Market Microstructure and Strategies
Stock Market Transactions
n Market order to buy/sell at the best possible price
n Limit order is a market order with a specific price maximum or minimum
n Stop-loss order
Margin Trading
n Federal Reserve sets margin requirements (%) or proportion of funds buyer must put down
l Used to dampen speculation and market crashes
l Currently 50%; half down, half borrowed
l Broker may set higher margin requirements
Margin Trading, cont.
n Customer establishes account with broker (margin account)
n Initial margin—broker’s minimum margin requirement for stock purchase
n Maintenance margin—minimum proportion of equity/total value of stock borrowing period
Margin Trading, cont.
n Margin trading magnifies returns to investor
l Investor must pay interest on borrowed funds
l Investor returns higher/lower with lower equity than a 100% purchase
n Margin Call
l Request for cash when stock price falls below maintenance margin requirements
l Broker/lender may sell stock to protect loan, thereby
Factors that Affect the Bid-Ask Spread
Regulation of Stock Trading
n Purpose of stock trading regulation
l To make market more efficient
u Promote and preserve competition
u Prevent unfair or unethical trading practices
l Provide full disclosure of material information
l To prevent market failure—circuit breakers
Securities and Exchange Commission
n SEC uses surveillance system to watch trading
l Insider trading
u Overcome using ‘trading halts’
n SEC possess authority to regulate stock markets
l May prescribe accounting standards and the extent of financial disclosure
l Establish regulations for stock trading and disclosure from “insiders”
Three Traditional Barriers to International Stock Trading
n Increased consolidation and increased efficiency of international stock exchanges
n Computerized order flow/matching provide more objective, fairer trading, lowering bid/ask differentials
n Transaction costs lowered by competition, technology, and less regulation
Three Traditional Barriers to International Stock Trading
n Information on foreign stocks now more accessible
n More uniform accounting standards between countries
n Increased disclosure reduces information gathering costs
Three Traditional Barriers to International Stock Trading
n Investing in foreign stocks denominated in foreign currency exposes investor to forex risk
n Changes in foreign exchange rates changes actual return from expected
n Exchange rate risk reduced as single currency adopted—euro example