Question

Alex Dale is a portfolio manager at ADIA Investment Company in Europe. Alex would like to buy 50,000 shares of alpha stock which is a new IPO that was previously offered at £30, but unfortunately he couldn’t get any shares of it. Now, he is still interested in these shares, but not at a price that is greater than £45. Jill Jones works for The Global Brokerage House, which provides execution services for ADIA. In his conversation with Alex, Jill has suggested that a market order is most suitable for the trade. Alex is also interested in using a market order to sell a large block of Gamma shares. However, he is worried that if he instructed a selling using a market order the price would decline and he loses on the value of the deal. Jill argued that this should not be a problem as automated order driven trading systems provide special arrangements for small trades (which are often market orders) as well as for block trades. Alex is also interested in reducing the cost of selling of his Christian Dior shares, Jill suggested that he should use European electronic crossing network to sell some of his shares. She told Alex that these networks are cheap, preserve anonymity and allows for 6 crossing opportunities of trades per day. They also allow participants to place some restrictions such as price and minimum fill. All orders submitted to the network is good for day which is means that any unfulfilled part of an order is automatically resubmitted to subsequent crossing sessions during the day. Following Jill’s advice, Alex has submitted his 150,000 CD shares to be sold in the European crossing network with a minimum fill of 125,000. The following orders are on the network for the shares of CD at the time of the first crossing session of the day. The most recent trading price of CD at the Paris Bourse is € 37.  A order: a market order to buy 100,000 shares  B order: a market order to sell 50,000 shares  C: an order to buy 20,000 shares at € 36 In the next crossing session new orders are submitted. The most recent trading price of CD at the Paris Bourse is € 38.  D order: a market order to buy 150,000 shares  E order: A market order to sell 50,000 In her speech to buy side clients Jill has made the following statements about electronic communication and crossing networks (ECNs): Statement 1: Electronic communication networks are order driven systems, in which the limit order book plays the a central role Statement 2: Electronic crossing networks anonymously match buy and sell orders by a pool of participants, generally institutional investors and broker dealers Statement 3: In an ECN, a trade takes place only during a crossing session time and only if there are offsetting orders entered by other participants.

Task: 1. For buying alpha shares, should Alex place a market order or a limit order? What would be the advantage and disadvantage of each type of order, given his purpose? (2 Marks) 2. In selling a large block of Gamma shares explain Jill’s argument that automated order driven trading systems must provide special arrangements for small and large trades? (1 Mark) 3. In the first crossing session discuss what trades would take place on the crossing network and what orders remain unfilled? (2 Marks) 4. In the second crossing session discuss what trades would take place on the crossing network and what orders remain unfilled? (2 Marks) 5. Which of Jill’s statement about electronic communication and crossing networks (ECNs) is true? Justify your answers. (1 Mark) 6. Indicate how you would assess the quality of financial markets? (2 Marks)

Answer 1

Answer to Task 1: For buying alpha shares, Alex should place a limit order as the maximum amount he is ready to pay is 45

Advantages and disadvantages:

(a) Market order: In case of market orders the orders are executed on current market price immediately. It is suitable in cases where execution is a priority and not price. In our case price is a priority,hence market order is not suitable for Alex. He should go for limit order.

(b) Limit order: Limit orders deal primarily with the price, if the security's value is currently resting outside the parameters set in the limit order, the transaction does not occur. Hence Alex should place a limit order as he is not ready to pay beyond 45 for the shares.

Answer to Task 2: Jill's argument is not correct. For buying Alpha shares market order is not suitable. In case of selling Gamma shares also placing a block order may result into providing a lower selling price,as the price paid in case of block orders is the average price of the shares. Hence it might at times result into an adverse effect on the portfolio. It is suitable only for large orders.

Answer to Task 3: In the first crossing session, A's order to buy 100000 shares will be matched with Alex's order to sell 150000 shares at the price of 37. Sell order of remaining 50,000 shares of Alex and 50,000 shares of B will remain unmatched at the end of the first crossing session.

Answer to Task 4: In the second crossing session, D's order to buy 150000 shares will be matched with Alex's remaing 50,000 shares, B's order to sell 50,000 shares and E's order to sell 50,000 shares. At the end if the second session C's order to buy 20,000 shares at 36 will remain unfilled.

Answer to Task 5: Following statements of Jill are true:

European electronic crossing network are cheap, preserve anonymity and allows for 6 crossing opportunities of trades per day. They also allow participants to place some restrictions such as price and minimum fill. All orders submitted to the network is good for day which is means that any unfulfilled part of an order is automatically resubmitted to subsequent crossing sessions during the day.

Justification: (1)European electronic crossing networks do not display the name of the seller or buyer. Hence, Jill is correct in saying that it preserves anonymity. (2) These networks are cheaper as you save the cost of intermediaries to execute a transaction. (3) Limit orders help to limit price while buying/selling . (4) Minimum fill feature ensures atleast prescribed number of shares will be matched.

Answer to Task 6:

Constructing a benchmark and measuring the performance of their portfolio in relation to the benchmark are central to investment process. Very often, the chosen benchmark is a market index and/or a combination of market indices.

Since the design is not affected by the securities chosen and since they benefit from the sound reputation of major financial institutions, credit rating agencies and major international stock exchanges, market indices appear to be the ultimate reference not only for strategic allocation but also as a measure of investment management performance.

The use of capitalisation-weighted indices is often justified.For purposes of asset allocation and performance measurement, the assumption of index efficiency is a central one.