CFA L3 Trading & Rebalancing

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CFA L3 Trading & Rebalancing by Mind Map: CFA L3 Trading & Rebalancing

1. Trading & Execution

1.1. Market Microstructure

1.1.1. In relation to the quote was the price improved:

1.1.1.1. For BUY orders

1.1.1.1.1. Price Improvement happens when:

1.1.1.1.2. In relation to the dealers # of shares at the ASK price.

1.1.1.2. For SELL orders

1.1.1.2.1. Price Improvement happens when:

1.1.1.2.2. Was there any impact on the quoted BID

1.1.1.2.3. In relation to the dealers # of shares at the BID price.

1.1.1.3. For orders where the # of shares I need to buy is GREATER than the # of shares available from a dealer at the ASK.

1.1.1.3.1. Revers is true for a SELL order where there is not enough shares offered at the BID quote. The order will "walk DOWN the order book" and get a lower and lower price until he completely sells out of his intended shares.

1.1.2. The roles of Brokers & Dealers

1.1.3. Evaluating Market Quality

1.1.3.1. Liquidity

1.1.3.1.1. Liquid markets are ones that have

1.1.3.1.2. Factors that contribute to making a liquid market.

1.2. Order types

1.2.1. Market

1.2.2. Limit

1.2.3. Market not held order

1.2.3.1. A market order where the floor broker is given flexibility as to the price and timing of execution.

1.2.4. Participate (do not initiate) order

1.2.4.1. Used when

1.2.4.1.1. Buy side traders are in no hurry to trade and want to solicity dealers orders to see what

1.2.5. Best Efforts order

1.2.6. Market on open/close Order

1.2.7. Special Types of Trades.

1.2.7.1. Principal Trade

1.2.7.1.1. Used for LARGE ORDERS or more urgent than can be accommodated with the normal ebb and flow of exchange trading.

1.2.7.1.2. Used if PRICE is NOT important to the client.

1.2.7.2. Portfolio Trade/Program Trade/Basket Trade

1.2.7.2.1. Just by entering one trade ticket I am executing selling multiple positions or buying multiple positions on just one trade ticket.

1.2.7.2.2. Used over trading each security 1 by 1

1.2.8. Undisclosed Limit Order/Reserve/Hidden/Iceberg order

1.2.8.1. Use when

1.2.8.1.1. PRICING is IMPORTANT

1.2.8.1.2. SPEED of execution is not as important

1.3. Automated Trading

1.3.1. Algorithmic Trading

1.3.1.1. The changing role of the trader

1.3.1.2. Algorithmic Trading Classificiations

1.3.1.2.1. Logical Participation Strategies

1.3.1.2.2. Opportunistic Strategies

1.3.1.2.3. Specialized Strategies

1.3.1.2.4. A Trade Blotter:

1.3.1.3. Order Fragmentation: The Meat Grinder effect

1.3.1.4. Algo trading vs. Using a Broker

1.4. 5 Types of Traders

1.4.1. Information-Motivated Traders

1.4.2. Value Motivated Traders

1.4.2.1. Cares more about price than speed.

1.4.3. Liquidity Motivated Traders

1.4.4. Passive Traders

1.4.5. Dealers & Day Traders

1.4.6. Their Trading Motivations

1.5. Trade Execution & Tactics

1.5.1. 5 Objectives in trading and trading tactics

1.5.1.1. Liquidity at any cost

1.5.1.2. Costs are not important trading focus

1.5.1.3. Need Trustworthy Agent

1.5.1.4. Advertise to Draw Liquidity

1.5.1.5. Low Cost Whatever the liquidity

1.5.2. Decisions Related to handling a trade

1.5.2.1. DMA (Direct Market Access)

1.6. The Context of Trading: Market Microstructure

1.6.1. Types of Markets

1.6.1.1. Brokered Markets

1.6.1.1.1. Where a trader relies on a broker to find the other side of a desirable trade.

1.6.1.2. Order-Driven Markets

1.6.1.2.1. ECN's

1.6.1.2.2. Auction Markets

1.6.1.2.3. Automated Auctions

1.6.1.3. Quote-Driven (Dealer) Markets

1.6.1.3.1. Members of the public trade with dealers rather than amongst each other.

1.6.1.4. Hybrid Markets

1.6.2. The Roles of Brokers and Dealers

1.6.3. Evaluating Market Quality

1.6.3.1. A liquid market is one that has the following charactersistics

1.6.3.1.1. Deep # of shares in the market.

1.6.3.1.2. Resilient market.

1.6.3.1.3. Low Bid-Ask Spreads

1.6.3.2. Factors that contribute to a LIQUID MARKET

1.6.3.2.1. Many buyers and sellers

1.6.3.2.2. Many different opinions & Investment needs (people willing to take other side of trade)

1.6.3.2.3. Convenience

1.6.3.2.4. Market Integrity.

1.7. Does the trade reflect price improvement?

1.7.1. For Sells

1.7.1.1. If the EP was above the BID then yes, price improvement occurred for that trade.

1.7.1.1.1. as a result the Effective spread WILL be lower than the Quoted spread. Which is a good thing.

1.7.1.1.2. Thus Eff spread < Quoted spread

1.7.2. For Buys

1.7.2.1. If the EP is below the Ask quote then Yes there was a price improvement for that trade.

1.7.3. Effective spread = Quoted Spread

1.7.3.1. If my sell order I place is sold at the Quoted BID. No price improvement or adverse

1.7.4. Effective spread < Quoted Spread

1.7.4.1. when my sell order executes at a higher price than the BID price. Or when my Buy order executes at a lower price than the ASK price.

