CHAPTER THREE THE MARKETPLACE Practical Investment Management Robert A. Strong

South-Western College Publishing © Outline  The Role of the Capital Markets  Economic Function  Continuous Pricing Function  Fair Pricing Function  The Exchanges  National Exchanges  Regional Exchanges  Trading Systems

South-Western College Publishing ©  The Over-the-Counter Market  The National Market System  Tiers of the OTC Market  Third and Fourth Markets  Regulation  The Exchanges  The SEC  The NASD  SIPC  Ethics  Illegal v.s. Unethical  The Chartered Financial Analyst Program  AIMR Standards of Professional Conduct Outline

South-Western College Publishing © The Role of the Capital Markets  Economic Function  Continuous Pricing Function  Fair Pricing Function

South-Western College Publishing © Economic Function Capital markets facilitate the flow of capital from savers to borrowers. Capital SaversBorrowers Capital Market

South-Western College Publishing © Economic Function: An Example Bank Banks offer home mortgages so that home buyers who are short of cash can borrow money to buy houses. $ $ Mortgage Home Seller Home Buyer Home Ownership

South-Western College Publishing © Economic Function: An Example $ $ Mortgage Mortgage- backed securities Bank Investors Gov’t Agency Facilitated by government agencies such as the Federal National Mortgage Association, banks sell the mortgages to investors with surplus cash.

South-Western College Publishing © Economic Function: An Example $ $ $ $ Mortgage Mortgage- backed securities Home Seller Home Buyer Bank Investors Gov’t Agency Home Ownership Cyclic Flow of Capital

South-Western College Publishing © Economic Function The primary market is the “new securities” market where securities are sold to the public for the first time. The secondary market is the “used securities” market, where previously issued securities are traded among security holders.

South-Western College Publishing © Continuous Pricing Function Capital markets enable market participants to get accurate, up-to-date price information.

South-Western College Publishing © Fair Pricing Function Capital markets remove the fear that people have of buying or selling at a rip-off price. The greater the number of participants and the more formal the marketplace, the “fairer” the price.

The Exchanges United States National Exchanges New York Stock Exchange (NYSE) American Stock Exchange (AMEX) Regional Exchanges e.g. Philadelphia Stock Exchange International Exchanges e.g. England, France, Japan, Thailand

South-Western College Publishing © Trading Systems  Specialists charged with making a fair and orderly market in one or more assigned securities at posts on the exchange floor  Marketmakers a crowd of competing individuals who maintain a fair and orderly market by open outcry trading in pits on the exchange floor  SuperDot an electronic system enabling NYSE firms to send orders directly to the specialists’ posts

South-Western College Publishing © The Over-the-Counter Market  National Market System / NASDAQ a worldwide computerized linkup of brokerage firms, investment houses and large commercial banks  Market Tiers - national market issues: issues by large and established firms e.g. Intel, Microsoft - small-cap issues: issues with a low level of capitalization - pink sheet issues: the smallest and most speculative OTC stocks  Includes Third and Fourth Markets

The “Markets” Primary Market via investment bankers Secondary Market via stock exchanges or OTC Third Market listed securities via OTC Fourth Market via telephone or Instinet Company Public Institution

South-Western College Publishing © Regulation  The Exchanges have rules regarding... - the financial capacity of members serving as stock specialists - the financial & market activity, as well as the disclosure & annual reporting of listed firms  The Securities and Exchange Commission (SEC) was established… - to ensure that investors have adequate information to make an informed investment decision - so as to help prevent price manipulation and abuses like the Ponzi scheme

South-Western College Publishing © Regulation  The National Association of Security Dealers - is a self-regulatory body that licenses brokers and generally oversees the trading practices of OTC securities  The Securities Investor Protection Corporation - protects investors from loss due to brokerage firm failure, fraud, natural disaster, or theft

South-Western College Publishing © Ethics  Illegal versus Unethical A wide range of investment activities may be legal, but these activities carry substantial ethical baggage.  The Chartered Financial Analyst Program - promotes investment education and ethical behavior among those involved in the investment business  AIMR Standards of Professional Conduct - a strict set of ethical guidelines

South-Western College Publishing © Review  The Role of the Capital Markets  Economic Function  Continuous Pricing Function  Fair Pricing Function  The Exchanges  National Exchanges  Regional Exchanges  Trading Systems

South-Western College Publishing © Review  The Over-the-Counter Market  The National Market System  Tiers of the OTC Market  Third and Fourth Markets  Regulation  The Exchanges  The SEC  The NASD  SIPC  Ethics  Illegal v.s. Unethical  The Chartered Financial Analyst Program  AIMR Standards of Professional Conduct