Financial Trading and Investing

Description

This book provides an introduction to trading and financial markets for upper-division undergraduates and graduate students who are planning to work in the finance industry. Unlike standard investments texts which cover trading as one of many subjects, it gives primary attention to trading, trading institutions, markets, and the institutions that facilitate and regulate trading activities-what economists call "market microstructure." The text will be accompanied by a website that can be used in conjunction with TraderEx, Markit, StocklinkU, Virtual Trade, Vecon Lab Experiment, Tradingsim, IB Student Trading Lab, Brenexa, Stock Trak and How the Market Works. By emphasizing the practical natures of trading concepts and environments over their theoretical aspects, this textbook gives students insights into all trading activities in the securities markets. Introduces the financial markets and the quantitative tools used in them so students learn how the markets operate and gain experience with their principal tools Helps students develop their skills with the most popular trading simulation programs so they can reuse the book to solve day-to-day problems Stretches from investor behavior to hedging strategies and noise trading, capturing recent advances in an up-to-date reference source 0i_Front-matter Financial Trading and Investing 0ii_Copyright Copyright page 0iii_Dedication Dedication 0xi_Preface Preface Acknowledgements 01_Chapter-1-Introduction-to-Securities-Trading-and-Markets Chapter 1 Introduction to Securities Trading and Markets 1.1 Trades, Traders, Securities, and Markets Trading Illustration Securities and Instruments 1.2 Securities Trading Algorithmic Trading: A Brief Introduction 1.3 Bargaining 1.4 Auctions Auction Outcomes Common Value Auctions Google’s Dutch Auction Format 1.5 Introduction to Market Microstructure Market Execution Structures 1.6 Orders, Liquidity, and Depth 1.7 Day Trading Online Brokers and Direct Access Trading Trading Platforms Quotations and Price Data Trading Arcades Additional Reading References 025_Chapter-2-Financial-Markets-Trading-Processes-and-Instruments Chapter 2 Financial Markets, Trading Processes, and Instruments 2.1 Exchanges and Floor Markets NYSE Euronext 2.2 The Way It Was National and Regional Exchanges Early Ancestors to Modern Exchanges Traditional New York Stock Exchange Structure Transforming the NYSE Demutualization and Governance Changes Diminished Floor Trading Activity Current New York Stock Exchange Equities Membership Types Option Exchanges 2.3 Over-the-Counter Markets and Alternative Trading Systems Over-the-Counter Markets Alternative Trading Systems 2.4 The Decline of Brick and Mortar Electronic versus Open Outcry 2.5 Crossing Networks and Upstairs Markets Internalization 2.6 Quotation, Intermarket, and Clearing Systems Clearing and Settlement 2.7 Brokerage Operations 2.8 Fixed-Income Securities and Money Markets U.S. Treasury Securities and Markets Agency Issues Municipal Securities and Markets Financial Institution Instruments Corporate Bonds and Markets Credit Ratings and Credit Agencies Eurocurrency Instruments and Markets 2.9 Markets around the World 2.10 Currency Exchange and Markets Exchange Rates Cross Rates Forward Exchange Rates and Contracts Futures Markets Currency Trading Interdealer Brokers and Electronic Broking Futures and Other FX Markets Orders, Quotes, and Spreads Additional Reading References 067_Chapter-3-Institutional-Trading Chapter 3 Institutional Trading 3.1 Institutions and Market Impact 3.2 Registered Investment Companies Managed Investment Company Types Managed Investment Company Fees and Structures ETFs 3.3 Unregistered Investment Companies Pension Funds Bank Trusts and Private Banking Private Equity Hedge Funds Rule 144A Markets 3.4 Best Execution, Execution Costs, And Price Improvement Spreads Illustration: Slippage and the Perfect Foresight Half Spread 3.5 Algorithmic Trading Algo Strategies Illustration: Slicing the Large Transaction 3.6 Dark Pools 3.7 Stealth And Sunshine Trading 3.8 High-Frequency Trading Latency Arbitrage HFT Strategies 3.9 Flash Trading And Sponsored Access Illustration: A Flash Trade Sponsored Access Additional Reading References 093_Chapter-4-Regulation-of-Trading-and-Securities-Markets Chapter 4 Regulation of Trading and Securities Markets 4.1 Background and Early Regulation Regulatory Approaches Pre-1930s Securities Regulation: The Background 4.2 U.S. Securities Market Legislation: The Foundation