Question

2. A portfolio manager would like to buy 5,000 shares of a very recent initial public offering (IPO) stock. However, he was not able to get any shares at the IPO price of $30. The portfolio manager would still like to have 5,000 shares, but not at a price above $45 per share. Should he place a market order or a limit order? What would be the advantage and disadvantage of each type of order, given his purposes?

Answer 1

1)

The portfolio manager should place a limit order.

2)

Advantages of market order:

Market orders place the order at whatever the current market price is.

Excecution of the trade is guaranteed.

Market orders are used when certainty of execution is a priority over price of execution.

Disadvantages:

If you are going to place a market order you have to pay whatever the current market price is and there are certain when a stock may jump at volatile sessions.

For example if the portfolio manager is viewing the price to be $45, by the time his order is received and executed, the price could go up to $50.

Advantages of limit order:

Limit orders specify the value at which to execute the order. The pro is that you know exactly how much you'll spend. This gives the portfolio manager control over the price at which the trade is to be executed. Here if the portfolio manager put a limit order of $45, the trade will be executed at a price of $45 or lower.

Disadvantage:

If he limit order the stock at $45 and if the stock price is already $47, his order won't execute unless it dips back don to $45 or below. If the stock goes upto $55 without dipping to $45, he will have bought zero shares and missed the oppurtunity. It is also possible the portfolio manager gets fewer shares than 5000.