Securities Trade Lifecycle Flashcards
What are the primary steps in the trade lifecycle?
- Front Office
1.2. Trade execution
1.3 Trade capture
2.Operations
2.1Trade Capture
2.2 Trade Enrichment
2.3 Trade Confirmation
2.4 Settlement Instructions
2.5 Pre-Settlement Statuses
2.6 Failed Settlement
2.7 Settlement
2.8 Reflecting Settlement
2.9 Reconciliation
What does the trade lifecycle include?
- Both internal & external management of trades
- Both outgoing & incoming information
What is Trade Execution?
The agreement to undertake a specific securities trade on specific terms
What parties are involved in a trade execution
- investor to broker
- broker to exchange
- broker to proprietary trader
- proprietary trader to proprietary trader
How are trades executed?
- order-driven markets
- quote-driven markets
Order-driven markets
Definition: An order-driven market is a type of financial market where trades are executed based on the orders placed by buyers and sellers. Participants display the prices and amounts they wish to trade, and trades occur when matching orders are found. This market is known for its transparency, as the entire order book is visible to investors.
Example: The New York Stock Exchange (NYSE) operates as an order-driven market. If an investor wants to buy 100 shares of a company at $50 per share, they place a limit order. This order will be executed only if another participant is willing to sell 100 shares at $50 or lower.
Quote-driven markets
Definition: A quote-driven market, also known as a dealer market, is a type of financial market where transactions occur based on prices quoted by market makers or dealers. In this market structure, dealers provide liquidity by quoting buy (bid) and sell (ask) prices for a security. Trades are executed through these dealers, who either fill orders from their own inventory or match them with other orders1.
Example: The foreign exchange (Forex) market operates as a quote-driven market. If an investor wants to buy euros with US dollars, they will see quotes from various dealers. The investor can choose to trade at the quoted price or negotiate for a better rate through their broker.
Hybrid Markets
Definition: Hybrid markets offer the flexibility of using both automated trading systems and traditional floor brokers to execute transactions. This dual approach provides the speed and efficiency of electronic trading while retaining the human judgment and discretion of floor brokers for large or complex trades.
Example: The New York Stock Exchange (NYSE) operates as a hybrid market. Traders can choose to execute their trades electronically for speed and efficiency or use floor brokers for more complex transactions that may benefit from human judgment.
What information do market makers/trader need in order to trade
Immediate knowledge of whether new trades result in profit or loss
- current trading position (accumulated effect if all purchases and sales
average price of the current trading position
Market Makers vs. Traders
Definition:
- Market Makers: Market makers are financial institutions or individuals that provide liquidity to the market by continuously quoting buy (bid) and sell (ask) prices for securities. They facilitate trading by being ready to buy and sell at these quoted prices, ensuring that there is always a market for the securities12.
- Traders: Traders are individuals or institutions that buy and sell securities to make a profit from price movements. They can be either speculators, who aim to profit from short-term price changes, or investors, who seek long-term gains1.
Example:
- Market Maker: A large bank acting as a market maker in the Forex market quotes both buy and sell prices for euros against US dollars, ensuring that traders can always find a counterparty for their trades1.
- Trader: An individual trader buys shares of a company at a low price and sells them at a higher price to make a profit from the price difference1.
Current Trading Position
Definition: The current trading position is the net amount of a particular security that a trader or market maker holds at any given time. It represents the balance of all purchases and sales of that security.
Example: If a trader has bought 1,000 shares of a stock and sold 600 shares, their current trading position is 400 shares long.
Information Needed:
- Current Holdings: Total amount of the security currently owned.
- Trade History: Record of all past transactions, including purchase and sale prices.
- Market Conditions: Real-time data on market prices, trends, and volumes.
- Order Book: For market makers, access to current buy and sell orders.
- Risk Management Metrics: Information on potential risks to manage positions effectively.
Average Price of the Current Trading Position
Definition: The average price of the current trading position is the mean price at which a particular security has been bought over a specified period. It is calculated by taking the sum of the purchase prices of all the units of the security and dividing it by the total number of units purchased.
Example: If a trader buys 100 shares of a stock at $50 each and another 100 shares at $60 each, the average price of the current trading position would be ((50 \times 100 + 60 \times 100) / 200 = $55).
Importance of Knowing Average Price of Current Trading Position
Definition: The average price of the current trading position is the mean price at which a particular security has been bought over a specified period.
Importance:
- Profit and Loss Calculation: Determines gains or losses by comparing the current market price to the average purchase price.
