Past Exam Questions

Question 1

Differences in trading before and after AT

Answer 1

1. Automation in executing trades
2. Role of trader has changed to more tactician
3. Investment in technology for investment
4. Volatility in the market - powerful market participants bullying the market
5. As it has become more integrated, AT has increased liquidity in the market

Question 2

What are two aspects of AT platforms that can be quantitatively assessed?

Answer 2

1. Implementation shortfall for execution algorithms is measurable
2. Latency

Question 3

Implementation Shortfall

Answer 3

Difference in value of a notional portfolio with trades executed at observed market price at time of deal and value of actual portfolio after execution of the actual trade. The lower the better

Question 4

Latency

Answer 4

Quant measurement. Time difference between stimulus and response (order generation by algorithm and response). Want first mover advantage and low latency

Question 5

Quantity Theory of Money

Answer 5

M x V = P x Q

M = the amount of money in the economy
V = the velocity of money - the number of times money circulates the economy over a specified period
P = average price level of goods, services, and assets
Q = the volume of goods, services, and assets produced/transacted

Question 6

What does the Quantity Theory of Money tell us?

Answer 6

• 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
• Which would likely lead to a doubling of prices and still the same amount of things to buy.
• This will bring a rising inflation level as the buying capacity of one unit of currency decreases

Question 7

Quantitative Easing (QE)

Answer 7

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

Question 8

Quantitative Tightening (QT)

Answer 8

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 in the market

• Key monetary policy at the moment

Question 9

What is the current climate to QE or QT?

Answer 9

The current climate in the US, and globally, is for a period of QT to happen.

The Federal Reserve’s balance sheet has been shrinking since July 2022 and will continue this trend until the middle of 2023

In Europe there has also been an expectation of QT

QT is in response to QE which pumped a lot of liquidity into the system

Too much liquidity, so reducing securities held has no massive impact. Less extreme impact than QE. However, as further liquidity removal occurs, it could affect multiple markets

Question 10

What is the effect of QE on asset prices?

Answer 10

1. Asset price inflation
2. Central bank purchases will push up (bond) prices in those (bond) markets
3. Asset prices increase in other markets too as (bond) sellers will look to buy other assets to replace them, etc - this continues recursively
4. Speculation further adds to inflation of prices

Question 11

What is the impact of QE on wealth and economic inequity?

Answer 11

1. Asset owners have wealth increases
2. No assets, no gains - will be worse off having no participation
3. Increase in inequality

Question 12

What is the impact of QE on hedge funds?

Answer 12

Inflation will make it harder to see what is over/under values

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

Question 13

What is the impact of QE on economic growth?

Answer 13

1. Growth increases due to the wealth effect
2. People with wealth gains have higher purchasing power - spend more so economic activity increases
3. Should mean increased employment
4. Most impact will be in areas with higher concentration asset owners
5. Those without assets will gain from the creation of jobs. - money trickles down
6. Not massive growth

Question 14

What is the impact of QE on interest rates?

Answer 14

1. Lowers interest rates on savings and loans - stimulates spending in the economy
2. Increasing the supply of money lowers interest rates further - provides liquidity to the banking system
3. On most fundamental level it is because interest rate is the price for money

Question 15

What is the impact of QE on price inflation?

Answer 15

1. Retail inflation rates stay low - less wealthy people will not see significant gains from QE
2. Retail price inflation my turn to deflation as relatively less well-off are worse off - demand for normal basket of goods falls

Example: House prices going up so need to save and don’t spend as much on groceries

Question 16

What is the impact of QE on bank lending?

Answer 16

1. Banks have more cash from selling bonds to central banks - can lend more
2. Will only lend to those who can repay (those with greater level of assets)
3. Low interest rates have detrimental impact on banks’ lending margins - dampens overall willingness to lend

Question 17

What are the risks arising from QE?