The Bedrock: The Securities Act of 1933 and the Securities Exchange Act of 1934 Additional Major Depression-Era Legislation 4.3 Crises and Updating the Regulatory System The 1960s Go-Go Years and Reform Updating Commodities Trading Regulation and the National Market System Insider Trading Regulation 4.4 Deregulation, Corporate Scandals, and the Financial Crisis of 2008 Deregulation Sarbanes-Oxley Post-SOX The 2008 Financial Crisis 4.5 Dodd-Frank 4.6 Government Oversight of Self-Regulation: The Securities and Exchange Commission and Commodity Futures Trading Commission The Securities and Exchange Commission The Commodity Futures Trading Commission 4.7 Impact of Regulatory Activity 4.8 Regulation: The International Arena Selected Country Regulatory Authorities 4.9 Privatization of Regulation and Exchange Rules NYSE Rules NYSE Circuit Breakers Additional Reading References 0117_Chapter-5-Adverse-Selection-Trading-and-Spreads Chapter 5 Adverse Selection, Trading, and Spreads 5.1 Information and Trading Adverse Selection 5.2 Noise Traders 5.3 Adverse Selection in Dealer Markets Kyle: Informed Traders, Market Makers, and Noise Traders The Setting and Assumptions The Informed Trader’s Problem: Profit Maximization Dealer Price Setting Informed Trader Demand and Dealer Price Adjustment Illustration: Kyle’s Adverse Selection Model 5.4 Adverse Selection and the Spread The Demsetz Immediacy Argument Glosten and Milgrom Information Asymmetry Model The Stoll Inventory Model The Copeland and Galai Options Model Additional Reading References 0135_Chapter-6-Random-Walks-Risk-and-Arbitrage Chapter 6 Random Walks, Risk, and Arbitrage 6.1 Market Efficiency and Random Walks Random Walks and Submartingales Brownian Motion Processes Weiner Processes 6.2 Risk Historical Volatility Indicators Extreme Value Estimators Implied Volatilities 6.3 Arbitrage Pairs Trading and Stat-Arb 6.4 Limits to Arbitrage Additional Reading References 6.A.1 Return and Risk Spreadsheet Applications 6.A.2 A Primer on Black-Scholes Option Pricing Calls and Puts The Black-Scholes Model Appendix Exercises Appendix Exercise Solutions 6.A.3 Estimating Implied Black-Scholes Variances Simple Closed-Form Procedures Aggregating Procedures 0165_Chapter-7-Arbitrage-and-Hedging-with-Fixed-Income-Instruments-and-Currencies Chapter 7 Arbitrage and Hedging with Fixed Income Instruments and Currencies 7.1 Arbitrage with Riskless Bonds 7.2 Fixed Income Hedging Bond Yields and Sources of Risk Fixed Income Portfolio Dedication 7.3 Fixed Income Portfolio Immunization Bond Duration Portfolio Immunization Immunization Illustration Convexity 7.4 Term Structure, Interest Rate Contracts, and Hedging The Term Structure of Interest Rates Term Structure Estimation with Coupon Bonds Bootstrapping the Yield Curve Simultaneous Estimation of Discount Functions 7.5 Arbitrage with Currencies Triangular Arbitrage Purchase Power Parity, Arbitrage, and Hedging in FX Markets Purchase Power Parity in Spot Markets 7.6 Arbitrage and Hedging with Currency Forward Contracts Parity and Arbitrage in FX Markets Purchase Power Parity Example 1: Purchase Power Parity Violation and Arbitrage Interest Rate Parity Example 2: Interest Rate Parity Violation and Arbitrage Exchange Rate Expectations The Fisher Effect The International Fisher Effect 7.7 Hedging Exchange Exposure Illustration: Managing Transactions Exposure Unhedged alternative Forward market hedge Money market hedge Other Hedging Strategies: Additional Reading References 7.8 Exercises 0197_Chapter-8-Arbitrage-and-Hedging-with-Options Chapter 8 Arbitrage and Hedging with Options 8.1 Derivative Securities Markets and Hedging 8.2 Put–Call Parity Illustration: Hedging with a Call, a Put, and a Collar 8.3 Options and Hedging in a Binomial Environment Arbitrage in the One-time Period Case Extending the Binomial Model to Two Periods Illustration: Two-Time-Period Hedges Extending the Binomial Model to n Time Periods Illustration: Three Time Periods Obtaining Multiplicative Upward and Downward Movement Values Binomial Model: An Illustration 8.4 The Greeks and Hedging in a Black-Scholes Environment Black-Scholes Model Sensitivities Illustration: Greeks Calculations for Calls Illustration: Hedging with Delta and Gamma Neutral Portfolios Put Sensitivities 8.5 Exchange Options Illustration: FX Option Valuation 8.6 Hedging Exchange Exposure with Currency Options Additional Reading References 8.A.1 The Binomial Model: Additional Considerations A Computationally More Efficient Version of the Binomial Model