Securities Markets

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Securities Markets

  1. 1. Chapter 2 Markets and Transactions
  2. 2. Markets and Transactions <ul><li>Learning Goals </li></ul><ul><ul><li>Identify the basic types of securities markets and describe the IPO process. </li></ul></ul><ul><ul><li>Explain the characteristics of broker markets. </li></ul></ul><ul><ul><li>Understand dealer markets, alternative trading systems, and the general conditions of securities markets. </li></ul></ul>
  3. 3. Markets and Transactions <ul><li>Learning Goals (cont’d) </li></ul><ul><ul><li>Review the key aspects of global securities markets, including the risks associated with foreign investments. </li></ul></ul><ul><ul><li>Discuss trading hours and regulation of securities markets. </li></ul></ul><ul><ul><li>Explain long purchases, margin transactions and short sales. </li></ul></ul>
  4. 4. Types of Markets <ul><li>Money Markets : the market where short-term securities are bought and sold </li></ul><ul><li>Capital Market : the market where long-term securities such as stocks and bonds are bought and sold </li></ul><ul><li>Primary Market : the market in which new issues of securities are sold to the public </li></ul><ul><li>Secondary Market : the market in which securities are traded after they have been issued </li></ul>
  5. 5. Primary Markets <ul><li>Initial Public Offering (IPO) </li></ul><ul><ul><li>First public sale of a company’s stock </li></ul></ul><ul><ul><li>Requires SEC approval </li></ul></ul><ul><li>Three Choices to Market Securities in Primary Market </li></ul><ul><ul><li>Public offering </li></ul></ul><ul><ul><li>Rights offering </li></ul></ul><ul><ul><li>Private Placement </li></ul></ul>
  6. 6. Going Public: The IPO Process <ul><li>Underwriting the offering : promoting the stock and facilitating the sale of the company’s shares </li></ul><ul><li>Prospectus : registration statement describing the issue and the issuer </li></ul><ul><li>Red Herring : preliminary prospectus available during the waiting period </li></ul><ul><li>Quiet Period : time period after prospectus is filed when company must restrict what is said about the company </li></ul><ul><li>Road Show : series of presentations to potential investors </li></ul>
  7. 7. The Investment Banker’s Role <ul><li>Underwriting the Issue : purchases the security at agreed-on price and bears the risk of reselling it to the public </li></ul><ul><li>Underwriting Syndicate : group formed by investment banker to share the financial risk of underwriting </li></ul><ul><li>Selling Group : other brokerage firms that help the underwriting syndicate sell issue to the public </li></ul><ul><li>Tombstone : public announcement of issue and role of participants in underwriting process </li></ul><ul><li>Investment Banker Compensation : typically in the form of a discount on the sale price of the securities </li></ul>
  8. 8. Figure 2.2 The Selling Process for a Large Security Issue
  9. 9. Secondary Markets <ul><li>Secondary Market : the market in which securities are traded after they have been issued </li></ul><ul><li>Role of Secondary Markets </li></ul><ul><ul><li>Provides liquidity to security purchasers </li></ul></ul><ul><ul><li>Provides continuous pricing mechanism </li></ul></ul><ul><li>Securities Exchanges : forums where buyers and sellers of securities are brought together to execute trades </li></ul><ul><li>Nasdaq Market : employs an all-electronic trading platform to execute trades </li></ul><ul><li>Over-the-counter (OTC) Market : involves trading in smaller, unlisted securities </li></ul>
  10. 10. Broker Markets and Dealer Markets <ul><li>Broker Markets : consists of national and regional securities exchanges </li></ul><ul><ul><li>60% of the total dollar volume of all shares in U.S. stock market trade here </li></ul></ul><ul><ul><li>New York Stock Exchange (NYSE) is largest and most well-known </li></ul></ul><ul><ul><li>Trades are executed when a buyer and a seller are brought together by a broker and the trade takes place directly between the buyer and seller </li></ul></ul><ul><li>Dealer Markets : consists of both the Nasdaq market and the OTC market </li></ul><ul><ul><li>Trades are executed with a dealer (market maker) in the middle. Sellers sell to a market maker at a stated price. The market maker then offers the securities to a buyer. </li></ul></ul>
