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Chapter 4Charles P. Jones, Investments: Analysis and Management,Tenth Edition, John Wiley & Sons

Prepared byG.D. Koppenhaver, Iowa State University

Securities Markets

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The Role of Financial Markets Help firms and governments raise cash

by selling claims against themselves Provide a place where investors can act

on their beliefs Help allocate cash to where it is most

productive Help lower the cost of exchange

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Markets in New Securities

New securities are issued in a primary market Initial public offerings versus seasoned new

issues Issue facilitated by investment banker

Specialists in advice, design, and sales Intermediaries between issuer and investor

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Investment Banking

Client advice includes type and features of security, offer price, and timing of sale

Underwriting services: Risk of selling to investors assumed from issuer

Coordinates marketing by helping issuer register securities, issue prospectus, and sell securities

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Investment Banking

Rule 415 (shelf rule) allows certain issuers to sell new securities over time after filing a single registration Reduces issuance cost

A private placement means new securities are sold directly to investors, bypassing the open market Registration not required

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Secondary Markets

Markets where investors trade previously issued securities

Auction markets involve bidding in a specific physical location Brokers represent investors for a fee Others trade for their own account

Negotiated markets consist of decentralized dealer network

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Stock Exchanges

NYSE is a secondary, auction market in equity shares Not-for-profit organization of members Listing requirements for traded firms “Specialists” assigned to each traded equity

to make a market in that stock AMEX and regional exchanges list

smaller firms, have less volume than NYSE

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NASDAQ

Network of competing dealers trading listed securities

Automated quotation system with no fixed number of participants NASDAQ National Market NASDAQ SmallCap Market

More firms listed than NYSE Network connects to other trading

systems

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Over-the-Counter Markets

Network of dealers standing ready to either buy or sell securities at specified prices Dealers profit from spread between buy and

sell prices Handle unlisted securities

OTC Bulletin Board ECNs: Additional trading mechanism,

especially after exchanges close

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Foreign Markets

US equity markets account for a decreasing share of world’s stock market capitalization Many different equity markets exist

Emerging market: Stable political system, low regulation, low standardization in trading activity Risks: Illiquidity, lack of information,

political uncertainty

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Equity Market Indicators

Provide a composite report of market behavior on a given day

Dow Jones Industrial Average Composed of 30 “blue-chip” stocks Price-weighted index: Essentially adds the

prices of 30 stocks, divides by 30 Adjusted for stock splits, stock dividends

Oldest, most well-known measure

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Equity Market Indicators

Standard & Poor’s Composite Index Composed of 500 “large” firm stocks Expressed as index number relative to a

base index value of 10 (1941-43) Value-weighted index: Prices and shares

outstanding considered Indicates how much the average equity value of

the 500 firms in the index has increased relative to the base period

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Equity Market Indicators

NYSE and NASDAQ Composite Indices Value-weighted indices of broad markets

Nikkei 225 Average Price-weighted index of 225 actively-traded

stocks on the Tokyo Stock Exchange

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Bond Markets

Secondary bond market is primarily an over-the-counter network of dealers NYSE features an automated bond system

to execute orders. Mostly corporate bonds, thinly traded

Treasury and agency bonds actively trade in dealer markets Municipal bonds less actively traded

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Market Developments

Growth of institutional trading associated with: Block trading of stocks (transactions of at

least 10,000 shares) Affects market structure and operation

Negotiated, not fixed, commissions Evolution of National Market System

Centralized system for price and activity reporting, order routing and sequencing

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