ch2.Liquidity, Trading, and Price Determination in Equity Markets

What factors transform fundamental information into share prices?

Expected future returns and liquidity risk

Expected future returns, uncertainty, and liquidity risk (correct)

Uncertainty and liquidity risk

Expected future returns and uncertainty

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?

2%

6%

10%

4% (correct)

Which of the following is true about a dealer in the financial market?

A dealer posts bid quotes to buy securities. (correct)

A dealer charges a commission for their services.

A dealer primarily serves retail customers.

A dealer is always on the buy side of the market.

What is the purpose of marking to market?

To reflect the current market value of an asset. Signup and view all the answers

What is a dark pool in the context of financial trading?

A private financial forum for trading securities. Signup and view all the answers

Which type of order is considered a 'liquidity-taker' in the market?

Market order Signup and view all the answers

What is the risk associated with limit orders?

Non-execution risk Signup and view all the answers

What is the advantage of using a limit order over a market order?

Lower trading costs Signup and view all the answers

What is a common special condition that can be attached to an order?

Fill or kill Signup and view all the answers

What are some characteristics of a non-frictionless equity market?

Price unaffected by large buy/sell orders Signup and view all the answers

What is the effect of expectations being divergent?

Prices being excessively volatile in brief intervals of time Signup and view all the answers

Who should understand the concepts discussed in the chapter, aside from business school students and other interested people?

All of the above Signup and view all the answers

What is the definition of liquidity?

The ability to buy or sell shares quickly, in reasonable amounts, and at reasonable prices Signup and view all the answers

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 Signup and view all the answers

What is the compensation investors receive for accepting risk?

Risk premium Signup and view all the answers

What is the compensation investors receive for buying shares that may be difficult to sell in the future?

Illiquidity premium Signup and view all the answers

What are information shocks?

Changes in news concerning a company, its industry, and/or the macroeconomy Signup and view all the answers

What is the meaning of 'liquidity' in the context of liquidity shocks?

Changes in investors' desire to hold shares of a stock Signup and view all the answers

What happens to a stock's price following a liquidity shock?

It reverts back toward the equilibrium value Signup and view all the answers

What is price discovery in the context of a marketplace?

Finding a stock's market price Signup and view all the answers

Which of the following is an example of an explicit cost in trading?

Commissions Signup and view all the answers

What is the minimum size of the bid-ask spread for stocks in the United States with discrete prices?

One cent Signup and view all the answers

When does a limit order buyer incur an opportunity cost?

When the stock's price rises and the limit order remains unexecuted Signup and view all the answers

What is short selling?

Selling shares you do not own but have borrowed Signup and view all the answers

Which of the following factors transform fundamental information into share prices?

All of the above Signup and view all the answers

What accounts for the premium in the stock's price?

Both risk and illiquidity Signup and view all the answers

Which of the following is an example of an implicit cost in trading?

Bid-ask spread Signup and view all the answers

What is the cost of a round trip for market order traders?

Bid-ask spread Signup and view all the answers

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 Signup and view all the answers

What drives trading in the market?

All of the above Signup and view all the answers

Which of the following is NOT a characteristic of a limit order?

It is a liquidity-taker in the market Signup and view all the answers

Which of the following is a special order type?

Iceberg order Signup and view all the answers

What is the definition of algorithmic trading?

A type of trading that operates at speeds that are impossible for a human trader to match Signup and view all the answers

What are the two categories of trading costs?

Explicit and implicit Signup and view all the answers

What is the main factor that investors are compensated for when buying shares that may be difficult to sell in the future?

Illiquidity Signup and view all the answers

What is the definition of liquidity?

The ease with which shares can be traded Signup and view all the answers

What is the cost associated with buying or selling shares with immediacy?

Bid-ask spread Signup and view all the answers

What is the main challenge for institutional-sized orders in terms of trading shares?

Size Signup and view all the answers

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. Signup and view all the answers

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. Signup and view all the answers

What is the purpose of marking to market?

To adjust the value of an asset to reflect its current market levels. Signup and view all the answers

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 Signup and view all the answers

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 Signup and view all the answers

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 Signup and view all the answers

What is the purpose of dark pools in financial trading?

To provide off-exchange, non-transparent trading facilities for large traders Signup and view all the answers

What are the two basic types of orders in the financial market?

Market orders and limit orders Signup and view all the answers

What is the purpose of a limit order?

To specify a price limit for buying or selling shares Signup and view all the answers

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. Signup and view all the answers

ch2.Liquidity, Trading, and Price Determination in Equity Markets

Questions and Answers

What factors transform fundamental information into share prices?

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?

Which of the following is true about a dealer in the financial market?

What is the purpose of marking to market?

What is a dark pool in the context of financial trading?

Which type of order is considered a 'liquidity-taker' in the market?

What is the risk associated with limit orders?

What is the advantage of using a limit order over a market order?

What is a common special condition that can be attached to an order?

What are some characteristics of a non-frictionless equity market?

What is the effect of expectations being divergent?

Who should understand the concepts discussed in the chapter, aside from business school students and other interested people?

What is the definition of liquidity?

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?

What is the compensation investors receive for accepting risk?

What is the compensation investors receive for buying shares that may be difficult to sell in the future?

What are information shocks?

What is the meaning of 'liquidity' in the context of liquidity shocks?

What happens to a stock's price following a liquidity shock?

What is price discovery in the context of a marketplace?

Which of the following is an example of an explicit cost in trading?

What is the minimum size of the bid-ask spread for stocks in the United States with discrete prices?

When does a limit order buyer incur an opportunity cost?

What is short selling?

Which of the following factors transform fundamental information into share prices?

What accounts for the premium in the stock's price?

Which of the following is an example of an implicit cost in trading?

What is the cost of a round trip for market order traders?

What is the difference between the price of an actual trade and the price of a hypothetical trade based on a benchmark value called?

What drives trading in the market?

Which of the following is NOT a characteristic of a limit order?

Which of the following is a special order type?

What is the definition of algorithmic trading?

What are the two categories of trading costs?

What is the main factor that investors are compensated for when buying shares that may be difficult to sell in the future?

What is the definition of liquidity?

What is the cost associated with buying or selling shares with immediacy?

What is the main challenge for institutional-sized orders in terms of trading shares?

Which of the following best describes the role of a dealer in the financial market?

What is the difference between sell-side traders and buy-side traders?

What is the purpose of marking to market?

Which of the following best describes the concept of price discovery in a marketplace?

What is the main difference between information shocks and liquidity shocks?

What is the role of brokers in the financial market?

What is the purpose of dark pools in financial trading?

What are the two basic types of orders in the financial market?

What is the purpose of a limit order?

What is the difference between homogeneous expectations and divergent expectations?

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