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Week 1 tutorial Q&A...

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UWA Business School

FINA3307 Tutorial Questions

WK 1: THE TRADING PROCESS 1. Discuss the differences between a primary and secondary market. Identify the contributions of secondary markets to the performance of primary markets. The securities are issued in primary market and then traded in secondary market. Securities represent the claim of future payments or company’s ownership. For future payment, it might have maturity, however, for equity like shares, it would be treated as perpetuity since it assumes that the company would exist forever. Secondary market provides chances for exchanging ownerships, so investors don’t need to hold the shares for a long time. Primary market: where the securities issued. The money would go to the companies/issuers Secondary market: trading. The sellers get the money. The secondary market would be an indicator for the value of the firm. It also adds liquidity to the primary market, gives indication to the primary market at what price the new stock should be issued. Primary market: issue of new shares / financial investments Secondary market: Buying and selling of existing financial institution. Transfer of ownership, no new fund raising by issuer. Primary market is where the IPO is newly issued. Secondary market is where securities are traded. Secondary market helps price discovery process. Investors are not going to buy securities in the primary market if they know they are not going to get fair price for it after, so secondary market helps to value those securities. 2. What factors would influence a trader to use a market order as opposed to a limit order? Market order: the order would be executed immediately at the market price. Limit orders: trade at best price available but do not violate limit price condition. Do not buy above price limit; do not sell below the price limit. There are two factors may influence trader’s choice: (1) timing; (2) cost. When the trader wants to buy/sell the shares immediately without considering the cost, the trader would choose market order instead of limit order. The market order would be used when some major affairs happen like panic, monetary policy announcement, earning announcement. 3. How does a stop order differ from a limit order? Exactly what does an investor expect from her broker when she places a stop limit order with a stop price to buy at 50 and a limit price of 50.10? Why might an investor place such an order? 1

Stop price: the broker would stop buying at the price of 50 but keep buying as the price goes below 50 at the market price. Limit price: buy at the price of 50.10 when the market price is below 50.1. Stop order: a trigger to buy/sell Limit order: buy/sell at the max price Stop limit order: 50 would be the trigger and the system would start to buy, and the limit price is 50.1, so the system would only buy in the range of 50 to 50.1. When the price goes higher than 50.1 the system would stop buying. It may miss out the upward trend. A limit order sets an upper price for a purchase or a lower price limit for a sell, preventing the broker from paying more or accepting less for the security. A stop order instructs the broker to place the buy order once the price has risen above a given level or place the sell order once the price of the security has fallen beneath a given level. The limit order restricts the price; the stop order triggers the order execution. This stop-limit order triggers the buy once the price rises to 50, but is executed only if the stock can be purchased for no more than 50.10. Stop orders to buy are often placed when the investor wants to buy the stock on upward price momentum, but the limit is typically placed when the investor wants protection from paying more than she wants for the stock. 4. Suppose that the last sale of Company X stock was at a price of $50. Further suppose that an investor wishes to place a market order to purchase 25,000 shares of Company X stock. What is the volume weighted average price that the investor will trade at in each of the market? Market A Market B # shares Offer ($) # shares Offer ($) 30,000 50.00 10,000 50.00 40,000 50.02 10,000 50.01 10,000 50.05 70,000 50.03 20,000 50.06 80,000 50.04 30,000 50.07 60,000 50.05 10,000 50.09 40,000 50.05 Market A: #25,000 @ $50 = 50 Market B: #10,000 @ $50 #10,000 @ $50.01 #5,000 @ $50.03 Average = (10k*50+10k*50.01+5k*50.03)/25k=$50.01 If it’s fill or kill (trade in one go or not trading), the order wouldn’t go through.

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Which market would be favorable when there’s high volume order due to the depth and the price gap. Depth: Best quantity at best available price. 5. See the two articles attached on the new securities exchange Chi-X publishes before and after the introduction of Chi-X. Discuss the issues raised in the articles. In particular, how has the introduction of the new exchange changed the landscape of share trading in Australia? ASX was monopoly over share trading before Chi-X entered the market and the control is over as Chi-X are allowed to operate in Australian market. Its profit and supervision power are facing challenges. It also has administration transition. Chi-X has issue about its chairman who is its independent non-executive director at the same time. Chi-X also gets questioned about if it caused more market fragmentation. Chi-X has about 20% in Australian trading market. Purposes: -

Bring up the competition Lower transaction fee Attract more investors and trading. May lead to arbitrage between 2 markets Market fragmentation, splitting into 2 markets. Information may be different. This would result in illiquidity. It might be solved by well communication. Dark Pool Issues (investors place orders and make trades without publicly revealing their intentions during the search for a buyer or seller). Hard to monitor, due to high speed of trading.

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