Price Transparency And Liquidity

Question 1

What are the two types of price dissemination?

Answer 1

1. Pre trade transparency
2. Post trade transparency

Question 2

Define “price dissemination”

Answer 2

Process of making prices of financial instruments like stocks/ bonds.. publicly available and widely accessible to market participants

Question 3

Explain pre-trade transparency

Answer 3

A market is pre-trade transparent if it publishes REAL TIME DATA about quotes and orders

Preferred by buy side traders

Question 4

Explain post-trade transparency

Answer 4

A market is post-trade transparent if it publishes trade prices and sizes SHORTLY AFTER TRADES OCCUR

Preferred by sell side traders

Question 5

Define what an OTC market is?

Answer 5

Over the counter markets is a decentralized market where stocks/ bonds.. are traded directly between buyer and seller without a centralised exchange like LSE/ NYSE.

Trades are conducted via market makers or dealers instead of through a formal exchange

They are less regulated than formal exchanges so introduce more risk due to less transparency

Question 6

Define market-depth

Answer 6

Measure of the size of order that is needed to move the market I.e. have an impact on the price by a certain amount

Question 7

What does it mean for an asset to be “illiquid”

Answer 7

It is difficult to sell due to uncertainty about its future market value or if there’s a lack of market depth

Shares traded on AIM are relatively illiquid

The AIM market is for small/ growing companies that have fewer shares so, reduced trade volumes hence, reduced liquidity

Question 8

Define Liquidity Risk

Answer 8

The risk of not being able to sell quickly with the potential for loss of value

Liquidity risk tends to be higher in low volume markets and emerging markets

Question 9

List some advantages of transparent and liquid markets

Answer 9

1. Trades are easy to arrange
2. Low transaction costs
3. Operationally efficient
4. Small bid-ask spreads
5. Can absorb large orders without substantial impact on prices

Question 10

Define bid-ask spread

Answer 10

The difference in price at which the buyer is willing to buy the stock (bid price) and the price at which the seller is willing to sell the stock (ask price)

Bid-ask spread is higher is opaque markets because it’s hard to find the best available price

The spread is smaller in transparent markets because, all prices are there in real-time

Question 11

Define informational efficiency

Answer 11

It’s a by-product of operational efficiency where trading leads to asset prices reflecting all relevant information about the value of the asset

Enhanced by price transparency

All investors have access to good quality, timely information about securities