Chapter 12 Securities Markets

Security Markets The primary markets Secondary markets -- stocks Secondary markets -- bonds

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.

Secondary Markets Trade previously owned shares of stock. Consist of organized exchanges and an over-the-counter market.

Secondary Markets: The Organized Exchanges Are used to facilitate trading between investors New York Stock Exchange (NYSE) American Stock Exchange (AMEX) Regional stock exchanges

Regional Stock Exchanges Pacific Stock Exchange Chicago Stock Exchange Philadelphia Stock Exchange Cincinnati Stock Exchange Intermountain Stock Exchange Spokane Stock Exchange Boston Stock Exchange

Make-up of the New York Stock Exchange Over 200 years old Limited 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 shares 80% of typical trading volume

Requirements for NYSE Listing, 1999 Profitability -- $2.5 million before tax earnings Size -- $40.0 million net tangible assets Market value -- $40.0 million publicly held stock Public ownership -- 1.1 million publicly held common shares

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.

Secondary Markets: Over-the-Counter (OTC) Market Consists of an electronic network of dealers used to execute trades

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

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.

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

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.

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.

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.

How Securities are Traded Specialists Buy and sell orders Brokers Brokerage services Cash and margin accounts

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.

Order Characteristics Order sizes Time period for which the order will remain outstanding Order types

Order Sizes Round lots -- orders of 100 shares Odd lots -- orders of 1 to 99 shares Discretionary account: Broker authorized to make trades for you. Exercise caution, or avoid.

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.

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.

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.

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.

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.

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

Asset Management Account Brokerage firm comprehensive financial services package: Checking account Credit card and loans Money market mutual fund Brokerage services

Types of Brokerage Firms Full service brokers Discount service brokers – 50% to70% discount Deep discount brokers – 90% discount On-line discount and deep discount brokers – Low cost, immediate trading

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

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.

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

Working With a Broker Remember 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.

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

The Cost of Trading Commissions Transaction fees Inactive account fees Annual fees Maintenance fees

On-line Trading Cheap, easy trading, but do your investment homework. For fast moving stocks, use limit orders not market orders.

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.

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.

Sources of Investment Information Corporate sources of information Brokerage firm reports The press The Wall Street Journal Magazines Investment publications Internet sources Investment clubs

Summary Primary securities markets Secondary securities markets Initial public offerings Seasoned new issues Secondary securities markets New York Stock Exchange American Stock Exchanges Regional Exchanges Over-the-counter markets

Summary (cont’d) Securities market regulation Order 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

Summary (cont’d) Types of brokerage firms, services, and fees Work with a broker or trade on-line? Day trading cautions Sources of investment information