Security Trading: MarketsPrimary MarketSecondary Market

Primary MarketMarket for new issues of securitiesInitial public offerings (IPO)Seasoned equity offering (SEO)Private placementInvestment BankingIssuing FirmsLead UnderwriterInvestment Banker AInvestment Banker BInvestment Banker CInvestorsUnderwriting Syndicate

Primary MarketGoing Public Choosing investment bankersNegotiation Competitive biddingFiling a preliminary registration statement with the SECA red herring:Describing the issue and the prospects of the companyApproval of the final statementby the SECProspectusThe issuing firmUnderwritersInvestorsThe issuing firmInvestorsUnderwritersFirm CommitmentBest Offers Agreement

Primary MarketIPO (Initial Public Offering)

Whats in for the underwriter?7% IPO, underpricing and allotment optionIPO PerformanceOverjoyed to get that IPO share? Think Again!UnderwritersPotential InvestorsPotential InvestorsPotential InvestorsRoad ShowsUnderwritersBookbuildingPotential InvestorsPotential InvestorsPotential InvestorsSelling: bargain prices

Secondary MarketMarket for existing securitiesStock Exchanges, OTC, ECNsStock ExchangesNYSE, AMEX, and 5 regional onesTrade open to members onlyMemberships/seats are tradable assetStock is assigned to a dealer (specialist).A specialist may handle several stocks.Stringent initial listing requirement

Secondary MarketOver-the-Counter (OTC) marketNASDAQMultiple dealer marketIncreasingly importantMSFT, INTC, AMZN, SUNW, WCOM, etc.Three levels of subscribersLevel 3: market makers (dealers)Level 2: brokers (receive all bid-ask quotes)Level 1: inactive investors (receive only inside quotes of the best bid-ask)

Secondary MarketElectronic Communication Network (ECN)A form of direct electronic trading systemsMatching stock trades electronically bypassing middlemenAllowed to become stock exchangesCompeting with NYSE and NASDAQExamples: Island Inc. (owner: Datek), Instinet (owner: Reuters Group), Archipelago (owner: Goldman Sachs, etc)

Secondary MarketOrdering Process in the Exchange

Type of Orders

Sheet1

Buy OrderSell Order

Marketat ask priceat bid price

Limitexecute order only at price = limit price

Stopmarket order if price greater than stopmarket order if price less than stop

Secondary MarketSpecialists Limit Order Book

ExampleBM buys 1000 share800 shares at 98 and 200 shares at 98 3/8SM sells 1200 share1000 shares at 98 and 200 shares at 97 7/8Simultaneous OrderTrading Inside the quote1000 shares at 98 1/8 and another 200 at 98 for SM

Sheet1

BuySell

NameBCBBBASASBSC

Depth50020001000Specialist8005001200

Price97 5/897 7/89898 1/498 3/898 1/2

Secondary MarketBlock SalesTransaction > 10K shares over 57% of all trading(ex) largest block transaction: $600 Million of ITT in 1995Block houses (brokerage firms) aid in the placement of block trades.Designated Order Turnaround SystemSuperDot: exchange members to send orders directly to the specialist over computer lines (for small orders or program trades)Account for approximately 85% of all orders SettlementSettlement is required within 3 days

Secondary MarketOTC System

Trading through multiple dealersLimit orders may not filled (traded through)Market order may not be filled at the best available price.Poor price discovery from segmented computer systemsLarge bid-ask spreads caused by collusion among dealers

Secondary MarketTrading CostsExplicit Commission: Lower for NASDAQ stocksDiscount brokers: no-frill service and low costTypically $8-$30 for less than 5,000 NASDAQ sharesE.g. Charles Schwab, E*Trade, DatekFull service: research & advice along with basic serviceAs high as several hundred dollars for 1,000 sharesE.g. Merrill Lynch, Morgan Stanley Dean WitterImplicit Cost: Lower for NYSE stocksBid-ask spread: price difference between buy and sellPrice concession: dealers willingness to trade beyond quoted depth, e.g. willing to sell 1000 shares at best ask of $70 while quoting only 100

Wrap-UpWhats primary market for?Whats secondary market for?

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