Book Reviews, Terminology

Book Review of An Introduction to Trading in the Financial Markets by R. “Tee” Williams

I picked up this book because it contained some materials about trade processing (e.g. clearing and settlement). I have always been curious as to the nitty-gritty details of clearing and settlement, and it is one area that I would like to know more about if I have the time.

This is a pretty high book and is the 1st book in a series of 4 books. This 1st book is meant more as an overview book while the other 3 books goes into more detail. Book 2 would detail more on the process, markets and instruments, Book 3 on trading systems, data and networks, Book 4 on risk, compliance and regulation.

I did understand more about some areas from the book, mainly on the function of clearing, bank’s custodian function, and the overview structure of sell-side organizations.

Overall, this is a decent book for someone new to the financial markets to understand the players, processes, and structures that makes the markets work. The book is filled with lots of graphics and reads somewhat like a textbook of sorts. I suppose that would be the case since it is published by Academic Press.

The Trading Process

  1. Pre-trade decision
    • Trade decision made by portfolio manager / investor, specifying number of shares and price range.
  2. Buy-side order management
    • Buy-side trader manages the execution, deciding on where to place the orders.
  3. Order routing
    • Broker/dealer routes the order to a market center.
  4. Execution
    • Order is matched in a market center or with a dealer.
  5. Trade confirmation
    • Buyer and seller are notified of the price and quantity. Buyer must provide acceptable funds to the intermediary, and seller must provide instructions for transfer of the security.
  6. Trade allocation
    • If a broker/dealer made multiple executions to fulfill an order, the broker/dealer calculates an average price and allocates the specific number of instruments to each account.
  7. Clearing
    • Between execution and settlement, if the trade details recorded by the buyer’s broker/dealer and the seller’s broker/dealer are different, these differences are resolved. Any issues prior to settlement are addressed in the clearing process.
    • A clearing corporation would guarantee the successful settlement of the trade to the buyer and to the seller.
  8. Settlement
    • Buyer through the intermediary’s cashier department, delivers good funds to the seller.
    • Seller presents proof of ownership in a form that can be transferred to the buyer for settlement, usually through a department in the seller’s intermediary known as the cage (i.e. making good delivery). The Seller’s securities movement and control department will need to interact with its custodian bank to give instructions to transfer the securities, after affirming the details of the trade.
    • This also occurs at the clearing corporation at the appointed time on the settlement date. The clearing corporation establishes the standard time, rules, and standards for good funds and good delivery.

Buy Side

  • Nonfinancial companies
  • Retail investors
  • Institutional investors
    • Investment counselors
    • Mutual funds / unit trusts
    • Trustees
    • Pension funds
    • Insurance companies
    • Hedge funds

Sell Side

  • Brokers
    • Retail
      • Introducing firms are retail brokers that do not perform their own processing for customers, securities, or both. They use the services of a correspondent broker/dealer.
      • Day-trading firms
    • Institutional
      • Agency brokers help trade very large orders (i.e. blocks) and other orders where the investing institution is interested in keeping costs low and/or the order quiet.
      • Prime broker is a firm that provides execution services for institutional investors, and also consolidate trades done through other broker/dealers. They provide order management systems and risk management services.
  • Dealers
    • Retail
      • Retail dealers that are not also brokers, are mainly limited to fixed income.
    • Institutional
      • Market makers
      • Wholesalers act as dealers for other broker/dealers for their own business objectives, by carrying inventory of securities from which the other firms can buy or sell.
      • Investment banks (dealers when holding securities during underwriting)
      • Merchant banks and private equity firms
      • Venture capital firms
  • Broker/Dealers
    • Retail
      • Full service firms that provides research, asset management and trading services.
      • Discount brokerages providing electronic access.
    • Institutional
      • Correspondent firms are broker/dealers whose primary business is to provide services to other broker/dealers. They provide only the securities processing services or customer accounting or both.


