48 Questions
What factors transform fundamental information into share prices?
Expected future returns, uncertainty, and liquidity risk
If the risk-free rate of interest is 4% and a stock is priced to yield a 6% premium, what is the expected return on the stock?
4%
Which of the following is true about a dealer in the financial market?
A dealer posts bid quotes to buy securities.
What is the purpose of marking to market?
To reflect the current market value of an asset.
What is a dark pool in the context of financial trading?
A private financial forum for trading securities.
Which type of order is considered a 'liquidity-taker' in the market?
Market order
What is the risk associated with limit orders?
Non-execution risk
What is the advantage of using a limit order over a market order?
Lower trading costs
What is a common special condition that can be attached to an order?
Fill or kill
What are some characteristics of a non-frictionless equity market?
Price unaffected by large buy/sell orders
What is the effect of expectations being divergent?
Prices being excessively volatile in brief intervals of time
Who should understand the concepts discussed in the chapter, aside from business school students and other interested people?
All of the above
What is the definition of liquidity?
The ability to buy or sell shares quickly, in reasonable amounts, and at reasonable prices
What is the term used to describe the difference between the price at which one can buy shares and the price at which one can sell shares?
Bid-ask spread
What is the compensation investors receive for accepting risk?
Risk premium
What is the compensation investors receive for buying shares that may be difficult to sell in the future?
Illiquidity premium
What are information shocks?
Changes in news concerning a company, its industry, and/or the macroeconomy
What is the meaning of 'liquidity' in the context of liquidity shocks?
Changes in investors' desire to hold shares of a stock
What happens to a stock's price following a liquidity shock?
It reverts back toward the equilibrium value
What is price discovery in the context of a marketplace?
Finding a stock's market price
Which of the following is an example of an explicit cost in trading?
Commissions
What is the minimum size of the bid-ask spread for stocks in the United States with discrete prices?
One cent
When does a limit order buyer incur an opportunity cost?
When the stock's price rises and the limit order remains unexecuted
What is short selling?
Selling shares you do not own but have borrowed
Which of the following factors transform fundamental information into share prices?
All of the above
What accounts for the premium in the stock's price?
Both risk and illiquidity
Which of the following is an example of an implicit cost in trading?
Bid-ask spread
What is the cost of a round trip for market order traders?
Bid-ask spread
What is the difference between the price of an actual trade and the price of a hypothetical trade based on a benchmark value called?
Implementation shortfall
What drives trading in the market?
All of the above
Which of the following is NOT a characteristic of a limit order?
It is a liquidity-taker in the market
Which of the following is a special order type?
Iceberg order
What is the definition of algorithmic trading?
A type of trading that operates at speeds that are impossible for a human trader to match
What are the two categories of trading costs?
Explicit and implicit
What is the main factor that investors are compensated for when buying shares that may be difficult to sell in the future?
Illiquidity
What is the definition of liquidity?
The ease with which shares can be traded
What is the cost associated with buying or selling shares with immediacy?
Bid-ask spread
What is the main challenge for institutional-sized orders in terms of trading shares?
Size
Which of the following best describes the role of a dealer in the financial market?
A dealer acts as an intermediary between buyers and sellers, earning a profit from the bid-ask spread.
What is the difference between sell-side traders and buy-side traders?
Sell-side traders work for investment banks and brokerage houses, while buy-side traders work for retail customers and institutional investors.
What is the purpose of marking to market?
To adjust the value of an asset to reflect its current market levels.
Which of the following best describes the concept of price discovery in a marketplace?
The process of finding a stock's value that reflects the market's desire to hold its shares
What is the main difference between information shocks and liquidity shocks?
Information shocks are due to the advent of new information, while liquidity shocks are due to changes in investors' desires to hold shares
What is the role of brokers in the financial market?
Brokers bring investors' orders to the market as an agent and are paid a commission
What is the purpose of dark pools in financial trading?
To provide off-exchange, non-transparent trading facilities for large traders
What are the two basic types of orders in the financial market?
Market orders and limit orders
What is the purpose of a limit order?
To specify a price limit for buying or selling shares
What is the difference between homogeneous expectations and divergent expectations?
Homogeneous expectations assume investors have identical expectations, while divergent expectations assume investors have different expectations.
Test your knowledge on factors affecting share prices, expected returns, dealers in the financial market, marking to market, dark pools, and order types in trading.
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