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Stock Markets FNCE 4070 – Financial Markets and Institutions.

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Presentation on theme: "Stock Markets FNCE 4070 – Financial Markets and Institutions."— Presentation transcript:

1 Stock Markets FNCE 4070 – Financial Markets and Institutions

2 Equity Securities Equity securities represents an ownership interest in a corporation. Holders of equity securities are entitled to the earnings of a corporation that are distributed in the form of dividends Holders of equity securities are entitled to a pro-rata share of remaining equity in the case of a liquidation of the company

3 Types of Equity Securities Common Stock – Has voting rights – Pays dividends – Holder hopes/expects that the price will rise Preferred Stock – Pays a fixed dividend – Price is relatively stable – Votes only if the firm fails to pay the dividend – Much more like a corporate bond than common stock

4 Exchanges An exchange is a marketplace where financial intermediaries come together to deliver and execute customer orders A Physical exchange has a trading floor where the financial intermediaries meet An electronic exchange has no trading floor and works electronically.

5 Financial Intermediaries Broker – A pure middleman who acts as agents for investors in the purchase or sale of securities – Their function is to match buyers with sellers for which they are paid a commission – There are typically two types of brokers Full service – Higher commissions – Proprietary research Discount Broker – Lower commissions – Simply offer execution service

6 Financial Intermediaries Dealer or Market-Maker – They link buyers with sellers by holding inventories of securities – Stand ready to buy or sell securities at given prices – Make their money through the spread between their bid (buy) and offer (sell) price – Provide liquidity into the market Especially important for smaller stocks

7 Order Driven Market In this market buy and sell orders of public participants who are the holders of the securities establish the prices at which other public participants trade. – Continuous market – a trade can be made at any moment in time when a buy and sell order meet – Call auction – orders are batched together for simultaneous execution. For smaller companies and in times of market stress there are no natural providers of liquidity in the market

8 Market Order Market Order – This order is to be executed at the best possible price available in the market – The positive is that you are filled no matter what – The negative is that in a fast moving market or illiquid market you will be filled at whatever price is available.

9 Conditional Orders Price of Security Limit OrderMarket if Touched Order Stop-Limit Order Stop Order Higher PricePrice specified for a sell order Price specified for a buy order Current Price---- Lower PricePrice specified for a buy order Price specified for a sell order CommentCan be filled only if price is better Becomes a market order when the price is reached Can only be filled if price is better Becomes a market order when the price is reached.

10 Order Qualifiers Day only – must be executed today Good until Cancelled – will stay valid until it is executed or cancelled Fill or Kill – this will be cancelled if it is not immediately filled completely Intermediate or Cancel – this will be cancelled immediately but allows partial fill.

11 An Order Book Buy QuantityBuy PriceSell PriceSell Quantity 10, ,000 14, ,000 5, ,500 3, ,000 5, ,000

12 Quote Driven Market In this market dealers – quote the prices at which the public participants trade. Market makers provide: – a bid quote (to buy) and – an offer quote (to sell).

13 Quote Driven Dealer Market DealerBidOffer A B C DealerBidDealerOffer A40.50C41.00 B40.35B41.10 C40.20A41.20

14 Hybrid Markets Many equity markets are a combination of an order driven market and a quote driven market. – The New York Stock Exchange is primarily a continuous auction order driven system but At the open and close and after any stop in trading it operates a call auction. Specialists enhance the liquidity by the market-making to maintain a fair market There are dealers who provide capital to execute block trades (large size).

15 NYSE Trades from 9:30 to 4 every day – Opening auction at 9:30 Orders can be entered into the auction from 7:30-9:30 – Closing auction at 4 Orders can be entered into the auction from 9:30-4 – For every stock there is a designated market maker (DMM) Charged with maintaining a fair and orderly market Provide liquidity as necessary to the market

16 Nasdaq Introduced in 1971 – The worlds first electronic exchange – Originally a bulletin board that did not connect buyers with sellers but simply gave better price transparency Primarily a dealer system where – Multiple dealers provide quotes and make trades – In 2002 introduced Super Montage An order based system

17 Electronic Communication Network (ECN) Essentially this is a limit order book – Widely disseminated and open to continuous trading for subscribers. – Offers Transparency, Anonymity, Automated Service Reduced Costs – Good for smaller trades – Often links best bid and offer to exchanges

18 Iceberg Order This is a limit order trade for which only a portion is shown to the order book at any given time. – Only the top of the order appears in the order book at any given time. – Once this portion is filled then a new limit order will appear in the order book for this same amount until the entire order is filled.

19 Crossing Network A network that matches buyers and sellers of larger sizes using prices from elsewhere Dark Pools – Private crossing networks – Allows for anonymous trading – Gives access to large liquidity pools that do not want to have their positions known publically – Trade reporting is delayed as long as possible to minimize market impact.

20 Explicit Costs of Trading Commissions – generally these are completely negotiable and will depend on the size of your trade and your relationship with your broker. Custodial Fees – These are the costs associated with holding a stock position. They would generally pay for dividend handling, corporate action handling, etc. Soft Dollars – These are costs for items such as research embedded in the commissions – Institutional clients will often negotiate with a broker exchanging a percentage of their order flow for free access to research – SEC is now strict about what can be bought with soft dollars – for example, one cannot receive free vacations.

21 Implicit Costs of Trading Impact Costs – These are the costs associated with completing a large order. If your trade is large relative to normal market size then it can move the market Timing Costs – These are the costs associated with the delay between when you instruct a broker to execute a trade and when the trade actually completes Opportunity Costs – In equity markets these are the costs associated with trades that do not complete due to the market moving against the trade during the execution of the trade

22 Mechanics of Short Sale (

23 Equity Long-Short A strategy that allows one to profit from the outperformance of one stock versus another stock. – The trader is trying not to take general market risk. The strategy should not make/lose money on general market moves. Stock selection would generally be made through fundamental analysis on stocks

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