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  1. 1. Chapter 3 Equities Markets
  2. 2. CHAPTER 3 OVERVIEW <ul><li>3.1 Major U.S. Securities Exchanges </li></ul><ul><li>3.2 Over-the-Counter (OTC) Markets </li></ul><ul><li>3.3 Large-Company Stock Indexes </li></ul><ul><li>3.4 Medium-Size Company Stock Indexes </li></ul><ul><li>3.5 Small-Company Stock Indexes </li></ul><ul><li>3.6 Global Stock Indexes </li></ul><ul><li>3.7 Securities Market Regulation </li></ul>
  3. 3. KEY TERMS Markets <ul><li>NYSE </li></ul><ul><li>agency auction </li></ul><ul><li>specialist </li></ul><ul><li>round lot </li></ul><ul><li>NASD </li></ul><ul><li>AMEX </li></ul><ul><li>public float </li></ul><ul><li>CBOE </li></ul><ul><li>CBOT </li></ul><ul><li>Nasdaq Stock Market </li></ul><ul><li>negotiated market </li></ul><ul><li>market makers </li></ul><ul><li>customer order flow </li></ul><ul><li>market maker spread </li></ul><ul><li>inside market </li></ul><ul><li>Nasdaq SmallCap Market </li></ul><ul><li>penny stock </li></ul><ul><li>OTCBB </li></ul><ul><li>ADR (American Depositary Receipts) </li></ul>
  4. 4. Major U.S. Securities Exchanges <ul><li>New York Stock Exchange--founded 1817 </li></ul><ul><li>Home to 3,025 companies </li></ul><ul><li>As of 12/99, 280.9 billion shares listed and available for trading — worth $12.3 trillion </li></ul><ul><li>Private partnership that provides agency auction market — brokers represent buyers and sellers; prices set by supply and demand </li></ul><ul><li>Largest exchange in terms of market capitalization: 3700 issues listed </li></ul><ul><li>Specialists manage markets for individual stocks, providing liquidity to buyers and sellers </li></ul><ul><ul><li>Liquidity: The ease with which the securities can be bought or sold without wide price fluctuation assuming that no significant information has arrived since the previous trade. </li></ul></ul><ul><li>Trades 80% of total trading volume (One billion shares per day) </li></ul>
  5. 5. NYSE Listing Requirements & Fees <ul><li>Requirements </li></ul><ul><li>Minimum firm size </li></ul><ul><li>Minimum number of round lot holders/distribution </li></ul><ul><li>Company position/stability within industries </li></ul><ul><li>Minimum earnings, cash flow, global market capitalization </li></ul><ul><li>Fees </li></ul><ul><li>Listing fees formula </li></ul><ul><li>Continuing annual fee formula; $500,000 maximum yearly fee </li></ul><ul><li>Attracts largest and most desirable U.S. and foreign firms </li></ul><ul><li>http:// www. nyse .com for more information </li></ul>
  6. 6. Quick Quiz <ul><li>T or F </li></ul><ul><ul><li>Roughly 37,000 issues from more than 30,000 companies are listed on the NYSE. </li></ul></ul><ul><li>T or F </li></ul><ul><ul><li>In the stock market, a round lot is 100 shares. </li></ul></ul><ul><li>T or F </li></ul><ul><ul><li>Listing on NYSE is open only to U.S. companies. </li></ul></ul><ul><li>T or F </li></ul><ul><ul><li>At the NYSE, each listed stock is assigned to a single post, where the auction process is managed by a floor trader. </li></ul></ul>
  7. 7. Major U.S. Securities Exchanges NASD-AMEX Market Group (1998) <ul><li>National Association of Securities Dealers, Inc.—industry self-regulation </li></ul><ul><li>AMEX — nation’s second largest floor-based stock exchange </li></ul><ul><li>Market capitalization of over $100 billion </li></ul><ul><li>Develops new investment products and innovative services </li></ul><ul><li>NASD-AMEX Minimum listing requirements: </li></ul><ul><ul><li>pretax income of $750,000 </li></ul></ul><ul><ul><li>public float of $3 million </li></ul></ul><ul><ul><ul><li>Public float: the market value of common stock held by unaffiliated institutional and individual investors </li></ul></ul></ul><ul><ul><li>share price of $3 </li></ul></ul><ul><ul><li>three year operating history </li></ul></ul><ul><ul><li>stockholders’ equity of $4 million </li></ul></ul><ul><ul><li>500,000 to 1 million shares available for trading </li></ul></ul>
  8. 8. OPTIONS <ul><li>Right to buy or sell a given amount or value of a particular asset at a fixed price until a given expiration date </li></ul><ul><li>Call Option: right to buy or call from the market </li></ul><ul><li>Put Option: right to sell or put on the market </li></ul>
