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Chapter 4 Securities Markets

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1 Chapter 4 Securities Markets

2 Learning Objectives Compare primary and secondary markets.
Equity markets - organization and operations Define third and fourth markets. Major stock market indicators. Bond and derivatives markets. Change in the securities markets 2

3 Importance of Financial Markets
Financing government and firm projects Channel funds from savers to borrowers Provide a place where investors can act on their beliefs Help allocate cash to where it is most productive Help lower the cost of exchange 2

4 Primary Markets New securities are issued in a primary market
Initial public offering (IPO) versus “seasoned” new issue IPO – Common stock shares of a company being sold for the first time Issue facilitated by investment dealers Specialists in advice, design, and sales Intermediaries between issuer and investor 3

5 Investment Dealers Client advice includes type and features of security, offer price, and timing of sale Underwriting services: Risk of selling to investors assumed from issuer Coordinate marketing by helping issuer register securities, issue prospectus, and sell securities 4

6 Underwriting Process The issuing company sell the securities to the financing group which consists of one or two firms The financial group sells the securities to the marketing group at a “draw down” price The securities are distributed for sale to the public

7 Issuance of Securities
Prompt Offering Qualification (POP) System allows senior reporting issuers to sell new securities over time via “short form” prospectuses Reduces issuance cost Listing process Global security issues A private placement means new securities are sold to a small group of institutional investors Registration not required 5

8 Secondary Markets Markets where investors trade previously issued securities Auction markets involve bidding in a specific physical location Brokers represent investors for a fee Others trade for their own account Negotiated markets consist of decentralized dealer network 6

9 Stock Exchanges Toronto Stock Exchange (TSX) is a secondary auction market for equity securities Largest Canadian stock market Listing requirements for traded firms TSX Venture Exchange is Canada’s “junior” stock market New York Stock Exchange (NYSE) is the largest secondary market in the world 7

10 Stock Exchanges Formal organizations approved and regulated by the SEC (or the provincial securities commissions such as the OSC in Canada) Members Can only trade listed stocks Must buy a seat on the exchange Listing requirements minimum capitalization, shareholder equity, average closing share price, etc.

11 NYSE Centralized continuous auction market Exchange participants
single specialist commission brokers independent floor brokers registered traders SuperDot Major roles of NYSE specialist Dealer Agent Catalyst Auctioneer Commissions deregulated in 1975

12 Over-the-Counter (OTC) Markets
Network of dealers standing ready to either buy or sell securities at specified prices Dealers profit from spread between buy and sell prices Handle unlisted securities Canadian OTC stocks are trading on the TSX Venture Exchange US OTC Market: NASDAQ 8

13 Over-the-Counter (OTC) Markets
Trading unlisted stocks Listing requirements Nasdaq stock market Nasdaq market tiers Nasdaq National Market (3,600 co.’s) Small Capitalization Market (850 co.’s) Nasdaq market makers Other OTC markets (8,000 co.’s) OTC Bulletin Board Pink Sheets

14 Third and Fourth Markets
Third Market: Over-the-counter transactions in securities listed on organized exchanges Fourth market: Trading network among investors interested in buying and selling large blocks of stock Brokers, dealers bypassed so costs are low Electronic or telephone network 9

15 Trading After-Hours Trading: Electronic Communications Networks (ECNs) allow investors to trade after exchange hours (4 to 8 P.M. EST, and sometimes early in the morning) In-House Trading: this new trend has significant implications for the NYSE

16 International Equity Markets
Toronto Stock Exchange is the eighth-largest stock exchange in the world Many different equity markets exist Emerging markets Generally less regulation and standardization of trading activity Risks: Illiquidity, lack of information, political uncertainty 10

17 Equity Market Indicators
Provide a composite report of market behavior on a given day S&P/TSX Composite Index Market value weighted In 2004, comprised of 223 companies representing almost 70 per cent of the market capitalization S&P/TSX 60 Index Designed to mimic the performance of the S&P/TSX composite Index 11

18 Equity Market Indicators
Dow Jones Industrial Average (DJIA) Composed of 30 “blue-chip” stocks Price weighted S&P 500 Composite Index Composed of 500 “large” firm stocks Market value weighted Nikkei 225 Average Price weighted index of 225 actively-traded stocks on the Tokyo Stock Exchange 12

19 Bond Markets Secondary bond market is primarily an over-the-counter network of dealers Government of Canada bonds actively trade in dealer markets Corporate bonds are not as actively traded as government issues 14

20 Market Developments Growth of institutional trading
Block trading of stocks (transactions of at least 10,000 shares) Affects market structure and operation Negotiated, not fixed, commissions Globalization of securities markets 24-hour trading Instinet 15

21 Stock Market Indexes S&P/TSX Composite Index
Dow Jones Industrial Average

22 Price Weighted  Arithmetic average of current prices  Assumes you purchase an equal number shares of each stock represented in the index  e.g., DJIA, Nikkei 225 Problems:  Must adjust denominator downward for splits  Stocks with higher prices have greater influence PWI = [  of stock prices ] / [number of stocks in index]

23 Value Weighted  Total value (mkt. cap.) of all stocks in the index
 Assumes you make a proportionate market value investment in each company in the index  e.g., S&P 500/ NYSE indexes Problem:  Market Cap.,  impact on index MVW = [ (Price today) (number of shares) / (Price base) (number of Shares)] (Index Value BEG)

24 Equal Weighted  Unweighted index (e.g. Value-Line Composite Average, Financial Times Index – LSE)  Assumed the investor makes an equal dollar investment in each stock in the index  Geometric average or arithmetic average Problem:  GA leads to downward bias since GA<AA

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