FTS Markets

We restrict attention to the a base set of standard cases below from a teaching perspective to illustrate the general principles behind this trading approach to learning finance theory.  It is recommended that the first trading session be aimed at understanding how markets work from an operational perspective.  For example, the standard cases are all order driven continuous double auction markets.  Globally, the initial difficult problem that faces the trading crowd is the distinction between making market (posting bids to buy a specified quantity or asks to sell some specified quantity) and market taking (buying from an ask or selling to a bid).  As a result, it is recommended that either the first trading session, or in a prior laboratory session, that a trading case with no uncertainty and basic securities trading (e.g., a coupon bond and a zero coupon bond market) is a good starting place for learning the operational features associated with trading in the FTS markets.  This lets students become acquainted with the price discovery problem in a relatively transparent world.

Note:  In each of the cases below no restrictions are placed on any member of the trading crowd.  They can be both market makers and/or market takers.  A subset of the trading crowd will naturally start specializing in market making activities and managing their book.  These traders often perform at above average trading levels.

Finally, by letting the trading crowd trade in repeated independent trials allows all participants to go down the learning curve in relation to each case's teaching objectives.  Some instructors find it useful to let students trade a few independent trials first to let markets settle down and spreads narrow.  Then the market can be paused so that important teaching concepts are introduced and related to closing prices.  Then again continue the markets for another few trials again so that traders can trade guided by important concepts just introduced.   Finally, a general discussion of trading and reinforcing the concepts should be conducted. In this way the trading crowd learns important concepts from personal trading experience.

The base fixed income cases are the "B0" series.  B01 starts with no uncertainty and a flat yield curve (i.e., spot rates equal future spot rates) so the trading crowd can become comfortable with using the system.  B02 stays in a world without uncertainty but introduces future spot rates that do not equal the future spot rates.  In addition, a richer set of cross market relationships is present by opening both a coupon bond market and a complete set of zero coupon bonds.  B02A is the same as B02 except that the future spot rates are uncertain and private information about the future realization is sprinkled around the trading crowd.  Now the issue regarding to what extent do fixed income prices reflect this information is also present.  B02A is a very dynamic and interesting case for students once they have become acquainted with the fundamentals of the setting from B02.

In B03 and B03A the B02 environment is extended to consider both spot and forward rates of interest.  Two forward markets are open in addition to the coupon and zero coupon bond markets that are open in B02.  B03 has no interest rate uncertainty and B03A has both interest rate uncertainty and private information.  A side issue here is whether opening a forward market enhanced the informational efficiency of the markets.

Variations:  In the base cases all trading is performed in decimal prices.  However, an important variation is to introduce real world quotation basis for the fixed income securities.  Trading in the FTS markets can be conducted using either decimal quotations (recommended for initial markets) or trading using the real world quotation basis (see online manual).

The base equity cases are the "RE" series.  RE1 starts with dividend uncertainty defined over two periods, private information, short selling permitted and permits borrowing and lending at a zero risk free rate of interest.  Teaching objectives behind RE1 are two fold, the dividend model of a stock's intrinsic value and the efficient markets hypothesis.  RE2 extends RE1 by introducing an additional set of no arbitrage restrictions and RE3 builds upon this theme by opening option markets designed to introduce both option trading strategies plus some important basic no arbitrage restrictions.

The RE base series has proved to be both popular trading exercises plus let students become acquainted, from personal trading experience, with some of the fundamental concepts in finance theory.

The base option pricing cases are the "OP" series.  This series puts the trading crowd into the simple binomial world where the underlying asset price can either go up or down each period.  This world provides an ideal environment for learning about modern derivative pricing theory from a trading approach.  It is useful for students being introduced to option pricing in an introductory course as well as to students who have had previous traditional option pricing courses.

OP1 starts with a one period world.  The underlying stock price is exogenous and traders can buy or sell at the exogenous stock price.  However in all other markets there is price discovery.  These markets are a call and put option with the same strike price and a zero coupon bond market.  As a result, a rich set of no arbitrage restrictions are endogenous to the setting.

OP2 extends the OP1 world to two periods and changes the option markets from European to American.  Now traders can consider the early exercise decision.  In OP3 the important concept for modern risk management, delta hedging, is introduced.  This is a three period binomial world and the trading objective is to protect the down side risk of a non tradable position by trading in the markets where trading is permitted.  This important case focuses attention on the trading implications of the riskless hedge insight employed by Black Scholes and Merton when solving the option pricing problem.

The base option forward pricing cases, for non interest rate forwards (see B03 for the latter) are the "IN" and "FX" series.  These cases permit the important cost of carry approach to arbitrage free forward pricing to be learned from personal trading experience.  In these cases there is simultaneous price discovery in both the underlying asset market and the forward market.  In addition, students must face the bid/ask spreads posted by the market makers in the trading crowd.  As a result, important concepts such as "cash and carry" and "reverse cash and carry" arbitrage relationships are endogenous to the setting.

In "IN1/IN2" a stock index and stock index future market is open.  The difference between IN1 and IN2 is again no private versus private information.  The purpose of IN1 is to first master the concepts behind arbitrage free forward pricing theory.  IN2, by introducing private information (private news headlines) creates a richer and more dynamic trading setting for applying the theory to.

In "FX1/FX2" the same applies as discussed with IN1/IN2 except that now the important Covered Interest Rate Parity relationship that links exchange rates and interest rates is the teaching objective.  In this market both spot and forward exchange rate markets are open as well as zero coupon bond markets in each country.  This is a useful case series for an international finance course.

The base cases here are the CA series.  In the base series the investment objective is to manage the risk and return of a position in stocks.  The parameters are such that CAPM theory can be applied to interpret the trading behavior in the case. 

Specific details for these cases are provided in the Instructor Help section online.

The base cases here are the ST and XR series.  The underlying asset price process follows the geometric Brownian motion assumed by Black and Scholes.  Students when trading in these cases can use the online support system provided (Excel spreadsheets that can be downloaded from the Virtual Classroom).  The FTS trader when linked to these support systems provide real time feedback on the "Greeks" (i.e., position delta, gamma etc.,) as well as implied volatility information applicable.  The case can be used to learn about both risk management techniques as well as applying option trading strategies designed around a view that can be formed from the case write-ups.

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