Question: You are among the OTC market makers in the stock of industrial, Inc. and quote a bid of 102 ¼ and an ask of 102 ½ . Suppose that you have 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: Assume 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.)
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 ¼ - 110 ½ . During day 2 you receive market sell orders for 8,000 shares and buy orders for 2,000 shares. What is the value of your inventory at the end of day 2?
C. Where did your profit or loss come from? What is a market makers objective, that is, how does a marker maker seek to make money? Is there anything you could have done during day 1, consistent with a market makers objective, that would have improved your performance over the two day period?