Obtaining Multiplicative Upward and Downward Movement Values 8.A.2 Deriving the Black-Scholes Model 0231_Chapter-9-Evaluating-Trading-Strategies-and-Performance Chapter 9 Evaluating Trading Strategies and Performance 9.1 Evaluating Investment Portfolio Performance Computing Net Asset Value and Returns Net Asset Value and Returns Illustration Portfolio Benchmarking Portfolio Performance Benchmarking Illustration 9.2 Market Timing Versus Selection The Quadratic Variable Approach The Dummy Variable Approach 9.3 Trade Evaluation and Volume-Weighted Average Price VWAP VWAP: A Simple Illustration 9.4 Implementation Shortfall Illustration: Implementation Shortfall 9.5 Value at Risk Equity Portfolio VaR: Illustration Additional Reading References 9.6 Exercises 0251_Chapter-10-The-Mind-of-the-Investor Chapter 10 The Mind of the Investor 10.1 Rational Investor Paradigms The St. Petersburg Paradox and the Expected Utility Paradigm Von Neuman and Morgenstern: Axioms of Choice 10.2 Prospect Theory Losses and Inconsistency Frames versus substance Maintaining the Status Quo: Joe and His Opera Tickets Anchoring 10.3 Behavioral Finance The Monty Hall Judgment Error Dumb, Dumber, and Dead Myopia and Overreaction Myopia Hyperbolic Discounting Overreaction Overconfidence Overconfidence, Gender, Entertainment, and Testosterone Sensation Seeking Investor Moods, the Weather, and Investment Returns Simplifying the Decision Process Rational Investors and Diversification 10.4 Neurofinance: Getting Into The Investor’s Head 10.5 The Consensus Opinion: Stupid Investors, Smart Markets? The Football Pool Analyst Estimates Rational Investors and Price Setting Herds and Swarms Additional Reading References 0285_Chapter-11-Market-Efficiency Chapter 11 Market Efficiency 11.1 Introduction to Market Efficiency 11.2 Weak form Efficiency Price Sequences, Momentum and Mean Reversion Relative Strength Filter Rules and Market Overreaction Moving Averages The January Effect The January Effect and Tax-Driven Selling The January Effect and Window Dressing The Small Firm and Price/Earnings Effects The Initial Public Offering Anomaly Sports Betting Markets Summary 11.3 Testing Momentum and Mean Reversion Strategies 11.4 Semistrong form Efficiency Early Tests Stock Splits Corporate Merger Announcements, Annual Reports, and Other Financial Statements Information Contained in Publications and Analyst Reports Analyst Reports and Conflicts of Interest Discounted Cash Flow Analysis and Price Multiples Political Intelligence Units Market Volatility 11.5 The Event Study Methodology Illustration: Event Studies and Takeovers 11.6 Strong form Efficiency and Insider Trading 11.7 Anomalous Efficiency and Prediction Markets The Challenger Space Shuttle Disaster Prediction Markets 11.8 Epilogue Additional Reading References 0325_Chapter-12-Trading-Gone-Awry Chapter 12 Trading Gone Awry 12.1 Illegal Insider Trading Notorious Insider Trading Cases William Duer Dennis Levine, Ivan Boesky, and Michael Milken Martha Stewart Raj Rajaratnam Monitoring Inside Trading Activity 12.2 Front Running and Late Trading Front Running and Parasitic Trading Market Timing and Late Trading 12.3 Bluffing, Spoofing, and Market Manipulation Bluffing Spoofing Illustration: Spoofing Buy, Lie, and Sell High Banging the Close Corners and Pools Vanderbilt v. Drew Modern Day Corners: Chase Medical, Porsche, and Solomon Wash Sales Fishing Other Quote Abuses 12.4 Payment for Order Flow 12.5 Fat Fingers, Hot Potatoes, and Technical Glitches The Flash Crash Hot Potato Volume A Textbook for $23,698,655.93 (Plus $3.99 Shipping) 12.6 Rogue Trading and Rogue Traders Rogue Traders Nick Leeson and Barings Bank John Rusnak and AllFirst Orlando Joseph Jett and Kidder Peabody Jérôme Kerviel and Société Générale 12.7 Trading and Ponzi Schemes Carlo Ponzi Other Ponzi Schemes Additional Reading References 0351_Mathematics-Appendix Mathematics Appendix A.1 A Brief Overview of Elementary Statistics Mean, Variance, and Standard Deviation Co-movement Statistics Hypothesis Testing Hypothesis Testing: Two Populations Introduction to Simple OLS Regression A.2 Essentials of Matrices and Matrix Arithmetic Matrix Arithmetic Multiplication of Matrices Inverting Matrices Solving Systems of Equations A.3 Derivatives of Polynomials A.4 Reference Tables 0369_Glossary Glossary 0381_End-of-Chapter-Exercise-Solutions End-of-Chapter Exercise Solutions Chapter 1 Chapter 2 Chapter 3 Chapter 4 Chapter 5 Chapter 6 Chapter 7 Chapter 8 Chapter 9 Chapter 10 Chapter 11 Chapter 12 0425_Index Index