  11. 11. Figure 2.3 Broker and Dealer Markets
  12. 12. Broker Markets <ul><li>The New York Stock Exchange (NYSE) </li></ul><ul><ul><li>Largest stock exchange—over 2,700 companies </li></ul></ul><ul><ul><li>Over 350 billion shares of stock traded in 2005 </li></ul></ul><ul><ul><li>Accounts for 90% of stocks traded on exchanges </li></ul></ul><ul><ul><li>Specialists make transactions in key stocks </li></ul></ul><ul><ul><li>Strictest listing policies </li></ul></ul><ul><li>The American Exchange (AMEX) </li></ul><ul><ul><li>About 700 companies and 4% of stocks traded </li></ul></ul><ul><ul><li>Major market for Exchange Traded Funds </li></ul></ul><ul><ul><li>Typically smaller and younger companies who cannot meet stricter listing requirements for NYSE </li></ul></ul>
  13. 13. Broker Markets (cont’d) <ul><li>Regional Stock Exchanges </li></ul><ul><ul><li>Typically lists between 100–500 companies, usually with local and regional appeal </li></ul></ul><ul><ul><li>Listing requirements are more lenient than NYSE </li></ul></ul><ul><ul><li>Often include stocks that are also listed on NYSE or AMEX </li></ul></ul><ul><ul><li>Best-known: Midwest, Pacific, Philadelphia, Boston, and Cincinnati </li></ul></ul><ul><li>Options Exchanges </li></ul><ul><ul><li>Allows trading of options </li></ul></ul><ul><ul><li>Best-known: Chicago Board Options Exchange (CBOE) </li></ul></ul><ul><li>Futures Exchanges </li></ul><ul><ul><li>Allows trading of financial futures </li></ul></ul><ul><ul><li>Best-known: Chicago Board of Trade (CBT) </li></ul></ul>
  14. 14. Dealer Markets <ul><li>No centralized trading floor; comprised of market makers linked by telecommunications network Both IPOs and secondary distributions are sold on OTC </li></ul><ul><ul><li>40% of the total dollar volume of all shares in U.S. stock market trade here </li></ul></ul><ul><ul><li>Both IPOs and secondary distributions are sold on OTC </li></ul></ul><ul><li>Bid Price : the highest price offered by market maker to purchase a given security </li></ul><ul><li>Ask Price : the lowest price at which a market maker is willing to sell a given security </li></ul>
  15. 15. Dealer Markets <ul><li>Nasdaq </li></ul><ul><ul><li>Largest dealer market </li></ul></ul><ul><ul><li>Lists large companies (Microsoft, Intel, Dell, eBay) and smaller companies </li></ul></ul><ul><li>Over-the-counter (OTC) Bulletin Board </li></ul><ul><ul><li>Lists smaller companies that cannot or don’t wish to be listed on Nasdaq </li></ul></ul><ul><ul><li>Companies are regulated by SEC </li></ul></ul><ul><li>Over-the-counter (OTC) Pink Sheets </li></ul><ul><ul><li>Lists smaller companies that are not regulated by SEC </li></ul></ul><ul><ul><li>Liquidity is minimal or almost non-existent </li></ul></ul><ul><ul><li>Very risky; many nearly worthless stocks </li></ul></ul>
  16. 16. Alternative Trading Systems <ul><li>Third Market </li></ul><ul><ul><li>Large institutional investors go through market makers that are not members of a securities exchange </li></ul></ul><ul><ul><li>Institutional investors (mutual funds, life insurance companies, pension funds) receive reduced trading costs due to large size of transactions </li></ul></ul><ul><li>Fourth Market </li></ul><ul><ul><li>Large institutional investors deal directly with each other to bypass market makers </li></ul></ul><ul><ul><li>Electronic Communications Networks (ECNs) allow direct trading </li></ul></ul><ul><ul><li>ECNs most effective for high-volume, actively traded securities </li></ul></ul>
  17. 17. General Market Conditions <ul><li>Bull Market </li></ul><ul><ul><li>Favorable markets </li></ul></ul><ul><ul><li>Rising prices </li></ul></ul><ul><ul><li>Investor/consumer optimism </li></ul></ul><ul><ul><li>Economic growth and recovery </li></ul></ul><ul><ul><li>Government stimulus </li></ul></ul><ul><li>Bear Market </li></ul><ul><ul><li>Unfavorable markets </li></ul></ul><ul><ul><li>Falling prices </li></ul></ul><ul><ul><li>Investor/consumer pessimism </li></ul></ul><ul><ul><li>Economic slowdown </li></ul></ul><ul><ul><li>Government restraint </li></ul></ul>
