1. ORGANIZATION AND FUNCTIONING OF SECURITIES MARKETS
Chapter 5
ORGANIZATION AND FUNCTIONING OF SECURITIES MARKETS

2. Chapter 5 Questions What is the purpose and function of a market?
What are the characteristics that determine the quality of a market?
What is the difference between a primary and secondary capital market and how do these two markets support each other?
What is the typical underwriting organization structure for corporate stock issues?

3. Chapter 5 Questions
For secondary equity markets, what are the two basic trading systems?
What are the major primary listing markets in the United States and how do they differ?
What are call markets and when are they typically used in U.S. markets?

4. Chapter 5 Questions
How are national exchanges around the world linked and what is meant by “passing the book”?
What is Nasdaq and how has its growth and influence impacted the securities market?
What are the regional exchanges and what securities do they trade?
What is the third market?

5. Chapter 5 Questions
What are Electronic Communications Networks (ECNs) and alternative trading systems (ATSs) and how do they differ from the primary listing markets?
What are the major types of orders available to investors and market makers?
What are the major functions of the specialist on the NYSE?

6. Chapter 5 Questions
What new trading systems on the NYSE and Nasdaq have made it possible to handle the growth in U.S. trading volume?
What are the three recent innovations that contribute to competition within the U.S. equity market?

7. What is a market?
The means through which buyers and sellers are brought together to aid in the transfer of goods and services
Does not require a physical location
“The market” itself does not have to own the goods and services involved
Buyers and sellers benefit from the market

8. Characteristics of a Good Market
Availability of past transaction information
must be timely and accurate
Liquidity: sell quickly at a good price
marketability
price continuity
depth
Transaction cost are low (Internal efficiency)
Prevailing market prices reflect all relevant information (External efficiency)

9. Decimal Pricing
The movement to decimal pricing is a case study in making a market better
Benefits:
Ease of understanding prices for investors
Reduction in minimum bid-ask spreads
Lower transaction costs through enhanced global competition

10. Organization of the Securities Market
Primary markets
New issues
Secondary markets
Outstanding securities are bought and sold

11. Primary Capital Markets : Government Bonds
Sold regularly through auctions
Treasury bills: one year maturity or less
Treasury notes: maturities of two to ten years
Treasury bonds: original maturities of more than ten years

12. Primary Capital Markets : Municipal Bonds
Sold by three methods
Competitive bid sales: sealed bids
Negotiated sale: contractual arrangements, underwriter helps prepare, price, and sell the issue
Private placements: Issuer sells directly to investors
Underwriters services
Origination: design of the issue
Risk-bearing: purchase the issue, risk reselling
Distribution: selling the issue

13. Primary Capital Markets: Corporate Bonds
Negotiated arrangement with an investment banking firm who maintains a relationship with the issuing firm
Underwriting firm often organizes a syndicate for distribution

14. Primary Capital Markets : Common Stock
New issues are divided into two groups
Seasoned new issues
New shares offered by firms that already have stock outstanding
Initial public offerings (IPOs)
Firms selling their stock to the public for the first time
New issues normally underwritten by investment banking firms

15. Relationships with Investment Bankers
The underwriting of corporate issues typically takes three forms:
1. Negotiated
Most common
Full services of underwriter
2. Competitive bids
Corporation specifies securities offered, then seeks bids
Reduced costs but also reduced services of underwriter
3. Best-efforts
Investment banker acts as broker, selling all it can at a specified price

16. Introduction of Rule 415 Shelf registration:
Allows firms to register securities and sell them piecemeal over the next two years
Increased flexibility for timing issues
Reduces registration fees and expenses
Mostly used for bond sales

17. Private Placements and Rule 144A
Firms sells to a small group of institutional investors, with some assistance of an investment banker
Lower issuing costs than public offering
Extensive registration not required
Issues can trade among large, sophisticated investors

18. Secondary Markets
Involves the trading of issues that are already outstanding
Provide a means obtaining cash for sellers
Provide buyers with more investment choices

19. Why Secondary Markets Are Important
Provide liquidity to investors who acquire securities in the primary market
Helps issuers raise needed funds in the primary market since investors want liquidity
Help determine market pricing for new issues

20. Secondary Bond Markets
Secondary market for U.S. government and municipal bonds
U.S. government bonds traded by bond dealers who specialize in these issues
Banks and investment firms make markets in municipal bond issues
Secondary corporate bond market
Traded in an OTC market by bond dealers
A much more limited market than for stock issues

21. Financial Futures
Bond futures contracts allow the holder to either buy or sell a specific bond issue at a specific price on a future date
Bond futures are traded in separate markets
Chicago Board of Trade (CBOT)
Chicago Mercantile Exchange (CME)