Answer 17

1. Likely lead to significant bubbles in asset markets
2. Low interest rates mean that future equity earnings will be discounted using very low interest rates
3. As interest rates move towards 0, theoretically, equity prices more to infinity - overvalued
4. QE likely to impact corporate finance decisions, meaning otherwise poor projects will get finance as they show profitability using the low interest rates
5. Idea of TINA - ‘There is No Alternative’. The idea was that the investor needed to invest, and the least overvalued alternative was equities

Question 18

What does QE impact in terms of corporate firms?

Answer 18

QE to push money into areas such a corporate bonds, thereby lowering corporations’ borrowing costs and, hopefully, sparking the productive use of capital

Question 19

What impact does QT have in terms of asset price?

Answer 19

1. Asset price deflation
2. Central bank eliminating its assets will push bond prices down
3. Asset prices decrease in other markets also as bond investors will look to sell other assets when they are buying back bonds, this continues recursively for many market players exacerbating the price decrease
4. Speculation adds to the deflation of prices also

Question 20

What impact will QT have on wealth?

Answer 20

1. Asset owners have wealth decreases
2. No assets - gains. Will be better off having no participation
3. Those less well-off hopefully benefit from less inflated prices

Question 21

What impact will QT have in terms of hedge funds?

Answer 21

1. Deflation of prices will make it harder to see what stocks are over/under valued - the stock prices of great companies could decrease for a sustained period of time
2. Investors will deplete as people have less liquidity to invest in assets
3. There is a lull in investor gains - gains fall

Question 22

What impact will QT have in terms of economic growth?

Answer 22

1. Slows economic growth as there is less money to be spent
2. Hope is that people with less wealth have higher purchasing power
3. Demand for goods and services decreases with cost of borrowing increasing so deflation occurs
4. Not massive growth nd may just be transitioning before asset prices revert to the mean levels in time

Question 23

What impact will QT have in terms of bank lending?

Answer 23

1. Higher interest rates have a positive impact on banks’ lending margins, increasing overall willingness to lend
2. May lend to peple they previously wouldn’t have because of favourable margins
3. Less demand for borrowing as costs are high

Question 24

What impact does QT have in terms of wages?

Answer 24

Decreased asset prices mean purchasing power of these real wages are higher

Question 25

What impact will QT have in terms of price inflation?

Answer 25

Interest rate hikes are known as the central bank’s one major tool to lower inflation, which it does by raising the cost of borrowing money to curb the demand for goods and services

Question 26

What impact will QT have in terms of interest rates?

Answer 26

1. Interest rates increase on savings and loans meaning in the short term there is less spending in the economy
2. Decreasing the supply of money increases interest rates further and means lack of liquidity in the banking system
3. Interest is the price of money - money is low in supply so it costs more

Question 27

What are the risks of QT?

Answer 27

1. Potential to destabilise financial markets - panic due to liquidity
2. QT likely puts upward pressure on interest rates - significant uncertainty about the magnitude of these effects
3. High interest rates - future equity earnings will be discounted using very high interest rates
4. Likely to impact corporate finance decisions, meaning good projects may not get finance as they don’t show profitability using the high interest rates, even though they might show profitability under normal interest rates

Question 28

How would a pension fund be affected by QE?

Answer 28

• Low yields on bonds reduce the scope for gaining from compound interest to provide generous future pensions
• Interest rates are lower than usual, overvaluing a pension’s likely future benefit payments (aka future liabilities)
• Stock price of companies with weak fundamentals could increase for a sustained period of time
• Pension fund may grow in size as more people/corporations have money to invest in their future
• Overall QE environment can destabilise pension plan finances
• With falling interest, there tends to be a shortfall in pension value, especially plans relying on bonds to fund regular payouts in the future. To cover this, funds have to invest even more.

Question 29

How would a pension fund be affected by QT?

Answer 29

• A lot of pension funds rely on bonds heavily - panic as central bank sells - need a plan
• Deflation of prices will make it harder to see what stocks are over/under valued - the stock price of companies with great fundamentals could decrease for a sustained period of time
• Investors will deplete as people have less liquidity to invest. There is a lull in pension gains - fund value may stop growing
• Higher yields on bonds potentially increase the scope for gaining from compound interest to provide generous future pensions

Question 30

What are the main requirements for an investment psychology framework to assess comparative advantage?

