OTC market
Topic 1: Financial Markets
1. You are among the OTC market makers in the stock of Bio-Engineering, Inc. and quote a bid of 102 1/4 and an ask of 102 1/2. Suppose that you have a zero inventory.
(a) On Day 1 you receive market buy orders for 10,000 shares and market sell orders for 4,000 shares. How much do you earn on the 4,000 shares that you bought and sold? What is the value of your inventory at the end of the day? (Hints: It is possible to have negative inventory. Further, there is more than one correct way to value an inventory, but please state what assumption your valuation is based on.)
I buy 4000 shares at the price of 102 ¼, for which the total cost is $409,000. I sell the inventory of 4000 shares at a price of 102 ½ and the profit from the sale is $410,000. The difference between the buy and the sale is $1000.
If the assumption is to execute the full buy order of 10,000 shares, I am left with 6000 shares that I can execute as a buy order at the end of the day. If I decide to do that, I can value the inventory at the bid or ask price. If I value at the bid price, then I have -$613,500 (6,000 x 102 ¼ = $613,500) of inventory value at the end of the day.
If I use the ask price, then the value of 6000 shares is (6000 x $102 ½) = - $615,000.
(b) Before trading begins on Day 2 the company announces trial testing of a cure for acne in mice. The quoted bid and ask jump to 110 1/4-1/2. During Day 2 you receive market sell orders for 8,000 shares and buy orders for 2,000 shares. What is your total profit or loss over the two-day period? What is the value of your inventory at the end of Day 2?
I sell 2,000 shares at a price of $110 1/2 for $221,000 . I buy 8,000 shares at a price of 110 1/4 for $882,000. I sold 6,000 of the shares from yesterday for a price of $615,000 (using the ask price). Inventory at the end of the 2nd day is 0. Losses were $221,000 + $615,000 - $882,000 = -$46,000.
(c) What is a market maker's objective? Is there anything you could
1. You are among the OTC market makers in the stock of Bio-Engineering, Inc. and quote a bid of 102 1/4 and an ask of 102 1/2. Suppose that you have a zero inventory.
(a) On Day 1 you receive market buy orders for 10,000 shares and market sell orders for 4,000 shares. How much do you earn on the 4,000 shares that you bought and sold? What is the value of your inventory at the end of the day? (Hints: It is possible to have negative inventory. Further, there is more than one correct way to value an inventory, but please state what assumption your valuation is based on.)
I buy 4000 shares at the price of 102 ¼, for which the total cost is $409,000. I sell the inventory of 4000 shares at a price of 102 ½ and the profit from the sale is $410,000. The difference between the buy and the sale is $1000.
If the assumption is to execute the full buy order of 10,000 shares, I am left with 6000 shares that I can execute as a buy order at the end of the day. If I decide to do that, I can value the inventory at the bid or ask price. If I value at the bid price, then I have -$613,500 (6,000 x 102 ¼ = $613,500) of inventory value at the end of the day.
If I use the ask price, then the value of 6000 shares is (6000 x $102 ½) = - $615,000.
(b) Before trading begins on Day 2 the company announces trial testing of a cure for acne in mice. The quoted bid and ask jump to 110 1/4-1/2. During Day 2 you receive market sell orders for 8,000 shares and buy orders for 2,000 shares. What is your total profit or loss over the two-day period? What is the value of your inventory at the end of Day 2?
I sell 2,000 shares at a price of $110 1/2 for $221,000 . I buy 8,000 shares at a price of 110 1/4 for $882,000. I sold 6,000 of the shares from yesterday for a price of $615,000 (using the ask price). Inventory at the end of the 2nd day is 0. Losses were $221,000 + $615,000 - $882,000 = -$46,000.
(c) What is a market maker's objective? Is there anything you could