22. Secondary Equity Markets
Basic Trading Systems
Pure auction market
Buyers “bid” and sellers “ask”
Buy and sell orders are matched at a central location
Price driven market: trades are made by determining the highest bid and the lowest ask
Dealer market
Dealers buy shares (at the bid price) and sell shares (at the ask price) from their own inventory
Dealers compete against each other

23. Call Versus Continuous Markets
Call markets trade individual stocks at specified times to gather all orders and determine a single price to satisfy the most orders
Used for opening prices on NYSE if orders build up overnight or after trading is suspended
Continuous markets trade any time the market is open

24. Classification of U.S. Secondary Equity Markets
Primary Market Listings
Regional Stock Exchanges
The Third Market
Alternative Trading Systems

25. Primary Market Listings
Large number of listed securities
Listing often seen as a sign of prestige
Wide geographic dispersion of listed firms
Diverse clientele of buyers and sellers
Firms wanting to list must meet listing requirements

26. Primary Market Listings: NYSE
Largest organized securities market in United States
Established in 1817, but dates back to 1792 Buttonwood Agreement by 24 brokers
About 3,000 companies listed
Market value over $12 trillion
Accounts for about 80% of the trading volume for listed stocks

27. Primary Market Listings: AMEX
Started by a group who traded unlisted stocks at the corner of Wall and Hanover Streets in New York as the Outdoor Curb Market
Emphasis on foreign securities
Doesn’t trade stocks listed on NYSE
Merged with Nasdaq in 1998, although operations remain separate

28. Primary Market Listings: Global Stock Exchanges
Tokyo Stock Exchange (TSE)
London Stock Exchange (LSE)
Other National Exchanges
Frankfurt, Toronto, Paris
New exchanges in emerging countries
Russia, Poland, China, Hungary, Peru, Sri Lanka

29. Primary Market Listings: Global Stock Exchanges
Trend toward consolidation of exchanges
Economies of scale, especially in terms of the required technology
Liquidity is enhanced with more firms trading
Larger firms dual-listed on a U.S. exchange
Must meet listing requirements of both
Strong exchanges abroad enable continuous global trading for firms

30. The Global Twenty-four Hour Market
Investment firms “pass the book” around the world to maintain nearly continuous trading by utilizing markets at Tokyo, London, and New York
This means that the markets are increasingly interrelated, moving toward a single world market

