3Secondary Markets Secondary Markets The market in which securities already issued are tradedBuyers and sellers are both investors
4Order Types Market buy: buy at best going price Market sell: sell at best going priceWhen price does this:SellStop-loss(Stop-sell)Limit sellBuyLimit BuyStop Buy
5Trading on OTC Market Investor places an order with broker. Broker tries to locate the dealer offering the best deal.Trades are negotiated through dealers who maintain an inventory of securities.Nasdaq initially just a computer quotation system for dealers.
6Trading on ECNsBrokers that have an affiliation with an ECN have computer access and can enter orders.Brokers can make terminals available to individual traders.Limit orders are entered in a limit order bookLimit orders provide liquidityThe ability to transact quickly at a fair priceEliminates the need for a dealer – the middle man.Keeps trade anonymous.
7Trading on ECNs 2006:Two largest ECNs bought by NYSE and Nasdaq NYSE bought ArchipelagioNow called NYSE ARCANasdaq bought Instinet
8Trading on Exchanges Investor places an order with broker. Broker can eitherSend order to exchange electronicallySend larger orders to floor brokers who “work” the orderFloor broker takes order to specialist desk
9Trading on Exchanges: Specialist Desk 1) Maintains a limit order book.Record of limit sells (sell if price goes above a threshold)Record of limit buys (buy if price goes below a threshold)
10Trading on Exchanges: Specialist Desk 2) Acts as a brokerCrosses limit orders with market orders not sent electronicallyGets paid a commissionThe specialist must get traders best possible priceMatch buy orders with lowest limit sellMatch sell orders with highest limit buy
11Trading on Exchanges: Specialist Desk 3) Acts as a dealerPosts own bid and ask prices if the spread gets too widePrice continuityDealer’s duty to maintain a fair and orderly marketPerformance monitored by exchange4) Floor brokers can also meet each other at the specialist desk and trade directly with each other.
12Trading on Exchanges Direct search market Brokered market Floor brokers can seek each other out at the specialist deskBrokered marketSpecialist acts as a brokerDealer marketSpecialist acts as a dealerAuction marketAll buy and sell orders come to one location and the best orders win the trades
13Bid-Ask PricesThe ask price is the price at which someone stands willing to sell.The bid price is the price at which someone stands willing to buy.Ask>Bid (always)
14Bid-Ask and OTC Markets On Over-the-Counter markets:Only dealers post bid-ask prices.Buy orders buy at lowest ask broker can findMarket buyLimit buyStop buySell orders sell at highest bid broker can findMarket sellLimit sell
15Bid-Ask and OTC Markets Ask: Bid: 45.50Market BuyBuy at 45.60Market SellSell at 45.50
16Bid-Ask and OTC Markets Ask: Bid: 45.50Limit Buy at 45.55Order not executed. Buy price (45.60) has not dropped below the threshold (45.55)Limit Sell at 45.55Order not executed. Sell price (45.50) has not jumped above the threshold (45.55)
17Bid-Ask and OTC Markets Ask: Bid: 45.50Stop Buy at 45.55Order executed immediately. Buy price (45.60) is above the threshold (45.55)Stop Sell (Stop Loss) at 45.55Order executed immediately. Sell price (45.50) is below the threshold (45.55)
18Trading on Exchanges and ECNs Any limit order is a bid-ask priceAny broker can post a limit ordermarket buy & stop buy orders executed atlowest ask (effective ask price)market sell & stop-loss orders executed athighest bid (effective bid price)
19Bid-Ask and Exchanges/ECNs Lowest Limit Sell: 45.60Highest Limit Buy: 45.50Ask: Bid: 45.50Market BuyBuy at 45.60Market SellSell at 45.50
20Bid-Ask and Exchanges/ECNs Ask: Bid: 45.50Limit Buy at 45.55Order not executed. The lowest price at which you can currently buy isOrder is entered in the limit order book.New bid price becomes 45.55, highest limit order buy.Limit Sell at 45.55Order not executed. The highest price at which you can sell isNew ask price becomes 45.55, lowest limit order sell.If these trades were both submitted by different investors, the specialist would “cross these trades” and take them off the limit order book.
21Bid-Ask and Exchanges/ECNs Ask: Bid: 45.50Stop Buy at 45.55Order executed immediately. Buy price (45.60) is above the threshold (45.55)Stop Sell (Stop Loss) at 45.55Order executed immediately. Sell price (45.50) is below the threshold (45.55)All stop buy orders are still executed at the askAll stop sell orders are executed at the bid
23Advantages record keeping and administration diversification professional managementlower transaction costs
24Mutual Funds Open-end funds You buy or sell shares directly through the mutual fundShares are purchased at NAV per shareNAV is calculated every day at 4:00pmAll orders placed before 4:00pm buy at this NAVFund companies adjust the number of shares according to the demand by investorsMarket value of assets - LiabilitiesNet asset value (NAV) =Shares outstanding
25Mutual Funds Open-end funds You buy or sell shares directly through the mutual fundShares are purchased at NAV per shareNAV is calculated every day at 4:00pmAll orders placed before 4:00pm buy at this NAVFund companies adjust the number of shares according to the demand by investors
26Open-End Fund Example Fund ABC 4:00pm Monday: Total Assets = 36 billionTotal Liabilities = 1 billionShares Outstanding = 900 millionNAV = 35B/900M = $38.89Throughout day on TuesdayAsset Value increases by 1%New flows of $500,000
27Open-End Fund Example 4:00pm on Tuesday New Flows of $500,000 Asset value is now 36B(1.01)=36.36BNAV = 35.36B/900M=39.29New Flows of $500,000500,000/39.29 = 12,726 sharesNew investors buy these shares at per shareTotal shares outstanding = 900M + 12,726Total Assets = 36.36B + 500,000
28Open-End ExampleIn this example, there are no fees, and no distributions (dividends or capital gains)Return from owning fund
29How Funds are SoldFund “underwriter” has exclusive rights to distribute shares of the fund.Funds are sold to public by underwriter, or indirectly through brokers who act in behalf of underwriter.Financial SupermarketsExample: Charles Schwab