Answer 30

• Based on adequately powerful narrative and practical
• Needs not just to create a better understanding of the market, but also be able to create a better understanding of the behaviour of others

Question 31

What are some key economic and monetary trends discussed in this course?

Answer 31

1. Bretton Woods
2. QE
3. QT
4. Media
5. Fiscal Influences and Politics

Question 32

Define technical analysis

Answer 32

Method for forecasting the direction of prices through the study of past marker. data, primarily price and volume.

Contrasts the fundamental analysis, which attempts to forecast market prices using financial and economic data.

Technical analysis helps identify trends, tendencies, and trading opportunities using a variety of techniques, but it cannot predict the future.

Built on the view that all relevant information impacting he market price is reflected in its price history.

Question 33

Psychologically astute investor using technical analysis

Answer 33

• Need deep narrative
• Investigate whether any of the technical analyses work in a particular market by looking at previous price action over various time periods and frequencies
• Examine why certain methods do not work
• Apply curiosity - being comfortable to combine techniques and examine for patterns
• Self-aware investor will recognise the purpose for investing
• Technical analysis only key for a short term investor or day trader - unpredictable over long periods
• Determine how ways to use technical analysis would work with or without modification
• Can then be used for market timing and trading, but only in the context of a deep overall narrative

Question 34

Explain Exchanges

Answer 34

A centra marketplace where securities can be bought and sold. They are regulated, and executed trade information is published at regular intervals for all market participants to see. Regulation is very absolute to ensure trading is conducted in an appropriate manner. There are rules around price, execution and settlement, and provision of information.

Question 35

Explain Over-the-Counter

Answer 35

OTC deals are agreed directly between buyers and sellers, typically a bank and a client.

Swaps are typically OTC. OTC markets do not have trades published.

Can offer different negotiation to agree transactions and customised products

Higher risk - counterparty default, non-transparency, lack of information

Each counterparty exposed to the risk of their counterpart

Risk generally mitigated through collateral

Question 36

Which is better, exchange or OTC?

Answer 36

Depends on purpose of trading/investment. For some securities regulators encourage market participants to transact deals on exchanges or to centrally clear transactions to improve transparency and reduce counterparty risks

Question 37

What is the ISDA Master Agreement?

Answer 37

The ISDA Master Agreement is an internationally agreed legal document outlining certain terms for derivative trades. This is essential as trading is a global affair so to have one key gold standard across the board allows for standardisation. big part of ISDA’s activity is ensuring the enforceability of the netting provisions in the Master Agreement as this stipulation is of massive importance

Question 38

Explain the idea of netting and why it came about?

Answer 38

Netting allows long and short exposure transacted between the same counterparties to be offset in the even of default, so that only the net exposure is considered as a claim against the defaulter.

The netting idea comes from a frequent occurrence where lots of payments are arising due to lots of contracts between two parties.

It is more simple and easier for each party to work out what they owe and the party owing the most can balance up in one payment

Question 39

Explain how the ISDA agreement as a netting agreement protects in transaction

Answer 39

The ‘International Swaps and Derivatives Association’ work in netting has seen laws being passed in many countries that give legal certainty in those jurisdictions for netting in the event of default.

When parties enter into individual transactions, a confirmation will be prepared, which details in advance the terms of that specific trade with reference to the Master Agreement.

All the trades are then covered by the terms of the (netting) Agreement.

All transactions depend upon each other under the agreement.

Therefore a default under one transaction counts as a default under all transactions.

This fact is a key protection against unfair behaviours, such as clients making some payments (profitable ones) and refusing to pay the unprofitable ones.

Question 40

Apart from outlining the rules of netter, what else is evident in ISDA’s work currently?

Answer 40

Netting opinions.

The other area where ISDA have been very active is obtaining legal opinions on the validity and scope of netting and updating those opinions when new products, like credit derivatives, are added under existing agreements.