31. Primary Market Listings: Nasdaq NMS
Historically known as the Over-the-counter (OTC) market
Not a formal organization or a single location
Almost 3,500 issues actively traded on Nasdaq’s NMS ( National Market System)
More issues traded, but less dollar trading in terms of total value than NYSE
National Quotation Bureau，NQB
pink sheet market
(1904)
OTC
NASD,1968
美国粉红单市场的发展经历了几个阶段，1904年之前，美国全国分布着许多柜台交易市场，由于各个市场都是散布在全国各地，彼此间信息隔绝，没有统一的管理和统计，券商和客户很难全面了解某种股票的报价和交易情况，也不知道是否得到了最好的报价。为了解决这个问题，1904年一家从事印刷和出版业务的私人公司(国家报价局National Quotation Bureau，NQB)开始向美国的券商和投资者提供报价服务，每天用粉红色纸张刊印公布10000多种柜台交易股票和5000多种债券的价格、交易量等，并将各种证券的报价信息定期制作成刊物印刷并发往全国，因此称之为粉红单市场。直到1968年美国证券商协会(NASD)决定创建“全美证券商协会自动报价系统”(NASDAQ)，并把该项任务交给一家叫Bunker Ramo的私人公司研制完成。1971年2月8日该系统正式启动，并从粉红单市场上挑选出2500多家规模、业绩和成长性都名列前茅的股票进行报价交易。1990年NASDAQ股票市场设立了OTCBB市场，由于其全国性电子报价系统的优势，并且与粉红单市场报价一样没有限制，“不强制公司作信息披露”，大量粉红单市场报价股票转到OTCBB市场报价。从1999年1月起美国证券交易委员会(SEC)整顿OTCBB市场，要求在OTCBB市场报价的公司必须定期提供财务报告，否则将被从OTCBB市场删除。从而大量在OTCBB市场报价的股票又重新回到了粉红单市场上报价。经过一年的整顿，OTCBB市场报价的股票从6600多支锐减至3300余只支，而粉红单市场报价的股票则不断增加，至2005年9月粉红单市场报价的股票有7821支，其中单独在粉红单市场报价的4782支，同时还在OTCBB双重报价的3039支。1999年9月，粉红单市场引进了以网络为基础的、实时报价的电子报价系统，提高了市场效率2000年6月又建立了信息网站(
粉红单市场的结构特点
　　粉红单市场是美国柜台交易(OTC)的初级报价形式，广义的美国OTC市场包括NASDAQ、OTCBB和粉红单市场，按其上市报价要求高低依次为：NASDAQ→OTCBB→粉红单。粉红单市场既不是在SEC注册的股票交易所，也不是NASDAQ系统的OTC，而是隶属于一家独立的私人机构(Pinksheets LLC)，有自己独立的自动报价系统—OTCQX。粉红单市场的功能就是为那些选择不在交易所或NASDAQ挂牌上市、或者不满足挂牌上市条件的股票提供交易流通的报价服务。在粉红单市场报价的是那些“未上市证券(Unlisted Securities)”，具体包括：一、由于已经不再满足上市标准而从NASDAQ股票市场或者从交易所退市的证券；二、为避免成为“报告公司”而从OTCBB退到粉红单市场的证券；三、其它的至少有一家做市商愿意为其报价的证券。
　　粉红单市场与其他OTC市场一样，采用做市商交易制度。只有经SEC注册作为NASDAQ会员的做市商才能为粉红单市场上的股票报价造市。报价系统与股票发行人之间无直接联系，证券发行人不用在粉红单市场申请上市和报价，而是通过做市商进行报价。做市商不了解或不经发行人同意也可以在粉红单市场上报价。
 　　在粉红单市场报价没有特别的上市标准要求，只要做市商填写一份真实反映发行人当前最新状况的211表格提交市场审核即可，并不要求审查发行人的财务状况等。粉红单市场是美国唯一一家对上市既没有财务要求，也不需要发行人进行定期和不定期的信息披露的证券交易机构。如果做市商已经在另外一个市场为证券报价了，就不需要任何其他条件，做市商可以和粉红单市场联系，并要求立即在粉红单市场为其报价。即满足其它市场上市条件的证券不用经粉红单市场的批准就可以在这里兼容报价了。  
　　粉红单市场仅仅是一个报价服务系统，不提供自动交易撮合，也不执行自动交易指令。它不是一个发行人上市挂牌交易系统，没有上市标准。因此它不受SEC注册要求的管制，不必向SEC上交财务信息和其它的公司常规文件，没有信息披露的要求。证券发行者在粉红单市场被报价无需支付费用。做市商给证券报价须每月支付很少的费用。
粉红单市场的监管  
　　粉红单市场不是一个股票交易所，它不受证券监管当局的监管，只要每天交易结束时公布挂牌公司的报价即可。但是NASD监管当局(NASDR)和SEC会对粉红单市场和黄单市场上证券的所有做市商进行严格的监管。其监管的内容包括：建立规范做市商行为的规则以管制做市商的商业行为；为证券从业人员建立资格标准；随时检查会员的财务及经营状况，以及是否违反相关规则和条例；调查证券的违规行为；用相关法律约束处罚违规者；对投资者和投诉予以回应等等。
 　　由上可知，因为粉红单市场上市报价的条件要求很低，在这个市场上报价的许多证券都是Penny Stock(仙股)，且资料不全，信息披露不及时，投资风险很大，即为聪明的消息灵通的投资者提供了巨大的投资机会，又潜藏着极大的投资风险。粉红单市场上主要是那些喜欢冒险的激进投资者及风险投资人。  
 粉红单股票类型
 投资者还应该知道，有两种不同类型的外国粉红单股票。一类是参与型(sponsored)，由公司挂牌交易；另一类是非参与型(unsponsored)，由经纪人挂牌交易。两种粉红单股票均透过纽约银行这类美国存讬凭证的存讬银行发行－－纽约银行资料显示，679支粉红单股票是参与型，220支粉红单股票是非参与型。
NASDQ
(1971)
OCTBB
(1990)
NMS
Pink sheet
SCM

32. Primary Market Listings: Nasdaq NMS
Operations
Any stock may be traded as long as it has a willing market maker to act a dealer
Nasdaq is a negotiated market with investors potentially dealing directly with dealers

33. Primary Market Listings: Nasdaq NMS
The Nasdaq System
National Association of Security Dealers Automated Quotation system
Dealers may elect to make markets in stocks
Average of about 8 dealers per stock in 2003
Three levels of quotations available
Level 1 shows a median representative quote
Level 2 shows quotes by all market makers
Level 3 is for Nasdaq market makers to change their quotes shown

