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©Copyright 2003, The Nasdaq Stock Market, Inc. All rights reserved.

Changes in Market Structure:Approaches to Securities Trading

15 April 2003

Alfred R. Berkeley, IIIVice Chairman

The NASDAQ Stock Market

Alfred R. Berkeley, IIIVice Chairman

The NASDAQ Stock Market


Slide 2

Creating An Efficient Consolidated Market

• Competitive Challenges – Fragmentation• Improve Access and Lower Costs

Secondary Markets

National Markets

Broker-Dealers

Electronic Brokerage

Firms (ECNs)


Three Liquidity Models

Bull

Bear

PanicTh

ree T

yp

es o

f M

ark

ets

Accelerated Steady Declining

Three Types of Growth

MultipleLiquidity Providers(NASDAQ)

SingleLiquidity Provider(NYSE, AMEX)

No Professional Liquidity Providers(ECNs)


Three Liquidity Models

Bull

Bear

PanicTh

ree T

yp

es o

f M

ark

ets

High Volume Medium Volume Low Volume

Three Types of Activity

MultipleLiquidity Providers(NASDAQ)

SingleLiquidity Provider(NYSE, AMEX)

No Professional Liquidity Providers(ECNs)


Slide 5

Average Daily Trades by Dollar Value of Float Category

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

$100 to$250

$250 to$500

$500 to$1,000

$1,000 to$5,000

$5,000 to$50,000

Greater than$50,000

Dollar Value of Float (mil.)

Ave

rage D

aily

Tra

des

NASDAQNYSE

Average daily trades for all stocks within each dollar value of float category. All common stock on NASDAQ National Market and NYSE; NYSE data represent specialist trades only. Source: NASDAQ ER DataMart, FactSet Research Systems. December 2002.


Slide 6

OldNASDAQ

NYSE ECN

Dealer InterventionContinuous Support

xLimit Order BookTransparency, Critical Mass

x Electronic ExecutionSpeed

x AuctionPrice Improvement x xCompetitionBenefits Investors x

Severe Competition in the 1990s


Slide 7

OldNASDAQ

NYSE ECNNew

NASDAQ

Dealer InterventionContinuous Support

x Limit Order BookTransparency, Critical Mass

x Electronic ExecutionSpeed

x AuctionPrice Improvement x x CompetitionBenefits Investors x

Integrating Market Models Improves Liquidity


Slide 8

NASDAQ Initiatives Reduce Liquidity Costs

• NASDAQ continues to enact a variety of initiatives to reduce liquidity costs, ultimately reducing the cost of capital and increasing shareholder value.

Value = NPV(Cash Flows)(1-Cost of Capital)

Direct Cost

TaxesFeesMarket Charges

Commissions

Opportunity Cost

Adverse Selection

Bid/Ask SpreadLong-termDecline in Spreads

Post-Trade Market Impact Cost

Depth at Quote, Reserve Size

Execution Delay

Pre-Trade Market Impact Cost

SuperMontageSM, Primex

Market MovementBefore ExecutionFast Execution

Cost of Capital = Risk Premium + Liquidity Premium

Risk Free Rate of Return

Company RiskIR tools,

Brand Development

Source: Amihud, Yakov and Haim Mendelson, “The Liquidity Route to a Lower Cost of Capital’” Journal of Applied Corporate Finance, Volume 12, Number 4, Winter 2000, 8-25.


Slide 9

SuperMontageSM Addresses Competitive Challenges

TotalViewSM Detail


Slide 10

Greater Depth, Stronger Center of Liquidity

Average Cumulative Depth of Book Before SuperMontageSM

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

$400,000

-5 -4 -3 -2 -1(Inside

Bid)

0 1(Inside

Ask)

2 3 4 5

Dolla

r V

alu

e o

f S

hare

s A

vaila

ble

ReserveDisplay

Source: NASDAQ.


Slide 11

Greater Depth, Stronger Center of Liquidity

Average Cumulative Depth of Book After SuperMontageSM

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

$400,000

-5 -4 -3 -2 -1(Inside

Bid)

0 1(Inside

Ask)

2 3 4 5

Dolla

r V

alu

e o

f S

hare

s A

vaila

ble

ReserveDisplay

• With more and more market makers submitting orders at multiple price levels, depth should continue to increase.

Source: NASDAQ.


Slide 12

Impact of Changes on Market Quality

Average Execution Speed (secs)

4.8

21.7

NASDAQ NYSE

Data represent execution quality for S&P 500 issues listed on NASDAQ vs. those listed on the NYSEIncludes time for Market Center’s proprietary systems as mandated by SEC Rule 11Ac1-5. Based on all marketable orders up to 9,999 shares. Marketable orders are represented by both true market orders and limit orders that are at or within the prevailing bid-ask quote.Source: Market Systems Inc. December 2002.

• NASDAQ-listed S&P 500 stocks execute faster, with lower transaction costs and better pricing than NYSE comparables.

Average Effective Spread (¢)

1.9

2.8

NASDAQ NYSE

Average Quoted Spread (¢)

1.1

2.5

NASDAQ NYSE

Average Ex. Price Rel. to the Quote

15% 23%

71% 56%

14% 20%

NASDAQ NYSE

Price Improvement

At theQuote

Price Dis-Improvement


Slide 13

Improved Liquidity as a Result of Changes

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

500,000

550,000

$100 to $250 $250 to $500 $500 to $1,000 $1,000 to $5,000 $5,000 to$50,000

Greater than$50,000

Dollar Value of Float (mil)

Avg A

miv

est

Liq

uid

ity R

atio (

000)

NASDAQNYSE

The Amivest Liquidity Ratio measures the amount of dollar volume of trading associated with a one percent change in price over a twenty-day period. Includes all domestic common stock on NASDAQ National Market and NYSE.Source: FactSet Research Systems. December 2002.

• More stock can be bought or sold on NASDAQ without impacting the price.


Slide 14

Offer Price

Goldman Sachs. . . . . 25.05NASDAQ SIZE. . . . . . 25.05Hong Kong. . . . . . . 25.10Schwab Capital Mkts. . 25.10CS First Boston. . . . 25.10Tokyo. . . . . . . . . 25.10Merrill Lynch. . . . . 25.10Salomon Smith Barney . 25.15...

Bid Price

Hong Kong. . . . . . . 25.00Morgan Stanley . . . . 25.00NASDAQ SIZE. . . . . . 25.00Merrill Lynch. . . . . 24.95Deutsche Börse . . . . 24.95Instinet . . . . . . . 24.95Spear Leeds. . . . . . 24.95Singapore. . . . . . . 24.95...

Tomorrow’s Market

• International Exchanges, Electronic Networks and Traditional Market Makers Compete for Every Trade.


Slide 15

Fair Allocation of Regulatory Costs

• Increasing Fragmentation of the Market for Trading NASDAQ Securities

•Need to Rebalance the Costs of Regulating that Trading

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