Market mechanics 1

Investment
An Introduction to Investments
Possible Investment Goals

◻ Funds to meet emergencies

◻ Funds to finance education expenses

◻ Funds to make a specified purchase

(e.g., a home)

◻ Funds for retirement

Diversification and Asset Allocation

◻ Reduction in asset specific risk

◻ Allocation of assets among alternatives:
? Stocks
? Bonds
? Money market instruments
? Real estate
? Derivatives
Preliminary Definitions

◻ Return
? Income and capital gains

? Return in monetary units and percentages

Preliminary Definitions

◻ Risk
? Possibility of loss

? Uncertainty of future returns

? Risk differentiated from speculation

Orders and Executions
Types of Orders

◻ Market orders

◻ Limit orders

◻ Stop orders
Types of orders
◻ Market order
? Fill buy or sell order immediately at best available price
◻ Limit order
? Buy at price less than or equal $W, where W < current price
? Sell at price greater than or equal to $X, where X > current
price
■ Can also classify as an MIT order (market-if-touched) if you desire
◻ Stop order (stop loss order)
? Sell at price $Z, where Z < current price
? Buy at price $Y, where Y > current price
■ Stop orders typically become market orders once stop price is hit
Order qualifications
◻ Day orders
? Order expires at day end if unfilled
◻ Good-till-canceled orders
? Order remains on books unless executed, cancelled or renewed (3-6
months – but this varies across brokers)
◻ Fill or kill
? Cancel order (or portion not filled) if it cannot be executed immediately
◻ Market-on-close
? Execute at closing price
? Attractive to mutual funds since deposits and redemptions based on
end-of-day valuation
Trading priority rules
◻ Order type priority
? Market orders get executed first then limit order.
◻ Price priority
? “best” prices get executed first
■ Lowest sell price (ask)
■ Highest buy price (bid)
◻ Time priority
? First in, first executed
Example 1 (Question)
◻ The stock market just opens for trade. Several orders are
submitted for stock XYZ as shown in below table.
? Match submitted orders and list executed orders by execution
sequence.
? Take a snapshot of limit order book for the stock after execution.
Limit order book before execution
Bid Ask
ID Price Size ID Price Size
B1 19.7 7 A1 19.8 1
B2 19.8 2 A2 20.0 6
B3 19.9 3 A3 20.1 2
B4 20.0 2 A4 20.2 5
B5 Market order 4
Example 1 (Answer)
◻ Match submitted orders and list executed orders in
chronological order.

Execution

Execution sequence ID Price Size

1 B5, A1 19.8 1

2 B5, A2 20.0 3

3 B4, A2 20.0 2
Example 1 (Answer)
◻ Take a snapshot of limit order book for the stock
after execution.

Limit order book after execution

Bid Ask

ID Price Size ID Price Size

B1 19.7 7 A2 20.0 1

B2 19.8 2 A3 20.1 2

B3 19.9 3 A4 20.2 5
Example 2
1. Suppose a market buy order for 150 shares arrives, at what
price will it be filled?
Answer: $50.25/100 shares, $51.50/50 shares.
2. At what price would the next market buy order be filled?
Answer: $51.50
Example 3

1. What price will a market buy order be executed?

2. What price will a market sell order be executed?
3. Suppose you have submitted a limit order to sell at
$55.62. What will happen?
4. Suppose you have submitted a limit order to buy at
$55.37. What will happen?