Explore BrainMass

the impact of bid-ask spreads on the relative investment

Please help me with the following:

1. What is the impact of bid-ask spreads on the relative investment attractiveness between US & Canada?

2. What are the bid-ask spreads for each currency (US & Canada)? Please show the calculations for each.

Solution Preview

Hi there,

Here are your answers:

When you view stock prices on a trading screen, you will find that a stock has two quotes - the so-called "bid" price and the so-called "ask" price. For example, suppose you own 100 shares of ABC Corporation, and you want to buy or sell these shares. You obtain a quotation which indicates that the current bid price - the price at which you can sell this stock - is $100 per share, and the current ask price - the price at which you could buy the shares - is $101. These quotes mean that someone is willing to buy at least 100 shares of IBM at $100 and that another person is willing to sell at least 100 shares of the stock at $101. The difference between these bid and ask prices is referred to as the 'bid-ask' spread. In the above example, the spread is one dollar.

If you were to simultaneously buy and sell 100 shares of this stock in the market you would lose the $1.00 spread.

Another way to describe the bid-ask is to say that the "bid price" represents the highest price that somebody will pay for a stock at a particular point in time, whereas the "ask price" is the lowest price at which someone is willing to sell a stock.

Why is there a bid-ask spread? To compensate for the risk that they run, Market Makers seek to buy shares at a lower price and sell at a higher price. The bid-ask spread is, therefore intended to compensate Market Makers for the risk they take in dealing with the stock and keeping the markets liquid.

The size of the bid-ask spread on a particular stock depends on several factors. In general, the more liquid (volume) a stock is the smaller its bid-ask spread will be. Less liquid stocks usually have larger spreads, as do lower priced stocks (in percentage terms). For a fairly liquid stock priced at around $100, a spread of around 75 cents or so is not uncommon.

Note that the bid-ask spread is a "hidden" cost for day traders and other investors. It is a cost that is additional to the normal commissions paid for executing trades. For frequent traders, the bid-ask spread can rapidly erode trading capital. These traders should avoid stocks with inordinately high bid-ask spreads, particularly when using market orders. In particular, it is best to avoid thinly traded stocks or stocks priced under $5.00.


Another good source of info:

Basic Rule: All trades result in the buying of one currency and the selling of another, simultaneously.

The objective of currency trading is to exchange one currency for another with the expectation that the market rate or price will change such that the currency you have bought has appreciated in value relative to the currency you have sold. If the currency you have bought appreciates in value and you close your open position by selling this currency, or effectively buying the currency that you originally sold, then you are locking in a ...