1.7.5. Effective Spread > Quoted Spread

1.7.5.1. WHen Sell order is executed below the BID. This is bad. I want to sell high.

1.7.5.1.1. This can occur if my order is huge and thus I would be trading down the limit order book hitting the next BID price.

1.8. ECN means Electronic Communication Network

1.8.1. Electronic CROSSING Network vs. Electronic COMMUNICATIONS Network

1.8.1.1. CROSSING (does not use acronym ECN)

1.8.1.1.1. used by instiutional traders and avoid paying bid ask spread. They just work directly with each other. (buyer and seller). It's like me directly buying a For Sale By Owner. There is no real estate agent involved to create a spread.

1.8.1.1.2. offers anonymity

1.8.1.1.3. offers low cost (no BA spread) because no dealer involved.

1.8.1.2. Communication (ECN)

1.8.1.2.1. Nasdaq

1.9. The Costs of Trading

1.9.1. Transaction Cost Components

1.9.1.1. Implicit Costs

1.9.1.1.1. Delay Costs

1.9.1.1.2. MTOC

1.9.1.1.3. Market Impact

1.9.1.1.4. B/A spread

1.9.2. What Benchmark price to use

1.9.2.1. Opening Price vs. VWAP

1.9.2.2. How a BROKER could GAME performance depending on which Bench Mark is used. VWAP, Opening Price, Closing Price.

1.9.2.2.1. Opening Price as BM

1.9.2.2.2. Closing Price as BM

1.9.2.2.3. VWAP as BM

1.9.3. Pretrade Analysis: ECONOMETRIC Models for Costs.

1.9.3.1. Example of an answer from the model

1.9.3.2. When evaluating what exchange an order should be placed on.

1.9.3.2.1. Look at sum of both explicit and implicit costs on the NYSE vs. the TSE.

1.9.3.3. Example of a question using the model

2. Monitoring & Rebalancing

2.1. Rebalancing the Portfolio

2.1.1. Rebalancing Diciplines

2.1.1.1. Calendar Rebalancing

2.1.1.1.1. Con

2.1.1.1.2. Pro

2.1.1.2. Percentage of Portfolio

2.1.1.2.1. At least 5 factors that should play a role in setting the corridor for an asset class.

2.1.1.3. Other Rebalancing Strategies

2.1.1.3.1. Calendar Plus % of Portfolio (Hybrid)

2.1.1.3.2. Equal Probability Rebalancing.

2.1.1.3.3. Tactical Rebalacing

2.1.1.4. & when Rebalancing does occur under any method the question is....

2.1.1.4.1. Rebalance to "Allowed Range" vs. "Target Weight"

2.1.1.5. Setting Optimal Thresholds

2.1.2. The Perold-Sharpe Analysis of Rebalancing Strategies

2.1.2.1. Marc's sheet for the different strategies

2.1.2.1.1. Buy & Hold

2.1.2.1.2. Constant Mix

2.1.2.1.3. CPPI

2.1.2.1.4. How much $ to put in stocks

2.1.2.2. The amount by which a portfolio's value exceeds the investment in cash is called the "Cushion"

2.1.2.2.1. The Cushion is therefore = the investment in stocks

2.1.2.2.2. Cushion is thought of as a buffer of value above the "floor value".

3. Randomly good tidbits

3.1. Trading & Execution

3.1.1. Relationship of Effective Spread to Quoted Spread

3.1.1.1. When would the EFFECTIVE SPREAD = QUOTED SPREAD

3.1.1.2. The difference between the quoted spread and the Effective Spread observed in the market

3.1.1.2.1. If the Effective spread is lower than Quoted spread....

3.2. Implementation Shortfall Components

3.2.1. Monday's

3.2.1.1. Decison Price = Benchmark Price

3.2.1.1.1. if trade was entered Monday before market close

3.2.1.2. Use the Realized G/L #'s of Monday to Delay's numbers for Monday.

3.2.1.3. Use Realized G/L # of Tuesday's to Monday's Delay numbers.

3.3. VWAP

3.3.1. is appropriate for small trades in relation to ADV.

3.3.2. Willing to see trade get executed througout the day.

3.3.3. Best in non-trending markets

3.4. Which trading tactic is appropriate based on urgency and size of trade relative to ADV and observed spreads

3.4.1. Algo trading is good when

3.4.1.1. High Liquidity and trade size represents a small % of Average Daily Volume

3.4.1.1.1. Use VWAP algo when Urgency is LOW

3.4.1.1.2. Use IS when urgency is HIGH.

3.4.2. Use a broker when

3.4.2.1. Large trade size relative to ADV, large B/A spreads, Urgency to trade is Low.

3.5. Rebalancing

3.5.1. Don't confuse RISK TOLERANCE with how the payoff diagram should look for CPPI, Constant Mix, Buy & hold.

3.5.1.1. Buy & Hold

3.5.1.1.1. Even though B&H has a linear slope of stock prices to % exposure to stocks

3.5.1.2. CPPI

3.5.1.3. Constant Mix

3.5.2. Pay attention to conflicting client wording that maybe says CPPI is better but also indicates that Constant Mix is better

3.5.2.1. Go with the Strategy that is in between the two.

3.5.2.2. For example: A client with a HIGH RISK TOLERANCE may consider the CPPI rebalancing strategy, HOWEVER, if they forecast flat market going forward it may be better to recommend them a strategy that would perform better in a FLAT market.

3.5.2.2.1. In this case B&H does better than Constant Mix

3.5.2.2.2. Constant Mix outperforms in a flat market THAT OSCILATES.

3.5.2.3. If a client does not want to see their portfolio drop below a specified level (aka floor level) but also doesn't want to experience cash drag

3.5.2.3.1. CPPI strategy accomplishes this. Cash decreases to buy more stocks as stocks rise but also sells stocks as they decline and maintains the floor value.