Function of Secondary Markets Trading Locations Market Structures Perfect Markets CONTENTS
There are actually two levels of the capital markets in which investors participate: • Primary Markets • Secondary Markets
Businesses and governments raise capital in primary markets , selling stocks and bonds to investors and collecting the cash. • In secondary markets, investors buy and sell the stocks and bonds among themselves.The issuer of the asset doesn’t receive funds from the buyer.
Functions of Secondary Markets • Provides regular information about the value of security. • Helps to observe prices of bonds and their interest rates. • Offers to investors liquidity for their assets. • Secondary markets bring together many interested parties. • It keeps the cost of transactions low.
MARKET STRUCTURES • Continuous markets, prices are determined continuously throughout the trading day as buyers and sellers submit orders. • Call market, in which orders are batched or grouped together for simultaneos execution at the same price.A market maker holds an auction for a stock at certain times in the trading days.
Example:Given the order flow at 10:00,the market clearing price of a stock may be $70; at 11:00 of the same trading day, the market clearing price goes up $80 with different order flows.(example for continous markets)
Example:London gold bullion market, which is a call market, and records prices set at the ‘morning fix’ and the ‘afternoon fix’.These fixes take place at the two call auctions which are held daily.
PERFECT MARKET • In perfect market, all buyers and sellers are price takers and market price is determined at the point that supply equals demand.
FEATURES OF PERFECT MARKETS • There are many buyers and sellers so that no one individual can influence market price. • Producers and consumers have perfect knowledge of events in the market. • Firms and customers act individually to maximize their position. • There are no barriers to entry or exit.
SECONDARY MARKET TRADING MECHANICS TYPES OF ORDERS
1-Market Orders The simplest type of order is the market order,an order executed at the best price available in the market.If more buy orders and sell orders reach market at the same time, the price can obtain.Buyers give priority offering lower price. Sellers give offering higher price. If there are more than one order at the same price.The priority rule is based on the time of arrival of the order.
The danger of a market order is that an adverse move may take place between the time the investor places the order and the time the order is executed.
2-Limit Orders It designates a price treshold for the execution of trade.It is a conditional order. A buy limit order indicates that the security may be purchased only at the designated price or lower. A sell limit order indicates that the security may be sold at the designated price or higher.
The danger of limit order is that it comes with no guarantee it will be executed at all. The designated price may not be obtainable.
3-Stop Order Stop order specifies that the order is not be executed until the market moves to a designated price at which time it becomes a market order. A stop order to buy specifies that the order is not to be executed until the market rises to a designated price. A stop order to sell specifies that the order is not to be executed until the market price falls below a designated price.
Two dangers of stop order: 1-Security prices sometimes exhibit abrupt price changes. 2-Stop order can be subject to the uncertainty of the execution price.
4-Market if Touched Orders This order becomes a market order if a designated price is reached.However,amarket-if-touched order to buy becomes a market order if the market falls to a given price.Amarket-if-touched order to sell beco- mes a market order if the market rise to a specified price.
5-Time Specific Order Orders may be placed to buy or sell at the open or close of trading for the day that is time specific orders.
6-Size Related Orders For common stock,orders are also classified by their size. • A round lot istypically 100 shares of a stock. • An odd lot is defined as less than a round lot. • A block trade is defined as an order of 10.000 shares of a given stock.
SHORT SELLING Suppose that an investor expects that the price of a security will decline and wants to benefit should price actually decline. WHAT CAN THE INVESTOR DO
The investor may be able to sell the security without owning it.This practice of selling securities that are not owned at the time of sale is referred to as selling short. A profit will be realized if the purchase price is less than the price that the investor sold short the security.
Tick test rules designate when a short sale may be executed in order to prevent investors from destabilizing the price of a stock when the market price is falling.
A short sale can be made only when either 1-The sale price of the particular stock is higher than the last trade price(It is referred to as an uptick trade) 2-There is no change in the last trade price of particular stock and the previous trade price must be higher than the trade price that preceded it.(It is referred to as a zero uptick.)
What is Margin Transactions? • Investors can borrow cash to buy securites themselves as collateral. • Mr. Brown
A transaction in which an investor borrows to buy additional securities using the securities themselves as collateral is called buying on margin.
The funds borrowed to buy the additional stock will be provided by a broker, and the broker gets the money from a bank. The interest rate that banks charge brokers for these transactions is known as the call money rate (also called the broker loan rate).
Margin requirements • The initial margin requirements is the proportion of the total market value of the securities that the investor must pay for in cash. • Maintenance margin requirement is the minimum amount of equity needed in the investor’s margin account as compared to the total market value.
Role of brokers and dealers in real markets
Brokers • A broker is an entity that acts on behalf of an investor who wishes to execute orders. In economic and legal terms, a broker is said to be an “agent” of the investors.
Brokers aid investors by collecting and transmitting orders to the market, by bringing wiilling buyers and sellers together,by negotiating prices,and by executing order. The fee for these service is the broker’s commission.
Dealers as market makers • Unmatchedorunbalancedflowcausestwoproblems. • Thesecurity’spricemaychangeabruptlyevenifthere has been no shift in eithersupplyordemandforthesecurity. • Buyersmayhaveto pay higherthan market-clearingpricesiftheywanttomaketheirtradeimmediately.
The fact of imbalances explains the need for the dealer or market maker, who stands ready and willing to buy a financial asset for its own account.
Dealersperform 3 functions in markets; • They provide the opportunity for investors to trade immediately rather than waiting for the arrival of sufficient orders on the other side of the trade(“immediacy”) and dealers do this while maintaining short-run price stability (“contunity”)
Dealers offer price information to market participants • Incertain market structures, dealers serve as auctioneers in bringing order and fairness to a market.
Whatfactorsdeterminethepricedealersshouldchargefortheservicestheyprovide? (bid-ask spread) • One of the most important is the order processing costs incurred by dealers.
Dealers have to be compensated for bearing risk. A dealer’s position may involve carrying inventory of a security(a long position) or selling a security that is not in inventory(a short position).
MARKET EFFICIENCY • Operationally efficient market • Pricing efficient capital market
OPERATİONAL EFFICIENCY In an operationally efficient market investors can obtain transaction services as cheaply as possible given the costs associated with furnishing those services.
Firstly United states exchanges were forced to adopt a system of competitive and negotiated commissions. • France adopted a system of negotiated commissions for large trades in 1985. • İn 1986 London Stock Exchange abolished fixed commissions.
PRICING EFFICIENCY • Pricing efficiency refers to a market where prices at all times fully reflect all available information that is relevant to the valuation of securities
EXPECTED RETURN The expected return =
EXAMPLE initial price of share is 10 TL. The end of the year share price will be 12 TL. Dividents of company is 1.50 TL. The expected return = 1.50+2/10 3.5/10 = % 35 is rate of expected return
THREE FORMS In defining the relevant information set that prices should reflect. Pricing efficiency of a market was classified in three forms. • Weak efficiency • Semi-strong efficiency • Strong efficiency