**6. Transaction Costs**

Question 1

Direct T-costs

Answer 1

Brokerage commissions, spreads, margin interest, etc.I

Question 2

Indirect T-costs

Answer 2

Price impact, price slippage, execution risk, price improvement, etc.

Question 3

Market order to buy

Answer 3

Instructs the broker to buy at the best price available - executed at the lowest ask price

Question 4

Market order to sell

Answer 4

Instructs the broker to sell at the best price available @ highest bid price

Question 5

Limit order to buy

Answer 5

instructs the broker to buy at the limit price or below

Question 6

Limit order to sell

Answer 6

instructs the broker to sell at the limit price or above

Question 7

Submitter of a limit order is a

Answer 7

market marker

Question 8

Submitter of a market order is a

Answer 8

price taker

Question 9

Brokers execute customers order by ____

Answer 9

sending limit and market orders to centralised limit order book (CLOB)

Question 10

NYSE is a ____ market, limit orders are quoted against the spread quoted by _____

Answer 10

Specialised market, the designated market maker (DMM)

Question 11

Drawbacks on limit orders

Answer 11

Once the price hits the limit, the order will be executed

Question 12

Buy limit orders will be executed on ___ news

Answer 12

Bad (price going down)

Question 13

Sell limit orders will be executed on ___ news

Answer 13

Good (price going up)

Question 14

Marketable limit orders can be executed ___

Answer 14

immediately

Question 15

marketable limit order to buy is an order to…

Answer 15

buy at or above the current best ask price

Question 16

marketable limit order to sell is an order to…

Answer 16

sell at or below the current best bid price

Question 17

Bid

Answer 17

Price people want to buy (highest on top)

Question 18

Ask

Answer 18

Price people want to sell (lowest on top)

Question 19

Stop-loss orders

Answer 19

Placed with a broker to buy or sell a specific stock once the stock reaches or breaks through a specified stop price - designed to limit an investor’s loss on a position

Question 20

Stop-limit orders

Answer 20

Triggers submission of a limit order
Stop price - price that activates the limit order and is based on the last trade price
Limit price - price constraint required to execute the order once triggered

Question 21

Is there a guarantee with a stop-limit order?

Answer 21

No - as both stop and limit price required

Question 22

Trailing stop order

Answer 22

sets the stop price at a fixed amount below the market price with an attached trailing amount (e.g. 10%)

Question 23

Price priority, time priority and quantity priority

Answer 23

Gives precedence to buyers with highest bid price and sellers with lowest ask price

If there are multiple orders at the same price, then order with an earlier time trades first

Orders at same price will get partial execution in proportion to the size of their order

Question 24

NASDAQ gives precedence to traders with

Answer 24

Highest quantity (for orders at the same price)

Question 25

NYSE uses ... allocation model

Answer 25

parity/priority

Question 26

Parity Priority Model

Answer 26

Rewards the person who sets the best price as they offer deep liquidity - price setter will receive full allocation of their shares and remaining shares at same price from other buyers will be split equally

Question 27

Bid Ask Spread Percentage

Answer 27

Ask - Bid/Bid

Question 28

Fair Price

Answer 28

Middle price of bid ask spread

Question 29

Part of the bid-ask spread is kept by the...

Answer 29

market maker who is handling the transaction

Question 30

Why doesn't all of the bid ask spread go to the market maker? (3)

Answer 30

* some traders might be able to trade at mid-spread prices * Spreads can move in volatile markets * market makers might have to give up some of the spread due to price improvements

Question 31

Bid ask spread compensates the market makers for... (3)

Answer 31

1. riskiness of holding inventory (29%) 2. costs associated with processing orders (expenses etc.) (61%) 3. adverse information cost (10%)

Question 32

Bid-ask spread is low for...

Answer 32

less volatile stocks, stocks with high trading volume and stocks with higher prices than their peers

Question 33

Relative bid-ask spread

Answer 33

Ask - bid/price

Question 34

Low priced stocks have _____ spreads

Answer 34

large

Question 35

DMM post prices at which they will ____

Answer 35

buy or sell a specific security

Question 36

Bid-ask bounce effect

Answer 36

Prices of securities bounces back and forth between bid and ask prices as some traders are buying at ask prices from DMM and others are selling at bid price to DMM

Question 37

Margin money

Answer 37

cash investors deposits to borrow a margin loan from broker to buy stock

Question 38

How margin account works?

Answer 38

Deposit money into your account, place the order with the broker and the broker will lend you up to 50% of the value of the trade/stock, your trade/stocks will remain with the broker as collateral

Question 39

Maintenance margin

Answer 39

Amount of equity an investor must maintain in the margin account - U.S. federal law requires that investors equity in the margin account should not fall below 25%

Question 40

Margin call

Answer 40

Margin account falls below maintenance, investor receives a call to deposit additional money to return the account to maintenance - this is a courtesy not legal requirement

Question 41

Price impact is part of ....

Answer 41

transaction costs

Question 42

What is price impact?

Answer 42

When prices move against you while you are trading (up when buying and down when selling)

Question 43

Why is there price impact? (2)

Answer 43

Markets are not completely liquid Informational - large trades attract the attention of other traders due to this potentially being related to new information

Question 44

Sunshine Trade

Answer 44

Trade involving a large block of stock that is publicised to the market before the order for the trade is made

Question 45

Why do sunshine trades exist?

Answer 45

to reduce price impact by illiquidity

Question 46

A stand in the market on NZX

Answer 46

Bid to buy (never to sell) a large block of stock during a pre-specified time window, to avoid price impact, can be on or off market

Question 47

Bidders in large stands are required to bid on market for at least

Answer 47

1/5 of the target purchase

Question 48

Price Slippage

Answer 48

Occurs when execution price of a trade is different from its requested price (e.g. orders could not be matched at preferred prices) - typically occurs in highly volatile fast moving markets

Question 49

Negative slippage

Answer 49

Investor places order to buy at $X --> order executed at price more than $X -

Question 50

Positive Slippage

Answer 50

Investor places order to sell at $X --> order executed at a price more than $X

Question 51

Price improvement

Answer 51

Amount of savings a trader may receive on trade compared to the price quoted at the time the order was priced

Question 52

Faster you order is executed, _____ likely to get a price improvement

Answer 52

less

Question 53

Magnitude and frequency of price improvements are _____ for stocks with wide spreads, fewer trades and smaller trade sizes

Answer 53

Greater

Question 54

Block trades

Answer 54

Large trading off-market order made by institutional investors of at last 10,000 shares or at a total market value of more than $200,000

Question 55

In NZ a stand in the market is also a____

Answer 55

private order

Question 56

Stands in the market in NZ take a long time to be ____

Answer 56

filled

Question 57

Off-market trade in NZ is similar to

Answer 57

Block trade

Question 58

When should you short sell?

Answer 58

When you expect the share price to go down

Question 59

Short-sell process (4)

Answer 59

1. borrow shares from broker 2. sell shares 3. buy back (typically at lower price) 4. return shares to broker

Question 60

How would you short sell for the purpose of hedging?

Answer 60

Write a short put option

Question 61

Uptick rule

Answer 61

you cannot short sell a stock if the price has ticked down