Chapter 5

Question 1

Trading Venues?

Answer 1

Facilitate the purchase and sale of listed instruments.

Question 2

What does a Stock Exchange do?

Answer 2

Provides liquidity to potential and existing investors.

Question 3

Price Formation?

Answer 3

Where exchanges aggregate and integrate trading activity on their systems. So the price at which trades are executed is the market price at any given time.

Question 4

What is a Broker?

Answer 4

• Arrange deals for clients / facilitate transactions.
• Provide advice on what to buy for a commission.
• Act as Agent.

Question 5

What is a Dealer?

Answer 5

• Buys and sells shares, sometimes from clients.
• Act as Principal.

Question 6

What is a Broker-Dealer?

Answer 6

Acts as an agent and on principal.

Question 7

In recent years there has been a proliferation in ATSs (compared to a traditional national exchange). What is an ATS?

Answer 7

Alternative Trading System - internalise customer’s trades by executing against customer trades or their own inventory.

Question 8

What are the 3 ways of trading equities under MiFID?

Answer 8

• Stock exchanges.
• MTFs.
• SIs.

Question 9

What is an MTF?

Answer 9

Multi-lateral Trading Facility - systems operated by a market operator that bring together third party buying interests.

Question 10

What is a SI?

Answer 10

Systematic Internaliser - firms dealing on their own account.

Question 11

What is OTC?

Answer 11

Over The Counter - buying and selling securities outside of official exchanges.

Question 12

What is a Dark Pool?

Answer 12

Trading systems where the stocks are traded without the order price being displayed until after the trade is completed.

Question 13

What are Private Transactions?

Answer 13

• Offering securities to a subset of investors.
• Not general public.
• No need for disclosures usually in IPOs and no prospectus.

Question 14

What are Private Placements?

Answer 14

• Funding round of securities sold without an IPO.
• No prospectus.
• Small number of private investors.

Question 15

What is a Frontier Market?

Answer 15

Markets less developed and liquid than emerging markets.

Question 16

Quote Driven?

Answer 16

• MM set a min number of shares to buy or sell at a quoted price.
• More liquid - MM offer two way pricing.

Question 17

Order Driven?

Answer 17

• Investors indicate a num of shares to buy or sell at a specified price.
• Illiquid - orders have to be matched.
• Commonly used in equity markets.

Question 18

What is an order book?

Answer 18

A book of orders waiting to be matched.

Question 19

What is a Hybrid System?

Answer 19

A trading system that’s both quote and order driven. E.g. LSEs exchange trading service (SETSqx).

Question 20

What is Principal?

Answer 20

• Firms purchasing shares for it’s own accounts. Aim to for it to increase its value before selling.
• Dealers only act on principal.

Question 21

What is Agent?

Answer 21

• Arranges deals on behalf of others.
• Brokers.

Question 22

What’s a Broker Dealer?

Answer 22

Dual capacity to buy and sell shares for themselves or others.

Question 23

What is a Market Maker?

Answer 23

• Provides liquidity to the market by offering bid and ask prices to firms wishing to buy or sell shares.

Question 24

How does a firm become a Market Maker?

Answer 24

• Apply to the exchange - provide prices at which it’s willing to purchase shares.
• Have sufficient resources to handle increased levels of risk.
• Receive steady stream of business.

Question 25

What's an Inter-Dealer Broker?

Answer 25

* Exchange member. * Acts as an agent between dealers. * Settles on principal to keep dealers anonymous. * Can't take on its own principal positions.

Question 26

What are the reasons for Algorithmic Trading?

Answer 26

* Removes emotion. * Preservation of strategy - strategy remains consistent regardless of market volatility. * Speed, accuracy and reduced cost.

Question 27

One issue of Algorithmic Trading?

Answer 27

A data glitch and lack of oversight can lead to errors which are costly.

Question 28

What is HFT?

Answer 28

High Frequency Trading - computers processing orders based on algorithms.

Question 29

Characteristics of HFT?

Answer 29

* Responds rapidly to market movements. * Places hundreds / thousands of small quantity orders.

Question 30

Cons of HFT?

Answer 30

* Uses market manipulations - places offers just above market price and cancels them when buy order is ordered. * Exploits ordinary investors. * Systemic risk due to price movements - can spill over to different exchanges.

Question 31

What is Latency?

Answer 31

Time taken for systems to interact with the market. Lower = better.

Question 32

How do firms improve latency?

Answer 32

By moving closer to data centers.

Question 33

What is Prime Brokerage?

Answer 33

A suite of services offered to hedge fund clients.

Question 34

What are the Prime Services?

Answer 34

* Secs lending and Borrowing. * Custody. * Access to OTC markets. * Rehypothecation. * Core settlement. * Cash management. * Leveraged trade execution.

Question 35

What is Secs lending and borrowing for?

Answer 35

Hedge funds to cover their short positions.

Question 36

What is Custody services?

Answer 36

Safekeeping and asset servicing clients assets for a fee.

Question 37

What's meant by access to OTC markets?

Answer 37

PB will be a counterparty / find a third party to take the order side of trades for instruments that are not traded on an exchange (e.g. swaps).

Question 38

What is Core Settlement?

Answer 38

Making sure that purchased securities are in the clients name, and that any cash is received in a timely manner.

Question 39

What is Cash Management?

Answer 39

Maximising the returns on clients cash.

Question 40

What's meant by Leveraged Trade Execution?

Answer 40

Execute clients trades that are partly financed by borrowed funds.

Question 41

What is Rehypothecation?

Answer 41

As well as holding collateral and charging a fee, PB has the right to recharge, dispose of and use customers assets that are subject to security. This is down to Right to Rehypothecation.

Question 42

What is Right to Rehypothecation?

Answer 42

Customers assets becomes the property of the PB. Assets are used to lend or sent to third parties for cheaper financing.

Question 43

What are the priority of trades on the order book?

Answer 43

Price then time. Price being the highest buying price and lowest selling.

Question 44

How is the opening price determined at the beginning of each day?

Answer 44

Using an Uncrossing Algorithm.

Question 45

How does the Uncrossing Algorithm work?

Answer 45

1. Member firms place orders. 2. Overlapping orders on the book are executed at the same price which maximises the number of shares traded. Simultaneously, an opening price is calculated. 3. Once OP is calc, orders are automatically matched and executed.

Question 46

Why might trades not automatically be executed?

Answer 46

Price of trade > price tolerance level away from the previous trade price.

Question 47

What is the usual price tolerance level?

Answer 47

Between 5% and 25%.

Question 48

How do you get access to the order book?

Answer 48

On Bloomberg.

Question 49

Who gets to interact with the order book?

Answer 49

Members of the exchange, usually only Broker-dealers.

Question 50

What must non-members do to see beyond the nearest bid/ask prices?

Answer 50

Pay an additional subscription.

Question 51

What is a Trading Halt?

Answer 51

Suspension of securities on a listed exchange.

Question 52

How are trades settled that have occurred but not settled at the time of suspension?

Answer 52

Settled as normal.