Quantitative and Qualitative Disclosures About Market Risk
Our market-making and trading activities expose our capital to significant risks. These risks include, but are not limited to, absolute and relative price movements, price volatility or changes in liquidity, over which we have virtually no control.

We employ an automated proprietary trading and risk management system which provides real time, on-line risk management and inventory control. We monitor our risks by a constant review of trading positions. For each trader, we have established a system whereby any trades that exceed pre-determined limits are monitored by senior management as are individual and aggregate dollar and share position totals and real-time profits and losses. The management of trading positions is enhanced by review of mark-to-market valuations and/or position summaries on a daily basis.

In the normal course of our market-making business, we maintain inventories of exchange-listed and OTC securities. The fair value of these securities at December 31, 1999 and 1998 was $135.8 million and $100.5 million, respectively, in long positions and $129.8 million and $108.9 million, respectively, in short positions. The potential change in fair value, using a hypothetical 10.0% decline in prices, is estimated to be a $0.6 million loss and a $0.8 million gain as of December 31, 1999 and 1998, respectively, due to the offset of losses in long positions with gains in short positions. The following table illustrates, for the period indicated, our average, highest and lowest month-end inventory at market value (based on both the aggregate and the net of the long and short positions of trading securities).

Beginning in the fourth quarter of 1998 and throughout 1999, there has been a sharp increase in the price volatility of many stocks, particularly of technology companies and companies that sell products or services via the Internet. This volatility has been coupled with record trading volume in many of these stocks, which are primarily listed on Nasdaq. Customers eager to trade Internet and technology stocks have flooded their brokers with larger numbers of orders, leading to large order imbalances, systems queues and backlogs. During these extreme market conditions, many firms have implemented procedures that are designed to preserve the continuous execution of customers' orders while also lessening the exposure of the firm to extraordinary market risk.

In the fourth quarter of 1998, we modified our execution policies in response to these changes in the marketplace. Our current policy is to provide continuous automatic execution on orders of up to 2,000 shares for investors in over 4,400 Nasdaq stocks under normal market conditions. We reserve the right at our sole discretion to reduce, modify, suspend or cancel any of our guaranteed or automated order handling protocols, including automated price improvement and automatic execution, without prior notice on a stock by stock or customer by customer basis, when periods of extreme or unusual market conditions exist, risk management protocols so dictate, attempts are made to circumvent our automated execution size limitations, or we otherwise deem it appropriate.

For working capital purposes, we invest in money market funds or maintain interest-bearing balances in our trading accounts with clearing brokers, which are classified as cash equivalents and receivable from clearing brokers, respectively, in the Consolidated Statement of Financial Condition. These amounts do not have maturity dates or present a material market risk, as the balances are short-term in nature and subject to daily repricing. Since its inception, neither Knight/Trimark nor any of its subsidiaries has traded or otherwise transacted in derivatives.