- Informed Decision-Making: Assists in deciding whether to hold, sell, or buy more of a security.
- Risk Management: Provides a clear cost basis for setting stop-loss orders and other strategies.
- Tax Implications: Necessary for calculating capital gains taxes.
- Performance Evaluation: Helps assess the performance of a trading strategy.
Example: If a trader buys 100 shares at $50 each and another 100 shares at $60 each, the average price is ((50 \times 100 + 60 \times 100) / 200 = $55).
Trade Execution Initiation by Institutional Investors
Definition: Institutional investors initiate trade executions through a structured process involving multiple steps. This process typically includes identifying investment opportunities, conducting thorough research and analysis, and then placing orders through a trading desk or electronic trading platform. The goal is to achieve the best possible execution price while managing risk and adhering to regulatory requirements.
Example: An institutional investor, such as a mutual fund, identifies a promising stock to add to its portfolio. The fund’s research team conducts an in-depth analysis of the stock’s fundamentals and market conditions. Once the decision to buy is made, the order is sent to the trading desk, where traders execute the order at the best available price, considering factors like market liquidity and timing.
Trade Execution Initiation by Brokers
Definition: Brokers initiate trade executions by receiving buy or sell orders from clients and then deciding which market to send these orders to for execution. The broker’s goal is to achieve the best possible execution price while considering factors like market liquidity, order size, and timing.
Process:
- Order Details: The salesperson records the details of the order, including:
- Client account at ‘block’ (parent) level or ‘allocation’ (child) level
- Buy or sell
- Quantity
- Specific security
- Desired price (e.g., limit, market)
- Order Placement: The order is then placed with the broker, who decides which market to send it to for execution.
- Execution: The broker ensures that the order is filled at the best available price, taking into account the current market conditions and available liquidity.
- Aims to Execute Trades at Best Possible Price: The broker aims to achieve the best possible execution price for the client.
- Salesman Forwards Order Details to Trader: The salesperson forwards the order details to the trader for execution.
Example: When a client places an order to buy 500 shares of a stock, the broker records the order details, including the client account, quantity, and desired price. The broker then sends the order to the New York Stock Exchange (NYSE) for execution, ensuring it is filled at the best available price.
How is an order communicated to the broker?
- telephone
- electronically
What is Trade Capture
process of formally recording details of an individual trade execution
What Minimum information must be captured
10 items
- trade date
- trade time
- contractual settlement date
- buy or sell
- quantity
- security
- market
- price
- internal owner
- counterparty
Trade date
the datw the trade was executed
Trade time
regulatory requirement to record HH/MM
Contractual settlement date
Definition: The contractual settlement date is the agreed-upon date by which all required securities, cash components, and any other cash amounts must be delivered to complete a transaction. This date is typically defined by the terms of the trade agreement between the buyer and the seller and is often determined by the customary settlement cycle in the relevant jurisdiction. For example, in the United States, the Securities and Exchange Commission (SEC) has established rules that govern the settlement process, with the settlement date for stocks usually being T+2 (two business days after the trade date).
Example: If an investor buys shares of a company on November 1st, and the customary settlement cycle is T+2, the contractual settlement date would be November 3rd. On this date, the buyer must pay for the shares, and the seller must deliver the shares to the buyer.
Bond Type Price
Definition: The bond type price is the price of a bond expressed as a percentage of its nominal amount or face value. This means that the price is quoted as a percentage of the bond’s par value, which is typically $100 or $1,000. The bond price can fluctuate based on market conditions, interest rates, and the credit quality of the issuer12.
Example: If a bond has a face value of $1,000 and is quoted at 95%, the bond price is $950. This means the bond is trading at a discount to its face value12.
Internal Party
- Definition: The internal party refers to the entity within the organization that is involved in the trade. This could be a department, a trading desk, or an individual trader who initiates or executes the trade.
- Example: In a financial institution, the internal party could be the equities trading desk that places an order to buy 1,000 shares of a stock.
Counterparty
- Definition: The counterparty is the other party that participates in the financial transaction. This can include individuals, businesses, governments, or any other organization. The counterparty is simply the other side of the trade—a buyer is the counterparty to a seller12.
- Example: If the equities trading desk of a financial institution buys 1,000 shares of a stock, the counterparty could be another financial institution or an individual investor selling those shares12.
Trade Enrichment
Definition:
Trade enrichment refers to the process of adding relevant information to the basic details of a trade to ensure it can be settled correctly. This involves selecting, calculating, and attaching specific trade data necessary for downstream processing. Trade enrichment can be achieved either manually or automatically, with the latter often referred to as static data defaulting.
