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Chapter 12

Securities Markets

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Security Markets

The primary markets

Secondary markets -- stocks

Secondary markets -- bonds

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The Primary Market -- Two Forms of Issues

Initial public offerings (IPO) -- the very first shares ever issued by a company.

Seasoned new issues -- new shares being issued by a company that is already publicly traded.

Investment bankers serve as underwriters.

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Secondary Markets

Trade previously owned shares of stock.

Consist of organized exchanges and an over-the-counter market.

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Secondary Markets: The Organized Exchanges

Are used to facilitate trading between investors

New York Stock Exchange (NYSE)American Stock Exchange (AMEX)Regional stock exchanges

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Regional Stock Exchanges

Pacific Stock ExchangeChicago Stock ExchangePhiladelphia Stock ExchangeCincinnati Stock Exchange Intermountain Stock ExchangeSpokane Stock ExchangeBoston Stock Exchange

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Make-up of the New York Stock Exchange

Over 200 years oldLimited to 1,366 seats since 1953;

highest price of a seat was $2.6 million.Over 3,000 listed companies$12.3 trillion (that’s 12 zeros) worth of

shares80% of typical trading volume

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Requirements for NYSE Listing, 1999

Profitability -- $2.5 million before tax earnings

Size -- $40.0 million net tangible assetsMarket value -- $40.0 million publicly

held stockPublic ownership -- 1.1 million publicly

held common shares

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Make-up of the American Stock Exchange

600 seats 780 firms listed Trading only 3% of

the volume of the NYSE.

Daily dollar trading less than some regional exchanges.

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Secondary Markets: Over-the-Counter (OTC) Market

Consists of an electronic network of dealers used to execute trades

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Secondary Markets: Over-the-Counter (OTC) Market

Trades executed by:– “Pink sheets”– National Association of Securities Dealer

Automated Quotations System (NASDAQ)– National Market System (NASDAQ/NMS)

Handles 35,000 smaller, less frequently traded securities with no listing requirements

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Secondary Markets -- Bonds

No organized secondary bond market, as little demand among individual investors.

Individual investors must work through a broker, who buys or sells with a bond dealer.

Government bond trading is dominated by investment houses, commercial banks, and the Federal Reserve.

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International Markets

International bond market exceeds $25 trillion To buy international stocks

– NYSE, AMEX, NASDAQ trade some companies– Trade American depository receipts (ADRs) --

international shares are held on deposit by foreign banks and the ADRs are sold to investors as a representative ownership of the shares

– Invest directly through www.intltrader.com

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Regulation of the Securities Markets

Securities and Exchange Commission (SEC) regulation.

Securities Act of 1933 -- requires disclosure of relevant information in a timely manner.

Securities Exchange Act of 1934 -- established the SEC.

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Regulation of the Securities Markets (cont’d)

Investment Advisors Act of 1940 – regulates advisor activity.

Investor Protection Act of 1970 -- (SIPC) provides investor insurance similar to FDIC bank deposit insurance.

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Self-Regulation“Circuit breakers” -- triggers that

momentarily stop trading to prevent disastrous market slides.

Insider trading and market abuses– insider trading -- use of non-public

information for personal gain in the market– churning -- excessive trading without

benefit to the client used to increase commissions.

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How Securities are Traded

Specialists Buy and sell orders Brokers Brokerage services Cash and margin

accounts

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Role of the Specialist in an Organized Exchange

To maintain order in the market. To reduce fluctuation, NYSE specialists represent almost 20% of the share volume traded.

To track and process buy and sell orders. To maintain an inventory of assigned stock. To maintain bid and ask prices of their

assigned stock.

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Order Characteristics

Order sizes Time period for

which the order will remain outstanding

Order types

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Order Sizes

Round lots -- orders of 100 sharesOdd lots -- orders of 1 to 99 shares

Discretionary account: Broker authorized to make trades for you. Exercise caution, or avoid.

