Operational Efficiency


DEFINITION of 'Operational Efficiency'

A market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally-efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation, without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.

Also known as an "internally efficient market".

BREAKING DOWN 'Operational Efficiency'

Consider the hypothetical example where all brokers charged a minimum commission of $100 per trade. If you were a huge mutual fund trading 20,000 share blocks at a time, this fee may not limit your ability to be operationally efficient in your trading. But if you were a small investor looking to trade 10 or 20 shares, this fee would keep you from trading almost entirely, making the market (as you saw it) extremely inefficient.

In the case of trading costs, the advent of electronic trade and increased competition have pushed fees low enough to be fair to investors while still allowing brokers to earn a profit.

In other areas of the market, certain structural or regulatory changes can serve to make participation more operationally efficient. In 2000, the Commodity Futures Trading Commission (CFTC) passed a resolution allowing money market funds to be considered eligible margin requirements, where before only cash was eligible. This minor change reduced unnecessary costs of trading in and out of money market funds, making the futures markets much more operationally efficient.

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