Week 1 - The Trading Process

Question 1

What is the basic function of markets?

Answer 1

Bring together buyers and sellers

Question 2

What is the importance of capital allocation?

Answer 2

• Allows access to capital for economic growth
• Allows for secondary markets

Question 3

What are secondary markets?

Answer 3

Trading between buyers and sellers after an initial offering

Question 4

What is price discovery?

Answer 4

The adjusting of an asset’s price to true value

Question 5

Are investment decisions and trading decisions the same thing?

Answer 5

no

Question 6

What is an investment decision?

Answer 6

The rational to buy or sell an asset

Question 7

What is a trade decision and the steps?

Answer 7

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

Question 8

What are the steps of a trade?

Answer 8

1. buyer/sell instructs advisor to buy/sell
2. operator submits buy/sell order
3. Trading mechanism matches order and executes the trade
4. Settlement of funds and shares through clearing house

Question 9

What is a trading mechanism?

Answer 9

Stock exchange

Question 10

What is a clearing house?

Answer 10

Third-party entity that handles the transaction of assets between parties

Question 11

What is the “buy side”?

Answer 11

People or firms that use financial services

Question 12

What is “sell side”?

Answer 12

Those who provide the financial services

Question 13

What is a utilitarian trader?

What are some examples?

Answer 13

Defined:
People that trade for reasons other than profit

Examples:
Investors
Borrowers
Asset exchange

Question 14

What are profit-motivated traders?

What are some examples?

Answer 14

Defined:
People that trade purely for profit

Examples:
Speculators
Arbitragers

Question 15

What are real assets

Answer 15

assets that directly generate cashflows

Question 16

What are financial assets

Answer 16

assets that represent ownership of real assets

Question 17

What is a derivative contract?

Answer 17

Contract that derives value from other instruments

Question 18

What details are always specified in an order?

Answer 18

1. item to be traded
2. Quantity
3. buy or sell

Question 19

What additional details may be specified in an order?

Answer 19

Price
Expiration
Method
timing
market
counter party

Question 20

What is a limit order?

Answer 20

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

Question 21

What is a market order?

Answer 21

Orders that are executed immediately at market price

consumes liquidity

Question 22

What is a stop order?

Answer 22

Buy/sell order with contingent orders
- activate when contingency is met
- Almost always at market price
- typically used to close losing conditions

Question 23

What is a Walrasian auction?

Answer 23

A theoretical auction where buyers submit demand and suppliers submit supply at every possible price

Question 24

What is an English auction?
Does it allow price discovery?

Answer 24

Public oral action that leads to price discovery once high willingness to pay is found

Question 25

What is a first-price Sealed-bid auction?

Does it allow price discovery?

Answer 25

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

Question 26

What is a Dutch Auction?

Who famously used this auction?

Answer 26

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

Question 27

What is a continuous double auction?

Answer 27

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

Question 28

What is a periodic auction ?

why are they used?

Answer 28

auction where bids and offers are matched in batches

used to overcome high frequency traders