Market Maker FAQ v1.0

3.    Are Market Makers risk adverse? a.        Does a Market Maker hold “stocks” of the shares they make a market in?                                                                i.      No.  Market Makers are there to make a market, not to act as some form of stock control system.  At any one time a Market Maker is likely to have a position in the stocks they are the Market Makers for, but this position could just as easily be short as long.  However having a position (of either persuasion gives market exposure and Market Makers try to avoid this.)  (See 3d.) b.        Can Market Makers take a short position?                                                                i.      No and yes.  Market Makers are not supposed to allow themselves to go short, but in process of making a market they may well find themselves short of a stock.  If this happens a Market Maker has a number of options, purchase from another Market Maker, fiddle with the price in the hope that enough sellers will emerge to cover the short or borrow the shares from an institutional investor. c.        What is market exposure?                                                                i.      Market exposure is the amount of money you have exposed to the vagaries of the market, i.e. the amount of money you could loose or gain from your positions open in the market. d.        Why do Market Makers avoid market exposure?                                                                i.      Simply because a Market Maker who is over exposed to the market is giving systematic risk to the whole market.  Ill explain…  If a Market Maker was to take up lots of large position across the whole range of shares they make a market in then if there was a market crash the Market Maker may find themselves bankrupt (ala Nick Leeson and Barings) and therefore unable to make a market.  Once there is no longer a market the shares will become pretty worthless (if you cant sell something, at any price, what is it worth?), this in turn could force other Market Makers to go bankrupt and the whole thing would spiral down into a very unpleasant mess.  We would all loose vast amounts of money from our pensions, endowment policies, insurance funds, Unit Trusts, Investment Trust and direct equity investments, in addition to which an important source of cash for companies would vanish! <<Previous Home Next>> The latest version of this FAQ can be found at http://www.financiallinks.co.uk/Insider/InsiderIndex.htm. © Copyright Niro Computers Ltd 1999.  This FAQ is maintained by Jason Ward. This FAQ can be freely distributed, so long as the URL to the original and copyright message remain intact.

Disclaimer : Please note that these articles do not necessarily represent the views of UK Share Net. The views expressed are those of the authors. The price of shares can go down as well as up. No infringement of copyright is intended, any offending articles will be removed as soon as possible when notified.