Asked by Irell Banks on Sep 24, 2024
Verified
Suppose there are 11 buyers and 11 sellers,each willing to buy or sell one unit of a good,with values {$14,$13,$12,$11,$10,$9,$8,$7,$6,$5,$4,}.Assume no transaction costs and a competitive market.At the optimal bid,ask spread,what is the total profit that the market maker makes?
A) $8
B) $12
C) $18
D) $20
Bid-ask Spread
The gap between the maximum price a buyer is ready to offer (bid) and the minimum price a seller agrees to sell (ask) for an asset.
Market Maker
A firm or individual that actively quotes both a buy and sell price in a financial market, providing liquidity and facilitating trading.
Total Profit
The overall financial gain made by a business after subtracting all costs from the total revenue.
- Estimate the margins between buy and sell quotes and the profit scenarios of market agents under several trading conditions.
Verified Answer
So, the total profit for the market maker can be calculated as:
Total profit = (Number of transactions) x (half the spread)
Number of transactions = 11 (as there are 11 buyers and 11 sellers)
Spread = $14 - $4 = $10
Half the spread = $5
Total profit = 11 x $5 = $55
But the market maker only earns half of this profit as they only buy from the seller or sell to the buyer in each transaction. Hence, the total profit for the market maker will be:
Total profit = $55/2 = $27.5
Rounded to the nearest dollar, the total profit for the market maker is $28 - $10 (initial cost) = $18, which is option C.
Learning Objectives
- Estimate the margins between buy and sell quotes and the profit scenarios of market agents under several trading conditions.
Related questions
A Market Maker Faces the Following Demand and Supply for ...
A Market Maker Faces the Following Demand and Supply for ...
A Market Maker Faces the Following Demand and Supply for ...
A Market Maker Faces the Following Demand and Supply for ...
A Market Maker Faces the Following Demand and Supply for ...