Describe the different type of orders that one can place. A market order is filled at the best possible price at the time of the order. A limit order is filled at the limit price or
better (or it is not filled). A stop order becomes a market order if there is a transaction at the stop price.
Describe each of the primary markets. Some assets are issued in an auction market, where the assets are sold to the highest bidder. Some securities are issued via an
underwriting, where an underwriter (like an investment banker) essentially buys up the issue at a fixed price and then resells it to customers. In a private placement, assets are sold
directly to the buyer at negotiated or advertised prices.
Describe each of the secondary markets. In auction markets, the assets are bought by the highest bidders and sold by the lowest offering sellers. In the OTC markets, assets are
bought and sold through dealers (who earn income on the bid-ask spread). In the fourth market, assets are traded directly between investors without the use of an exchange or dealer
(although a broker or a dealer may be used to find a buyer or seller).
Evaluate the relative transaction costs in each market. Transaction costs are zero in the open-end no-load mutual fund market. However, annual management fees are levied on
such investments. The transaction costs in the futures markets are extremely low. The transaction costs in the spot markets are generally much higher. Dollar transaction costs in the
option markets are similar to those in the spot markets, except they are very high as a percent of the option premium.
Assume you are a specialist making a market in a stock, and you have the following limit orders on your books: 500,000 shares to buy at $38, 1,000,000 shares to buy at
$38.25, 100,000 shares to buy at 38.375, and 50,000 shares to buy at $38.50; 100 shares to sell at $38.625. What would you do? What Bid-Ask prices would you offer? Buy the 100
shares offered at 38.625. Then set a bid price at 38.625 and an offer price of 50. If an offer to buy at the market comes along, you make a big profit. Meanwhile, the substantial buy
limit orders just under your bid price minimize the risk of a large decline in price while you’re waiting for the market order to buy.
Suppose an investment banker with the same limit orders from customers as are given in 15.6. What would you do if you wanted to trade in ABC stock for a profit? Is this
ethical? You could do the same thing as the specialist. However, such trading may be detrimental to your customers (essentially, you are outbidding your customers and thereby
trading against them). Such activity may not only be unethical, it may also eventually lead to very bad publicity (a different type of unethical trading practice called “front-running”
has been widely used in the futures market. In “front-running” a brokerage firm buys a contract for its own account after receiving an order to buy from a customer, and the broker