Chapter 4 Securities Markets

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Chapter 4Securities Markets
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Learning Objectives

• 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

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Importance of Financial Markets

• 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

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Primary 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

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Investment Dealers

• 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

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Underwriting Process

• 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

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Issuance of Securities

• 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

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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

• 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 Canadas junior stock
  market
• New York Stock Exchange (NYSE) is the largest
  secondary market in the world

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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.

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NYSE

• 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

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Over-the-Counter (OTC) 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
• Canadian OTC stocks are trading on the TSX
  Venture Exchange
• US OTC Market NASDAQ

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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

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Third and Fourth 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

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Trading

• 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

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International Equity Markets

• 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

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Equity Market Indicators

• Provide a composite report of market behavior on
  a given day
• SP/TSX Composite Index
• Market value weighted
• In 2004, comprised of 223 companies representing
  almost 70 per cent of the market capitalization
• SP/TSX 60 Index
• Designed to mimic the performance of the SP/TSX
  composite Index

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Equity Market Indicators

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

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Bond Markets

• 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

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Market Developments

• 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

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Stock Market Indexes

• SP/TSX Composite Index

• Dow Jones Industrial Average

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Price Weighted

• ? 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

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Value 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., SP 500/ NYSE indexes
• Problem ? Market Cap., ? impact on index
• MVW ?(Price today) (number of shares) /
• ?(Price base) (number of Shares) (Index Value
  BEG)

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Equal 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 GAltAA