  9. 9. OPTIONS EXCHANGES <ul><li>Chicago Board Options Exchange (CBOE) </li></ul><ul><li>Created standardized listed stock options </li></ul><ul><li>Became the country’s 2nd largest securities exchange </li></ul><ul><li>World’s largest option exchange </li></ul><ul><li>Options now traded on 5 U.S. exchanges </li></ul><ul><li>Options on 1200 widely traded stocks plus broad indexes </li></ul>
  10. 10. AUCTION MARKETS Futures Exchanges <ul><li>Futures: Financially secured binding agreement to buy or sell a commodity at a future time </li></ul><ul><li>Seven futures exchanges for agricultural, financial, and raw material products </li></ul><ul><li>Largest 3 account for 90% of volume: </li></ul><ul><ul><li>Chicago Board of Trade — ag commodities </li></ul></ul><ul><ul><li>Chicago Mercantile Exchange — forex </li></ul></ul><ul><ul><li>New York Mercantile Exchange — oil products, precious metals </li></ul></ul>
  11. 11. QUICK QUIZ <ul><li>T or F </li></ul><ul><ul><li>U.S. futures and futures option trading is concentrated on seven major exchanges. Among these seven futures exchanges, the CBOT, CME and the New York Board of Trade are commonly regarded as the “big three.” </li></ul></ul><ul><li>T or F </li></ul><ul><ul><li>The CBOE is a forum for trading stocks. </li></ul></ul>
  12. 12. OVER-THE-COUNTER (OTC) MARKETS <ul><li>Negotiated markets — price determined through bargaining, often electronically </li></ul><ul><li>Nasdaq ranks second among world’s security markets in terms of total dollar volume </li></ul><ul><li>Features market makers — 500 NASD member firms who represent stocks and compete to buy and sell stocks to customers </li></ul>
  13. 13. NEGOTIATED VS. AUCTION MARKETS <ul><li>Nasdaq market makers compete for customer order flow — each stock usually has 10 market makers </li></ul><ul><li> Customer order flow: customer sell/buy activity </li></ul><ul><li>Bid : offer to buy at a particular price </li></ul><ul><li>Ask : offer to sell at a particular price </li></ul><ul><li>Spread: difference between bid and ask prices; represent market makers’ profits </li></ul><ul><li>Inside market is narrowest spread — highest bid and lowest offer prices </li></ul>
  14. 14. QUICK QUIZ <ul><li>At the NYSE, the auction process for each listed stock is assigned to a: </li></ul>a. Broker b. Market Maker c. Dealer d. Specialist a. Broker b. Market Maker c. Dealer d. Specialist
  15. 15. NASDAQ Listing Requirements <ul><li>Significant net tangible assets or operating income </li></ul><ul><li>Minimum public float of 500,000 shares </li></ul><ul><li>At least 400 shareholders </li></ul><ul><li>Bid price of at least $5 </li></ul><ul><li>Nasdaq competes with AMEX and NYSE for company listings </li></ul>
  16. 16. Nasdaq SmallCap Market <ul><li>1400 smaller companies that trade prior to listings on Nasdaq proper </li></ul><ul><li>No penny stocks — minimum share price $1 </li></ul><ul><li>Lower requirements, but safeguards for market credibility </li></ul>
  17. 17. QUICK QUIZ <ul><li>T or F </li></ul><ul><ul><li>Nasdaq is an agency auction market. </li></ul></ul><ul><li>T or F </li></ul><ul><ul><li>On Nasdaq, each listed stock is assigned to a single post, where the specialist manages the auction process. </li></ul></ul><ul><li>T or F </li></ul><ul><ul><li>The difference between the price at which a market maker is willing to buy a security and the price which the firm is willing to sell is called customer order flow. </li></ul></ul><ul><li>T or F </li></ul><ul><ul><li>The spread, difference between bid and ask prices, in a Nasdaq security is the inside market. </li></ul></ul>
  18. 18. Over-the-Counter Bulletin Board (OTCBB) <ul><li>Regulated quotation service that displays real-time quotes,last-sale prices, and volume info in OTC securities </li></ul><ul><li>Established as part of Penny Stock Reform Act of 1990 to prevent manipulation and fraud </li></ul><ul><li>Monitored by online market surveillance systems </li></ul><ul><li>More information: http:// www. nasdaq - amex .com </li></ul>
  19. 19. QUICK QUIZ <ul><li>T or F </li></ul><ul><ul><li>The OTCBB is an unregulated quotation service that displays real-time quotes, last sale prices, and volume information in OTC equity securities. </li></ul></ul>
