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Electronic Trading: Technological Comparisons and Special Considerations

Electronic Trading: Technological Comparisons and Special Considerations

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A term paper written for an International Finance Course. Finance isn't really my thing, but the course was interesting, and the IT aspect made it much more so.
A term paper written for an International Finance Course. Finance isn't really my thing, but the course was interesting, and the IT aspect made it much more so.

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Published by: Apostolos Koutropoulos on Apr 15, 2010
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Apostolos KoutropoulosMBA AF 626 Term PaperInternational Financial ManagementDecember 15, 2006Topic:Electronic Trading: Technological Comparisons andSpecial Considerations
 
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Electronic Trading: Technological Comparisons and Special Considerations.
The Internet and Information Technology (IT) have been major forces in everyaspect of our lives. These two have touched and altered the way that we go about our day-to-day lives, how we get information and even how we conduct business. Financialtrading is no exception; it too has been changed by the connectedness, efficiencies, andwealth of information that the Internet and IT provide.In this paper I will discuss some of the historical background of foreign exchange(forex) trading how it developed, some of the pros and cons of the different models of electronic trading, as well as some of the pros and cons of electronic trading in general ascompared to traditional trading. There are a few considerations that come in mind whenone compares an electronic medium of exchange to a physical medium where twohumans interact. There are definite pros and cons associated with electronic forex, whenone compares electronic forex with conventional “open-outcry” systems that are in placenow.The pros of electronic forex systems deal mostly with efficiency and improvedcapability over non-electronic, face-to-face systems of exchange. Electronic forexsystems are not location based like traditional forex systems. One does not need to be at aspecific place at a specific time in order to benefit from forex. Electronic forex systemscan function twenty four hours a day, in many markets internationally. In contrast,traditional forex consists of national markets that do not necessarily speak to foreignmarkets and are only open for a specified amount of time per day.Additionally, because of their electronic nature, there is a noticeable reduction inerrors, errors inherent in human-to-human communication. Electronic systems providePage 2 of 13
 
two more security features that are usually not inherent in traditional markets: auditingand monitoring. In traditional forex markets there is no audit trail per se, therefore dealsmight or might not be effectively executed, and there is little recourse, other that the goodreputation of the bank. Electronic forex systems also provide monitoring services.Gallaugher provides us with an example of a rogue trader that worked for the Allied IrishBank that managed to accumulate $619 million in losses before he was discovered.Electronic forex systems would be able to have prevented this abuse with their built-insafeguards.There are of course cons to electronic forex systems. The top three consassociated with electronic forex systems include system failure, reduction of margins, anddelays in cancellation of execution of orders. First, reduction of dealer margins is themain non-technical downside of electronic forex systems. Reduction of dealer marginscan result in fewer dealers entering into the market, which in turn might affect the qualityof service provided by those dealers that remain.The two other downsides of electronic forex systems are a consequence of thesystem’s electronic nature. First, are inherent system failures such as power-loss, lack of expansion space, and computer crashes. Traditional forex methods are not troubled by power loss or system failure, and if there is a surge of orders, human counterparts candeal with a momentary spike in orders. In contrast, computers that might receive thatspike in forex activity, might not be able to adequately process those orders, thus either not executing the orders that were submitted, or malfunctioning to the point that it alsocorrupts records from previous orders that were in the system. One last con is that there isa limitation of the system appears to be that there is a delay in the processing of Page 3 of 13

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