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Time Period the Order Will Remain Outstanding

Day orders -- good until the end of the trading day.

Open orders (GTC) -- good until filled or canceled.

Fill or kill orders -- must be filled or canceled immediately.

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Order Types

Market orders -- an order to sell or buy a specific number of shares at the best available price.

Limit orders -- an order to sell or buy a specific number of shares at a certain price or better.

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Order Types (cont’d)

Stop (or stop-loss) orders -- an order to sell a specific number of shares if the stock falls below a certain price or buy a specific number of shares if the stock rises above a certain price.

Use care to set prices to safeguard against major fluctuations.

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Short Selling -- Sell High and Buy Low

An almost reverse investment strategy which involves selling stock you don’t own and then buying it back later -- at a lower price.

Desirable when the market is expected to drop.

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Short Selling -- Sell High and Buy Low (cont’d)

Must meet margin requirement.Because you sold the broker’s stock,

you must repurchase the stock and you also must repay any dividends to the original owner.

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Dealing with Brokers

Brokerage accounts Types of brokers; choosing one Cash versus margin accounts Registration: street name or your name Joint accounts Brokers and individual investors The cost of trading On-line trading

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Asset Management Account Brokerage firm

comprehensive financial services package:

Checking account Credit card and loans Money market mutual

fund Brokerage services

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Types of Brokerage Firms

Full service brokersDiscount service brokers – 50% to70%

discountDeep discount brokers – 90% discountOn-line discount and deep discount

brokers – Low cost, immediate trading

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Account Types

Cash accounts -- use your money to pay for the purchase in-full within 3 business days

Margin accounts -- use the brokerage firm’s money to purchase part of the stock. This can amplify both gains and losses.– Maintenance margin– Margin call

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Account Types (cont’d)

Automated Clearing House (ACH) Network -- electronic payment system among 14,000 financial institutions that can be linked to your brokerage firm. Cheap, convenient, fast payment.

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Accounts Types (cont’d)

Street name registration -- shares of stock remain in the broker’s custody. May be charged “maintenance fee” for dormant accounts.

Joint accounts -- shares owned with a spouse or partner– Joint tenancy with the right of survivorship– Tenancy-in-common

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Working With a BrokerRemember Axiom 12: The Agency

Problem in Personal Finance.Do your homework and take

responsibility.Keep transaction costs to a minimum.Use a discount broker or consider

mutual funds.For bonds, go full service or buy direct.

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Choosing a Broker

Integrity, intelligence, and efficiency Experience in both up- and down-markets Someone who understands your investment

philosophy Reputation for allowing customers to say no

without undue pressure Up front regarding costs and commissions

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The Cost of Trading

Commissions Transaction fees Inactive account

fees Annual fees Maintenance fees

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On-line Trading

Cheap, easy trading, but do your investment homework.

For fast moving stocks, use limit orders not market orders.

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On-line Trading (cont’d)Make sure all cancellations were

processed. If your account falls below the

maintenance margin requirement, your securities can be sold without a margin call.

No regulations govern the time for executing a trade.

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Day-trading Cautions

Be prepared for financial losses.Don’t confuse day trading with investing

– it’s speculating.Don’t believe claims of easy profits.Watch out for “hot tips” and “expert

advice” for day traders.

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Sources of Investment Information

Corporate sources of informationBrokerage firm reportsThe press

– The Wall Street Journal– Magazines– Investment publications

Internet sources Investment clubs

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SummaryPrimary securities markets

– Initial public offerings– Seasoned new issues

Secondary securities markets– New York Stock Exchange– American Stock Exchanges– Regional Exchanges– Over-the-counter markets

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Summary (cont’d)

Securities market regulationOrder size, duration, and type

– Round lots and odd lots– Day, GTC, or fill-or-kill orders– Market, limit, and stop orders

Cash or margin accounts

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Summary (cont’d)

Types of brokerage firms, services, and fees

Work with a broker or trade on-line?Day trading cautionsSources of investment information