Finance 3630: Equity Securities and Markets - Chapter 3 Part 2

What is a trailing stop order?

- A sell trailing stop order sets the stop price at a fixed amount below the market price with an attached "trailing" amount. - As the market price rises, the stop price rises by the trail amount, but if the stock price falls, the stop loss price doesn't change, and a market order is submitted when the stop price is hit.

What are the differences between a stop-loss order, a limit sell order, and a market order?

- A stop order is a trade is not to be executed unless stock hits a price limit - The stop-loss is used to limit losses when prices are falling - An order specifying a price at which an investor is willing to buy or sell a security is a limit order - A market order directs the broker to buy or sell at whatever price is available in the market.

What is high frequency trading?

- A subset of algorithmic trading that relies on computer programs to make very rapid trading decisions - High frequency traders compete for trades that offer very small profits - If those opportunities are numerous enough, they can accumulate to big money

What does a brokerage firm do?

- Acts as a broker to bring together buyers and sellers of financial assets in the secondary market - Can also act as a dealer by trading from their own account

What is the difference between an IPO and an SEO (seasoned equity offering)?

- An IPO is the first time a formerly privately-owned company sells stock to the general public - A seasoned issue is the issuance of stock by a company that has already undergone an IPO

Where would a non-liquid security in a developing country MOST LIKELY trade? Why?

- An illiquid security in a developing country is most likely to trade on broker markets - Because the security is illiquid (meaning it is not heavily traded), the expertise of a broker is useful in pricing the security and in matching buyers and sellers

What is an over the counter dealer market?

- An informal network of brokers and dealers who negotiate sales of securities - Brokers register with the SEC to be security dealers

What is a limit buy/sell order?

- An order made to a broker specifying a price at which an investor is willing to buy or sell a security - Limit Buy/Sell Orders tend to have higher transaction costs relative to market orders - This is changing due to increased competition

What is an electronic communication network?

- Computer networks that allow direct trading without the need for market makers - These allow participants to post market and limit orders over computer networks - ECN's are true trading systems, not merely price quotation systems

What are dark pools?

- Electronic trading networks where participants can anonymously buy or sell large blocks of securities - Trades may not even be reported, and those that are reported are usually lumped together in an attempt to provide anonymity

What is a specialist market?

- In these systems, exchanges such as the NYSE assign responsibility for managing the trading in each security to a specialist - These have been largely replaced by electronic communication networks, but as recently as a decade ago, they were still a dominant form of market organization for trading in stocks

What is meant by the phrase "broker-investor relations?"

- Investment advice does not guarantee solid returns/performance - Principal-Agent Conflict ---> Because brokers work for commissions, this can create a conflict of interests

Why have average sized trades declined in recent years?

- Many large investors seek anonymity for fear that their intentions will become known to other investors - Large block trades attract the attention of other traders - By splitting large transactions into smaller trades, investors are better able to retain a degree of anonymity

What does a full service broker do that a discount broker does not?

- Provide investment advice, wealth management and financial planning, and are a dedicated advisor - Some customers allow a full service broker to make buy and sell decisions for them by establishing a discretionary account ---> In this account, the broker can buy and sell prespecified securities whenever deemed fit

What are some different components of the effective costs of buying or selling shares of stock?

- The effective price paid or received for a stock includes items such as bid-ask spread, brokerage fees, commissions, and taxes (when applicable) - These reduce the amount received by a seller and increase the cost incurred by a buyer

What is the difference between the primary market and the secondary market?

- The primary market is the market where newly-issued securities are sold, while the secondary market is the market for trading existing securities - After firms sell their newly-issued stocks to investors in the primary market, new investors purchase stocks from existing investors in the secondary market

How do security dealers earn their profits?

- The primary source of income for a securities dealer is the bid-ask spread - This is the difference between the price at which the dealer is willing to purchase a security and the price at which they are willing to sell the same security

What is algorithmic trading?

- The use of computer programs to make rapid trading decisions - Traders seek to profit from the bid/ask spread by buying a stock at the bid price and rapidly selling it at the ask price before the price can change

What are the responsibilities of a discount broker?

- They deal with account maintenance and order execution 1: Buy/sell securities 2: Hold securities for safekeeping 3: Offer margin loans 4: Facilitate short sales - The only information they provide about the securities they handle are price quotations

What is a stop-buy order?

- This specifies that a stock should be bought when its price rises above a certain limit - Associated with short sales

What is co-location?

- Trade execution times for high-frequency traders are now measured in milliseconds, even microseconds - This has caused firms to co-locate their trading centers next to the computer systems of the electronic exchanges - If execution or latency times are more than a millisecond, it makes a trade nearly impossible to win

----> A market order has: - a: price uncertainty but not execution uncertainty - b: both price uncertainty and execution uncertainty - c: Execution uncertainty but not price uncertainty

- a: price uncertainty but not execution uncertainty

What is the role of a prospectus?

A prospectus is a description of the firm and the security it is issuing.

What are market orders?

Buy or sell orders that are to be executed immediately at current market prices

What impact on financial markets has high frequency trading had?

High frequency traders have displaced the market liquidity that was provided by brokers who made a market in the security

What is the bid-ask spread?

The difference between the bid and asked prices

What global development has given rise to high frequency trading and algorithmic trading?

The emergence of technology

What is the bid price?

The price at which a dealer or other trader is willing to purchase a security

What is the ask price?

The price at which a dealer or other trader will sell a security

What is a stop-loss order?

The stock is to be sold if its price falls below a stipulated level

What did the NYSE Hybrid Market allow brokers to do and when was it implemented?

This allowed brokers to send orders either for immediate electronic execution or to the specialist, who could seek price improvement from another trader

What are the two strategies associated with high frequency trading?

1: Entail "market making" and attempt to profit from the bid-ask spread 2: The other strategy relies on tiny price discrepancies across markets, which allow the firm to buy a security at one price and simultaneously sell it at a slightly higher price

What are the two types of secondary markets?

1: Exchanges (national and regional) 2: Over the counter (NASDAQ)

What are the two kinds of brokers?

1: Full Service Broker 2: Discount Broker

What are the three trading systems employed in the United States?

1: Over-the-counter dealer markets 2: Electronic communication networks (ECN's) 3: Specialist market

What is a stop order?

Trade is not to be executed unless stock hits a price limit

What is the role of an underwriter?

Underwriters purchase securities from the issuing company and resell them.