Quote Driven And Order Driven Markets

Question 1

Explain the concept of order-driven systems

Answer 1

1. Used for highly liquid securities and traded in large volumes
2. Orders from all customers are inputted to an electronic order book

Question 2

What are the two main types of orders in an electronic order book?

Answer 2

1. Limit orders
2. Market orders

Question 3

Explain what a “market order” is in an electronic order book

Answer 3

1. Orders that specify a quantity to be traded by NOT a price
2. Then, they are matched with the best order in the order book at that time (whichever has the lowest price)
3. Orders can be fully filled or partially filled. If an order is partially filled - the remaining portion of the order is cancelled because it cannot sit in the order book
4. If you want the remaining order to remain in the order book, you have to place a limit order.

Question 4

Explain what a “limit order” is in an electronic order book

Answer 4

1. Buyer states the quantity AND price they are willing to pay.
2. Sellers also state the prices they are willing to accept.
3. The orders are only matched once the quantity and price stated in the order is available/ better price is available
4. Priority for the matching is first by price and then by time the order was input

Question 5

Explain the concept of “quote-driven” systems

Answer 5

1. Market makers maintain liquidity and efficiency in trading
2. Best prices are NOT given automatically like in order-driven systems

Question 6

How are market makers involved in quote-driven systems?

Answer 6

1. Market makers are financial institutions that continuously quote bid-ask prices
2. They should also be ready and able to buy or sell at those publicly quoted prices
3. Prices quoted must be atleast 1 x NMS (normal market size)
4. Market makers input their prices in a central market system like SEAQ