Beruflich Dokumente
Kultur Dokumente
1.1
Scope of the Book
- Market Microstructure
o Branch of financial economics that investigates trading and the
organization of markets
o Field has substantially grown in size and importance since 1987 crash
1.2
Objectives
1.3
Instruments and Markets
- Instruments
o Common stocks, preferred stocks, bonds, convertible bonds, warrants,
options, futures contracts, forward contracts, foreign exchange
contracts, swaps, reinsurance contracts, commodities, pollution
credits, water rights, and even many betting contracts, etc
o Used to examine organized trading
- Markets
o The place where traders gather to trade instruments
Physical trading floor
NYSE
Chicago Mercantile Exchange
EuroNext Amsterdam Options Exchange
Electronic system where traders can easily communicate with
each other
Nasdaq
EuroNext
Hong Kong Futures Exchange
Interbank foreign exchange market
1.4
A Brief Overview of Trading and Exchanges
- Quantities
o Traders have to find enough people willing to trade with them
- Sizes
o see Quantities
- Dealers
o Trade with their clients when their clients want to trade
- Bid
o Price at which dealer will buy from clients
- Ask
o Price at which dealer will sell to clients
- Brokers
o Agents who arrange trades for their clients
o Help clients find traders willing to trade with them
o Profit by charging commissions
- Speculators
o Traders who trade to profit from information they have about future
prices
- Well-informed speculators
o Able to predict futures prices better than other traders
o Choose to buy or sell based upon which side they expect will profit
o Often beat dealers
1.5
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Bluffers
o People who fool uninformed traders into trading unwisely
o Able to profit if price impacts of their buying and selling are not exactly
opposite to each other
Zero-sum game
o Someone can win only if somebody else loses
Investors
o Use the markets to move money from the present to the future
Borrowers
o Use markets to move money from future to present
o Opposite of investor
Hedgers
o Trade to manage financial risks they face
Asset exchangers
o Trade one asset for another they value more
Gamblers
o Trade to entertain themselves
Arbitrageurs
o Ensure that prices do not vary much across markets
o When prices diverge, they buy in cheaper markets and sell in more
expense markets
o Connect sellers in cheaper markets to buyers in more expensive
markets
Fungible
o If one unit (a share, bond, contract, etc) of the instrument is
economically indistinguishable from all other units
o Easier to trade since buyers dont care which units they receive, and
will buy best price, and sellers can sell to any buyer
o Easier to trade that instruments with idiosyncratic characteristics
o In derivative markets, cause trading to concentrate in just a few
standardized contracts
Key Recurrent Themes
Information Asymmetries
o Traders who know more about values and traders who know more
about what other traders intend to do have a great advantage over
those who do not
o Well-informed traders profit at the expense of less-informed traders
Options
o The option to trade
o People who write limit orders give free trading options to other traders
Externalities
o positive externalities
created when people do something that benefits other people
without compensation
o negative externalities
created when people do something that harms other people
without penalty
order flow externality
1.6
-
1.7
1.8
-
An Important Disclaimer
Summary
Understand theory and practice of trading in exchange markets and dealer
networks
- Markets have changed substantially the last 100 years, and will continue to
for the next 100
- Current pace of change is fast, and accelerating
- Economic principles governing markets and traders, however, will not
2 Trading Stories
2.1
A Retail Trade in an NYSE-Listed Stock
- Market order
o Instructs broker to buy at the best price available
- Limit order
o Instructs broker to buy at the best price possible, but in no event pay
more than limit price
o Include when order expires
- Limit price
o Price at which buyer instructs broker to not go above when buying
- Day order
o Order that will expire when the day trading session ends
2.2
A Retail Trade in a Nasdaq Stock
2.3
An Institutional Trade in a NYSE Stock
2.4
An Institutional Trade in a Nasdaq Stock
2.5
A Very Large Block Stock Trade
2.6
Some Cash Commodity and Associated Futures Market Trades
- Exchange for physical
o
- Cash exchange
o
2.7
An Options Market Trade
2.8
A Bond Market Trade
2.9
A Foreign Exchange Trade
3 The Trading Industry
3.1
Who Are the Players?
