Trading

Question 1

Market Order

Answer 1

execute trade immediately at best possible price; time > price

price uncertainty

Question 2

Limit Order

Answer 2

trade at limit price or better; price > time

• buy: price < limit price
• sell: price > limit price

execution uncertainty

Question 3

Effective Spread

Answer 3

2 * | execution price - midquote |

eff spread > quoted spread = bad trade

lower spread = higher liquidity

Question 4

Market Quality Characteristics

Answer 4

1. liquidity (larger bid-ask spreads)
2. transparency
3. assurity of completion

Question 5

Dealer Market

Answer 5

quote-driven market

dealer has an inventory of securities and trades at bid/ ask prices; liquidity, credit risk

Question 6

Trader Market

Answer 6

quote-driven market

prices set by supply and demand; lower liquidity

electronic crossing network, auction market, automated auctions

Question 7

Brokered Market

Answer 7

broker acts as trader’s agent to find counterparties for trades

anonimity

Question 8

VWAP

Answer 8

volume weighted average price

+ easy, simple, fast, small trades

• can be “gamed”, doesn’t consider delayed/ unfilled orders or trade volume

Question 9

IS

Answer 9

implementation shortfall; emphasis on speed, limits costs

+ identify costs/ trade offs, cannot be “gamed” (considers delays; cannot delay trade to make profit)

• more complicated, need data

Question 10

Explicit Trade Costs

Answer 10

fees, commisions

Question 11

Implicit Trade Costs

Answer 11

delay/ slippage = | BP* - DP | * # shares executed later

market/ price impact = | EP - DP or BP* | * # shares executed at EP

opportunity cost = | CP - DP | * # shares canceled

Question 12

Trader Types

Answer 12

1. info motivated: time; market order
2. value motivated: price; limit order
3. liquidity motivated: time; market order
4. passive: price; market order

Question 13

Trading Tactic

Answer 13

1. liquidity at any cost: info motivated
2. costs not important: many
3. need trustworthy agent: not info motivated
4. advertise to draw liquidity: not info motivated
5. low cost whatever liquidity: passive, value motivated

Question 14

Algorithmic Trading

Answer 14

1. logical participation
   
   1. break up orders to exc at better price: VWAP, TWRR, % volume
   2. implementation shortfall
2. opportunistic
3. specialized = hunter, market on close, smart routing

Question 15

Best Execution Characteristics

Answer 15

1. related to inv decision
2. only assessed after the trade
3. ongoing process (including disclosure and record retention)