Dr. P.V. Viswanath

pviswanath@pace.edu

Courses / FIN American Capital Markets /

FIN : American Capital Markets Summer 2005

Classes will meet in room W524 on the New York campus
Email: pkadiyala@pace.edu Tel: (914) 773-3610
Email: pviswanath@pace.edu Tel: (212) 618-6518
Webpage: http://www.pviswanath.com
Blackboard: http://blackboard.pace.edu

Course Description

This course could concisely be described as dealing with the macrostructure (the first half) and the microstructure (the second half) of American capital markets. The first part starts with a description of the primary market, the process by which new securities are sold to the investing public. The characteristics of the major categories of publicly traded securities are discussed with an emphasis on the tradeoff between a security's risk and its return. A well functioning capital market requires a transparent, orderly system to handle trades between investors in these publicly held securities. The second half of the course compares and contrasts various trading systems put in place by major US exchanges. The course culminates with a discussion of the globalization of trading mechanisms.

Course Text

Market Macrostructure (Prof. Padmaja Kadiyala)

 

Classnotes

Market Microstructure (Prof. P.V. Viswanath)

Main Text: Trading and Exchanges, by Larry Harris, Oxford University Press, 2003
Supplementary Text: Robert Schwartz and Reto Francioni, “Equity Markets in Action: The Fundamentals of Liquidity, Market Structure and Trading,”, Wiley Trading Press, 2004
Classnotes

Course Objectives

When you have completed this course successfully, you will be familiar with

Market Macrostructure (Prof. Padmaja Kadiyala):

• How firms raise capital
• the characteristics of different financial assets
• the relationship between risk and return

Market Microstructure (Prof. P.V. Viswanath):

• the structure of the trading industry
• the benefits of trade
• information generation and revelation in securities markets
• the role of liquidity in securities markets
• relative advantages of different security market structures

Course Content

Time permitting, the second half of the course will consist of the following topics:

Session 1:

(1st half): Overview of the course; Introduction to Corporate Finance
(2nd half): The process of issuing new equity

Session 2:

(1st half): Why underpricing, international IPOsCharacteristics of financial assets
(2nd half): Characteristics of financial assets

Session 3:

(1st half): Characteristics of financial assets
(2nd half): WSJ video

Session 4:

(1st half): Risk and Return – history, single security
(2nd half): Risk and Return – two securities

Session 5:

(1st half): Beta risk, CAPM
(2nd half): APT, million dollar bet

Session 6:

Review and final exam for first half of course

Session 7:

In this class meeting, the students will be introduced by means of a few examples, to the important elements of how trades get made; to the different players in the trading industry.

I Trading Stories (Chapter 2 of Trading and Exchanges by Larry Harris; future references to Chapters are also from this book)
Go over Trading Stories and point out key features:

a. Retail Trade in an NYSE-listed stock
b. Retail Trade in a Nasdaq stock
c. An institutional Trade in a NYSE stock
d. An institutional Trade in a NASDAQ stock
e. A very large block stock trade

II The Trading Industry (Chapter 3)
Who are the players?

a. Buy side
b. Sell side
c. Exchanges
d. Clearing and Settlement Agents, Depositories and Custodians

Session 8:

In this class meeting, we will go on to a discussion of the different securities markets that operate in the US and discuss the variety of order types that an investor can use to accomplish a purchase or a sale of securities.

III Where are the Trading Markets (Chapter 3, section 4)

a. US markets
b. International markets

IV Orders and Order Properties (Chapter 4)

a. Market Orders
b. Limit Orders
c. Stop Orders
d. Market-not-held Orders

Session 9:

In this class meeting, students will be exposed to different kinds of market structures.

V Market Structures (Chapter 5)

a. Trading Sessions – Continuous and call markets
b. Execution Systems (Section 5.3)

i. Quote-driven Dealer Markets (Section 5.3.1)
ii. Order-driven Markets (Section 5.3.2)
iii. Brokered Markets (Section 5.3.3)

Session 10:

In this class meeting, we will start a discussion of one of the important market types -- an order driven market. We will also conduct a simulation of such a market.

VI Order Driven Markets (Chapter 6)

a. Oral Auctions (Chapter 6.1)
b. Rule-Based Order Matching Systems

i. Order Precedence Rules
ii. The Matching Procedure
iii. The Uniform Pricing Rule and Single Price Auctions
iv. The Discriminatory Pricing Rule and Continuous Two-Sided Auctions
v. The Derivative Pricing Rule and Crossing Networks

TraderEx Simulation

Talk by Mr. Fred S. Cohen, Senior Municipal Trader, Bernstein Investment Research and Management.