  20. 20. KEY TERMS Indexes <ul><li>DJIA </li></ul><ul><li>DJIA divisor </li></ul><ul><li>S&P 500 Index </li></ul><ul><li>equity benchmark </li></ul><ul><li>Russell 3000 Index </li></ul><ul><li>Russell 1000 Index </li></ul><ul><li>Wilshire 5000 Equity Index </li></ul><ul><li>Nasdaq Composite Index </li></ul><ul><li>Nasdaq 100 Index </li></ul><ul><li>S&P Midcap 400 Index </li></ul><ul><li>Wilshire 4500 Index </li></ul><ul><li>Russell 2000 Index </li></ul><ul><li>S&P SmallCap 600 Index </li></ul><ul><li>FTSE-100 </li></ul><ul><li>Nikkei 225 Index </li></ul><ul><li>TSE-35 </li></ul><ul><li>Hang Seng Index </li></ul><ul><li>EAFE Index </li></ul><ul><li>Emerging Markets vs. Developed Markets </li></ul>
  21. 21. INDEXES DJIA <ul><li>Way to track stock market at a glance </li></ul><ul><li>Started as simple averages of stock prices </li></ul><ul><li>First was the Dow Jones Industrial Average, which is now a price-weighted average of 30 large industrial companies’ stock prices </li></ul><ul><li>Now uses the DJIA divisor, an adjustment factor to account for splits and substitutions </li></ul><ul><li>Formula: Textbook </li></ul>
  22. 22. DJIA-Problem <ul><li>DJIA Divisor: 0.20142568 </li></ul><ul><li>(a)               A $1 rise in any component stock would cause the DJIA to rise by ______ points. </li></ul><ul><li>(b)               A 10% rise in a DJIA stock selling for $100 results in a ______ -point rise in the DJIA. A 10% rise in a DJIA stock selling for $200 results in a ______ -point rise in the DJIA </li></ul><ul><li>a.       A 10% change in the value of a high-priced DJIA stock would have a much (larger, smaller) on the index than a similar percentage change in the value of a low-priced component. </li></ul><ul><li>b.      (T, F) Higher-priced stocks tend to affect the index more than do the lower-priced stocks. </li></ul><ul><li>(c)               A 1-point rise in the DJIA reflects an average increase in the price of each component stock of _________. </li></ul><ul><li>(d)               DJIA = 11,000. One share of all 30 component companies costs roughly __________. </li></ul>
  23. 23. DJIA-Problem **DJIA Divisor = 0,15 DJIA = 12000. A round lot of all 30 component stocks has an investment cost of _______. **DJIA Divisor = 0.15, a 100-point rise in the DJIA reflects an average increase in the price of each component stock of ______.
  24. 24. LARGE-CAP INDEXES Largest & Most Stable Companies <ul><li>S&P 500: value-weighted average market index </li></ul><ul><ul><li>Most popular equity benchmark for institutional investors — 97% of money managers use it </li></ul></ul><ul><ul><li>Broad cross-section of representative American companies — 75% of market capitalization </li></ul></ul><ul><ul><li>Uses 1941-43 as base year </li></ul></ul><ul><ul><li>Formula: Textbook </li></ul></ul>
  25. 25. S&P 500-Problem <ul><li>(a) On September 28, 2000, the ratio of the closing market values of the S&P 500 composite stocks to the 1941-1943 base-period closing market values was 145.829 which results in an index value of ______. </li></ul><ul><li>(b)               September 28, 2000 S&P 500 Index = 1458.29 The lowest S&P 500 Index in the preceding 365-day period = 1247.41.  It represented an increase of ____% in the market values of the stocks in the index. </li></ul><ul><li>(c)               MSFT comprises roughly 4% of the market value of stocks included in the S&P 500 Index. On a day that MSFT stock rises by 2%, it causes a rise in the S&P 500 of ______%. </li></ul>
  26. 26. LARGE-CAP INDEXES Largest & Most Stable Companies <ul><li>Russell 3000 and 1000: tracks largest companies in terms of total market capitalization </li></ul><ul><li>Wilshire 5000 Equity Index: tracks total dollar value of the US equity market by weighted stock values — broadest equity coverage. </li></ul>
  27. 27. U.S. MIDCAP INDEXES Opportunities for Stable Growth? <ul><li>Nasdaq Composite Index: market-value weighted index of 5,000 Nasdaq stocks </li></ul><ul><li>Nasdaq 100: largest Nasdaq issues across industry groups </li></ul><ul><li>S&P MidCap 400 Index: 400 companies with total market cap between $1.5 and $10 million </li></ul><ul><li>Wilshire 4500: 6,700 companies’ stocks; excludes S&P 500. Accounts for about 25% of U.S. total market capitalization </li></ul>
