Market Organization and Efficiency

Question 1

3 Functions of Financial System

Answer 1

1) Funding for companies, manage risk, exchange info
2) Determine return that balances savings and borrowings
3) Efficient allocation of capital

Question 2

Financial Intermediaries

Answer 2

1) Brokers, exchanges, trading systems connect buyers and sellers at same time and location
2) Dealers match buyers and sellers at different points in time
3) Arbs connect buyers and sellers at same time but different location

Question 3

Margin Transactions

Answer 3

Leverage = Asset/Equity

All Cash Return x Leverage factor when LF = 1/Initial margin %

Return on margin = Increase in value - costs)/(Initial funds invested - costs)

Return on margin net of costs = ((SP - Margin $ amt)/Margin $ amt) - 1

Margin call price = Purchase price x (1-initial margin/1-maintenance margin)

Question 4

Execution, validity, and clearing instructions

Answer 4

Execution = how to trade (market vs. limit)

Validity = when to trade (day, GTC, and stop orders)

Clearing = how to settle a trade

Question 5

Limit and Stop Orders

Answer 5

Limit order to buy = placed below current market price

Limit order to sell = above current MP

Stop order to buy = above market price

Stop order to sell = below MP

Stop order becomes a market order if the price is hit

Question 6

Market Trading Types

Answer 6

Quote-driven: investors trade with dealers that maintain inventories

Order-driven: order-matching and trade-pricing match buyers and sellers

Brokered: brokers locate counter party to take other side of the trade

Call market = securities only trade at specific times

Question 7

Objectives of market regulation

Answer 7

Protect unsophisticated investors.
Establish minimum standards of competency.
Help investors to evaluate performance.
Prevent insiders from exploiting other investors.
Promote common financial reporting requirements so that information gathering is less expensive.
Require minimum levels of capital so that market participants will be able to honor their commitments and be more careful about their risks.

Question 8

Behind the Market

Answer 8

Limit buy is behind the market when limit price is below the best bid

Limit sell is behind when the limit is above the best bid

Market orders are never behind the market

An order is inside the market when it is in between the best bid and the best ask