karoliukas

Market A has average bid and ask sizes of 400 shares. Market B has average bid and ask sizes of 600 shares. Market C has average effective spreads of $0.034. Market D has average effective spreads of $0.039. Comparing A to B and C to D, which markets are of the highest quality?

A) B and D.

B) A and C.

C) B and C.

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Lower quoted and effective spreads as well as higher bid and ask sizes indicate greater liquidity and greater market quality.

karoliukas

Which of the following is NOT a characteristic of a liquid market?

A) Integrity.

B) Homogenous traders.

C) An abundance of traders.

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The factors contributing to liquidity are an abundance and diversity of traders, convenience, and integrity. Homogenous traders are not diverse.

karoliukas

Which of the following relationships is adversarial?

A) Broker and dealer.

B) Trader and broker.

C) Trader and dealer.

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The relationship between a trader and a dealer is adversarial. The dealer would like to maximize the trade spread and the trader would like to minimize it. Also, when a trader has information that the dealer does not, the trader profits at the dealer’s expense.

karoliukas

In which of the following is there a principal-agent relationship?

A) Trader and broker.

B) Broker and dealer.

C) Trader and dealer.

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A principal-agent relationship exists between a trader and the broker. The broker acts as the trader’s agent and locates the necessary liquidity at the best price. The trader can also extract information from the broker regarding the depth of a market and the identity of other traders.

karoliukas

In which of the following relationships does the adverse selection risk problem pertain?

A) Trader and broker.

B) Trader and dealer.

C) Trader and investor.

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A trader is more likely to trade with a dealer when he has information that the dealer does not. This results in adverse selection risk for the dealer. The trader’s profit is the dealer’s loss once the information is revealed to the market.

karoliukas

Where would an illiquid security in a developing country most likely trade?

A) Electronic crossing networks.

B) Electronic limit-order markets.

C) Broker markets.

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In brokered markets, brokers find the counterparties to a trade. This service is valuable when the trader has a large block to sell, when they want to remain anonymous, and/or when the market for the security is small or illiquid. Brokered markets are important in countries where public capital markets are not well developed.

karoliukas

In which of the following markets is an order most likely to go unfilled or partially filled?

A) Auction markets.

B) Electronic crossing networks.

C) Electronic limit-order markets.

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In an electronic crossing network, trades are executed at the average of the bid and ask quotes. They do not adjust based on supply and demand. As such, prices do not adjust to fill orders. In an auction market and automated auctions (also known as electronic limit-order markets), orders compete for execution and prices can adjust to fill orders.

karoliukas

Which of the following markets does NOT provide price discovery?

A) Electronic limit-order markets.

B) Electronic crossing networks.

C) Auction markets.

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In an electronic crossing network, there is no price discovery because trades are executed at the average of the bid and ask quotes. The trader usually does not know the identity of their counterparty or of their trade size. In an auction market and automated auctions (also known as electronic limit-order markets), orders compete for execution and provide price discovery.

karoliukas

Suppose a trader is quoted a market bid price of $16.00 and an ask of $16.10. The execution price of a sell order is $16.03. What is the effective spread?

A) $0.02.

B) $0.04.

C) $0.03.

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If a trader placed a sell order, a dealer may offer a better bid price than the previous bid to earn the trader’s business. The midquote of the quoted bid and ask prices is $16.05. The effective spread for this sell order would then be calculated as: 2 × ($16.05 - $16.03) = $0.04, which is 6 cents better than the quoted spread of $0.10 ($16.10 - $16.00).

karoliukas

Suppose a trader is quoted a market bid price of $30.00 and an ask of $30.07. The execution price of a buy order is $30.04. What is the effective spread?

A) $0.01.

B) $0.06.

C) $0.02.

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If a trader placed a buy order, a dealer may offer a better ask price than the previous ask to earn the trader’s business. The midquote of the quoted bid and ask prices is $30.035. The effective spread for this buy order would then be calculated as: 2 × ($30.04 - $30.035) = $0.01, which is 6 cents better than the quoted spread of $0.07 ($30.07 - $30.00).