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PART THREE Valuation of Future Cash Flows

As you approach the specialist's post where Wal-Mart is traded, you check the terminal screen for information on the current market price. The screen reveals that the last executed trade was at 60.25 and that the specialist is bidding 60 per share. You could immediately sell to the specialist at 60, but that would be too easy.

Instead, as the customer's representative, you are obligated to get the best possible price. It is your job to "work" the order, and your job depends on providing satisfactory order execution service. So, you look around for another broker who represents a customer who wants to buy Wal-Mart stock. Luckily, you quickly find another broker at the specialist's post with an order to buy 20,000 shares. Noticing that the dealer is asking 60.10 per share, you both agree to execute your orders with each other at a price of 60.05. This price is exactly halfway between the specialist's bid and ask prices, and it saves each of your customers .05 X 20,000 = $1,000 as compared to dealing at the posted prices.

For a very actively traded stock, there may be many buyers and sellers around the specialist's post, and most of the trading will be done directly between brokers. This is called trading in the "crowd." In such cases, the specialist's responsibility is to maintain order and to make sure that all buyers and sellers receive a fair price. In other words, the specialist essentially functions as a referee.

More often, however, there will be no crowd at the specialist's post. Going back to our Wal-Mart example, suppose you are unable to quickly find another broker with an order to buy 20,000 shares. Because you have an order to sell immediately, you may have no choice but to sell to the specialist at the bid price of 60. In this case, the need to execute an order quickly takes priority, and the specialist provides the liquidity necessary to allow immediate order execution.

Finally, note that colored coats are worn by many of the people on the floor of the exchange. The color of the coat indicates the person's job or position. Clerks, runners, visitors, exchange officials, and so on wear particular colors to identify themselves. Also, things can get a little hectic on a busy day, with the result that good clothing doesn't last long; the cheap coats offer some protection.

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