Chapter Two

1
Chapter Two

• Securities Markets Present and Future

2
Primary vs Secondary Markets

• Primary markets refer to market transactions in
  which the issuer of the security is the seller of
  the security.
• The role of the primary market is to raise
  capital.
• Secondary markets refer to market transactions in
  which the seller of the security is NOT the
  issuer.
• Provides liquidity
• Provides valuation information

3
Investment Banking

• Primary markets are organized primarily by
  investment bankers.
• Underwritten vs Best Efforts offerings
• Private Placements
• Initial Public Offerings

4
Organized vs Over-The-Counter Exchanges

• An organized exchange is a market with a
  physical, centralized trading location (trading
  floor) where securities are traded.
• Examples of organized exchanges include the NYSE,
  AMEX, Regional Exchanges (Chicago, Pacific,
  Philadelphia, etc), CBOT, CME, and the KCBOT (as
  well as many others.)
• An over-the-counter market refers to a market
  with no physical, centralized trading location
  (trading floor.) Instead, trades are conducted
  through a telecommunications network with
  geographically diverse dealers.
• Examples of over-the-counter markets include the
  Nasdaq, bond markets, currency markets and
  markets for many other financial securities.
• Note that the distinction between Organized and
  Over-the-Counter exchanges is shrinking as most
  trades are done electronically.

5
Electronic Communication Networks

• ECNs are markets which electronically match buy
  and sell orders.
• ECNs grew rapidly during the early-2000 period
  and recently have been acquired by the major
  exchanges.
• Island and Instinet merged to form Inet
  (http//www.nasdaqtrader.com) and has been
  acquired by the Nasdaq
• Archipelago (http//www.tradearca.com) was
  acquired by the NYSE
• Brut was acquired by the Nasdaq and is being
  rolled into Inet
• While initially they were primarily responsible
  for after-hours trading, they are now an
  extensive part of the market during normal hours
  as well.

6
Securities Act of 1933

• Requires securities to be registered with SEC
• Registration statement must be filed 20 days in
  advance of offering and be approved by SEC for
  completeness and accuracy
• New issues must be accompanied by a prospectus
  and be made available to potential investors
• Officers of the company can be sued for
  presenting fraudulent or incomplete data in the
  prospectus.

7
Securities Exchange Act of 1934

• Guidelines for insider trading established.
  Insiders must hold securities for at least 6
  months. An insider is defined as someone having
  material non-public information.
• Federal Reserve Board sets margin requirements
  Current initial margin is 50 and maintenance
  margin 25.
• Security manipulation is prohibited.
• SEC controls proxy procedures.
• Quarterly and Annual Financial reports must be
  filed.
• All securities exchanges must register with the
  SEC.

8
Program Trading and Trading Curbs

• Program trading refers to the process of trading
  a large basket of securities simultaneously.
• Program trading was partially blamed for the 1987
  market crash and as a result, the NYSE has
  instituted trading curbs to limit program
  trading.
• In addition, some people feel that herd
  behavior can cause irrational swings in prices
  and that trading halts can help prevent
  overreactions, this has led to the introduction
  of circuit breakers on the NYSE.

9
Trading Curbs/Circuit Breakers (Cont)

• 150 point increase in the DJIA will lead to
  restrictions on program buy trades and 150 point
  decrease in the DJIA will lead to restrictions on
  program sell trades. Restrictions stay in effect
  until DJIA is within 70 points of previous close.
• 1100 (10 percent) point decline in DJIA will
  result in a 1-hour halt if prior to 200, a
  30-minute halt if between 200-230, and no halt
  after 230.
• 2200-point decline (20 percent) in DJIA will
  result in a 2-hour halt if prior to 100, a
  1-hour halt if between 100 and 200, and market
  closing after 200.
• 3300-point decline (30 percent) in the DJIA will
  close the market for the day.
• Note that the above point levels are for the 3rd
  quarter 2006 and are revised quarterly.

10
Homework

• Q 2, 4, 5, 7, 11
• What important role(s) do primary/secondary
  markets play for firms? What important role(s)
  do they play for investors?
• What is an ECN and how have ECNs helped
  investors?
• What are the guidelines for insider trading and
  why are they important?
• What is security manipulation and why is it
  illegal?
• Why are there limits to the amount of margin
  investors can use?
• What is program trading and why do some people
  feel that it adds to volatility in the markets?
• What are trading/curbs and circuit breakers? Do
  you think they are a good or bad idea and why?