BKM CHAP 3
CHAPTER 3: HOW SECURITIES ARE TRADED
2. Who sets the bid and asked price for a stock traded over the counter (OTC)? Would you expect the spread to be higher on actively or inactively traded stocks?
OTC stock markets are dealer markets (as opposed to “exchange markets” like the NYSE). In dealer markets, the dealer buys the asset from the seller and then holds the assets until he or she is able find a buyer. The dealer’s profit comes from buying at the bid and selling at the ask. The difference between the bid and ask is called the spread. Since all transactions are between sellers and dealers or buyers and dealers, the prices are set by the dealers.
Active stocks will have more dealers. To compete for business, dealers will decrease the profit margin and therefore quote smaller (tighter) spreads. Spreads will be larger for inactively traded stocks and smaller on actively traded stocks.
3. Suppose you short sell 100 shares of IBM, now selling at $120 per share.
(a) What is your maximum possible loss? Potential losses from a short position are unbounded, since the price can go infinitely high. (b) What happens to the maximum loss if you simultaneously place a stop-buy order at $128?
The stop-buy order (also known as a “stop-loss buy order to go flat”) becomes a market buy order if the stock trades at or above $128. If the order is filled at $128, the maximum loss per share is $8. If the price of IBM shares goes above $128 before it is filled, the loss would be greater.
4. A market order has:
The answer is (a) – Price uncertainty but not execution uncertainty.
A market order is an order to execute the trade immediately at the best possible or current market price. An advantage is immediate execution. The disadvantage is that the price at which it will be executed at is not known ahead of time (price uncertainty).
5. Where would an illiquid security in a developing country most likely trade?
Given these three choices, the
2. Who sets the bid and asked price for a stock traded over the counter (OTC)? Would you expect the spread to be higher on actively or inactively traded stocks?
OTC stock markets are dealer markets (as opposed to “exchange markets” like the NYSE). In dealer markets, the dealer buys the asset from the seller and then holds the assets until he or she is able find a buyer. The dealer’s profit comes from buying at the bid and selling at the ask. The difference between the bid and ask is called the spread. Since all transactions are between sellers and dealers or buyers and dealers, the prices are set by the dealers.
Active stocks will have more dealers. To compete for business, dealers will decrease the profit margin and therefore quote smaller (tighter) spreads. Spreads will be larger for inactively traded stocks and smaller on actively traded stocks.
3. Suppose you short sell 100 shares of IBM, now selling at $120 per share.
(a) What is your maximum possible loss? Potential losses from a short position are unbounded, since the price can go infinitely high. (b) What happens to the maximum loss if you simultaneously place a stop-buy order at $128?
The stop-buy order (also known as a “stop-loss buy order to go flat”) becomes a market buy order if the stock trades at or above $128. If the order is filled at $128, the maximum loss per share is $8. If the price of IBM shares goes above $128 before it is filled, the loss would be greater.
4. A market order has:
The answer is (a) – Price uncertainty but not execution uncertainty.
A market order is an order to execute the trade immediately at the best possible or current market price. An advantage is immediate execution. The disadvantage is that the price at which it will be executed at is not known ahead of time (price uncertainty).
5. Where would an illiquid security in a developing country most likely trade?
Given these three choices, the