- Traders
o People who trade
o Arrange their own trades, have other arrange trades for them, or
arrange trades for others
- Proprietary traders
o People who trade for their own accounts
- Brokers
o People who arrange trades as agents for their clients
- Agency traders
o See Brokers
- Commission traders
o See Brokers
- Commission merchants
o See Brokers
- Proprietary trading
Brazilian straddle
Often used when traders know that they are technically
bankrupt and have nothing to lose
Massively increase positions, so that if price changes, they can
escape financial problems. If prices change against them, those
who guarantee their trades suffer the losses
- Depositories and Custodians
Hold cash and securities on behalf of clients
Help settle trades by quickly delivering cash and security
certificates
Help ensure security of clients assets
o Depository Trust Company
Largest depository in the world
o Straight-through processing
Trading systems that fully automate the clearing and settlement
process
Cheap and minimizes potential for error
3.3
Trading Instruments
- Trading Instruments
o Securities, contracts, commodities, and currencies that traders trade
Include: real assets, financial assets, derivative contracts,
insurance contracts, and gambling contracts
- Financial Instruments
o Include financial assets, derivative contracts, and insurance contracts
3.3.1 Real Assets
- Real assets
o Include physical commodities, real estate, machines, patents, and
other ntellectual properties
o Include pollution credits
o Appear only on assets section of BS
- Pollution credits
o Right to emit a specified quantity of a given pollution
3.3.2 Financial Assets
- Financial assets
o Instruments that represent ownership of real assets and the cash flows
they produce
o Stocks and bonds (represent ownership of the assets of a corp)
o Include currencies warehouse receipts, and trust units
- Issuers
o Creators of all financial assets
Corporations issue stocks, bonds,and warrants
Governments issue currencies and bonds
Warehouses issue commodity receipts
Trusts issue trust units
- Primary markets
o Where issuers first create and sell issues
- Secondary markets
o Subsequent trading of issues after first sold
o
New issues
o Newly issued issues
- Seasoned securities
o Issues after being initially issued
- IPO
o Where primary trading in new equity issues happens
- Underwriters
o Help issuers sell their securities
o Broker-dealers at IBs who find buyers for securities
o Charge issuers fees for their services
- Best efforts offering
o Underwriter acts strictly as a broker
- Underwritten offering
o Underwriter guarantees the issuer an offering price
- Fixed-price open offering
o Underwriter sets a price and buyers subscribe to the offering
If oversubscribed, underwriter conducts a lottery to allocate
shares
- Spot markets
o Markets where commodities and currencies trade for immediate
delivery
- Forward markets
o Market where commodities and currencies trade for future deverly
- Futures markets
o See Forward markets
3.3.2.1
Definitions of Some Common Financial Assets
- Equities
o Stocks
Represent ownership of corporate assets, net of corporate
liabilities
Value depends on corporate asets, liabilities, and income
Depend on how well traders expect corporate managers will use
corp assets in the future
o Preferred stocks
Stocks that pay diviends at contractually specific rates
Must pay all accrued dividends on preferred stocks before
paying any dividends on common stock
o American depository receipts
Trust units that traders use to trade foreign stocks in US markets
Each trust holds only the stock of a single foreign company
Allow traders to avoid international settlement problems
o Exchange traded funds
Mutual funds that trade at exchanges
Mostly index funds trying to mimic returns of a market or
industry index
o Reast estate investment trusts
Trusts that own real estate
o
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Debt
o
o
o
o
o
o
o
o
o
o
o
o
o
o
o
o Right to do something
Option contract
o Gives holders the option to buy or sell an underlying instrument at a
fixed price
- Writer
o Trader who sold the contract
- Written upon
- Underlying instrument
- Call option
o Option to buy at a fixed strike price
- Strike price
o Price at which holder can exercise its option
- Put option
o Option to sell at a fixed strike price
- Expiration date
o Date before which an option holder can exercise the option
- American-style option
o Option holder can exercise option any time before expiration date
- European-style option
o Option holder can only exercise on the expiration date
- Derivative contracts
o Option contracts depend on underlying security values
- Futures option contract
o Option contract written on a futures contract
o Holder of call option on futures contract has the right to purchase a
futures contract at a specified price
o Trade at exchange where underlying futures contracts trade
- Swaps
o Contracts for the exchange of two future cash flows
- Cash flow
o Series of payments
- Interest rate swap
o Provides for the exchange of a future series of fixed-rate income
payments for a future series of variable floating-rate interest payments
- Currency swap
o Provides for the exchange of a future series of fixed payments in one
currency for a future series of payments in another currency
- Derivative contracts
o Values of contracts depend on values of cash flows that traders swap
- Swaptions
o Options on a swap contract
o Trader who owns a swaption call has the right to buy a swap at the
specified strike price
- Swaps yield curve
o
3.3.4 Insurance Contracts and Gambling Contracts
- Insurance contracts
o Instrument that derives its value from outcomes of future events
-
People who are concerned about the loss that they would experience if
some future event takes place
- Gambling contracts
o See Insurance contracts
o Arranged by people for entertainment
- Hedgers
o People who buy insurance contracts
3.3.5 Hybrid Contracts
- Equity warrant
- Warrants
o Options that allow the holder to purchase stock at a specified price
from the issuing corporation at some time in the future
- Convertible bonds
o Holder can exchange bond for stock under some circumstances
o Combination of straight bond plus an option to exchange the bond for
stock
3.4
Where are the Trading Markets?
3.4.1 The Magnitude of Trading
3.4.2 Stock Markets
- List
o When companies have their stocks available to be traded on
exchanges
- Listing fees
o Fees paid by corporations to be listed on an exchange when they
match exchange listing standards
- Listing standards
o Require listed companies to meet specific minimum standards for
capital value, numbers of shareholders, and financial strength
- GAAP
o Method of reporting accounts
- Control structures
o How shareholders elect the board of directors who appoint the
managers and set company policy
3.4.2.1
The US Stock Markets
- Primary listing market
o Exchange where a corporate stock issue is primarily listed
- Listed stocks
o Stocks listed at the NYSE and American stock exchange
- Over-the-counter
o Stocks listed on the NASDAQ
o Now just Nasdaq stocks
- Specialists
o Dealers who assist floor brokers arrange trades for their clients on the
floor of the exchange
- Regional exchanges
o Boston stock exchange, Chicago stock exchange, Cincinnati stock
exchange, archipelago exchange, and Philadelphia stock exchange
- Unlisted trading privileges
o
4.12 Summary
4.13 Some Points to Remember
4.14 Questions for Thought