ISDAs netting opinions cover a lot of countries in the world and there is an established case history now from actual case defaults involving derivatives to draw on.

The latest version of the ISDA Master agreement is 2002.

Overall, the practicalities of derivatives trading are massively improved with the agreement in place.

Question 41

Define a cash market

Answer 41

In a cash or spot market, purchasers take immediate possession of goods at the point of sale. Stock exchanges are considered cash markets because shares are exchanged for cash at the point of sale.

Question 42

Define derivatives markets

Answer 42

Investors purchase the right to take possession at some future date.

Question 43

What is the usefulness of derivatives versus cash markets?

Answer 43

Often depends on the purpose of your investment, how long you intend to hold it, and when you want to own/be exposed to the asset.

General thoughts:
- Derivatives more accessible to smaller investors
- Hedging risk - currency hedging
- More liquidity
- Trading with lower costs in most cases - watch rollover costs
- Leveraged investment
- Tax

Question 44

Why are derivatives markets better for smaller investors?

Answer 44

Often the cash markets can require a lot of capital to invest directly into assets so smaller investors find derivatives markets more accessible because of minimum contract sizes. An example of how to gain exposure to assets in derivatives markets is using financial spread betting.

Question 45

How do banks make money?

Answer 45

Playing the yield curve. In practice when a bank receives deposits it keeps the regulatory amount and lends out the rest. Profitability is limited by the size of the funds it has to lend. A larger balance sheet means more loans.

A bank typically lends for relatively long terms at a fixed rate which funds itself short term with a floating rate in the form of deposits. These floating rates are typically lower than the fixed rate which gives them a healthy profit.

Banks could create synthetic lending. Derivatives enable banks to create further leverage, beyond what is suggested, which some banks may take advantage of. This is because things like interest rate swaps create similar cash flows to normal bank lending.

Question 46

Define the psyche

Answer 46

The Psyche is a word to refer to the full human mind in its widest sense. It can be translated to mean Mind or soul. The simple tripartite model of the Psyche has three parts namely: Nous, Logos and Pyr.

Question 47

Define Nous

Answer 47

Nous is your perspective in life and probably the most important part of the psyche. It includes your thought or imagination for reality, intuition, reflection and narrative development. It’s the mental picture of the world the individual is using and often formulates our narratives.

Question 48

Define Logos

Answer 48

Logos is logic or rational thinking. The function of logos is to condition the mental picture created by Nous. Logos is logic everyone understands, it’s not necessarily personal to you.

Question 49

Define Pyr

Answer 49

Means fire in the belly and refers to the mind’s impulse and drive. It is the energy used in and by the psyche.

Question 50

Explain how the three parts of the psyche work together and what’s important for investors to be aware of about Nous, Logos and Pyr.

Answer 50

• These three parts of the mind can work together but can also limit each other.
• Engaging each part of the mind requires contrasting things, for example Nous requires openness and vulnerability , Logos needs stability and Pyr needs passion.
• To apply all three parts well, individuals need a healthy ego and to be comfortable with applying Nous.
• Working in investment markets, it is essential to create a methodology to evaluate rationalisations regarding investments from a psychological perspective.
• Firstly one must be aware of how their mind works.
• Building up this method by assessing the narrative to determine the use of Nous and Ego.
• It’s also helpful to assess any analysis to determine the degree to which Logos was used.
• The level of Pyr also needs to be considered.

Question 51

Define Ego

Answer 51

An individual sees the world partly the way the world is and partly the way they are. The Ego is the individual self and is something that’s constructed over time. It can be thought of as a filter through which an individual sees the world.

Every individual has an ego that influences their mind, it’s just the extent to which we can identify ego defence mechanisms and be open to change.

An individual’s Ego can defend them from realities that they don’t like and only the individual can open their eyes to these realities using what’s called ego defence mechanisms.

Question 52

Healthy Ego

Answer 52

A person sees the world as it really is and constructively tries to engage with the world.

Question 53

Unhealthy Ego

Answer 53

A person uses degrees of self-deception to justify their actions to make themselves feel better about the world.

