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FINA5524: Trading and Markets

Sample Final Exam

MULTIPLE CHOICE. Choose one alternative that best completes the statement or answers the question. Mark your selection on the Multiple Choice Answer Sheet. THIS SECTION IS WORTH 20% OF TOTAL MARK.

1. Which of the following statements regarding transaction cost measurement is true?

A. The gaming problem can be avoided by averaging across many transactions.

B. All estimation methods produce noisy results when applied to single trades.

C. It is not possible to obtain negative transaction cost estimates.

D. Both A and B.

E. All of the above.

2. Transaction costs measured relative to some benchmark may be systematically high or low depending on whether the investor pursues momentum or contrarian trading strategies. Which of the following statement/s is/are true?

A. Investors pursuing contrarian trading strategies are more likely to underestimate their transaction costs when the opening price is used as the benchmark.

B. Investors pursuing contrarian trading strategies are more likely to overestimate their transaction costs when the volume weighted average price is used as the benchmark.

C. Investors pursuing momentum trading strategies are more likely to underestimate their transaction costs when the opening price is used as the benchmark.

D. Both A and B.

E. All of the above.

3. Empirical studies have documented investors’ reluctance to sell their under-performing stocks.  Which of the following behavioural bias can be used to explain this?

A. Anchoring effect

B. Endowment effect

C. Hindsight bias

D. All of the above

E. None of the above

4. Which of the following statement is true?

A. Self-attribution bias can lead to overtrading and an undiversified portfolio.

B. Overconfident traders can overreact to private information and underreact to public information.

C. Overreaction to information can lead to stock price reversal in the intermediate term.

D. Both A and B.

E. All of the above.

5. Brown and Warner (1980, 1985), in their classic studies of event study methodologies, suggest three models of normal returns.  Which of the following model is not suggested in their studies?

A. Market and risk adjusted returns

B. Mean adjusted returns

C. Three-factor risk adjusted returns

D. Market adjusted returns

E. None of the above. 

6. You observed two weeks of market close prices for stock XYZ.  Assuming there is no public holiday in those two weeks, what is the expected number of price runs in this price sequence?

A. 4

B. 5

C. 6

D. 7

E. None of the above.

7. One trading algorithm to buy 10,000 shares of stock XYZ can be represented with the following pseudo-code:

for timer = 1 to 10;

quantity = 1000;

trade(quantity);

pause(10 minutes);

end;

Which of the following statement can be used to specify the trade( ) function?

A. Place limit orders.

B. Dynamically choose the optimal order type based on market conditions

C. Place market orders.

D. Both A and B.

E. All of the above.

8. Which of the following statement is false in regards to pairs trading?

A. Pairs trading strategies involve taking same positions in two different securities with strong positive returns correlations.

B. When conducting a pairs trading strategy, traders anticipate that the deviation of a recent pricing relation between two securities is permanent.

C. Holding periods for most pairs trading strategies are usually short-term, ranging from minutes to days.

D. Both A and B.

E. All of the above.

9. Suppose we are in November.  You expect a big swing in the market before the next Federal Open Market Committee (FOMC) meeting in December and you want to bet on the rising volatility.  Which of the following strategy does not fit in your proposal?

A. A short strangle using S&P 500 index options

B. A short position in VXX

C. A short position in VIX futures

D. Both A and B.

E. All of the above

10. In the study of financial data, a stylized fact is a feature that is consistent enough to be generally accepted as truth.  Which of the following stylized facts is true for volatility?

A. Volatility and returns have a negative correlation and this effect is symmetric.  

B. Volatility and volume have a strong negative relationship.

C. Volatility tends to mean-revert.

D. Both A and B.

E. All of the above.

THIS SECTION CONTAINS FIVE (5) QUESTIONS WORTH 80% OF THE TOTAL MARK.  

11. Assume that you are a portfolio manager at Challenger Fund. You have just concluded a portfolio strategy meeting with your team of analysts and decided to sell down the stocks in Trouble Some Mining (TSM). You observed that the share price of TSM was $5.50 at the close and decided to place a sell order with your trader at MacQuary Equities (ME) for 1,000,000 shares with a limit price of $5.25. Your trader at ME was instructed to find the best way to execute your order. The market opened the next day at $5.45 and the following table contains the trades that were executed in the market for the entire day. The trades carried out for you are marked with the indicator ME.   (20 marks)

a) Compute and discuss the ME trader’s performance using the volume-weighted average price as a benchmark. (6 marks)

b) Compute and discuss the ME trader’s performance using the implementation shortfall method. The brokerage cost including all explicit fees is $0.01/share. (8 marks)

c) As a trader for a large hedge fund that uses momentum strategies in small cap stocks, your end-of-year bonus is awarded based on your trading performance. Your manager is considering which of the two previously mentioned benchmarks to use to determine your performance. Discuss how the two methods could affect the outcome of your bonus. (6 marks)

