Day 1

Market Microstructure
- The Trading Environment
- Refer to the slides for Day 1 Notes

Day 2
Part 1 - Professor Glosten
- Capital Market Vocabulary
- Bids and Offers
- Market participants put in quotes on the allowable price grid
- The tick (or MPV) is the smallest price increment
- A penny for stocks over $1, $0.0001 for stocks under $1
- Bid / Below, Ask, Offer / Above, Over
- Market Quote
- Market (Inside) Quote is the best (highest) bid and the best (lowest) offer
- AKA Top of the Book or National Bid Offer (NBBO)
- The market bid should be less than the market offer
- Other Features of the Quote
- Bid comes before Offer
- A signal towards sophistication
- Market Participants
- Broker - an agent of a client that wishes to trade, finds someone willing to sell
(think real estate broker)
- Dealer - takes the other side of a clients trade (think art dealer)
- Limit Order
- A limit order seeks execution of a specific number of shares at the limit price or
better
- Types of limit orders
- Immediate or Cancel (IOC)
- Day
- Good Until Canceled (GTC)
- Fill or Kill (FOK)
- Hidden or exposed, partially hidden (iceberg order)
- Midpoint peg, market peg
- Marketable and Non-Marketable Orders
- A limit buy order is marketable if the limit price is at or above the best offer
- “Crosses the spread” to get an immediate execution
- AKA Aggressive order, aggressor
- Non-marketable if the li
- Market Orders
- A market order is an order to transact a specified number of shares at the best
possible price
- A market buy seeks the lowest offer
 - A market sell seeks the highest bid
Part 2 - Professor Fox
- Overview of the Regulatory Structure
- 1934 is a watershed moment in the history of regulation
- Securities and Exchange Act is passed
- But capital markets were regulated prior to that
- 1910s and 1920s
- Where did the rules come from?
- The exchanges themselves - particularly the NYSE
- These rules were self-interested, but there were limits
given alternative exchanges
- 1929
- Stock market crash - blame placed on the ‘shenanigans’ during the 10s
and 20s
- There are countervailing narratives
- 1934
- With the popular idea of 1929 causing the depression, the Securities
Exchange Act of 1934 created (Exchange Act)
- Allowed the promulgation of rules and regulations, which has
expanded over time
- Sources of Regulation and Enforcement
- Securities Exchange Act of 1934 (Exchange Act)
- SEC Rules
- Self Regulation
- State Common Law
- In the background, brokers subject to state fiduciary duty laws
- Regulation of Traders
- Microstructure economics can help our understanding of a variety of
kinds of regulation relating to traders
- Manipulation - traders influencing price to their advantage
- Short Selling - seen as economically advantageous, but there are
circumstances where regulation is positive
- Insider Trading -
- Market Structure Regulation: Transparency
- Who knows (and when) the prices…
- At which securities are being offered for sale and bid for
purchase
- At which actual trades occurred and the volume
- The information is valuable
- For traders and liquidity suppliers to assess supply and demand
- This requires regulation of collection, consolidation, and dissemination
of info as well as of the price of access
- The National Market System (NMS)
 -Saw an opportunity to encourage exchange competition
(Professor Fox - great foresight)
- The overall trend is towards much more transparency
- Market Structure Regulation: Brokers and Execution
- Concerns of brokers: honesty, competency, financial capacity?
- Section 15 of the Exchange Act
- FINRA
- State fiduciary duty law

Day 3
Last Class:
- Subdividing regulation into the major participants
- Regulation of the trading venues
- Regulation of the intermediaries (brokers/dealers)

Class Today
- Market Structure Regulation
- Brokers make money by:
- charging commissions, which used to be a significant amount
- Regulation NMS began phasing out those commissions
- Receiving payment from exchanges for sending non-marketable limit orders
(create liquidity) - this is a maker payment
- Dealers make money by:
- Markups - remember, you are buying from the dealer
- Regulation:
- Size
- FINRA Rules of Fair Practice
- Rule 10b-5
- Disclosure
- Rule 10b-10
- Internalization
- Not prohibited and not regulated beyond disclosure
- *This is a larger topic that should be explored deeper
- Trading Venues and Execution
- Total results from the whole NMS reform
- Limit orders are everything
- Greater true competition among markets
- Smaller spreads
- Assurance Mechanisms - mechanisms to facilitate and assure performance
- These sales are contracts that must be completed, brokers ‘backup’ the contracts
and assure payment - increases level of trust that is mutually beneficial

- Social Criteria for Measuring Regulation

- “Why are we talking about these general economic concepts?” - to form a benchmark
- The Criteria:
- Use of Existing Productive Capacity
- Allocation of Capital
- Allocation of Resources Over Time
- Allocation of Risk

- Key Characteristics Relating to the Market’s Capacity to Create Social Value in These
Ways
- Liquidity
- Core concepts of liquidity
- Ability to trade quickly, in quantity, and at low cost (time, $)
- Value of Liquidity
- Liquidity is a value in and of itself - the ability to trade is valued
for the future potential of trade (greater price for equal cash
flow)
- Resource Allocation
- Risk Allocation - less costly to reach desired portfolio
- Price Accuracy - less friction / transaction cost induces more
trading, = price accuracy
- Price Accuracy - the expected deviation between current price and actual value
- Price is related to future expected cash flow
- There is a difference between an unbiased price (one that reflects all
publicly available information) and an accurate price
- Other Considerations
- Consumption of real resources
- Market power of participants
- Fairness
- Efficient Market Hypothesis - assures price fairness (though
not accuracy)

- What Securities Markets Do

- Facilitate the transfer of ownership of financial instruments
- Bring together buyers and sellers in a way that keeps the search costs of each low

- The Social Value of Accurate Prices

- 1) More accurate prices play a role in setting limits on managerial discretion
concerning use of existing capacity and choice of new real investments
- 2) They also play a more direct role in the efficient allocation of society’s scarce
capital