SECONDARY MARKETS

CONTENTS

Function of Secondary MarketsTrading LocationsMarket StructuresPerfect Markets

There are actually two levels of the capital markets in which investors participate:

Primary Markets

Secondary Markets

Businesses and governments raise capital in primary markets , selling stocks and bonds to investors and collecting the cash.

In secondary markets, investors buy and sell the stocks and bonds among themselves.The issuer of the asset doesn’t receive funds from the buyer.

Functions of Secondary Markets

Provides regular information about the value of security.

Helps to observe prices of bonds and their interest rates.

Offers to investors liquidity for their assets.

Secondary markets bring together many interested parties.

It keeps the cost of transactions low.

TRADING LOCATIONS

LONDON INTERNATIONAL STOCK EXCHANGE

FRANKFURT STOCK EXCHANGE

PARIS BOURSE

TOKYO STOCK EXCHANGE

ISTANBUL STOCK EXCHANGE

MARKET STRUCTURES

Continuous markets, prices are determined continuously throughout the trading day as buyers and sellers submit orders.

Call market, in which orders are batched or grouped together for simultaneos execution at the same price.A market maker holds an auction for a stock at certain times in the trading days.

Example:Given the order flow at 10:00,the market clearing price of a stock may be $70; at 11:00 of the same trading day, the market clearing price goes up $80 with different order flows.(example for continous markets)

Example:London gold bullion market, which is a call market, and records prices set at the ‘morning fix’ and the ‘afternoon fix’.These fixes take place at the two call auctions which are held daily.

PERFECT MARKET

In perfect market, all buyers and sellers are price takers and market price is determined at the point that supply equals demand.

FEATURES OF PERFECT MARKETS

There are many buyers and sellers so that no one individual can influence market price.

Producers and consumers have perfect knowledge of events in the market.

Firms and customers act individually to maximize their position.

There are no barriers to entry or exit.

SECONDARY MARKET TRADING MECHANICS

TYPES OF ORDERS

1-Market Orders

The simplest type of order is the market order,an order executed at the best price available in the market.If more buy orders and sell orders reach market at the same time, the price can obtain.Buyers give priority offering lower price.Sellers give offering higher price. If there are more than one order at the same price.The priority rule is based on the time of arrival of the order.

The danger of a market order is that an adverse move may take place between thetime the investor places the order and thetime the order is executed.

2-Limit Orders

It designates a price treshold for the execution of trade.It is a conditional order. A buy limit order indicates that the security may bepurchased only at the designated price or lower. A sell limit order indicates that the security may be sold at the designated price or higher.

The danger of limit order is that it comes with no guarantee it will be executed at all.The designated price may not be obtainable.

3-Stop Order

Stop order specifies that the order is not be executed until the market moves to a designatedprice at which time it becomes a market order. A stop order to buy specifies that the order is not to be executed until the market rises to a designated price. A stop order to sell specifies that the order isnot to be executed until the market price falls below a designated price.

Two dangers of stop order:

1-Security prices sometimes exhibit abrupt price changes.

2-Stop order can be subject to the uncertainty of the execution price.

4-Market if Touched Orders

This order becomes a market order if a designated

price is reached.However,a market-if-touched orderto buy becomes a market order if the market falls toa given price.A market-if-touched order to sell beco-mes a market order if the market rise to a specified price.

5-Time Specific Order

Orders may be placed to buy or sellat the open or close of trading for the day that is time specific orders.

6-Size Related Orders

For common stock,orders are also classified

by their size.A round lot is typically 100 shares of a stock.An odd lot is defined as less than a round lot.A block trade is defined as an order of 10.000 shares of a given stock.

SHORT SELLING

Suppose that an investor expects that the price of a

security will decline and wants to benefit should price actually decline.

WHAT CAN THE INVESTOR DO

The investor may be able to sell the security

without owning it.This practice of selling securitiesthat are not owned at the time of sale is referredto as selling short. A profit will be realized if the purchase price is less than the price that the investor sold short thesecurity.

Tick test rules designate when a shortsale may be executed in order to preventinvestors from destabilizing the price of a stock when the market price is falling.

A short sale can be made only when either

1-The sale price of the particular stock is higher than the last trade price(It is referred to as an uptick trade)

2-There is no change in the last trade price of particular stock and the previous trade price must be higher than the trade price that preceded it.(It is referred to as a zero uptick.)