  18. 18. Globalization of Securities Markets <ul><li>Diversification : the inclusion of a number of different investment vehicles in a portfolio to increase returns or reduce risks </li></ul><ul><li>Use of International Securities Improves Diversification </li></ul><ul><ul><li>More industries and securities available </li></ul></ul><ul><ul><li>Securities denominated in different currencies </li></ul></ul><ul><ul><li>Opportunities in rapidly expanding economies </li></ul></ul><ul><li>International Investment Performance </li></ul><ul><ul><li>Opportunities for high returns </li></ul></ul><ul><ul><li>Foreign securities markets do not necessarily move with the U.S. securities market </li></ul></ul><ul><ul><li>Foreign securities markets tend to be more risky than U.S. markets </li></ul></ul>
  19. 19. Globalization of Securities Markets (cont’d) <ul><li>Indirect Ways to Invest in Foreign Securities </li></ul><ul><ul><li>Purchase shares of U.S.-based multinational with substantial foreign operations </li></ul></ul><ul><li>Direct Ways to Invest in Foreign Securities </li></ul><ul><ul><li>Purchase securities on foreign stock exchanges </li></ul></ul><ul><ul><li>Buy securities of foreign companies that trade on U.S. stock exchanges </li></ul></ul><ul><ul><li>Buy American Depositary Receipts (ADRs): dollar denominated receipts for stocks of foreign companies held in vaults of banks </li></ul></ul>
  20. 20. Risks of International Investing <ul><li>Usual Investment Risks Still Apply </li></ul><ul><li>Government Policies Risks </li></ul><ul><ul><li>Unstable foreign governments </li></ul></ul><ul><ul><li>Different laws in trade, labor or taxation </li></ul></ul><ul><ul><li>Different economic and political conditions </li></ul></ul><ul><ul><li>Less stringent regulation of foreign securities markets </li></ul></ul><ul><li>Currency Exchange Rate Risks </li></ul><ul><ul><li>Value of foreign currency fluctuates compared to U.S. dollar </li></ul></ul><ul><ul><li>Value of foreign investments can go up and down with exchange rate fluctuations </li></ul></ul>
  21. 21. Trading Hours of Securities Markets <ul><li>Regular Trading Session for U.S. Exchanges and Nasdaq </li></ul><ul><ul><li>9:30 A.M. to 4:00 P.M. Eastern time </li></ul></ul><ul><li>Extended-Hours Electronic-Trading Sessions </li></ul><ul><ul><li>NYSE: 4:15 to 5:00 P.M. Eastern time </li></ul></ul><ul><ul><li>Nasdaq: 4:00 P.M. to 6:30 P.M. Eastern time </li></ul></ul><ul><ul><li>Orders only filled if matched with identical opposing orders </li></ul></ul><ul><ul><li>24-hour market probably in near future </li></ul></ul>
  22. 22. Regulation of Securities Markets <ul><li>Insider Trading </li></ul><ul><ul><li>Use of nonpublic information about a company to make profitable securities transactions </li></ul></ul><ul><li>Blue Sky Laws </li></ul><ul><ul><li>Laws imposed by individual states to regulate sellers of securities </li></ul></ul><ul><ul><li>Intended to prevent investors from being sold nothing but “blue sky” </li></ul></ul>
  23. 23. Regulation of Securities Markets <ul><li>Securities Act of 1933 </li></ul><ul><ul><li>Required full disclosure of information by companies </li></ul></ul><ul><li>Securities Act of 1934 </li></ul><ul><ul><li>Established SEC as government regulatory body </li></ul></ul><ul><li>Maloney Act of 1938 </li></ul><ul><ul><li>Allowed self-regulation of securities industry through trade associations such as the National Association of Securities Dealers (NASD) </li></ul></ul><ul><li>Investment Company Act of 1940 </li></ul><ul><ul><li>Created & regulated mutual funds </li></ul></ul>
  24. 24. Regulation of Securities Markets <ul><li>Investment Advisors Act of 1940 </li></ul><ul><ul><li>Required investment advisers to make full disclosure about their backgrounds and their investments, as well as register with the SEC </li></ul></ul><ul><li>Securities Acts Amendments of 1975 </li></ul><ul><ul><li>Abolished fixed-commissions and established an electronic communications network to make stock pricing more competitive </li></ul></ul><ul><li>Insider Trading and Fraud Act of 1988 </li></ul><ul><ul><li>Prohibited insider trading on nonpublic information </li></ul></ul><ul><li>Sarbanes-Oxley Act of 2002 </li></ul><ul><ul><li>Tightened accounting and audit guidelines to reduce corporate fraud </li></ul></ul>

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