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Homework answers / question archive / Suppose that you are one of the market makers in the stock of a new smartphone company
Suppose that you are one of the market makers in the stock of a new smartphone company. You quote a bid of 50 % and an ask of 50 %. Since this is your first day, you have a zero inventory. (a) Suppose that you receive market sell orders for 5000 shares and market buy orders for 3000 shares. How much do you earn on the 3,000 shares that you sold and bought? How many stocks left in your inventory after the first day? (6) Before trading begins on the second day, the company announces new smartphone will be delayed. As a result, the quoted bid and ask declined to 45 A and 45 y. During that day you receive market sell orders for 3000 shares and buy orders for 5000 shares. What is the total profit or loss over the two- day period? How many stocks left in your inventory? c) What is a marker maker's objective? Is there anything you could have done during the first day, consistent with a market maker's objective that would have improved your performance over the two-day period?
A): On Day 1 You bought 3,000 shares at a price of 50.25 which cost $150,750. You sold 3,000 shares at a price of 50.50 which made $151,500.
Your profits were $750 (151,500-150,750)
Assuming you executed the full sell order, you were short 2,000 shares at end of the day. You could value your inventory at either at the bid price or at ask price. If you use the bid price, then the value of your inventory was -$100,500. If you use the ask price, then the value of your inventory was -$101,000. You might also use the average the bid and the ask which would result in an inventory value of $101,750.
Part B)You sell 5,000 shares at a price of 45.50
for $227,500. You buy 3,000 shares at a price of $45.25 for $135,750. 2,000 of the shares you
Sold you had bought yesterday for a price of $100,500. Therefore your profits/losses on these 5,000 shares was 135750+100500 -227500=$8750. Your inventory at the end of the is $8750
Part C:- Solution. The profits came from picking up the 1/4 point bid-ask spread.
However this profit was over-shadowed by losses on the outstanding negative inventory held over-night when the price went up. A market-maker seeks to make money on the bid-ask spread and not from speculation about price movements. Therefore to have avoided any P&L
from speculation, we could have only filled some of the buy order on the 1st day in order to avoid taking a short position overnight.
