Week 1 - The Trading Process Flashcards
What is the basic function of markets?
Bring together buyers and sellers
What is the importance of capital allocation?
- Allows access to capital for economic growth
- Allows for secondary markets
What are secondary markets?
Trading between buyers and sellers after an initial offering
What is price discovery?
The adjusting of an asset’s price to true value
Are investment decisions and trading decisions the same thing?
no
What is an investment decision?
The rational to buy or sell an asset
What is a trade decision and the steps?
Trade decision:
How to execute a trade
Steps:
1. Gather information about the trade decision
2. Routing of order through market
3. Execution of the trade
4. Confirmation, clearance and settlement
What are the steps of a trade?
- buyer/sell instructs advisor to buy/sell
- operator submits buy/sell order
- Trading mechanism matches order and executes the trade
- Settlement of funds and shares through clearing house
What is a trading mechanism?
Stock exchange
What is a clearing house?
Third-party entity that handles the transaction of assets between parties
What is the “buy side”?
People or firms that use financial services
What is “sell side”?
Those who provide the financial services
What is a utilitarian trader?
What are some examples?
Defined:
People that trade for reasons other than profit
Examples:
Investors
Borrowers
Asset exchange
What are profit-motivated traders?
What are some examples?
Defined:
People that trade purely for profit
Examples:
Speculators
Arbitragers
What are real assets
assets that directly generate cashflows
What are financial assets
assets that represent ownership of real assets
What is a derivative contract?
Contract that derives value from other instruments
What details are always specified in an order?
- item to be traded
- Quantity
- buy or sell
What additional details may be specified in an order?
Price
Expiration
Method
timing
market
counter party
What is a limit order?
Instructions for a broker to trade at best available price without violating limit price conditions
buy does not go above
sell does not go below
If it does not execute => goes in limit order book and provides liquidity
What is a market order?
Orders that are executed immediately at market price
consumes liquidity
What is a stop order?
Buy/sell order with contingent orders
- activate when contingency is met
- Almost always at market price
- typically used to close losing conditions
What is a Walrasian auction?
A theoretical auction where buyers submit demand and suppliers submit supply at every possible price
What is an English auction?
Does it allow price discovery?
Public oral action that leads to price discovery once high willingness to pay is found
What is a first-price Sealed-bid auction?
Does it allow price discovery?
All bidders submit prices that are unknown to other bidders
Does not allow price discovery. Introduces “winners curse” as they do not know if they over paid
What is a Dutch Auction?
Who famously used this auction?
auction where bidders submit demand specifying price and quantity
Seller uses data to derive a “clearing price” that sells the most volume at highest possible price
google IPO
What is a continuous double auction?
Auction where buyers submit bids and sellers submit offers.
bids/offers are ranked by price and transactions occur when highest bid and lowest offer match
What is a periodic auction ?
why are they used?
auction where bids and offers are matched in batches
used to overcome high frequency traders
