1. Chapter 5 Equity: Markets and Instruments

2. Problem 1: The central electronic limit order book is the hub of those automated markets that are order-driven (not price-driven.) Statement III, therefore, is not correct.

3. Problem 2: a)The market order will be executed against the best matching order(s). Accordingly, Vincent Jacquet will buy 500 shares at €146 each, 500 shares at €147 each, and the remaining 500 shares at €149 each. b)Again, the market order will be executed against the best matching order(s). Accordingly, Vincent Jacquet will sell 500 shares at €145 each and 500 shares at €143 each.

4. Problem 3: On the Paris Bourse, the investor who placed the limit order at €24 stands to lose. Informed market participants can sell the share to this investor at €24, although the share is truly worth only €21. In contrast, the dealer is exposed to lose on Nasdaq. The dealer quote is $23.90 – 24.45, which is equivalent to €24.90 – 25.47 at the prevailing exchange rate. Informed market participants can sell the share to the Nasdaq dealer at the bid price of $23.90, although the share is truly worth only €21 or $20.16.

5. Problem 4: Small orders are generally market orders (buy or sell at the best price available in the market). In an order-driven system without developed market making, the automated limit order book generally shows a huge spread between the lowest ask and the highest bid of the orders currently in the system. When a new market order reaches the system, it is unlikely that a matching opposing market order will reach the system at exactly the same time. So, the market order will be executed against the limit order book. Given the wide spread, this will generally imply a transaction at a price that is very different from that of the previous transaction. To avoid this problem, one could have a periodic auction system in which all small orders are stored for a while and an auction takes place infrequently. Another alternative is the “trading halt” used in Tokyo.

6. Very large orders (such as block trades—trades of 10,000 shares or more) run a serious risk of being “picked off” on an order-driven system. A large limit order is likely to remain posted for a long time on the computer system. The client is exposed to the risk that someone gets some news about the company or the market before the client is able to revise the posted limit price on the order. Buyers or sellers of large blocks of shares do not wish to be exposed to such a risk. Hence, special procedures have been put into place. Generally, block trades take place off the automated system and are reported only after some accepted delay.

7. Problem 6: a)There are not enough buy orders to meet the minimum fill requirement of Participant C, and his order would not be fulfilled. Participant A would buy 50,000 shares at €37 each, and Participant B would sell 50,000 shares at €37 each. Half of Participant A’s order would remain unfulfilled. Because the prevailing price is €37, Participant D’s order to buy at €36 would remain unfulfilled. All unfulfilled orders of Participants A, C, and D would be resubmitted to the next crossing session because they are all GFD orders.

8. b)Taking into account the trading activity in the first crossing session and the new orders submitted to the next session, the following orders would be there for the next session: A: a market order to buy 50,000 shares C: a market order to sell 150,000 shares, with a minimum fill of 125,000 shares D: an order to buy 20,000 shares at €36 E: a market order to buy 150,000 shares F: a market order to sell 50,000 shares In this session, the orders of Participants A, C, E, and F would be completely filled. Participants A and E would buy 50,000 and 150,000 shares, respectively. Participants C and F would sell 150,000 and 50,000 shares, respectively. All the transactions would be at €38 per share. Participant D’s order would still not be executed and would be resubmitted to the next crossing session later that day.

9. Problem 7: Unlike U.S. banks, it is common for European banks to own shares of their client banks. Accordingly, the answer is (b).

10. Problem 8: Because there are no cross-holdings by either Beta or Gamma in Alpha, IWF for Alpha = 100%. For Beta, IWF = 100 - 5 - 15 = 80%. For Gamma, IWF = 100 - 5 = 95%.

11. Problem 12: The correct answer is (c): Investors in nondomestic common stock normally avoid double taxation on dividend income by receiving a tax credit for taxes paid to the country where the investment is made.

12. Problem 15: The cost in British pounds, including commission and transaction tax, would be £3.60/share  10,000 shares  (1 + 0.0010 + 0.0050) = £36,216. So, the cost in dollars would be £36,216  $1.5010 per £ = $54,360.22.

13. Problem 16: The receipt in TW$, after excluding commission and transaction tax, would be TW$150.35/share  20,000 shares  (1 - 0.0010 - 0.0030) = TW$2,994,972. So, the receipt in euros would be TW$2,994,972 /( TW$ 32.88 per €) = €91,087.96.