Question 54

Explain ‘Big Ego’ and what it means

Answer 54

If an individual has a ‘big ego’, our meaning is they have higher self-regard , and a greater sense of self.

If this is true then they are more liable to ego-defence mechanisms being activated to protect their high self-regard.

It is possible to have a high self-regard and a healthy ego, so it is more appropriate to label an unhealthy or healthy ego.

Question 55

Explain rationalisation

Answer 55

When an individual makes a judgement based partly on the way they are and partly on the way the world is.

The more emotional or the higher our expectations of a certain scenario, the greater the likelihood and severity of any rationalisations that we make in response.

In investing this is particularly prominent often there are high amounts of money at stake.

The quality of rationalisation would also be influenced by the degree of Nous and Pyr (effort) applied. - can be positive or negative.

Question 56

Explain how to assess rationalisation using the Psyche

Answer 56

Evaluating rationalisations we should assess the narrative to determine the use of Nouns and Ego.

Secondly, we should set the analysis to determine the degree to which Logos was used.

Pyr also needs consideration.

Ego defence mechanisms are a type of rationalisation caused by high emotion and high expectations of something that didn’t happen.

It’s like a protective bubble to stop the hard reality we are about to face crashing down on us.

It’s a key skill to practise enduring truth - we do this by engaging Nous.

Question 57

What are the characteristics of an astute investor?

Answer 57

• Having a psychologically sound way of investing-its high pressure position. Need a disciplined, well defined and practised approach.
• Exercise patience and humility when investing.
• Always create their own unique, realistic narrative that is deep. It looks for cause and
  effects and they are constantly trying to improve their narrative
• They can question existing narratives in a progressive manner
• They understand the implication of opposing theories like the Efficient Market
  hypothesis.
• They dig deeper into any media narratives they come across.
• One of the hardest things to do as an investor is either do nothing or stick to your stops
  on potential losses. It is key for investors if they are not in a psychologically good way
  to step away from trading.
• Stick to stop loss.
• Astute investor will have the ability to persist and start over.

Question 58

Briefly overview the historical development of derivatives markets

Answer 58

Modern derivatives markets began in Chicago in the mid 1800s.

To begin contract was between farmers and purchasers when transacting grain.

This was to reduce the risks faced by both parties whereby the price was agreed in advance for delivery to arrive at a specified date.

The risks for farmers and purchasers was the price, as when harvest was greater than expected prices would be lower and vice versa.

Contract reduced their risks, but there was a new addition of counterparty risk.

This defined the idea of derivatives markets.

Financial derivatives have caught on in the 1970s and have been growing exponentially since then.

Chicago is the biggest derivative exchange location globally with the Chicago Mercantile Exchange and the Chicago Board Options Exchange.

Question 59

Why might investors use derivatives instead of cash markets?

Answer 59

• Asset transitions.
• More liquid - lower trading costs.
• Currency hedging programmes.
• Leveraged investments.
• Long/Short portfolios.
• Non-linear/options based strategies.

Question 60

What are structured investment products?

Answer 60

Structured investment products are collective investment vehicles offering investors a target return profile typically linked to a combination of standard indices and often with variable leverage or protection features. Example: Equity linked return but minimum guaranteed payment of 90% initial investment after a period of time.

Question 61

What are the advantages of structured investment products?

Answer 61

• Principal protection, though often there are hidden costs not advertised.
• Can obtain a tailored investment return.
• More tax efficient in some cases than underlying asset.
• Typically have lower volatility than the underlying asset, but with scope to participate
  in rising equity markets.

Question 62

What are the disadvantages of structured investment products?

Answer 62

1. Counterparty or credit risk - the possibility of a loss resulting from a borrower’s failure to repay a loan or meet contractual obligations.
2. Low liquidity
3. Complex underlying structure with opaque pricing - embedded fees are high.

Question 63

What are a CFD and spread betting?

Answer 63

A contract for differences (CFD) is a financial contract that pays the differences in the settlement price between the open and closing trades and is priced based on the prices of other assets and derivatives.

