Question

Which of the following characteristics accurately describes the stock market?

An active market that determines the price of a firm’s shares
A fixed-income market where participants buy and sell debt securities
The bid-ask spread in a dealer market represents the profit that a dealer would make on a transaction involving a security. Which of the following statements best describes the bid-ask spread?
The difference between the closing price of the security and the opening price of the security on the day of the transaction.
The sum of the price at which a dealer is willing to buy a security and the price at which a dealer is willing to sell it.
The difference between the price at which a dealer is willing to buy a security and the price at which a dealer is willing to sell it.
Fernando, a trader, wants to buy 1,000 shares of XYZ stock, while a second trader, Ally, is willing to sell 1,500 shares of the same stock. Unfortunately, Fernando and Ally don’t know one another and must complete their transactions using the stock exchange’s market-making dealer. XYZ’s market maker is willing to sell her shares for $26.80 per share and purchase additional shares for $26.25 per share. Select the most appropriate values in the following table:
Bid price 26.25, 25.80, 31.50
Ask price 40.20,26.80,26.25
Bid-ask spread 26.25,87.67,0.55
If the market maker is willing to purchase the entire block of 1,500 shares from Ally and, from that block, resell 1,000 shares to Fernando, then the market maker’s net profit from Fernando’s transaction—excluding any inventory effects—will be:_________
a) 275,00
b) 825.00,
c) 503.00,
d) 550.00

Answer 1

1. The characteristic that accurately describes the stock market is:

An active market that determines the price of a firm’s shares.

2. The statement that best describes the bid-ask spread is:

The difference between the price at which a dealer is willing to buy a security and the price at which a dealer is willing to sell it.

3. Bid price = $26.25; Ask price = $26.80

4. Fernando’s transaction—excluding any inventory effects—will be:_________

d) 550.00

Step-by-step explanation:

a) Data and Calculations:

XYZ's market maker:

Sell shares at $26.80 * 1,000 = $26,800

Buy shares at $26.25 * 1,000 = 26,250 ($39,375 - 13,125)

Net profit $550

Thus, the inventory of shares = $13,125 ($26.25 * 500)

b) The bid price is the amount per share that the XYZ market maker is willing to buy the 1,500 Ally shares. The ask price is the amount per share that the market maker is willing to sell the 1,000 shares to Fernando. The bid-ask spread represents the difference between the bid price and the ask price. It is the profit margin for the market maker.