J. Describe how securities, contracts, and currencies are traded in quote-driven markets, order-driven markets and brokered markets.

Question 1

securities markets are “driven”

Answer 1

Quote-driven: Investors trade with dealers that maintain inventories of securities, currencies, or contracts.

Order-driven: Order-matching and trade-pricing rules are used to match the orders of buyers and sellers.

Brokered: Brokers locate a counterparty to take the other side of a buy or sell order.

Question 2

Trading Sessions

Answer 2

Call markets gather all trade to a single
point in time and place.
– Liquidity is easy to find when the market is
called.
securities are only traded at specific times

• Continuous markets allow traders to
arrange trades whenever they can find
counterparties (while the market is
open).
– Convenient, but often difficult to find
counterparties.
trades occur at any time the market is open.
Continuous markets are markets where trades occur at any time the market is open (i.e. they do not need to be open 24 hours per day). Setting one negotiated price is a method used in major continuous markets to set the opening price.
In continuous markets, the price is set by either the auction process or by dealer bid-ask quotes.

Question 3

Quote Driven Markets

Answer 3

Investors trade with dealers that maintain inventories of securities, currencies, or contracts.

• Dealers provide liquidity to their
clients.
– The dealers quote prices.
• Brokers contact dealers to arrange
trades for their clients.
• Most fixed income and many contracts
trade over-the-counter (OTC) in quote driven
dealer markets.

In a quote-driven market, customers trade with dealers at bid and ask prices set by the dealers.

Question 4

Order Driven Markets**

Answer 4

Order-matching and trade-pricing rules are used to match the orders of buyers and sellers.

• Most exchanges are order driven
markets.
• Traders submit orders to the market.
• The market separately sorts the buy and
sell orders using its order precedence
rules.
– The primary precedence rule is price priority.
– Secondary precedence rules rank orders at
the same price.
– Examples: Display, time, and size
precedence.

• The market matches the highest
ranking buy orders to the highest
ranking sell orders.
• The process continues until all
matches that can result in trades occur.

• The matches are priced using the
exchange’s order pricing rules.
• The uniform pricing rule is used for a
single price auctions.
– A single price for all trades.
• The discriminatory pricing rule is used
for continuous trading.
– The standing limit orders and quotes
determine the trade prices.

In an order-driven market, buy orders and sell orders are matched up by the exchange according to order matching rules

Question 5

Brokered Markets

Answer 5

Brokers locate a counterparty to take the other side of a buy or sell order.

• Brokers help buyers find sellers and
vice versa.
• The dominant market structure for
extremely large trades or instruments
that dealers are unwilling to trade
because they are too risky or too
expensive to hold in inventory.
– The natural must find the natural.
• Real estate is generally a brokered
market.

Brokered markets are typically the best market structure for unique items. A broker adds value by locating a counterparty to take the opposite side of a trade of such an item.

In a brokered market, brokers organize trades among their clients.