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Chapter 4 Securities Markets

Chapter 4 Securities Markets. 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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Chapter 4 Securities Markets

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  1. Chapter 4Securities Markets

  2. 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

  3. 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

  4. 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

  5. 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

  6. 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

  7. 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

  8. 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

  9. 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 Canada’s “junior” stock market • New York Stock Exchange (NYSE) is the largest secondary market in the world

  10. 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.

  11. 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

  12. 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

  13. 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

  14. 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

  15. 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

  16. 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

  17. Equity Market Indicators • 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

  18. 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

  19. 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

  20. 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

  21. Stock Market Indexes • S&P/TSX Composite Index • Dow Jones Industrial Average

  22. 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]

  23. 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., 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)

  24. 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 GA<AA

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