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Difficulty: MediumTypes of Orders and Order Execution Strategies

An investor holding a short stock position currently trading at 78persharedecidestoplaceaBuyStoporderat78 per share decides to place a Buy Stop order at 85 to limit potential upside losses. Additionally, the investor enters a separate Market-on-Close (MOC) order to exit another position. Which of the following statements regarding these order types and their execution mechanics are correct?

  1. The Buy Stop order at 85istriggeredandactivatedasamarketorderonlyafterthestocktradesatorabove85 is triggered and activated as a market order only after the stock trades at or above 85.Answer
  2. The Market-on-Close order must be executed as close to the official closing price as possible and is subject to exchange-mandated cutoff times for cancellation.Answer
  3. C
    Once activated by a transaction at 85,theBuyStoporderguaranteesthattheinvestor′sbuybackpricewillbeexactly85, the Buy Stop order guarantees that the investor's buyback price will be exactly 85.00 per share.
  4. D
    Executing these orders requires the broker-dealer to act strictly in a principal capacity, earning a mark-up on the trades.

Answer

The correct statements are that the Buy Stop order is triggered into a market order when the stock trades at or above $85, and that Market-on-Close orders execute near the end of trading subject to firm exchange cutoff rules.
The statement explaining that a Buy Stop order activates as a market order once the stock trades at or above $85 is accurate because buy stop orders are placed above the current market price to protect short positions and trigger upon reaching the stop price. Furthermore, the statement describing Market-on-Close orders is correct because MOC orders are designed to capture the official closing price and are subject to strict exchange cutoff deadlines to ensure orderly closing procedures.

Step-by-Step Solution

1
Analyze the mechanics of a Buy Stop order used to protect a short position.
A Buy Stop order is placed above the market (at 85whentradingat85 when trading at 78). It is triggered when a trade or bid occurs at or above $85, converting it into a market order.
Understanding the trigger condition for stop orders prevents confusing activation with guaranteed execution price.
2
Evaluate the execution rules for Market-on-Close (MOC) orders.
MOC orders aim to execute at the closing price and must adhere to exchange cutoff times, after which modifications or cancellations are prohibited.
MOC orders provide execution certainty near market close but carry regulatory cutoff constraints.
3
Evaluate distractor concepts regarding price guarantees and broker capacity.
Stop orders turn into market orders (no guaranteed price), and routine agency execution incurs commissions rather than dealer mark-ups.
Distinguishing market orders from limit orders and broker (agency) roles from dealer (principal) roles confirms which options are false.

Key Concept

Buy Stop Mechanics & Market-on-Close Order Execution Rules
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Topics

Types of Orders and Order Execution Strategies