Spread betting involves this action of speculating on the direction of a financial market without actually owning the underlying security.

Question 64

What are some merits to spread betting and/or CFDs

Answer 64

Can gain exposure to assets in derivative markets even with smaller amounts of capital.

Tax merits to these methods. Spread betting is classified usually as gambling and taxed accordingly meaning gains are often tax-free. If you were to directly invest into the underlying asset you would have to pay tax on any income and capital gains.

Costs of buying and selling tend to be less. This is because the bid/offer spread in financial spread betting and CFDS is often narrower than in underlying cash markets.

Question 65

What are some problems arising in CFDs or spread betting?

Answer 65

Investing directly into assets does somewhat protect against losses as they can be offset against future profits, unlike losses on spread betting and CFDs which cannot. This is why it’s considered “gambling” and is often subject to restriction. It requires a lot of discipline to engage in to prevent significant losses.

Additional costs to rollover any positions in spread betting and CFDs as contracts periodically expire. Costs of this nature add up as expected holding time increases - something to consider if you are looking to take a more long term position.

Question 66

What are three reasons why you need to understand AT?

Answer 66

1. Efficiency: Algorithmic Trading allows investors to execute trades with high speed and precision, reducing the potential for human errors and emotional decision-making. Understanding how automated trading systems work can help you take advantage of the efficiency and automation that they offer.
2. Algorithmic Strategies: Algorithmic Trading relies on algorithmic strategies to make trading decisions. By understanding these algorithms and how they work, you can develop or customize trading strategies that align with your investment goals and risk tolerance.
3. Market Opportunities: Algorithmic Trading systems can identify and execute trading opportunities in real-time, making them well-suited for capturing fleeting market conditions. By understanding automated trading, you can harness these opportunities, which might be difficult to spot and act upon manually.

Question 67

Name one thing you can quantitatively assess about algorithms

Answer 67

Monitoring any trading algorithms in place is really important to assess the quality of the algorithms in place. This could be done in multiple different way including tracking quantitative data like how often the trade makes money, but also what narrative the algorithm is assuming. Is it current? Is it kept up to date, how will it be altered etc/. These are all factors to consider.

Question 68

List the main participants in financial markets

Answer 68

• 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.

Question 69

What is the role of financial intermediaries in the investment industry?

Answer 69

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.

Question 70

What is the role of financial organisations in the investment industry?

Answer 70

Financial organisations - bank investment managers, insurers, hedge funds. Create new instruments depending on the risks and cash flows of other instruments.

Question 71

What is the role of exchanges and online trading platforms in the investment industry?

Answer 71

• Exchanges - places where trades can be arranged/ executed. Regulated.
• 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.

Question 72

Back Office

Answer 72

Task driven

Question 73

Middle office

Answer 73

Judgement, strategy, risk management

Question 74

Front office

Answer 74

Direct involvement in making decisions

Question 75

Do people usually use primary or secondary markets?

Answer 75

The majority of cases the secondary markets are where transactions take place in existing securities. It’s a much more liquid environment.

Question 76

What is a quote driven market?

Answer 76

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.

Question 77

How does it practically work in a quote-driven market?

Answer 77

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.

Question 78

What is an order driven system?

Answer 78

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.

Question 79

What are the rules regarding pricing of trades and when orders have the same prices?

Answer 79

There are different rules for what price a trade is executed at.

Example: 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:
1. Order displayed go before hidden orders
2. Earliest order goes first

These rankings ensure liquidity goes up as traders are encouraged to price aggressively, display their order and trade earlier

Question 80

What does the term AT usually refer to?

Answer 80

AT or algorithmic 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.

Question 81

Factors influencing the development of AT

Answer 81

• 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.

Question 82

Define market fragmentation

Answer 82

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.

Question 83

What are the aims of AT platforms?

Answer 83

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 are used minimise market impact, achieving an execution price as close to the market price as possible.

Often AT is used to disguise/ hide deals from other market participants.

Example: Placing trades to match the expected volume pattern during a trading day or just to palace trades evenly over time.