  28. 28. SMALL CAP INDEXES Ready to Break Out? <ul><li>Small Caps: publicly traded corporations with less than $1.5 billion in market capitalization </li></ul><ul><li>Russell 2000: smallest companies, about 8% of total capitalization </li></ul><ul><li>Usually young and growing firms; list changes annually </li></ul><ul><li>S&P SmallCap 600 Index: value weighted index of 600 domestic stocks chosen for market size, liquidity, and industry group; index is popular due to lower turnover </li></ul>
  29. 29. GLOBAL STOCK INDEXES <ul><li>Nikkei 225 Index: Japan is second largest national stock market; index measures performance of 225 most liquid issues on Tokyo Stock Exchange </li></ul><ul><li>FTSE 100: capitalization-weighted index of 100 top market cap companies in 27 industries </li></ul><ul><li>TSE-35: market basket of 35 blue-chip Canadian stocks listed on the Toronto Stock Exchange </li></ul><ul><li>Hang Seng Index: 33 largest companies from 10 industries listed on Hong Kong market </li></ul>
  30. 30. Morgan Stanley Capital International Indexes <ul><li>Global equity benchmarks for international and regional markets </li></ul><ul><li>Most widely used benchmark by international portfolio managers </li></ul><ul><li>EAFE Index — tracks investment returns of 21 developed countries outside of North America </li></ul><ul><li>Emerging vs. developed markets </li></ul>
  31. 31. KEY TERMS Regulation <ul><li>Securities and Exchange Commission (SEC) </li></ul><ul><li>Self-regulatory organizations (SROs) </li></ul><ul><ul><li>NASD </li></ul></ul><ul><ul><li>NYSE </li></ul></ul><ul><ul><li>AMEX </li></ul></ul><ul><ul><li>CBOE </li></ul></ul><ul><ul><li>Municipal Securities Rulemaking Board </li></ul></ul><ul><li>Stock Watch </li></ul><ul><li>Intermarket Surveillance Group </li></ul><ul><li>Securities arbitration </li></ul><ul><li>Circuit breakers and trading limits </li></ul>
  32. 32. SECURITIES MARKET REGULATION Legislation Important to Investors, Issuers of Securities, and Brokers/Dealers <ul><li>Securities Act of 1933 </li></ul><ul><ul><li>Applies to firms going public—issuing new securities </li></ul></ul><ul><ul><li>Requires firms to register with government </li></ul></ul><ul><ul><li>Requires firms to provide investors with financial and material information </li></ul></ul><ul><ul><li>Exempts private placements and small issues </li></ul></ul><ul><li>Securities Exchange Act of 1934 </li></ul><ul><ul><li>Focuses on securities trading </li></ul></ul><ul><ul><li>Creates and authorizes Securities and Exchange Commission (SEC) to enforce statutes, rules, and regulations </li></ul></ul><ul><ul><li>Protects investors against fraud </li></ul></ul>
  33. 33. WALL STREET WISDOM <ul><li>Current competition for regulatory control </li></ul><ul><li>Federal Reserve, Comptroller of Currency, and Federal Deposit Insurance Corporation each lay claim to authority </li></ul><ul><li>1999: Repeal of Glass-Steagall Act </li></ul><ul><li>Among the questions: who protects federally insured bank deposits in new landscape? </li></ul>
  34. 34. Self-Regulatory Organizations (SROs) <ul><li>SEC delegates regulatory authority </li></ul><ul><li>National Association of Securities Dealers (NASD) </li></ul><ul><ul><li>Regulates Nasdaq and OTC </li></ul></ul><ul><ul><li>Monitors sales practices </li></ul></ul><ul><ul><li>Administers tests and licenses for individuals </li></ul></ul><ul><ul><li>Ensures accurate sales information </li></ul></ul><ul><li>NYSE, AMEX, CBOE--business practices and market operations </li></ul><ul><li>Municipal Securities Rulemaking Board </li></ul><ul><li>Banks — Fed Reserve, Comptroller of Currency, FDIC </li></ul>
  35. 35. MARKET SURVEILLANCE <ul><li>NYSE’s Stock Watch </li></ul><ul><ul><li>Flags unusual volume or price changes </li></ul></ul><ul><ul><li>Investigates questionable trades </li></ul></ul><ul><li>Intermarket Surveillance Group </li></ul><ul><ul><li>Shares information and coordinates efforts to detect manipulation </li></ul></ul><ul><li>Securities Arbitration </li></ul><ul><li>Circuit Breakers and Trading Limits </li></ul>
  36. 36. Qualifying As Securities Professional <ul><li>Register with NASD and others </li></ul><ul><li>Clear FBI screening </li></ul><ul><li>Challenging exams </li></ul><ul><ul><li>Series 7 (stock brokers) </li></ul></ul><ul><ul><li>Series 3 (commodities) </li></ul></ul><ul><ul><li>State exams </li></ul></ul>