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June 30, 2004

The Nasdaq Closing Cross

By Adena Friedman

The most common response to any question about the value of a stock is

"Where did it close?" To many people the closing price is the most important price set by a market. With the introduction of the Closing Cross, Nasdaq has created a better mechanism for establishing the true closing price in Nasdaq securities. The true' closing price, in our view, is the price that best reflects the buy and sell

interest in the stock at market close. The Closing Cross provides an electronic auction process. There is no unique informational advantage for any participant, thus introducing a very fair and efficient closing process.

The needs of the open and close, when trading surges to as many as 2,000 executions per second, are different from the efficient, continuous market that Nasdaq operates throughout the trading day.

Market Needs

By introducing the nation's first electronic closing auction at the close - when there is a naturally high concentration of order interaction - Nasdaq also meets specific market needs at that single instant each day.

The Closing Cross changes the common practice of setting the close with the last trade reported to Nasdaq. Instead, trading interest from multiple participants, sometimes reaching well over a million shares, is exposed to the market. This occurs through frequent dissemination of indicative closing data. The indicative closing data provides continuous and effective price discovery. This enables all market participants to have an equal opportunity to resolve imbalances and receive executions at the close.

Historically, the common issue with the Nasdaq close was that the risk associated with closing on the last sale increased the cost of executions. Moving to an electronic auction with near-real time data distribution creates a closing price that is not only transparent but also predictable and tradable. While firms continue to have many choices for late-in-the-day trading, the Closing Cross creates robust benchmark prices for indexers, funds, issuers and investors.

For participants looking to execute on-close volume on an agency basis, the cross exposes orders to a large number of potential counterparties in a competitive auction. For firms willing to execute as principal, the cross reduces risk and increases transparency for buyside clients. Finally, the cross creates a large pool of liquidity for any potential buyer or seller.

Nasdaq created the cross in response to requests for a reliable, quality close to the trading day. To ensure the design met industry needs, Nasdaq kicked off the development process by inviting the buyside, the sellside, and "Dr. Auction" Professor Robert Schwartz of Baruch College, to be full participants in creating the cross. Within a month of its launch, the Closing Cross did an $18 million trade.

To ensure the Closing Cross is competitive, Nasdaq accepts on-close orders from all participants before 3:50 p.m., Eastern Time. Nasdaq also encourages all participants to be a principal' and react to the on-close orders by providing offsetting liquidity through quotes, orders and special Imbalance Only orders.

At 4:00 p.m., the cross combines on-close orders with auto-ex orders and quotes from the Nasdaq market center into a single print at the price where supply and demand meet.

So that it is easy for traders to provide liquidity, Nasdaq releases indicative prices frequently in the ten minutes before the close through its own data feeds and through all major data vendors. This transparency makes the Nasdaq close predictable with traders able to watch the closing auction unfurl as 4:00 p.m. approaches.

Ultimately, the cross depends on traders. Since Nasdaq has never had an auction before, a critical issue is acceptance. The results for the first three months are very encouraging. The cross has executed over a million shares on a number of occasions and there is strong support from major firms. Now, an opening cross is due to be implemented in the second half of 2004.

Adena Friedman is executive vice president of corporate strategy and data products at the Nasdaq Stock Market.