Organization of the Securities Market

1
Organization of the Securities Market

• Primary markets
• Market where new securities are sold and funds go
  to issuing unit
• Secondary markets
• Market where outstanding securities are bought
  and sold by investors. The issuing unit does not
  receive any funds in a secondary market
  transaction

2
Government Bond Issues

• 1. Treasury Bills negotiable, non-interest
  bearing securities with original maturities of
  one year or less
• 2. Treasury Notes original maturities of 2 to
  10 years
• 3. Treasury Bonds original maturities of more
  than 10 years

3
Municipal Bond Issues

• Sold by three methods
• Competitive bid
• Negotiation
• Private placement
• Underwriters sell the bonds to investors
• Origination
• Risk-bearing
• Distribution

4
The Underwriting Function

• The investment banker purchases the entire issue
  from the issuer and resells the security to the
  investing public.
• The firm charges a commission for providing this
  service.
• For municipal bonds, the underwriting function is
  performed by both investment banking firms and
  commercial banks

5
Corporate Bond and Stock Issues

• New issues are divided into two groups
• Seasoned new issues - new shares offered by firms
  that already have stock outstanding
• Initial public offerings (IPOs) - a firm selling
  its common stock to the public for the first time

6
Secondary Equity Markets

• 1. Major national stock exchanges
• New York, American, Tokyo, and London stock
  exchanges
• 2. Regional stock exchanges
• Chicago, San Francisco, Boston, Osaka, Nagoya,
  Dublin, Cincinnati
• 3. Over-the-counter (OTC) market
• Stocks not listed on organized exchange

7
Trading Systems

• Pure auction market
• Buyers and sellers are matched by a broker at a
  central location
• Price-driven market
• Dealer market
• Dealers provide liquidity by buying and selling
  shares
• Dealers may compete against other dealers

8
New York Stock Exchange (NYSE)

• Largest organized securities market in United
  States
• Established in 1817, but dates back to the 1792
  Buttonwood Agreement by 24 brokers
• Over 3,000 companies with securities listed
• Total market value over 13 trillion

9
The Global Twenty-four Hour Market

• Investment firms pass the book around the world
  to maintain nearly continuous trading by
  utilizing markets at Tokyo, London, and New York
• THE TRADING DAY
• Local Time EST
• TSE 0900 - 1100 2300 - 0100
• 1300 - 1500 0300 - 0500
• LSE 0815 - 1615 0215 - 1015
• NYSE 0930 - 1600 0930 - 1600

10
Over-the-Counter (OTC) Market

• Not a formal organization
• Largest segment of the U.S. secondary market
• Unlisted stocks and listed stocks (third market)
• Lenient requirements for listing on OTC
• 5,000 issues actively traded on NASDAQ NMS
  (National Association of Securities Dealers
  Automated Quotations National Market System)
• 1,000 issues on NASDAQ apart from NMS
• 1,000 issues not on NASDAQ

11
Operation of the OTC

• Any stock may be traded as long as it has a
  willing market maker to act a dealer
• OTC is a negotiated market

12
The NASDAQ System

• Automated electronic quotation system
• Dealers may elect to make markets in stocks
• All dealer quotes are available immediately
• Three levels of quotations provided
• Level 1 provides a single median representative
  quote for the stocks on NASDAQ
• Level 2 shows quotes by all market makers
• Level 3 is for OTC market makers to change their
  quotes shown

13
Third Market

• OTC trading of shares listed on an exchange
• Mostly well known stocks
• GM, IBM, ATT, Xerox
• Competes with trades on exchange
• May be open when exchange is closed or trading
  suspended

14
Fourth Market

• Direct trading of securities between two parties
  with no broker intermediary
• Usually both parties are institutions
• Can save transaction costs
• No data are available regarding its specific size
  and growth

15
Detailed Analysis ofExchange Markets

• Exchange Membership
• Major Types of Orders
• Exchange Market Makers

16
Exchange Membership

• Specialist
• Commission brokers
• Employees of a member firm who buy or sell for
  the customers of the firm
• Floor brokers
• Independent members of an exchange who act as
  broker for other members
• Registered traders
• Use their membership to buy and sell for their
  own accounts

17
Major Types of Orders

• Market orders
• Buy or sell at the best current price
• Provides immediate liquidity
• Limit orders
• Order specifies the buy or sell price
• Time specifications for order may vary
• Instantaneous - fill or kill, part of a day, a
  full day, several days, a week, a month, or good
  until canceled (GTC)

18
Major Types of Orders

• Short sales
• Sell overpriced stock that you dont own and
  purchase it back later (at a lower price)
• Borrow the stock from another investor (through
  your broker)
• Can only be made on an uptick trade
• Must pay any dividends to lender
• Margin requirements apply

19
Major Types of Orders

• Special Orders
• Stop loss
• Conditional order to sell stock if it drops to a
  given price
• Does not guarantee price you will get upon sale
• Market disruptions can cancel such orders
• Stop buy order
• Investor who sold short may want to limit loss if
  stock increases in price

20
Exchange Market MakersU.S. Markets

• Specialist is exchange member assigned to handle
  particular stocks
• Has two roles
• Broker to match buyers and sellers
• Dealer to maintain fair and orderly market
• Specialist has two income sources
• Broker commission, without risk
• Dealer trading income from profit, with risk

21
New Trading Systems

• Daily trading volume has increased from 5 million
  shares to over a billion shares
• NYSE routinely handles days with volume over a
  billion shares
• Technology has allowed the market process to keep
  pace

22
Super DOT

• Electronic order-routing system
• Member firms transmit market and limit orders in
  NYSE securities to trading posts or member firms
  booth
• Report of execution returned electronically
• 85 of NYSE market orders enter through Super DOT
  system

23
Electronic Communication Networks (ECN) - off
exchange screen based electronic markets

• Instinet
• Island
• RediBook
• Archipeligo
• Brut

24
Alternative Trading Systems - off exchange screen
based electronic markets

• Posit - an off exchange crossing system (orders
  are batched until a crossing time) that competes
  with NYSE member firms for institutional traders
  equity orders. It is owned by ITG which is
  regulated as a NASD broker dealer, but is not a
  NYSE member.