Week 6 - Institutional Trading Flashcards
What is the basic definition of liquidity?
An asset’s ability to be easily purchased or sold without causing significant change in price
What is the Black (1971) definition of liquidity?
- There is always a small bid-ask spread available to investors looking to trade in small quantities
- Without special information, investors can trade large quantities of an asset over time without impacting price
- Investors can sell large quantities of an asset immediately at a premium or discount
What are Kyle (1985) liquidity dimensions?
- Width
- Unit cost - Depth
Available size at a given cost - Resiliency
- Time that passes before traders realise uninformed traders have caused price changes
What are institutional traders?
Defined:
Buy-side institutions that accept money from investors for the purpose of investing on their behalf
What are the two types of investment companies?
- closed-end:
- company that issues a specific number of shares that can be traded on an exchange - open-end (mutual funds)
- Accept additional funds and repurchase shares directly from investors - Exchange traded funds:
- Shares are traded on an exchange but differ from closed-end companies
What is the normal variance in true value do the different investment company types have?
Closed-end: roughly 10 to 30%
open-end: n/a
ETF: roughly 1%
What is an ETF?
How are they created?
ETF:
A fund created by a sponsor that chooses an objective and/or index to track
Created:
- portfolio of investments to meet objective
- Sponsor create trust to act as an investment vehicle
Why are ETFs popular?
- Low-cost
- Diverse
- Transparent
What are the different types of unregistered investment companies (UIC)?
- Pension funds
- Funds made for employees to management retirement savings - Private Equity
- Asset managers that invest in private companies - Hedge funds
- Private funds that allow investors to pool money for investments
- invest in higher risk assets that are prohibited for institutional investors
What are the three major needs for institutional investors?
- “Best execution”
- due to large quantities, they look for the most favourable terms - Transparency
- Normally want hidden orders - Consolidation of order flow
- Pooling of orders in a market to consolidate liquidity and improve price discovery
- Fragmentation of orders to minimise price impact + hide intention
What are the different price impacts of institutional trading?
- Permanent:
- Market changes the perception of value - Temporary:
Price movements needed to supply liquidity
Total price effect: perm + temp
What did research by kraus and Stoll (1972) find?
Found:
markets react differently to buy/sell block orders
Buy order blocks have larger upward price effect than sell order blocks
What was the explanation of kraus and Stoll (1972) findings?
Sell orders largely driven by liquidity needs
buy orders supported by research therefore holding more information of true value
What is the main goal of an institutional trading team?
reveal minimal information of intentions to reduce trading costs
What are execution costs?
- order processing costs
- Market impact costs
