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RITCaseBriefAT1VWAP

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133 views3 pages

RITCaseBriefAT1VWAP

fin 448

Uploaded by

sean
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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RIT Case Brief – AT1

Agency Trading 1 | © Kevin Mak and Tom McCurdy, 2012 build 1.01

It’s 7:00 AM and you’ve just come into the office where you’re a trader for Jennings Global. The sales
call wrapped up a few minutes ago and the Sales team from your S&T desk has been busily calling
their clients relaying research, trading ideas, and market chatter to the different pension fund and
hedge fund clients.

Based on M&A activity from the past 6 months, your firm is recommending that their clients should
buy shares of TNX Corp. due to attractive valuation and the possibility of a takeover offer coming in
the next few months. You are expecting to get a fair number of orders to purchase shares for your
clients this morning.

In order to prepare for this, you’ve decided to pull up the historical intra-day trading volumes for
the stock over the past three weeks. Summarizing and averaging the data into 10 minute segments,
you generate the following graph:

1,200,000
Intraday Average Trading Volume for TNX
1,000,000 (10 minute intervals)
800,000

600,000

400,000

200,000

0
9:40 10:40 11:40 12:40 13:40 14:40 15:40

Average daily volume: 12.36 million


- Excel Data Available at: http://rit.rotman.utoronto.ca/cases.asp

It’s 8:15 AM and your sales team has concluded some very productive calls. They’ve got client
orders to purchase a total of 100,000 shares of TNX Corp. The instructions are to purchase shares

1
throughout the day and your clients will measure your execution skill based on the fill1 that you
assign them versus the daily VWAP of TNX.

Agency Trading Simulation #1 – AT1

Using the Rotman Interactive Trader (RIT) software, accumulate a position of 100,000 shares of
TNX Corp. using only market orders. Your goal is that your total weighted average cost of the
position is less than the VWAP for all TNX trades that occur throughout the simulation. The trading
simulation is designed such that an entire day of trading will occur over a 10 minute (real-time)
trading period.

TNX shares will begin trading at a price of $25.00. Each time the 10-minute case is run, a new
random-walk will be generated. During the simulation, programmed liquidity traders (ANON) will
buy and sell shares to force the market clearing price to approximately follow that path. Your
transactions will have a small effect on the market price, but the relative size of the ANON trades
will be very large relative to those from human traders. That is, the latter are participating in a very
liquid market so that, in this case, their trades just have a small effect on the market clearing prices.

Important Note
Please note that the portfolio window on the RIT Client shows both the market VWAP and your
VWAP. The market VWAP is reported in the second column from the right; while your VWAP will be
shown in the “Cost” column. For example, in the screenshot below the market VWAP is $25.16
(VWAP column) while your VWAP is $25.25 (Cost column).

Discussion Questions and Follow Up:

(1) How does your average cost compare to the market average cost? What is the optimal
strategy to employ so that your average cost is close to the average cost of the market?

(2) What if you were to buy all 100,000 shares in the first minute? What is the likelihood that
your average cost would be near the VWAP for the day? Assuming the market follows a
random walk that does not trend up or down, what is the likelihood that you will be lower
(or higher) than the daily VWAP.

(3) How will your hedge fund and pension fund clients react when you report their fills as being
better or worse than the daily VWAP?

(4) Trade the same simulation but this time, purchase shares only by submitting limit orders
into the limit order book. What are the differences between using limit orders versus using
market orders?

1
A “fill” is the number of shares, and average price of those shares, that an agency trader executed for their client.
i.e. “I spent the whole day buying shares for you, your fill is 1 million shares at an average price of $24.87

2
(5) A simpler execution strategy is called a Time Weighted Average Price “TWAP” which
involves buying an even number of shares at even intervals (i.e. 5000 shares every 30
seconds). What is the disadvantage of a TWAP vs VWAP order?

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