chapter 4 securities markets. compare primary and secondary markets. equity markets - organization...

Chapter 4

Securities Markets

Compare primary and secondary markets. Equity markets - organization and

operations Define third and fourth markets. Major stock market indicators. Bond and derivatives markets. Change in the securities markets

Learning Objectives

Financing government and firm projects Channel funds from savers to borrowers 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

Importance of Financial Markets

New securities are issued in a primary market Initial public offering (IPO) versus “seasoned”

new issue IPO – Common stock shares of a company being sold

for the first time

Issue facilitated by investment dealers Specialists in advice, design, and sales Intermediaries between issuer and investor

Primary Markets

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

Underwriting services: Risk of selling to investors assumed from issuer

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

Investment Dealers

• The issuing company sell the securities to the financing group which consists of one or two firms

• The financial group sells the securities to the marketing group at a “draw down” price

• The securities are distributed for sale to the public

Underwriting Process

Prompt Offering Qualification (POP) System allows senior reporting issuers to sell new securities over time via “short form” prospectuses Reduces issuance cost

Listing process Global security issues A private placement means new securities are sold to

a small group of institutional investors Registration not required

Issuance of Securities

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

Secondary Markets

Toronto Stock Exchange (TSX) is a secondary auction market for equity securities Largest Canadian stock market Listing requirements for traded firms

TSX Venture Exchange is Canada’s “junior” stock market

New York Stock Exchange (NYSE) is the largest secondary market in the world

Stock Exchanges

Formal organizations approved and regulated by the SEC (or the provincial securities commissions such as the OSC in Canada)

Members Can only trade listed stocks Must buy a seat on the exchange

Listing requirements minimum capitalization, shareholder equity,

average closing share price, etc.

Stock Exchanges

Centralized continuous auction market Exchange participants

single specialist commission brokers independent floor brokers registered traders

SuperDot Major roles of NYSE specialist

Dealer Agent Catalyst Auctioneer

Commissions deregulated in 1975

NYSE

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

Canadian OTC stocks are trading on the TSX Venture Exchange

US OTC Market: NASDAQ

Over-the-Counter (OTC) Markets

Trading unlisted stocks Listing requirements Nasdaq stock market Nasdaq market tiers

Nasdaq National Market (3,600 co.’s) Small Capitalization Market (850 co.’s)

Nasdaq market makers Other OTC markets (8,000 co.’s)

OTC Bulletin Board Pink Sheets

Over-the-Counter (OTC) Markets

Third Market: Over-the-counter transactions in securities listed on organized exchanges

Fourth market: Trading network among investors interested in buying and selling large blocks of stock Brokers, dealers bypassed so costs are low Electronic or telephone network

Third and Fourth Markets

After-Hours Trading: Electronic Communications Networks (ECNs) allow investors to trade after exchange hours (4 to 8 P.M. EST, and sometimes early in the morning)

In-House Trading: this new trend has significant implications for the NYSE

Trading

Toronto Stock Exchange is the eighth-largest stock exchange in the world Many different equity markets exist

Emerging markets Generally less regulation and standardization of

trading activity Risks: Illiquidity, lack of information, political

uncertainty

International Equity Markets

Provide a composite report of market behavior on a given day

S&P/TSX Composite Index Market value weighted In 2004, comprised of 223 companies

representing almost 70 per cent of the market capitalization

S&P/TSX 60 Index Designed to mimic the performance of the

S&P/TSX composite Index

Equity Market Indicators

Dow Jones Industrial Average (DJIA) Composed of 30 “blue-chip” stocks Price weighted

S&P 500 Composite Index Composed of 500 “large” firm stocks Market value weighted

Nikkei 225 Average Price weighted index of 225 actively-traded

stocks on the Tokyo Stock Exchange

Equity Market Indicators

Secondary bond market is primarily an over-the-counter network of dealers Government of Canada bonds actively trade in

dealer markets Corporate bonds are not as actively traded as

government issues

Bond Markets

Growth of institutional trading Block trading of stocks (transactions of at

least 10,000 shares) Affects market structure and operation

Negotiated, not fixed, commissions Globalization of securities markets

24-hour trading Instinet

Market Developments

S&P/TSX Composite Index

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Stock Market Indexes

Dow Jones Industrial Average

Arithmetic average of current prices Assumes you purchase an equal number shares of each stock represented in the index e.g., DJIA, Nikkei 225

Problems: Must adjust denominator downward

for splits Stocks with higher prices have

greater influence PWI = [ of stock prices ] / [number of

stocks in index]

Price Weighted

Total value (mkt. cap.) of all stocks in the index

Assumes you make a proportionate market value investment in each company in the index

e.g., S&P 500/ NYSE indexes Problem: Market Cap., impact on index MVW = [ (Price today) (number of shares) /

(Price base) (number of Shares)] (Index Value BEG)

Value Weighted

Unweighted index (e.g. Value-Line Composite Average, Financial Times Index – LSE)

Assumed the investor makes an equal dollar investment in each stock in the index

Geometric average or arithmetic average Problem:

GA leads to downward bias since GA<AA

Equal Weighted