Unit 2 - 5. Secondary Markets

Question 1

Trading Venues

Unit 2 - 5. Secondary Markets

Answer 1

Exchanges used to just trade stocks, some now trade options, corporate bonds, etfs, so called ‘securities exchange’.

Acting as a broker is often described as dealing as agent. Broker facilitates the transaction between the two parties, but don’t buy/sell themselves.

Dealers, in contrast, actually buy/sell securities. Described as dealing as principal, often what investment banks do on exchanges.

Investment banks act as both, called broker-dealers

ATSs = alternative trading systems

MiFID distinguishes 4 trading venues

• regulated markets
• multilateral trading facility
• Systematic internalizes
• organsied trading facility

OTC = over the counter

Dark pool = traded without the order price being displayed until after the trade is complete.

Emerging/frontier markets are mostly equity exchanges, less sophisticated and generally smaller and less liquid.

Question 2

Methods of Trading and Participants

Unit 2 - 5. Secondary Markets

Answer 2

Quote driven system = market makers agree to buy/sell at least a set minimum number of shares at quoted prices.

Order driven system = investors indicate how many securities they want to buy/sell, and at what price. The system then brings together the buyers/sellers. Orders that await matching are included in the order book.

Algorithmic trading = trading by computers

• remove emotion of trading
• preservation of discipline
• speed, accuracy and reduced costs

Primer Broker Services

• Securities lending and borrowing
• leveraged trade execution
• cash management
• core settlement
• custody
• rehypothecation
• access to OTC markets

Question 3

Stock Exchanges

Unit 2 - 5. Secondary Markets

Answer 3

Order book - Orders are given priority first by price, and then by time.

Opening auction, first established by firms entering orders in the period leading up to the auction. Uses uncrossing algo for orders that overlap are executed at the single price that maximises the number of shares traded.

Order Types

• limit orders
• iceberg orders
• market orders
• execute and eliminate orders
• fill or kill orders
• al or none order

The Central Counterparty (CCP)
The intermediary for certain transactions, counterparty for both buyer and seller.
- reduced counterparty risk
- providing total anonymity
- reduced administration
- facilitating netting of transactions
- improved prices

Cost of trading

• broker’s commission
• account fees
• exchange fees, regulatory fees, clearing fees, taxes/duties

Question 4

Indices

Unit 2 - 5. Secondary Markets

Answer 4

Index is a way to measure performance of a section/group of the stock market.

Examples

• FTSE100
• DJIA
• Nikkei Stock 225
• Hang Seng
• STOXX
• CAC40
• S&P500

Can have national and sector indices.

Usually are market cap weighted.
DJIA is price weighted.

Price return = disregards income from dividends
Total return = both price return and dividend reinvestment

Free float = estimate of the proportion of shares that are not held by large owners (5% or more) and that are not stock with sales restrictions or insider holdings.

Free float factor = free-float as a % of issued shares.
Often factored into index weighting.

Question 5

Government Bonds

Unit 2 - 5. Secondary Markets

Answer 5

Participants

• Governments issuing agency
• Primary dealers
• Broker dealers
• Inter-dealer brokers

Question 6

Corporate Bond Markets

Unit 2 - 5. Secondary Markets

Answer 6

Dealing in corporate bonds tends to be away from major exchanges, typically in decentralised dealer market.

Market makers provide liquidity and act as a facilitator or agent in trades between principles.

A decentralised dealer market structure is one that enables investors to buy/sell without a centralised location. There is still a technical infrastructure for bid/ask prices and systems to deal directly with other traders/dealers.

Companies can default on their bonds.

Retail bond market less popular, there is an active retail market provided by stock exchanges. LSE has Order Book for Retail Bonds.

Question 7

Dealing Methods

Unit 2 - 5. Secondary Markets

Answer 7

Trading Methods for bonds
Dealer - to - dealer
- direct telephone contact
- indirect via an IDB voice-broking deal
- via an electronic market (electronic trading platform)

Trends in trading methods

• electronic trading is much more popular (inter-dealer platofrms like MTS cash, BrokerTec)
• RFQ = request for quote used for dealer-to-customer system

Factors that influence bond pricing

• Issuer factors (credit rating, etc)
• Market factors (liquidity, method of trading, ability to borrow (repo))

Question 8

Bond dealing, increased use of electronic multi-dealer trading platforms, name B2B and B2C

Answer 8

B2B

• Brokertec
• eSpeed
• MTS Cash

B2C

• MTS BondVision
• TradeWeb