Session 11:

In this class meeting, we will go on to discuss the second important type of market structure, a quote driven market, otherwise known as a dealer market. We will discuss how dealers make decisions regarding inventory and limit order placement in these markets, and we will look at how these decisions result in an equilibrium bid-ask spread. We will end by engaging in a simulation of such a market.

VII Dealers and Dealer Markets (Chapter 13)

a. Who are Dealers (13.1)
b. Dealer Quotations (13.2)
c. Attracting Order Flow (13.4)
d. Dealer Inventories (13.6)
e. Inventory Risk (13.7)

i. Diversifiable Inventory Risk
ii. Adverse Selection Risk

f. Dealer Responses to Adverse Selection (13.8)

VIII Bid-Ask Spreads (Chapter 14)

a. Spread Components

i. The Transaction Cost Component (14.2.1)
ii. The Adverse Selection Spread Component (14.2.2)

b. Adverse Selection and Uninformed Traders (14.3)
c. Equilibrium Spreads in Continuous Order-Driven Auction Markets (14.4.1)
(read Handa and Schwartz, 1996 and Stoll, 2001)

i. A Simple Timing Option Example (p. 308)

Head Trader Simulation

Session 12:

In this class meeting, we will look at the societal functions of markets and look, in particular, at their informational role.

IX Good Markets (Chapter 9)

a. Private Benefits of Trading
b. Public Benefits of Trading

i. Informative Prices
-- Allocation Decisions- Primary Markets
-- Allocation Decisions- Secondary Markets
ii. Liquid Markets

X Informed Traders and Market Efficiency (Chapter 10)

a. Competition, Trading Profits and Informative Prices (Section 10.6)

i. Informative Prices (10.6.1)
ii. Informed Trading Profits (10.6.2)
iii. The Role of Uninformed Traders (10.6.3)
iv. The Paradox of Market (In)efficiency (10.6.4)
v. Competition among Informed Traders (10.6.5)
vi. The Trade-off between Liquidity and Informative Prices (10.6.6)
vii. The Benefits of Public Information (10.6.7)

Session 13:

Student Presentations

Computer Use and E-mail Policy:

Check your e-mail and the FIN American Capital Markets website on a regular basis, particularly for the second half of the course.  This will enable you to get the maximum from the course. The course instructors are available for consultation by e-mail at pkadiyala@pace.edu and pviswanath@pace.edu. I check my e-mail practically every day, and, in most cases, you should get a speedy response to any questions.  

We will also be using Blackboard as a gateway for some aspects of the course.  Please log in to Blackboard at the earliest opportunity.    Blackboard login procedures can be found on the appropriate Blackboard site. 

Course Requirements

Class Attendance and Participation

Class attendance is mandatory and is highly recommended.  This is for two reasons: one, I believe that you will understand the material much better if you attend the class sessions; two, modifications to the class schedule will be announced in class and/or on the BlackBoard website.  Also, on occasion, I conduct classroom exercises, give short quizzes, or assign additional work. If you miss a class session during which we have such a classroom exercise, or additional work is assigned, your grade will be adversely affected for this reason as well.  (Of course, it goes without saying that missing quizzes will affect your grade adversely.)  In any case, you should consult fellow students on what was done during the class time that you missed, and collect handouts for that day's session. You should also bring a calculator to all class meetings.

For the second half of the course, in particular, you are required to read the Wall Street Journal. Some exam questions will be based on current newspaper and magazine articles that are related to course material. Hence you should cultivate and improve your ability to read newspaper articles critically. 

There are two other reasons why you should try to attend as regularly as possible. One, classroom participation will help your grade. By participation, I mean answering questions and making intelligent comments. Two, we will sometime do learning exercises in class; doing them can help you substantially in understanding the material.  I often also give credit for participation in these classroom exercises.

Assignments

Assignments are required to be handed in. Please see Course Timetable.

Academic Integrity

Any student taking this course is presumed to agree to abide by standards on academic integrity. If any student is caught cheating or plagiarising or otherwise doing anything contrary to academic integrity, s/he can get a failing grade for the entire course.

Exams

See schedule of classes, above, as well on the Class Schedule page.

Media Articles (for the Microstucture part of the course -- second half)

I will alert you to interesting media articles that show up on the Wall Street Journal. There are several reasons why you should look regularly at these and other articles.  

• It will be a useful way for you to keep abreast of topical issues (in addition to your regular perusal of the Wall Street Journal.)
• I will pose questions on the subject matter of several of the articles.  These questions will be good preparation for the media article based questions on the exams.
• You can draw on the articles for classroom discussions.
• These articles and the appended questions are useful preparation for job interviews.

The password, necessary to access the Media Articles section, will be announced in class and can also be found at the Blackboard website. In case of emergency, you can contact me for the password.