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W1 Tute

Trading in Securities Markets (University of Western Australia)

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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?
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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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