week 1 Flashcards
Why do markets exist?
o Basic function of the market is to bring together buyers and sellers
Capital allocation
• Necessary for economic growth
• Companies need capital to fund projects
Price Discovery and Liquidity
• Price discovery is the process of determining the price for an asset through the interaction of buyers and sellers
o Investing is linked to the rationale to buy or to sell
o Trade decision concerns how to execute the investment decision, in which markets, at what prices and times through which agents
o Difference between Primary markets & Secondary markets
Primary markets always ‘help’ the company get the money, secondary market is a trading market
Who are the participants?
o Buy side / sell side is not talking about those who sell/buy shares
o Difference between brokers & dealers
Brokers are companies who execute orders / implement investment decisions
Dealers are middlemen -> make themselves available to trade against you
• Brokers do not make themselves available to trade
• Dealers need to manage inventories
Why do they trade?
o Two types: utilitarian traders
Trade for reasons other than for profit
E.g. investors, borrowers, asset exchangers, hedgers, tax-avoiders
o Profit-motivated traders
Provide financial services
Do so for profit
E.g. speculators, arbitrageurs, dealers, Algorithmic traders
o Not exclusive mapping, its rough -> people have different motives to trade
Reduce risk -> hedgers
Limit Orders
o Instructs broker to trade at the best price available, but do not violate limit price condition.
Do not buy at a price above the limit price
Do not sell at a price less than the limit price
o Properties
Execution uncertainty
If price runs away, ultimate execution price may be poor
Subject to exposure regret -> regret doing so due to maybe apple price dropping
• Adverse selection risk
• Dealers scared
Orders
o Instructions to trade, given to brokers and/or exchanges o They always specify Item to be traded Quantity Side – buy or sell
o They may specify
Price, method, timing, expiration, market, counterparts
Market orders
o Buy or sell orders that are to be executed immediately at the market price
o Don’t need a price to be instructed
o Suitable for those who are keen on trading -> very certain to trade
o Takes away some liquidity
Consumption of liquidity
o Execution is near certain, but the execution price maybe uncertain
Stop Orders
o Special type of market order
o Price contingent orders
Puts a condition on this order
Only active when their price contingency is met
Almost always market orders
Typically are used to close losing positions
Bargaining
o Negotiation process over contract terms that occurs between a buyer and a seller
o Useful when dealing in large sizes
o Expensive to transacting large blocks in ‘downstairs’ market
Auctions
o A competitive market process involving multiple buyers, multiple sellers / both
Useful and cost-effective method for pricing a security with an unknown value
o Walrasian Auction
Simultaneous auction
Each buyer submits to the auctioneer his demand and each seller submits his supply for a given security at every possible price
• e.g. opening and closing auctions on the ASX
o English Auction
Public sequences of bids, provides for some degree of price discovery before it concludes
Ends and a winner is declared when no participant is willing to bid higher
o First-price Sealed bid auction
All bidders submit simultaneously sealed bids.
The winner is the one that submits the highest bid and pays the bid price
No price discovery
Winners course -> auctioned item’s value is not known with certainty
o Continous double auctions
Buyers submit bids and sellers submit offers
Bids and offers are ranked by their price levels
Transactions occurs when the highest bid and lowest offer match
