Financial Education Association

TEACHING THE ART OF MARKET MAKING WITH A GAME SIMULATION

Author(s): Thomas H. McInish
Source: Journal of Financial Education, No. 9 (Fall, 1980), pp. 74-76
Published by: Financial Education Association
Stable URL: https://www.jstor.org/stable/41947999
Accessed: 11-09-2019 10:05 UTC

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 74

JOURNAL OF FINANCIAL EDUCATION

FALL 1980

TEACHING THE ART OF MARKET MAKING

WITH A GAME SIMULATION

Thomas H. Mclnish*

This paper describes a game simulation which has been used by the author in a beginning under-
graduate securities course to introduce finance students to the art of market making. Market making
by specialists on the stock exchange and by over-the-counter traders provides the mechanism by which
investors are assured that, at any given time, there will be a buyer or seller available for their
securities. An appreciation of the market making process is essential for an understanding of
securities markets. While the game simulation is relatively simple and can easily be integrated
into discussions of the operations of securities markets, it offers students an opportunity to
experience a simulated dynamic business environment. Complete rules for playing the game are provided
in Appendix I.

Essentials of the Game

The game is played by 2-5 players whose goal is to maximize their terminal wealth. Each player
begins with an initial endowment of shares and money, and by the end of the game must reach a specific
share balance. Hence, each player must trade at least minimally. Because the banker maintains a
market of $35 bid-$40 asked throughout the game, trading cannot take place outside this range even
though the shares themselves have no intrinsic value. Within the trading range of $35-$40 the
dynamics of the game are determined entirely by the student participants. Since each player begins
with a different initial endowment and ending share target, the performance of players within a group
is not directly comparable. But several groups of five students each may play the same game, either
simultaneously or at different times, so that the outcome of player number one in group number one
could be compared with that of player number one in group number two, etc.
Based on the author's experience, several suggestions which may improve the usefulness of the
game are:

1. The instructor should review both the rules of the game and potential strategies before play
begins. It can also be helpful for students to be given time and encouragement to consider
alternate strategies.
2. Several practice rounds might be played before the game begins in earnest.
3. The instructor might interrupt the game at some point to review alternate strategies and to
discuss actual strategies which are being employed.

University of Delaware

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Benefits and Conclusions

Students could benefit from the game because the game provides opportunities for:
1. Active participation in their own learning
2. An understanding of the importance and nature of the market making function
3. Analysis and consideration of strategies for dealing with a complex and dynamic business
environment, and
4. Experience in a simulated market in which competitors may react to one another's action.
Thus, use of the game simulation

for teaching the art of market making Use of the game simulation should stimulate
should stimulate student interest in student interest and contribute to a greater
securities markets and contribute to understanding.
a greater understanding of the

operations of these markets.

APPENDIX

RULES

This game requires a banker, quote clerk* and 2-5 players.

Beginning the Game

At the beginning of the game each player is given an envelope which contains the following items:
1. $60,000 in play money.
2. Certificates issued by the bank for the number of shares with which the player begins the
game. If the player begins the game in a short position only a note so stating will be
included.

3. Blanks for issuing new shares (additional blanks can be obtained from the bank)
4. A card indicating the target ending share balance.
5. A share ledger for keeping a running balance on one's share position.
At the beginning of the game the quote clerk prepares the blackboard as follows:

PI nayer
PI nayer aver
aver Bid
Quotes
Asked
Bank 35 40

Player #1 35 40
Player #2 35 40
Etc.

♦These positions may be combined if the pace of play is moderate.

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 76

Playing the Game

The play begins when the instructor announces that the market is open. Thereafter, each player
must maintain a continuous market, i.e., must always have a bid and asked price posted. The bid
(asked) is the price at which other players may sell to (purchase from) a given playerš Players may
change their quotes (bid/asked prices) at any time by informing the quote clerk. The bank maintains
a continuous market of $35 bid-$40 asked throughout the game and players may trade with the bank at
these prices at any time. Hence, trades will never occur outside the range of $35-$40. A player may
issue any number of shares by simply writing his number at the bottom of a blank certificate and
filling in the appropriate number of shares. (It is advisable for participants to keep a running
account of their share position.) Players may not borrow money and all trades must be publicly
announced. Players may purchase from each other or the bank at the appropriate bid/asked price at
any time.*
Each player is obligated to trade at least 100 shares on either side of his market. Suppose
Player A has a quote listed as $36 bid-$37 asked. If another player wishes to trade with Player A at
his bid/asked price, Player A must trade at least 100 shares. Further, if Player A is not willing to
trade additional shares at that price, he must immediately change his quote to a bid/asked price at
which he is willing to make trades. Whenever a trade is agreed to the players exchange stock cer-
tificates and money as appropriate.
At the beginning of the game the banker is given a deck of cards which represent (exogeneous)
market orders for customers of the bank.** Periodically, the instructor will announce that the
banker is to execute the next market order. It is the banker's duty to obtain the best price for his
customer.

End of the Game

At the end of the game the procedure is as follows:

1. Each player gives his shares to the banker receiving credit for their full number.
2. Any shares issued by each player and credited to another player are subtracted from the
issuing player's balance to determine a net ending balance.
3. To reach their target ending balance, players may enter into closing transactions with each
other at prices which are negotiated among themselves.
4. Any difference between the net ending balance and the target ending balance (after step 3
above) must be purchased from the bank at $40 or sold to the bank at $35.
5. Each player determines his cash balance.

*If two or more market makers have a bid/ask at the same price, the instructor may wish to
require that all trades be made with the oldest or most senior bid/ask.

**Note to the instructor: The cumulative orders of the banker should be just sufficient to
supply or absorb the difference between the aggregate beginning and target balances of players.

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