34. Primary Market Listings: Nasdaq NMS
Listing Requirements for Nasdaq
Two lists
National Market System (NMS)
Regular Nasdaq
Must meet at least one standard for initial and continued listing
See Exhibit 6.6
Making trades
Broker determines which dealer has the best price (lowest ask price/highest bid price)

35. Primary Market Listings: Nasdaq
Other Nasdaq Market Segments
The Nasdaq Small-Cap Market (SCM)
More lenient listing requirements
The Nasdaq OTC Electronic Bulletin Board
Report service for smaller stocks
The National Quotation Bureau (NQB) Pink Sheets
Price quotation sheets for smaller stocks

36. Regional Exchanges
Provide secondary markets for stocks not listed on a major exchange
Listing requirements vary
Some regional exchanges list issues also listed on a national exchange
Regional Exchanges in United States
Chicago, Boston, Pacific (San Francisco/Los Angeles), Philadelphia, Cincinnati

37. Third Market
Dealer and broker trading of shares listed on an exchange away from the exchange
Mostly well known stocks
May be important to investors particularly when the exchange is closed or when trading is suspended on the exchange
Success depends on relative costs of transactions compared to the exchange

38. Alternative Trading Systems (The Fourth Market)
Area of great innovation
Electronic Communication Networks (ECNs)
Buy and sell orders are matched via computer, mainly for retail and small institutional trading
Electronic Crossing Systems (ECSs)
Electronic means for matching larger buy and sell orders

39. Detailed Analysis of Exchange Markets
Listed exchange markets have evolved into rather unique institutions; they can be described with a number of attributes:
Exchange Membership
Major Types of Orders
Exchange Market Makers

40. Exchange Membership Four categories of membership: Specialists
Maintain an orderly market in a stock
Commission brokers
Member firm employees executing orders for clients of the firm
Floor brokers
Independent brokers who work for other brokers
Registered traders
Members who buy and sell for their own accounts

41. Major Types of Orders Market orders Limit orders
Buy or sell at the best current price
Limit orders
Order specifies the buy or sell price
Time specifications for order may vary
Instantaneous - “fill or kill”, part of a day, a full day, several days, a week, a month, or good until canceled (GTC)

42. Major Types of Orders Short sales
Sell overpriced stock that you don’t own and purchase it back later (at a lower price)
Borrow the stock from another investor (through your broker)
Can only be made on an uptick trade
Must pay any dividends to lender
Margin requirements apply

43. Major Types of Orders Special Orders Stop loss Stop buy order
Conditional market order to sell stock if it drops to a given price
Does not guarantee price you will get upon sale
Market disruptions can cancel such orders
Stop buy order
Investor who sold short may want to limit loss if stock increases in price

44. Major Types of Orders Buying on Margin:
On any type order, instead of paying 100% cash, borrow a portion of the transaction, using the stock as collateral
Interest rate is based on the call money rate from a bank
Regulations limit proportion borrowed and the investor’s equity percentage (margin)
Margin requirements are from 50% up
Changes in price affect investor’s equity

45. Major Types of Orders The rate of price change=(70-60)/60=16.67%
Margin Example:
Buy 100 shares at $60 = $6,000 position
Borrow 50%, investment of $3,000
If price increases to $70, position
Value is $7,000
Less $3,000 borrowed
Leaves $4,000 equity for a
$4,000/$7,000 = 57%equity position
( Margin rate =equity/market value )
The rate of price change=(70-60)/60=16.67%
The rate of return=( )/3000=33.33%

46. Major Types of Orders The rate of price change=(50-60)/60= -16.67%
Margin Example:
Buy 100 shares at $60 = $6,000 position
Borrow 50%, investment of $3,000
If price decreases to $50, position
Value is $5,000
Less $3,000 borrowed
Leaves $2,000 equity for a
$2,000/$5,000 = 40% equity position
The rate of price change=(50-60)/60= %
The rate of return=( )/3000= %
Leverage rate=1/percent margin

47. Major Types of Orders Question?
Margin Order Details
Initial margin requirement at least 50%
Lower margin requirements allow you to buy more
Maintenance margin
Required proportion of equity to stock value
Protects broker if stock price declines
Minimum requirement is at least 25%
Margin call on undermargined account to meet margin requirement
If call not met, stock will be sold to pay off the loan
Question?
If Buy 100 shares at $60 = $6,000 position and Minimum requirement is 25%, when the investor will receive margin call?

48. Exchange Market Makers
A NYSE specialist is exchange member assigned to handle particular stocks
Has two roles:
Broker: match buy and sell orders and to process any limit orders as prices change
Dealer: buy and sell from their own account to maintain fair, liquid, and orderly market
Specialist has two income sources
Broker commission, without risk
Dealer trading income from profit, with risk, but also with significant information advantages