2.4.2 Auction Markets

Introduction to Auction Markets

In an auction market, securities are bought and sold by investors through the facilitation of investment dealers who typically act as agents to execute buy and sell orders on behalf of their clients. This chapter broadly covers the mechanism of auction markets, elaborates on key concepts such as bid-ask spreads, and details the various stock exchanges in Canada.

Understanding the Auction Market

Core Concepts

• Bid Price: The highest price a buyer is willing to pay for a security being quoted.
• Ask Price (Offer): The lowest price a seller will accept for a security being quoted.
• Bid-Ask Spread: The amount by which the ask price exceeds the bid price, representing the difference between what one is willing to pay and the lowest price at which someone is willing to sell.
• Last Price: The most recent trading price of a stock. This price can fluctuate between the bid and ask prices as trades are executed. Note that the last price is not necessarily indicative of the price at which a stock can currently be bought or sold.

Illustration: Bid-Ask Spread

    pie
	    title Bid-Ask Spread
	    "Bid Price" : 50
	    "Ask Price" : 55

The chart above illustrates the concept of a bid-ask spread where the bid price is $50 and the ask price is $55. The spread, in this case, is $5.

Example of Trade Execution

Three investors each want to buy a share of ABC Inc. They enter bids of $5.00, $5.03, and $5.06. Conversely, three investors wanting to sell their shares place offers at $5.06, $5.07, and $5.11.

A trade is executed only when a bid matches an offer. Here, a trade occurs between the buyer who bid $5.06 and the seller who offered $5.06. Following this trade, the next best bid and offer become $5.03 and $5.07 respectively, creating a spread of $0.04.

The Structure of Exchanges

Stock exchanges operate as auction markets where buyers and sellers of securities meet to trade, and prices are formed via supply and demand dynamics. Trading typically involves common and preferred shares, rights and warrants, exchange-traded funds (ETFs), income trusts, and a few convertible debentures.

Key Canadian Exchanges

• Toronto Stock Exchange (TSX): Trades equities, convertible debt instruments, income trusts, and ETFs.
• TSX Venture Exchange: Primarily lists equities and few debenture issues.
• TSX Alpha Exchange: Facilitates trading in securities listed on the TSX and TSX Venture Exchange.
• Montréal Exchange: Deals in financial and equity futures and options listed in Canada.
• ICE NGX Canada: Electronic trading and clearing for North American natural gas and electricity markets.
• Canadian Securities Exchange (CSE): Lists equities of emerging companies.
• NEO Exchange: Provides listing services and facilitates trading of securities listed on NEO Exchange, TSX, and TSX Venture Exchange.

Liquidity in Exchanges

A fundamental characteristic of a well-functioning exchange is liquidity. Liquidity features:

• Frequent trades
• Narrow bid-ask spreads
• Minimal price fluctuations between trades

Noteworthy Facts

The TMX Group Limited amalgamates TSX Group companies, including the TSX, TSX Venture Exchange, TSX Alpha Exchange, and the Montreal Exchange, into an integrated multi-asset exchange group. TMX Group offers listing, trading, clearing, and market data services for both cash and derivatives markets across multiple asset classes. TMX Group Limited’s common shares trade on the Toronto Stock Exchange under the symbol X.

Key Takeaways

• In auction markets, prices are determined by the competitive bids and offers from various investors.
• The bid-ask spread is a crucial concept, reflecting the difference between the highest bid price and the lowest ask price.
• Canadian stock exchanges support a broad range of securities trading including equities, debt instruments, and derivatives.
• Liquidity ensures market efficiency through frequent trading, narrow spreads, and minimal price fluctuation.

Frequently Asked Questions (FAQs)

Q: What is the bid-ask spread?

A: The bid-ask spread is the difference between the highest price a buyer is willing to pay for a security (bid price) and the lowest price at which a seller is willing to sell (ask price).

Q: Why is liquidity important in auction markets?

A: Liquidity is vital as it ensures efficient market operations via frequent trades, narrowing the price differences between bid and ask prices, which ultimately results in minimal price movements between trades.

Q: Which exchanges are part of the TMX Group?

A: The TMX Group includes the Toronto Stock Exchange (TSX), TSX Venture Exchange, TSX Alpha Exchange, and the Montreal Exchange (Bourse de Montréal).