Market Practices & Marketplaces

Execution Procedures

Having examined participants and products, this topic examines how transactions are concluded. Practices vary from product to product, and from place to place, but the following common elements merit consideration:

• The 'two-way' price
• Long & short positions
• Settlement dates
• Settlement procedures & documentation

The 'two-way' price

Differing Price Quotations

Care must be taken with some price quotations. For instance, bond prices are generally quoted as a percentage of par value. For instance, an investor holds 100 bonds, each of which will pay USD 10,000 upon maturity. The two-way price might be quoted as 99.75 (bid) - 100.25 (offer). If the investor chose to sell the bonds they
would receive :

Proceeds = 100 × 10,000 × 0.9975 = USD 997,500

Settlement Dates


Although an economic transaction can be agreed at a particular time, the fulfillment of that transaction will not usually take place until sometime in the future. If an agent agrees to pay USD 600 per ounce for 1,000 ounces of gold, the buyer and seller must agree a time at which the gold and cash will be simultaneously transferred – the settlement date. Most markets have a common spot date when economic transactions must be 'immediately' settled. 'Immediate' means different things in different markets. A spot foreign exchange transaction involving US dollars and euro has a price agreed at time T, but delivery at time T + 2 business days. A spot gold transaction usually involves settlement within 24 hours. If the parties agree, transactions can be executed at a different time from that which is customary, though the price may be different from that which is usual for spot transactions.




Settlement procedures & documentation



Another factor that must be considered by market participants is the relevant settlement procedure for a transaction. Securities may need to be re-registered or delivered. A number of clearance systems exist which facilitate these transactions; for instance, the Depository Trust Company (DTC) manages security accounts for equities and government bonds in the United States and organizes the transfer of securities without excessive paperwork. Bank accounts need to be debited or credited – the SWIFT network is designed to securely handle large-value payments.

There are risks attached to settlement - for instance, monies may be debited before assets are received. Each market has procedures designed to mitigate such risks. There may be significant documentation associated with transactions; for instance, an interest rate swap will usually be documented with reference to a long and complex agreement.

Domestic & International Markets



Trading Locations - Exchanges and OTC markets and their global spread.

In the case of exchanges, there has historically been a central physical location where trading has taken place. For instance, for many years, futures exchanges in Chicago conducted all business via 'open-outcry' transactions conducted between agents located in 'trading pits'. The New York Stock Exchange (NYSE) has a trading floor on Wall Street where a continuous auction operated by floor members sets prices for the stocks traded on the exchange.


However, this has changed dramatically in recent years. Modern exchanges, particularly those outside the United States, are now predominantly electronic, 'virtual' exchanges – traders do not need to be physically located in a particular place. Most major European futures exchanges are electronic, and there is no physical trading center for the London Stock Exchange; instead market-making firms conduct business through the utilization of electronic networks and messaging.

Some exchanges have side-by-side (SBS) trading; products can be traded either physically or else using an electronic network. It is noticeable that in nearly all these cases, electronic volume eventually supersedes that conducted physically.




Trading Locations - OTC

Since an OTC trade is generally a matter of bilateral negotiation, parties can be located anywhere so long as they can contact each other. A client in Europe might conduct business with a financial institution in the United States. For the most part, trades are negotiated on the telephone and transactions are finalized by the simple process of verbal agreement. Most institutions will record telephone conversations in order to clarify any post-trade disagreements.

In some markets, telephone transactions are being replaced by electronic networks. A customer who wishes to transact in foreign exchange, for instance, need not necessarily call one or many relationship banks in order to obtain a quotation. They may be able to access a number of prices using an electronic marketplace on the Internet, and transact simply through 'pointing and clicking'. For complex products, where sales advice is useful or even obligatory, it may still be necessary to contact an institution.


Global Spread of Markets
Electronic markets, mergers between exchanges, and the increasing ease of international communication have all increased the ease of overseas investing. Cross-border capital flows are ever-increasing; USD 10 trillion is one estimate of such flows in 2007, estimated to be triple the 1997 amount. 20% of all equities and 25% of all bonds are probably held offshore.* As agents make choices between transactions across asset classes and jurisdictions, they increasingly focus on the relative values offered in different markets.

Furthermore, market observers have identified a tendency for market values in different markets to be closely correlated, as the 'risk appetite' of international investors changes. When the 'risk appetite' is high, investors are more willing to purchase assets that are perceived as being 'riskier'; they are happier taking on credit risk, or investing in less-developed markets. If the risk appetite falls, there is a 'flight to quality'; the prices of 'safe' assets, such as government bonds, increase relative to these riskier assets. Consequently there is an association between price changes in quite different markets; a general fall in the level of a less-developed stock index might be associated with a fall in the level of corporate bonds.

Many investment banks attempt to measure this association through various 'risk appetite indexes'. However, correlation and association have historically proven difficult to quantify, though the qualitative issues seem clear-cut. There have been a number of occasions in the past when previously distinct markets have exhibited a clear correlation in price behavior.