Question

The Knight Capital Group story (see page 293 in the 12th edition), demonstrates that: A. regulated markets always run well. B. dark pools operate better than public markets. C. high frequency trading can destroy capital value by accident in a short time. D. changes in oil prices and interest rates are highly correlated.

Answer 1

Answer- The Correct answer is C. high frequency trading can destroy capital value by accident in a short time.

Description of the Incident

Knight Capital caused a major stock market disruption leading to a large trading loss for the company. The incident happened after a technician forgot to copy the new Retail Liquidity Program (RLP) code to one of the eight SMARS computer servers, which was Knight's automated routing system for equity orders. RLP code repurposed a flag that was formerly used to activate the old function known as 'Power Peg'. Power Peg was designed to move stock prices higher and lower in order to verify the behavior of trading algorithms in a controlled environment. Therefore, orders sent with the repurposed flag to the eighth server triggered the defective Power Peg code still present on that server. When released into production, Knight's trading activities caused a major disruption in the prices of 148 companies listed at the New York Stock Exchange. For example, shares of Wizzard Software Corporation went from $3.50 to $14.76. For the 212 incoming parent orders that were processed by the defective Power Peg code, Knight Capital sent millions of child orders, resulting in 4 million executions in 154 stocks for more than 397 million shares in approximately 45 minutes. Knight Capital took a pre-tax loss of $440 million. This caused Knight Capital's stock price to collapse, sending shares lower by over 70% from before the announcement. The nature of the Knight Capital's unusual trading activity was described as a "technology breakdown".