asset allocation decision
choosing between broad asset classes. This decision is made first in a “top-down” approach
When constructing an investment portfolio, investors make two main decisions
asset allocation decision
security allocation decision
security selection decision
choosing specific securities to invest in within each broad asset class. Selection is assisted by security analysis to determine value and attractiveness of securities.
when you forgo consumption of wealth today, where do you place the wealth?
In real assets
what are financial assets
claims to income generated by real assets
features of financial assets
- Overcome consumption timing issues that can be associated with real assets;
- Allow investment risk to be shared in a manner that cannot be achieved with real assets; and,
- Allow a separation of ownership and control to occur.
- these features faciliate diversification and liquidity
Financial assets are traded in financial markets including:
The money market, which facilitates short-term lending and borrowing;
The capital market, which assists in longer-term lending and borrowing;
The derivative market, which facilitates the transference of risk between market participants; and,
The foreign exchange market, which facilitates international trade.
New securities are issued to raise funds for the issuing firm via
a primary market transaction
New securities are issued to raise funds for the issuing firm via a primary market transaction. They could be issued by:
Public offering, which may be underwritten in a firm commitment or best-efforts arrangement or may not be underwritten at all; or,
Private placement, which reduces disclosure requirements, but is subject to size limitations.
price the dealer is willing to buy a security;
price at which the dealer is willing to sell the security
difference between the bid and ask price is the dealer’s profit.
Price and Order Types
Investors might want to execute one of two types of order through these mechanisms, namely:
A market order:
A price-contingent order
A market order
A buy or sell order that is to be executed straight away at the prevailing market price;
A buy or sell order only to be executed at a specified price. Limit orders awaiting execution are known as the limit order book.
The difference between the highest buy and the lowest sell order
he difference between the highest buy and the lowest sell order, or the inside quotes, is called the inside spread
secondary markets employ one of 3 trading mechanisms
Dealer, or Over-The-Counter (“OTC”) Markets; Electronic Communication Networks (“ECNs”);
Market makers accept market order from customers
Market makers also trade among themselves
Electronic communication network
A Computer Network that manages the limit order book and matches buy/sell orders directly without the intervention of a broker
On formal exchanges such as the NYSE, trading in each security is
On formal exchanges such as the NYSE, trading in each security is managed by a specialist (now called a “designated market maker”), who acts as broker or dealer that:
designated market maker
- Maintains a fair and orderly market and is obligated to provide price continuity to the market
- Intervenes through supplying liquidity, i.e. act as a buyer/seller when no other trader can be found for the other side of the transaction.
- Trades out of his/her own portfolio; and,
- Earns income from commissions and spreads
Difference between ASX and NYSE
- Trading currently occurs electronically via ASX Trade:
- Unlike the NYSE, no specialists are involved;
- Brokers enter client trades (including those submitted online) on ASX Trade; and,
- Orders are then sent to the market, and seen by all participants, where they are executed based on price and time priority.
once a trade has occurred
Once a trade has occurred, CHESS effects settlement within 3 days by Delivery versus Payment (“DvP”), which involves:
- Transferring title of the instruments between the seller and buyer; and,
- Facilitating the movement of funds between the traders’ banks accounts.
Algorithmic trading is
Algorithmic trading is the use of computerised trading rules that are programmed to achieve certain objectives. Examples include:
Iceberging and high frequency trading
arge orders are broken down and submitted over time to minimise the price impact (often measured by VWAP)
computers made decisions based on information submitted to them electronically before humans would be able to analyse and act on it
Allows traders to match orders away from the “lit” market and disclose them within a specified timeframe;
Reduces the price and volatility impact of large trades resulting from short-term differences in the demand and supply of instruments; and,
Is permissible under the rules of markets including the ASX.
Recent technological advances mean many smaller traders now
Recent technological advances mean many smaller traders now also trade alongside larger investors in dark pools
If dark pools steal too much trade from the lit market
- displayed orders may not execute;
- This may make placing orders in the market less attractive and have liquidity and trading cost impacts for everyone; and,
- Regulators are concerned there is sufficient transparent trading to ensure price discovery along with market depth and liquidity.
Short selling is
Short selling is the selling of borrowed shares with the intention of profiting from an expected decline in the share’s price. More specifically, the investor:
- Borrows shares through a dealer;
- Sells the borrowed shares; and,
- Closes the position by purchasing and returning an equivalent number of shares at a later date.