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FIN 214

Securities Trading and Market Mechanism

TU BBA-F · Semester 7 · BBA-F curriculum (2021 Common Core)

Requirement
elective
Credits
3
Study Guide
7 units available

Chapter notes

Authoritative study guide across 7 syllabus units

Open a unit to read its study notes.

Unit 1: Introduction to Securities Trading and Markets· 4 LHs· ~5 marks

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Introduction to Securities Trading and Markets

Market Microstructure Foundations and Trading Mechanics

Market Microstructure

The study of the specific trading mechanisms, institutional rules, and market architectures through which latent investor demands are translated into executed transactions and observed market prices (Larry Harris framework).

Price Discovery

The continuous, dynamic process by which market participants incorporate new public and private information into transaction prices through the submission of buy and sell orders.

Bilateral Bargaining

A decentralized trading arrangement where individual buyers and sellers negotiate transaction prices directly without an organized central order book or designated specialist.

Price Discovery, Capital Allocation, and Real Economic Linkages

Market Microstructure and Real Economic Linkages

  1. Capital Allocation Efficiency: Liquid, transparent secondary markets reduce the cost of capital for productive real corporate investments.
  2. Liquidity Provision: Enabling savers to liquidate long-term corporate securities on demand without substantial price concessions.
  3. Information Feedback Loop: Secondary market equity valuations provide vital managerial signals regarding investment project appraisal and executive compensation.
  4. Monitoring & Corporate Governance: Continuous market pricing facilitates hostile takeovers and proxy contests against entrenched, value-destroying corporate management.

Comparative Trading Mechanisms: Bilateral Search vs Centralized Order Books

Dimension Bilateral Bargaining (Over-the-Counter) Centralized Auction Market (Exchange)
Search Costs High search and negotiation friction Negligible; instantaneous centralized matching
Transparency Low / Opaque; private bilateral terms High pre-trade and post-trade price transparency
Counterparty Risk Bilateral default risk borne by parties Mitigated by Central Counterparty Clearing (CCP)

Market Microstructure Friction and Price Impact Analysis

Applied Problem: Price Impact and Microstructure Friction

An institutional fund manager liquidates 50,000 shares of a commercial bank on NEPSE:

  • Current pre-trade midpoint price: Rs. 300
  • Average realized execution price across all fills: Rs. 294
  • Post-trade benchmark midpoint price after 1 hour: Rs. 295
  1. Compute the Effective Spread and Price Impact.
  2. What proportion of total execution shortfall represents temporary vs permanent market impact?

Solution:

Effective Half-Spread=300−294=Rs. 6.00 per share\text{Effective Half-Spread} = 300 - 294 = \text{Rs. } 6.00 \text{ per share}
Permanent Price Impact=300−295=Rs. 5.00 per share (permanent information effect)\text{Permanent Price Impact} = 300 - 295 = \text{Rs. } 5.00 \text{ per share (permanent information effect)}
Temporary Price Impact=295−294=Rs. 1.00 per share (liquidity concession)\text{Temporary Price Impact} = 295 - 294 = \text{Rs. } 1.00 \text{ per share (liquidity concession)}

Total Execution Shortfall=50,000×6.00=Rs. 300,000\text{Total Execution Shortfall} = 50,000 \times 6.00 = \text{Rs. } 300,000

The permanent information impact constitutes 5.006.00=83.33%\frac{5.00}{6.00} = 83.33\% of the execution cost, reflecting market perception of adverse institutional information.

Key analytical nuance: they define market microstructure as macroeconomic monetary policy, confusing granular order execution mechanisms with macroeconomics.