What is Margin Transactions?

Investors can borrow cash to buy securites themselves as collateral.

Mr. Brownhas $ 10.000

buy 500 shares

borrowed $ 10.000

buy 500 shares

A transaction in which an investor borrows to buy additional securities using the securities themselves as collateral is called buying on margin.

The funds borrowed to buy the additional stock will be provided by a broker, and the broker gets the money from a bank. The interest rate that banks charge brokers for these transactions is known as the call money rate (also called the broker loan rate).

Margin requirements The initial margin requirements is the

proportion of the total market value of the securities that the investor must pay for in cash.

Maintenance margin requirement is the minimum amount of equity needed in the investor’s margin account as compared to the total market value.

Role of brokers and dealers

in real markets

Brokers A broker is an entity that acts on behalf

of an investor who wishes to execute orders. In economic and legal terms, a broker is said to be an “agent” of the investors.

Brokers aid investors by collecting and transmitting orders to the market, by bringing wiilling buyers and sellers together,by negotiating prices,and by executing order. The fee for these service is the broker’s commission.

Dealers as market makers Unmatched or unbalanced

flow causes two problems.1. The security’s price may

change abruptly even if there has been no shift in either supply or demand for the security.

2. Buyers may have to pay higher than market-clearing prices if they want to make their trade immediately.

The fact of imbalances explains the need for the dealer or market maker, who stands ready and willing to buy a financial asset for its own account.

Dealers perform 3 functions in markets;

1. They provide the opportunity for investors to trade immediately rather than waiting for the arrival of sufficient orders on the other side of the trade(“immediacy”) and dealers do this while maintaining short-run price stability (“contunity”)

2. Dealers offer price information to market participants

3. Incertain market structures, dealers serve as auctioneers in bringing order and fairness to a market.

What factors determine the price dealers should charge for the services they provide? (bid-ask spread) One of the most important is the order

processing costs incurred by dealers.

Dealers have to be compensated for bearing risk. A dealer’s position may involve carrying inventory of a security(a long position) or selling a security that is not in inventory(a short position).

MARKET EFFICIENCY

Operationally efficient market

Pricing efficient capital market

OPERATİONAL EFFICIENCY In an operationally

efficient market investors can obtain transaction services as cheaply as possible given the costs associated with furnishing those services.

Firstly United states exchanges were forced to adopt a system of competitive and negotiated commissions.

France adopted a system of negotiated commissions for large trades in 1985.

İn 1986 London Stock Exchange abolished fixed commissions.

PRICING EFFICIENCY

Pricing efficiency refers to a market where prices at all times fully reflect all available information that is relevant to the valuation of securities

EXPECTED RETURN

The expected return =

EXAMPLE

initial price of share is 10 TL.The end of the year share price will be

12 TL.Dividents of company is 1.50 TL.

The expected return = 1.50+2/10 3.5/10 = % 35 is rate of

expected return

THREE FORMSIn defining the relevant information set

that prices should reflect. Pricing efficiency of a market was classified in three forms.

Weak efficiency Semi-strong efficiency Strong efficiency

Weak efficiency : means that price of the security reflect the past price and trading history of the securities.

Keen investors looking for profitable companies can earn profits by researching financial statements.

Semi-strong efficiency : means that the price of the security reflects all public information which includes but is not limited to historical price and trading patterns.

Meaning that neither fundamental nor technical analysis can be used to achieve superior gains.

Strong efficiency : exists in a market where the price of security reflects all information whether or not it is publicly available.

Not even insider information could give an investor the advantage.

TRANSACTION COSTS

Transaction costs consist of commissions, fees, execution costs and opportunity costs.

Commissios are the fees paid to brokers to trade securities.

Fees are seperated two group custodial fees and transfer fees.

Custodial fees are fees charged by an instution that hold securities in safekeeping for an investor.

EXECUTION COSTS

Execution costs represent the difference between the execution price of a security and the price that would have existed in the absence of the trade.

OPPORTUNITY COSTS The cost of not transacting

represents an opportunity cost. It may arise when a desired trade fails to be executed. This component of costs represents the difference in performance between an investor’s desired investment and the same investor’s actual investment after adjusting for execution costs,commissions and fees.

PREPARED BY

HATUN AYDAN HİLAL DURMUŞ TUBA TEKİN ALİ ÖNER