However this might not be the case for certain larger orders or even certain

However this might not be the case for certain larger

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However, this might not be the case for certain larger orders or even certain smaller orders.
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1 Tutorial 2 Questions and Suggested Solutions Question 1 Discuss the differences between brokers and dealers? Explain why you should observe only brokers but not dealers on the ASX? Dealers x Dealers are profit-motivated traders who profit by supplying liquidity to others who wants to trade x Dealers buy when others want to sell and sell when others want to buy x The profit they earn comes from the positive spread they quote (spread is the difference between buy and sell quote) Brokers x Brokers are agents who arrange trades for their client x Receive a commission for their service x Some may offer investment advice and information Dealers are present in quote driven or hybrid markets. The ASX is an order driven market, liquidity supply is provided through the submission of limit orders by traders. Orders are matched based on the price/time priority and no dealers are involved in this process. Therefore, on the ASX, we should observe brokers, who submit orders on behalf of their clients, but not dealers. Question 2 How do market makers manage their inventories to keep them at target level? Why do they need to do this? Solutions Inventories = shares Holding too many shares exposes market makers to risk of share price decline Holding too few shares may result in lower profit (i.e: cannot satisfy large buy orders) Î Having a target level of inventories If inventories > target level Æ adjust quotes to sell more shares (i.e: reduce the selling quote) If inventories < target level Æ adjust quotes to buy more shares (i.e: increase the buying quote) Question 3 Briefly explain the role of a stock broker and apparent risks faced by the investor when dealing with brokers. The role of broker x Brokers are agents who arrange trades for their clients and they receive commissions for their services.
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2 x In order flow markets, brokers take orders from their clients and match them with orders by other traders. x In block markets, brokers take large client orders and try to find other traders to fill them Risks to the investor x Dual trading problem o Dual trading (Principle trading) occurs when brokers function also like a dealer. They buy and sell for their own account x Conflict of interest o Arise when they internalize orders. They will try to buy at the lowest possible price while their clients want to sell at the highest possible price x Problem of front running o Front running occurs when a broker improperly allows one order to trade ahead of another. The order that goes first usually profits from the price impact of the following order. x Order Preferencing o Order preferencing is the routing of order flow by a broker to a preferred dealers x Inappropriate Order Exposure o Occurs when a broker shows an order to another trader for the other trader’s benefit rather than for his client’s benefit o Brokers must expose orders only for their client’s benefit.
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