Aug 28, 2012

Are you going for programming jobs at investment banks or financial institutions? Knowing some investment and trading terms will be useful

The investment banks and financial organizations do pay a very competitive remunerations and many of you aspire to work for such organizations. Here are a  few questions and answers on different securities, derivatives, and FIX engine/trading system basics to familiarize yourself  with some of the terminologies.

Q. What is a stock, share, or equity?
A. Whether you say shares, equity, or stock, it all means the same thing. A stock is a share in the ownership of a company. Stock represents a claim on the company's assets and earnings. As you acquire more stock, your ownership stake in the company becomes greater. A stock is represented by a stock certificate. This is a fancy piece of paper that is a proof of your ownership. In today's computer age, you won't actually get to see this document because your brokerage keeps these records electronically.

Q. What is a Security?
A. Security is a broader term which includes shares as well. There are two types of securities:
  •    Equity security (e.g. Share, Common Stock, Options, Warrants, etc. )
  •    Debt security (e.g. Bonds, Debentures, Bank Notes, Coupons, FICC (Fixed Income, Currencies, and Commodities), etc)
Q. How do primary and secondary financial markets differ?  
A. A financial market is a market in which people and entities can trade financial securities. The primary market refers to the market where securities are created, while the secondary market is one in which the previously created stocks are traded among investors. In the primary market, a company that needs money sells stock. In the secondary market, someone who owns stock sells their stock to someone else. The secondary market does not bring in money for a company.

Q. What is a derivative?
A. A derivative is anything that is valued based upon some other asset.  The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. For example,  A call option is a derivative that gives the buyer the option (but not the obligation) to buy 200 shares of a certain stock at a pre-determined price. It is a derivative because the value of the option depends on what the underlying stock does. The most common underlying assets include stocks, bonds, commodities, currencies, and interest rates.  Derivatives are generally used as an instrument to hedge risk, but can also be used for speculative (i.e betting) purposes as most derivatives are characterized by high leverage.

Q. What is the difference between options and warrants?
A. The warrants are issued by companies to raise money, and the options are not. But both have lots of similarities.
  • Both options and warrants are based on an underlying asset such as stocks. They are exercised at a pre-determined price or strike price. The seller of an option or warrant is obliged to honor the terms of the option or warrant. The buyer of an option or warrant must pay a price (or premium) up front.
  • Both options and warrants expire at a pre-determined date.

Q. What are the different ways a company can raise money (i.e raise capital)?

1. Borrowing from a bank (debt security): Always short term (1 year or less) and the banks have the first claim on assets of a bankrupt firm.

2. Issuing preferred stocks (equity security): By choosing to issue new "preferred" stock to raise capital. Buyers of these "preferred stock" have special rights in the event the underlying company encounters financial trouble. If profits are limited, preferred-stock owners will be paid their dividends after bondholders receive their guaranteed interest payments but before any common stock dividends are paid.

3. Issuing common stocks (equity security): The companies that are in good financial health can raise capital by issuing common stock. Although common shareholders have the exclusive right to elect a ccompany's board of directors, they rank behind holders of bonds and preferred stock when it comes to sharing profits.

4. Issuing bonds (debt security): By issuing bonds, companies must make semi-annual or annual interest payments on the bond and must buy back the bond when it matures. Bonds can be both long and short term. This can be a substantial drain on a company's cash.

5. Issuing warrants (equity security): Warrants allow a company to generate money by selling stocks to the owner of a warrant who exercises the warrant. The warrants will only be exercised if the stock price is higher than the exercise price.

Q. What is a debt security?
A. Debt securities are legal obligations to repay borrowed funds at a specified maturity date and provide interim interest payments as specified in the contract. Examples of debt securities include bonds, certificates of deposit, commercial paper, loans, and debentures. The debt securities increase the probability of bankruptcy and expected bankruptcy costs; reduce financial flexibilities

Q. What is the difference between equity security and debt security?
A. Debt securities represent indebtedness or borrowing by the issuing company. On the other hand, equity securities represent ownership of the issuing company.

Bonds and stocks are both securities, but the major difference between the two is that stockholders have an equity stake in the company as the part owners of the company, whereas bondholders have a creditor stake in the company as the lenders. Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding indefinitely. A bond is a formal contract to repay borrowed money with interest at fixed intervals (semiannual, annual, sometimes monthly).

Bonds generally can trade anywhere in the world that a buyer and seller can strike a contractual deal. There is no central place or exchange for bond trading, as there is one for publicly traded stocks. The bond market is known as an "over-the-counter" market, rather than an exchange market. There are some exceptions to this as some corporate bonds are listed on an exchange. But the majority of bonds do not trade on exchanges.

Q. What is a share contract note?
A. It is the confirmation of the share order via a contract note, which is sent to you via email or post to you by your broker.

