the form of algorithms

27
Q

Two uses of Algorithm trading

A
  • 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
28
Q

Aim of Algorithm trading

A
  • 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
29
Q

Methods of Algorithm trading

A
  • 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.

-

30
Q

What are black, grey and white boxes

A

Black - hidden workings
Grey - facilliate some external interaction
White- logic + workings clearly visible (have greater external interaction)

31
Q

Aim of high frequency Algorithm trading

A
  • track high frequency data, use algorithm to make decision on how to trade/when or what to trade
32
Q

Development of Algorithmic Trading

A
  • 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.
33
Q

Uses of Algorithm Trading

A
  • 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
34
Q

Advantages + Disadvantage of Algorithm trading

A
  • 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
35
Q

important aspects of equity markets

A
  • equity security represents part ownership of a company.
  • entitles to a share in the dividends,
  • proportional voting right at general meetings of company,
36
Q

Advantage and Disadvantage of Ownership and management separated

A
  • no disruption to the running of the company as ownership changes
  • agency problem - interests are not fully aligned,
37
Q

Main types of equities securities

A
  • ordinary shares.

-Preference shares: cumulative preference shares, participating preference shares, non participating preference shares..

  • Cullable and Puttable ordinary shares.
38
Q

Private company
- how raise money
- advantages

A
  • raise money from new or existing shareholders - Eg venture capital investments .
  • advantages: volatile industries : not subject to shorter term performance measures and reporting
39
Q

Which is the most volatile of the asset classes

A

equity

40
Q

characteristics of equities

A

cashflows should be real
dividends usually increase in line with companies profits.

41
Q

Problems with ownership being in electronic form

A

counterparty risk - electronic share certificate lodged in the name of their broker or custodian, and if custodian goes bankrupt.

42
Q

Unquoted Shares - Privately issued shares

A

not listed on stock exchange

43
Q

Disadvantage of Unquoted Shares

A

-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

  1. Lack of Info - less public available info
  2. Uncertain valuation - lack of regular market and limited publically info - difficult to put fair price on unquotes shares.
  3. Risk - tend to smaller, much risker
44
Q

Advantages of Unquoted Shares

A

1- potential for higher returns, higher risk , higher return

  1. Expect signicatn return if the company decides to go public at some time in the future.
  2. Lack of information - pricing anomalies can exist , investor with good info can take advantage
  3. Obain better overall diversification of portfolio
45
Q

Venture Capital

A

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
46
Q

how can invest in venture capital ?
some features of VC?

A

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.
47
Q

important aspects of fixed income markets

A
  • 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

-

48
Q

Different fixed income markets

A
  • government bonds
  • corporate bonds
    foreign bonds
    asset back securities
    repos
49
Q

other investment markets

A

property markets
currency markets
commodity markets

Investments (4 decks)

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