Example:
Imagine a trade where a company buys 100 shares of a stock. The basic details include the stock name, quantity, and price. Trade enrichment would add information such as the settlement date, broker details, and any applicable fees to ensure the trade is processed smoothly.
How is Trade Enrichment achieved?
- Manual Enrichment: This involves human intervention where trade details are manually reviewed and additional information is added. This can include verifying and entering settlement dates, broker details, and any applicable fees.
- Automated Enrichment: This process uses software and algorithms to automatically add necessary information to trade details. This is often referred to as static data defaulting. The system pulls data from various sources and attaches it to the trade record to ensure all required information is present for downstream processing.
For example, in a trading system, when a trade is executed, the basic details such as the stock name, quantity, and price are recorded. The enrichment process would then add additional details like the settlement date, broker information, and any fees associated with the trade. This ensures that the trade can be processed and settled correctly without any delays or errors.
Would you like more detailed information on any specific aspect of trade enrichment?
Accrued Interest with Bonds
Definition:
Accrued interest is the interest that has accumulated on a bond since the last interest payment up to, but not including, the settlement date. This interest is owed to the bond seller by the bond buyer.
Example:
Imagine you buy a bond that pays interest semiannually on January 1 and July 1. If you purchase the bond on April 1, you owe the seller the interest that has accrued from January 1 to April 1. This ensures the seller is compensated for the interest earned during their holding period.
Information Enriched in the Settlement System
List the 14 items of information
Typical Information Enriched:
- Settlement Date: The date on which the trade is to be settled.
- Broker Details: Information about the broker involved in the trade.
- Counterparty Information: Details about the other party involved in the trade.
- Security Identifier: Unique identifier for the security being traded (e.g., ISIN, CUSIP).
- Trade Amount: The total value of the trade.
- Fees and Charges: Any applicable fees or charges associated with the trade.
- Settlement Instructions: Specific instructions for how the trade should be settled.
- Currency Details: Information about the currency in which the trade is denominated.
- Account Information: Details of the accounts involved in the trade.
- Trade Status: Current status of the trade (e.g., pending, completed).
- Commission: The fee charged by a broker for executing the trade.
- Net Settlement Value: The total value of the trade after deducting any fees and charges.
- Firm’s Custodian SSIs: Standard Settlement Instructions (SSIs) for the firm’s custodian, detailing how and where the securities should be delivered.
- Counterparty Custodian SSIs: Standard Settlement Instructions (SSIs) for the counterparty’s custodian, detailing how and where the securities should be delivered.
Delivery Versus Payment (DVP)
settlement basis
Definition: Delivery Versus Payment (DVP) is a settlement mechanism where the delivery of securities occurs simultaneously with the payment. This ensures that the transfer of securities and the corresponding payment happen at the same time, reducing the risk of one party defaulting on their obligation.
Example: Imagine a company buys 1,000 shares of stock. Under DVP, the shares are delivered to the buyer’s account only when the payment is made to the seller’s account. This simultaneous exchange minimizes the risk of non-payment or non-delivery.
Free of Payment (FOP)
settlement basis
Definition: Free of Payment (FOP) is a settlement mechanism where the delivery of securities occurs without the simultaneous transfer of funds. This means that the securities are delivered without an immediate payment, which can be used for margin maintenance or other purposes.
Example: Consider a scenario where a company needs to transfer 500 bonds to a custodian for margin maintenance. Under FOP, the bonds are delivered to the custodian’s account without an immediate payment. The payment can be settled at a later date or through other arrangements.
What happens if information is missing during the trade settlement process?
- Settlement Delays: Missing information can cause delays in the settlement process as additional time is needed to gather the required details. This can result in trades not being settled on time, which can affect the overall efficiency of the trading system
- Settlement Failures: Incomplete information can lead to settlement failures, where the trade cannot be completed. This can occur if critical details such as settlement instructions, account information, or security identifiers are missing
- Increased Operational Risk: Missing information increases the risk of errors and discrepancies in the settlement process. This can lead to financial losses, reputational damage, and increased operational costs as additional resources are needed to resolve the issues
- Regulatory Non-Compliance: Incomplete trade information can result in non-compliance with regulatory requirements. This can lead to fines, penalties, and other regulatory actions against the involved parties
- Manual Intervention: When information is missing, manual intervention is often required to resolve the issues. This can be time-consuming and prone to human error, further complicating the settlement process