Q. What do you understand by the term "settlement and transfer"?
A. When you buy shares, on the other side of the transaction there is a seller. For every buy, there is a sell. The money you owe for the shares is owed to the seller and must be exchanged for the seller’s ownership in the company. This process is called settlement and transfer.

Q. What are the diffrent types of stock market orders?
A. The most common ones are "on market" and "at limit". The orders could also be either  "buy order" or "sell order"

On market: Usually one gets the stock at the ask price of the moment when the order reaches the exchange. A market order is the default option and is likely to be executed because it does not contain restrictions on the buy/sell price or the timeframe in which the order can be executed. So, you don't enter any price info while placing an order.

At limit: A limit order is an order to buy or sell a stock at a specific price or better. So, you need to enter a limit price when placing an order. A buy limit order can only be executed at the limit price or lower, and a sell limit order can only be executed at the limit price or higher.  A limit order is not guaranteed to execute.  A limit order can only be filled if the stock’s market price reaches the limit price.  While limit orders do not guarantee execution, they help ensure that an investor does not pay more than a pre-determined price for a stock.

Stop order: An order to buy or sell a security when its price surpasses a particular point, thus ensuring a greater probability of achieving a predetermined entry or exit price, limiting the investor's loss or locking in his or her profit. Investors normally place a stop order before they go on a holiday.

Q. What is an exchange traded fund (ETF)?
A. An exchange-traded fund (ETF) is a security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. An ETF holds assets such as stocks, commodities, or bonds, and trades close to its net asset value over the course of the trading day. ETFs are attractive as investments because of their low costs, tax efficiency, and stock-like features.

Q. What is a FIX protocol?
A. FIX stands for Financial Information eXchange protocol, which is an open specification intended to streamline electronic communications in the financial securities industry. FIX supports multiple formats and types of communications between financial entities including trade allocation, order submissions, order changes, execution reporting,  email, and texting. For example, the  CameronFIX is an engine that uses the open FIX standards. QuickFixJ is a free open source Java based FIX engine. Here is a simplified high level over view of a trading system written in Java.

FIX simplies the implementation of interfaces by using so called FIX engines. There are open source implementations as well as commercial ones. The FIX engine takes care of the functional aspects like defining the message semantics, supporting different types of messages like heart beat, test request, resend request, execution report, new order, rejection message, etc and non functional aspects like logging FIX messages, dealing with dropped connections, handling high trading volumes, etc.

A FIX message has the following structure:
  • Message header: Contains the message type, length, sender/receiver name, sequence number, time stamp, etc.
  • Message body: Contains session/application specifc data. 
  • Message trailer: Contains a message checksum and an optional signature.

The FIX message fields are basically the combination of a tag, which is a numerical identifier, with a value, which is a string and a delimiter, which is written as ^ (i.e. ASCII 0x01). In addition to hundreds of predined tags, FIX also supports custom tags between field numbers 5000 and 9999.  Here is an example of a FIX message with a header, body, and trailer.


Tag meaning: Please refer to  FIX Tag Details

8 (FIX Version - always first field), 9 (body length -- always last field), 35 (Msg Tpe, for example 0 - Heartbeat, 1 - TestRequest, D - NewOrderSingle, etc), 49 (company that is sending the message id), 50 (message originator id), 55 (Symbol), 48 (Security Id), 22 (alternative security id), 54 (side of order, for e.g. 0 - buy, 1 - sell, etc), 38 (order quantity), 40 (order type, 0 - Market, 1 - Limit, etc), 44 (price), 59 (order expiry, 0 - day, 1 - Good Till Cancel, etc), 10 (3 byte checksum -- always last field)

Q. What are some of the required capabilities of a trading system?
  • Place buy, sell, on market, at limit, etc orders to the market.
  • Handle status updates from the market asynchronously. The order statuses include partially-filled, rejected, cancelled, pending, completed, suspended (due to pending corporate actions), etc.
  • Validate orders against market rules before placing on to the market.
  • Process contract notes.
  • Produce graphs and reports for a trader to make a more informed decision.
  • Handle trade embargo and staff trade restrictions.
  • Handle high volume, especially during market crash and panic selling

Q. What do you understand by the term portfolio value, and how do you calculate the value?
A. The term portfolio refers to any collection of financial assets such as stocks, bonds, and cash.

  • Listed securities are valued at number of shares owned times the market price per share
  • plus the number of calls times the excess of the market price per share over the call price
  • plus the number of puts times the excess of the put price over the market price per share.
  • plus any managed funds owned
  • plus any bonds, term deposits, cash, and other fixed interests assets.



Anonymous Stock Market said...

Hi this one is great and is really a good post. I think it will help me a lot in the related stuff and is very much useful for me. Very well written I appreciate & must say good job..

10:57 PM, August 27, 2012  
Blogger akiindia01 said...

Thanks for sharing this knowledge. I had been searching for techincal operations carried out at stock exchanges to complet one user request.

10:12 PM, September 28, 2012  

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