Question

Use the following exchange quotes to help answer problems 18-19. NYSE NASDAQ Bid Ask Bid Ask Company Y mpom $ 127.88 | $ 128.12|$ 127.70 | $ 128.30

Based on the bid-ask spreads for Stock X & Y, the NASDAQ is more liquid than the NYSE while Stock Y is more liquid than Stock X. Evaluate the underlined words in italics. True or False? Hint: Calculate spread as a percentage of the midpoint of the bid-ask quotes.

A. True B. False

Answer 1

At first, we have to understand the relation between the bid-ask spread of a security and its liquidity. A bid price in a price at which the buyer is willing to buy a security and the ask price is the price the seller is willing to sell the security. A lower bid-ask spread in an indication of a liquid market, as oppose to a higher bid-ask spread. Essentially, in a well-informed liquid market, difference in prices between the buyer and seller (bid and ask prices) would be lower as there are high volume of trade (liquid market).

For this question, we shall first calculate the actual bid-ask spread. This can be done by subtracting the ask prices of each security with the bid prices. For example, for Company X in NYSE, the bid-ask spread would be $0.90 ($150.45-$149.55) and so on.

The table below shows the bid-ask spread:

Company	NYSE	NASDAQ
Company X	$0.90	$0.26
Company Y	$0.24	$0.60

The hint in the questions ask us to calculate spread as a percentage of the mid-point of the bid-ask quotes. Thus, the mid-point calculating would be the average of the two quotes. For example, for Company X in NYSE, the mid-point would be $150.00 (Average of $149.55 and $150.45)

The table below shows the mid-points:

Company	NYSE	NASDAQ
Company X	$150.00	$150.00
Company Y	$128.00	$128.00

The next step is to calculate the bid-ask spread as a percentage of mid-point. For example, for Company X in NYSE, the bid-ask spread as a percentage of mid-point would be 0.6% [($0.90/$150.00)*100].

The table below shows the the bid-ask spread as a percentage of mid-point:

Company	NYSE	NASDAQ
Company X	0.6%	0.2%
Company Y	0.2%	0.5%

As seen above, Company Y has a lower total bid-ask spread percentage, i.e. 0.7% (0.2%+0.5%) as compared to Company X's total 0.8% (0.6%+0.2%). We can thus regard Company Y to be more liquid than Company X.

Also, NASDAQ has a lower bid-ask percentage, i.e. 0.7% (0.2%+0.5%) as compared to NYSE's total 0.8% (0.6%+0.2%). We can thus regard NASDAQ to be more liquid than NYSE.

Thus, the given statement in the question can be answered to be TRUE. (A)