Question

7. Describe the process that occurs when an investor places an order with a broker to buy or sell stocks under the market marker/specialist system.

9. What problems does an institutional investor face when it places a very large buy or sell order for a block of stock through an exchange?

13. Describe insider trading? Why is it illegal?

Answer 1

7.

To trade in stocks investors must have a client account with a broker, through which buy and sell orders will be placed.It is commanly done over telephones.

Once client places an order with the broker, it is submitted for execution. There are two major ways to execute the trade -

a) Face to face method which involves a designated market maker. It is a traditional approach where brokerage firms have representatives at stock exchange called floor brokers. Local broker submits clients order to these representatives. At exchange, each stock is being traded at a particular spot in a large floor like auction process which is supervised by a designated market maker or specialists. They are reponsible for conducting orderly markets in their stocks. To do this they must buy/ sell on their own accounts when a buyer can not find a seller or vice a versa. Market makers buy and sell at different prices.

When floor broker receives an order, he takes it to the location of the stock's market maker along with other floor brokers and make the trade. Once transaction is done, its information is passed back to local brokers and their clients. Actual settlemet doesn't happen for few days.

This process is now being replaced by ECN's (Electronic Communications Network). Where trade is processed through computers by finding matching buy and sell orders submitted by varioud traders. Once matches are found, orders are executed electronically with a fee. Today very few orders take place face to face.

Fig: Systematic representation of a stock market transaction -

9.

Two problems are faced by institutional investors face while placing a large buy/ sell order of stock through an exchange - Cost and the fact that large traders move markets against the trader due to the transparency of exchanges.

Eg. If a large trader places an order to sell , then the order is seen by the entire market because of transparency , this order will create an increase in supply as more shares become available for sale and the market price goes down. SImilarly large buy orders move markets to higher price. Demand and supply theory.

13.

Insider trading is defined as a malpractice wherein trade of a company's securities is undertaken by people who by virtue of their work have access to the otherwise non public information which can be crucial for making investment decisions.

Insider trading is the illegal use of non-public material information for profit.

For example, suppose the CEO of a publicly-traded firm inadvertently discloses their company's quarterly earnings while getting a haircut. If the hairdresser takes this information and trades on it, that is considered illegal insider trading, and the SEC may take action.

The SEC is able to monitor illegal insider trading by looking at the trading volumes of any particular stock. Volumes commonly increase after material news is issued to the public, but when no such information is provided and volumes rise dramatically, this can act as a warning flag. The SEC then investigates to determine precisely who is responsible for the unusual trading and whether or not it was illegal.