  • Exchanges with broker/dealers as members.
  • OTC dealers
  • Interdealer brokers, registered as brokers to facilitate trades among other dealers so that their identities are masked.
  • Alternative Trading Facilities / Alternative Trading Systems (e.g. ECNs – Electronic Communications Networks in U.S., and MTFs – Multilateral Trading Facilities in Europe)

Revenue sources for Market Centers (in order of magnitude from largest to smallest)

  1. Trading fees
  2. Clearing and settlement fees
  3. Market data fees
  4. Listing fees
  5. Technology
  6. Other

Support Organizations

  • Clearing corporations
    • Serve to ‘insure’ transactions between the time the trade is complete to the point when funds are formally exchanged for the securities on settlement.
    • Charge fees for all transactions they process, and income on the float of funds left on deposit overnight at the clearing corporation and margin funds posted.
  • Depositories
    • Warehouse and manage the official ownership records of instruments. Permits the transfer of ownership by bookkeeping entries rather than physical movements of certificates, and physical registrations of securities certificates (i.e. the securities are immobilized or dematerialized).
    • Depository maintains a master list of which person or entity owns all traded instruments.
    • Charges fees for services, and profit from dividend and interest payments that the depository holds for extended periods when the beneficial owner of securities cannot be identified.
  • Banks
    • Warehousing and custodian
      • Provide warehousing or custodian services for the securities owned by buy-side entities. Serves as the ‘depository’ prior to the creation of central depositories.
      • With depositories, banks are one-step removed, i.e. the banks hold accounts at the depositories, and the depositories record the banks as holding the securities. When a security is purchased or sold, positions in the depository switch from the seller’s bank to the buyer’s bank. The bank maps its total holdings to the actual ownership by its customers (can be institutional investors and broker/dealers).
      • Banks can serve as the intermediary between the broker/dealer and the depository.
      • Custodian banks instruct depositories to initiate changes in ownership; to separate or segregate securities for special purposes, such as collateral for a loan; and to collect payments for customers from interest and dividends.
    • Trustee
      • Act as trustee for corporate securities, monitors that the covenants in the instrument agreement are maintained.
      • Hold securities in trust to enable trades of derivative securities (e.g. American Depository Receipts, or options on underlying securities held in trust in the bank).
    • Financing
      • Lend funds to broker/dealers to support their trading positions and capital requirements.
    • Securities lending
      • Bank acting as custodian may furnish securities to be loaned, provided the owner of the position grants the bank permission. This can generate interest revenue for the owner of the position and fees for the bank.

Buy Side Organization Structure

  • Front office
    • Account management, portfolio management, sales and marketing, research, and trading
  • Middle office
    • Customer accounting and compliance
  • Back office
    • Securities valuation, securities movement and control (affirms trade details, instruct custodian bank to transfer securities, ensure funds are prepared for settlement), and regulatory accounting.

Sell Side Organization Structure

  • Front office
    • Broker services
      • Sales traders may help to select where to send the order, or “shop” an order to other customers using a special message type known as an indication of interest (IOI).
    • Dealer services
      • Position traders are responsible deciding what positions to take for the firm and determines prices at which the firm is prepared to buy or sell.
      • A treasury department manages the capital required and excess capital for its operations.
    • Investment Banking
      • Underwriting, syndication, and financial engineering to develop new products.
  • Middle office
    • Customer-side processes
      • Maintain positions held in customers’ names including all changes due to valuation and corporate actions.
    • Compliance
      • Retail customer protection rules, and best execution for institutional clients.
  • Back office
    • Purchases and sales
      • Receive all trade reports from markets, match all orders from customers and internal accounts with the trade reports, resolve difficulties with the execution, reconcile differences of trade details between buyer and seller, ensure customer has provided funds or instructions necessary for settlement or make  alternative arrangements.
    • Cage
      • Control securities positions that must be delivered during the period prior to settlement (for sales) and receiving securities positions following settlement (for purchases). Manage segregated securities pledged for loans and other purposes, arrange for securities that must be borrowed or that are available for loan, and manage customer holdings maintained in street name or in customer’s name but managed by the firm.
    • Cashier
      • Manage the cash funds required for securities settlement, manage cash and short-term securities demanded to meet margin calls from an exchange or clearing corporation.
    • Position accounting and risk management
      • For dealers, performs accounting for positions created so to manage the firm’s capital and control risks. Supports the treasury function and position trading.



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