Charles P. Jones, Investments: Analysis and Management,

1
Securities Markets

• Chapter 4
• Charles P. Jones, Investments Analysis and
  Management,
• Ninth Edition, John Wiley Sons
• Prepared by
• G.D. Koppenhaver, Iowa State University
• Additional Information by Axel Grossmann

2
The Role of Financial Markets

• Governments and Firms need vast amounts of
  capital
• Help firms and governments raise cash by selling
  claims against themselves
• Provide a place where investors can act on their
  beliefs
• Help allocate cash to where it is most productive
  allocationally efficiency
• Help lower the cost of exchange
• Well functioning primary and secondary market
  import for economy

3
Markets in New Securities

• New securities are issued in a primary market
• Initial public offerings (IPOs) versus seasoned
  new issues
• Transaction in the secondary market do not affect
  the initial issuer of a security
• Performance of IPOs

4
Investment Banking

• Issue facilitated by investment banker
• Investment Banks
• Merrill Lynch (investment banking and brokerage)
• Salomon Smith Barney
• JP Morgan
• Goldman Sachs
• Lehman Brothers
• Banc of America
• Deutsche Bank
• Specialists in advice, design, and sales
• Intermediaries between issuer and investor

5
Investment Banking

• Investment Banks (IBs)
• Client advice includes type and features of
  security, offer price, and timing of sale
• Underwriting services
• Investment bankers purchase an issue of
  securities from a firm and resell it to the
  public
• Risk of selling to investors assumed from issuer
• IBs are compensated by a spread
• Coordinates marketing by helping issuer register
  securities, issue prospectus, and sell securities

6
Investment Banking

• One originating investment banks forms a an
  underwriting syndicate group of investment
  bankers
• Diversification of risk
• The syndicate becomes part of a large group that
  sells the securities
• Underwriting group plus brokerage houses

7
Investment Banking

• Rule 415 (shelf rule) allows certain issuers to
  sell new securities over time after filing a
  single registration
• Reduces issuance cost
• A private placement means new securities are sold
  directly to investors, bypassing the open market
• Registration not required

8
Secondary Markets

• Markets where investors trade previously issued
  securities
• Auction markets involve bidding in a specific
  physical location
• Brokers represent investors (buyers and sellers)
  for a fee Commission Brokers
• Others trade for their own account Independent
  Floor Brokers
• Electronic net work of dealers (market makers)

9
Secondary Markets

• Three major markets
• NYSE
• AMEX
• Nasdaq
• Regional Exchanges
• Over-the-counter
• Electronic Communication Networks (ECNs)
• Most stocks are listed at the first three, but
  also traded at ECNs (e.g 45 of Nasdaq shares
  were traded through ECNs)

10
NYSE

• Secondary auction market in equity shares
• Has a physical location
• Specialists assigned to each traded equity to
  make a market in that stock
• Broker with no vested interest in whether a
  customer places a buy or a sell order
• Not-for-profit organization of members
• Member firms own seats
• Only member firms are allowed to sell securities
  at the trading floor

11
NYSE

• Listing requirements
• Specified amounts of earning power and assets
• At least 40,000,000 market value of publicly
  traded shares
• 1,100,000 common shares publicly held
• Listing fees

12
NYSE

• Broker
• An agent representing customers order to buy an
  sell
• Commission Brokers
• Employed by Member firms
• Independent Floor Brokers
• Work for themselves
• Handle orders for brokerage houses that do not
  have a full time broker

Public Investor
Sales Personnel of Brokerage House
Commission Broker at Trading Floor
13
NYSE

• Specialist
• They manage the auction process
• Assigned to trading posts and handle one or more
  stocks
• Act as Agents
• Executes orders for the floor brokers
• As Catalyst
• Match sellers and buyers
• As Auctioneers
• Establish fair market price
• Quote bids and offers
• Stabilize Prices
• Ensure smooth trading and minimal fluctuations
• Provide Capital
• Minimizes sell and buy imbalance with own capital

14
AMEX and regional stock exchanges

• Organization and procedures resemble NYSE
• List smaller firms
• Less volume than NYSE
• Listing requirements are less stringent
• Lower listing fees

15
NASDAQ

• Network of competing dealers (market makers)
  trading listed securities
• Dealers stand ready to buy and sell securities
• They conduct transaction directly with each other
  or customers
• They a vested interest in each transaction
• Spread is their profit
• Automated quotation system with no fixed number
  of participants
• NASDAQ National Market
• NASDAQ SmallCap Market
• More firms listed than NYSE
• Network connects to other trading systems
• ECNs
• Nasdaq InterMarket (trades stocks at NYSE and
  AMEX)

16
Secondary Markets

• Over-the-counter
• Companies not listed at one of the three markets
• They may fail to qualify
• They may not want to be listed
• Securities are traded in two ways
• OTC Bulletin Board (OTCBB)
• Registration with SEC
• Operated by Nasdaq but separated from Nasdaq
  market
• Pink Sheet LLC
• Not registered with SEC
• Privately owned company

17
Over-the-Counter 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

18
Electronic Communications Networks (ECNs)

• A computerized trading network
• Compete with
• Auction markets
• Computerized Nasdaq market Network of dealers
  standing ready to either buy or sell securities
  at specified prices
• It matches buy and sell orders from
• Own subscribers
• As well as customers orders routed from other
  brokerage firms.
• No spreads, 0.01 per share traded
• Examples
• Instinet (operates around the clock, world wide)
• Island

19
Foreign Markets

• US equity markets account for a third of worlds
  stock market capitalization
• Many different equity markets exist
• Emerging market Stable political system, low
  regulation, low standardization in trading
  activity
• Risks Illiquidity, lack of information,
  political uncertainty

20
Equity Market Indicators

• Provide a composite report of market behavior on
  a given day
• Dow Jones Industrial Average
• Composed of 30 blue-chip stocks
• Price-weighted index Essentially adds the prices
  of 30 stocks, divides by 30
• Adjusted for stock splits, stock dividends
• Oldest, most well-known measure

21
Equity Market Indicators

• Standard Poors Composite Index
• Composed of 500 large firm stocks
• Expressed as index number relative to a base
  index value of 10 (1941-43)
• Value-weighted index Prices and shares
  outstanding considered
• Indicates how much the average equity value of
  the 500 firms in the index has increased relative
  to the base period

22
Equity Market Indicators

• NYSE and NASDAQ Composite Indices
• Value-weighted indices of broad markets
• Wilshire Index
• Broadest measure of the market (more than 6,500
  stocks
• Nikkei 225 Average
• Price-weighted index of 225 actively-traded
  stocks on the Tokyo Stock Exchange

23
Bond Markets

• Secondary bond market is primarily an
  over-the-counter network of dealers
• NYSE features an automated bond system to execute
  orders.
• Mostly corporate bonds, thinly traded
• Treasury and agency bonds actively trade in
  dealer markets
• Municipal bonds less actively traded