Chapter 4 Securities Markets. Compare primary and secondary markets. Equity markets - organization...
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Transcript of Chapter 4 Securities Markets. Compare primary and secondary markets. Equity markets - organization...
Chapter 4
Securities Markets
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
Learning Objectives
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
Importance of Financial 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
Primary Markets
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
Investment Dealers
• 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
Underwriting Process
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
Issuance of Securities
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
Secondary Markets
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 Canada’s “junior” stock market
New York Stock Exchange (NYSE) is the largest secondary market in the world
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.
Stock Exchanges
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
NYSE
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
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
Over-the-Counter (OTC) 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
Third and Fourth Markets
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
Trading
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
International Equity Markets
Provide a composite report of market behavior on a given day
S&P/TSX Composite Index Market value weighted In 2004, comprised of 223 companies
representing almost 70 per cent of the market capitalization
S&P/TSX 60 Index Designed to mimic the performance of the
S&P/TSX composite Index
Equity Market Indicators
Dow Jones Industrial Average (DJIA) Composed of 30 “blue-chip” stocks Price weighted
S&P 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
Equity Market Indicators
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
Bond Markets
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
Market Developments
S&P/TSX Composite Index
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Stock Market Indexes
Dow Jones Industrial Average
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]
Price 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., S&P 500/ NYSE indexes Problem: Market Cap., impact on index MVW = [ (Price today) (number of shares) /
(Price base) (number of Shares)] (Index Value BEG)
Value 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 GA<AA
Equal Weighted