CHAPTER FOUR Securities Markets Cleary / Jones Investments: Analysis and Management

Learning Objectives n To distinguish between primary and secondary markets n To describe how the equity markets are organized and how they operate n To explain what we mean by the third and fourth markets

Learning Objectives n To state the major stock market indicators n To briefly describe the bond and derivatives markets n To discuss the factors behind rapid change in the securities markets

The Role of Financial Markets n Help firms and governments raise cash by selling securities n Channel funds from savers to borrowers n Provide a place where investors can act on their beliefs n Help allocate cash to where it is most productive n Help lower the cost of exchange

Primary Markets n New securities are issued in a primary market –Initial public offering (IPO) versus “seasoned” new issue n Issue facilitated by investment dealers –Specialists in advice, design, and sales –Intermediaries between issuer and investor

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

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

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

Stock Exchanges n Toronto Stock Exchange is a secondary auction market for equity securities –Largest Canadian stock market –Listing requirements for traded firms n Canadian Venture Exchange is Canada’s new “junior” stock market n New York Stock Exchange is the largest secondary market in the world

Over-the-Counter Markets n 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 n Canadian Over-the-Counter Automated Trading System (COATS) n NASDAQ

Third and Fourth Markets n Third Market: Over-the-counter transactions in securities listed on organized exchanges n 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

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

Equity Market Indicators n Provide a composite report of market behaviour on a given day n TSE 300 Composite Index –Market value weighted –Divided into 14 major industry groups n S&P / TSE 60 –Designed to give index funds sufficient diversification

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

Bond Markets n 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

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