12. Kyle (1985) developed a theoretical model that describes the trading behaviour of traders in a one-period single price auction model. (15 marks)

a) Describe the three trader types in Kyle’s (1985) model. (3 marks)

b) When deciding to place an order to trade a stock, an informed trader has to make a number of choices. The theoretical results of Kyle (1985) appear to only assist us in studying one aspect of their decision, i.e., size of the order. Discuss the other choices that an informed trader will have to make and what you would expect to observe by extending Kyle’s model. (6 marks)

c) During the September holidays in 2016, you decided to extend the knowledge that you acquired in the trading unit, FINA3307, by enrolling in an online course with the trading outfit Headtrader. After paying the exorbitant fee of $3,000, you received your course package via email and you sat down to review the material.

In the “Market trends and patterns” module, you came across a graph showing how the trading volume and bid-ask spread varied throughout the day. The trading volume and the quoted bid-ask spread both show a reverse J-shape pattern, as illustrated in the Figure on the left. The patterns appear at odds with what you know about the relationship between trading volume and spread.

 

Discuss what you expected to find with regards to the relationship and describe how the patterns might be consistent with theory. (6 marks)

 

13. In a release dated July 8, 2003, the Australian Securities and Investments Commission (ASIC) banned Sydney securities dealer Mr Hamish Philip McRae Watson from acting as a representative of a dealer, investment adviser, futures broker or futures adviser, for three years. Mr Watson was banned as a result of ASIC’s ongoing investigation into Harts Australasia Ltd (Harts), a formerly listed public company. ASIC’s investigation into Mr Watson focused on trading in Harts shares and his involvement in the acquisition by Harts of the Sydney funds manager Cardinal Financial Securities Ltd (Cardinal) in 2000. ASIC found that in late 2000, Mr Watson, via two private companies associated with him, Blackshort Pty Ltd and Watson Benefit Services Pty Ltd, engaged in washed trades or matching orders. As a result of these findings, ASIC banned Mr Watson on the grounds that he had not performed his duties as an authorised representative, efficiently, honestly and fairly. (8 marks)

a) What are wash trades? Explain the roles the two private companies, Blackshort Pty Ltd and Watson Benefit Services Pty Ltd, would have played in the manipulation. (4 marks)

In a release dated November 5, 2001, the Securities Exchange Commission (SEC) in the US announced in a litigation release an action against Israel Shenker. In the announcement, the SEC provided the following example of a series of transactions executed by Shenker:

14:44:44 - Shenker placed an order to buy 500 shares of the target security at $34.0625, and directed that it be routed to the ECN. The order raised the NBBO bid price from $31.50 to $34.0625.

14:44:46 - Shenker entered a limit order to sell 500 shares of the target security through SOES at a price of $34.0625, and the order was immediately executed.

14:44:48 - Shenker cancelled his buy order, causing the NBBO bid price to drop from $34.0625 to $31.25.

By manipulating the public quote to obtain a better execution price for his 500-share sell order, Shenker was unjustly enriched in the amount of $1,281.25 (Securities and Exchange Commission, 2001).

b) What is the name of the type of market abuse alleged by the SEC? Explain the purpose of each order used in the strategy. (4 marks)

14. Consider the following stock price sequence:

Day	1	2	3	4	5	6	7
Price	25	27	26	28	24	29	30

(12 marks)

a) Based on the table above, compute the five-day moving averages for days 5, 6 and 7.  If you assume that the five-day moving average price represents the true value of the stock, should you buy or sell shares on days 5, 6 and 7? (4 marks)

b) Using a dataset comprising the entire history of closing prices for this stock, your analysis reveals the stock realised 198 runs in each series of 900 closing prices.  You find the magnitude of the decline is similar to the previous day’s increase, and vice versa.  You believe the result of the runs test is statistically significant and that this relationship between closing prices and prior day closing prices will prevail in the future.   Assume that you will trade for short term profits if you are able to forecast one-day returns, explain what you should do at the open on days 6 and 7?  (4 marks)

c) If you are a trend follower, what is your view of market efficiency?  Discuss how you could prove that the market is inefficient or efficient in this form.  (4 marks)

15. Suppose that you were to perform an experiment on university students to determine whether they prefer to have coffee mugs or money. You plan to use a large representative sampling of individuals and endow half of the participants in your experiment with coffee mugs and then ask those to whom mugs were given what would be the lowest price at which they would sell. Those subjects who were not given mugs were asked how much they would pay for a mug (9 marks)

a) If student participants are rational and consistent in their preferences, how should purchase prices differ from selling prices? (3 marks)

b) Assume that the endowment effect described by Kahnemann and Tversky is true for individuals. How should purchase price differ from selling prices? (3 marks)

c) What would be the relevance of this type of experiment to stock markets? (3 marks)