1. Security Markets

2. Market Types Direct Search Market Dealer Market Brokered Market
Auction Market

3. Secondary Markets Secondary Markets
The market in which securities already issued are traded
Buyers and sellers are both investors

4. Order Types Market buy: buy at best going price
Market sell: sell at best going price
When price does this:
Sell
Stop-loss
(Stop-sell)
Limit sell
Buy
Limit Buy
Stop Buy

5. Trading on OTC Market Investor places an order with broker.
Broker tries to locate the dealer offering the best deal.
Trades are negotiated through dealers who maintain an inventory of securities.
Nasdaq initially just a computer quotation system for dealers.

6. Trading on ECNs
Brokers that have an affiliation with an ECN have computer access and can enter orders.
Brokers can make terminals available to individual traders.
Limit orders are entered in a limit order book
Limit orders provide liquidity
The ability to transact quickly at a fair price
Eliminates the need for a dealer – the middle man.
Keeps trade anonymous.

7. Trading on ECNs 2006:Two largest ECNs bought by NYSE and Nasdaq
NYSE bought Archipelagio
Now called NYSE ARCA
Nasdaq bought Instinet

8. Trading on Exchanges Investor places an order with broker.
Broker can either
Send order to exchange electronically
Send larger orders to floor brokers who “work” the order
Floor broker takes order to specialist desk

9. Trading on Exchanges: Specialist Desk
1) Maintains a limit order book.
Record of limit sells (sell if price goes above a threshold)
Record of limit buys (buy if price goes below a threshold)

10. Trading on Exchanges: Specialist Desk
2) Acts as a broker
Crosses limit orders with market orders not sent electronically
Gets paid a commission
The specialist must get traders best possible price
Match buy orders with lowest limit sell
Match sell orders with highest limit buy

11. Trading on Exchanges: Specialist Desk
3) Acts as a dealer
Posts own bid and ask prices if the spread gets too wide
Price continuity
Dealer’s duty to maintain a fair and orderly market
Performance monitored by exchange
4) Floor brokers can also meet each other at the specialist desk and trade directly with each other.

12. Trading on Exchanges Direct search market Brokered market
Floor brokers can seek each other out at the specialist desk
Brokered market
Specialist acts as a broker
Dealer market
Specialist acts as a dealer
Auction market
All buy and sell orders come to one location and the best orders win the trades

13. Bid-Ask Prices
The ask price is the price at which someone stands willing to sell.
The bid price is the price at which someone stands willing to buy.
Ask>Bid (always)

14. Bid-Ask and OTC Markets
On Over-the-Counter markets:
Only dealers post bid-ask prices.
Buy orders buy at lowest ask broker can find
Market buy
Limit buy
Stop buy
Sell orders sell at highest bid broker can find
Market sell
Limit sell

15. Bid-Ask and OTC Markets
Ask: Bid: 45.50
Market Buy
Buy at 45.60
Market Sell
Sell at 45.50

16. Bid-Ask and OTC Markets
Ask: Bid: 45.50
Limit Buy at 45.55
Order not executed. Buy price (45.60) has not dropped below the threshold (45.55)
Limit Sell at 45.55
Order not executed. Sell price (45.50) has not jumped above the threshold (45.55)

17. Bid-Ask and OTC Markets
Ask: Bid: 45.50
Stop Buy at 45.55
Order executed immediately. Buy price (45.60) is above the threshold (45.55)
Stop Sell (Stop Loss) at 45.55
Order executed immediately. Sell price (45.50) is below the threshold (45.55)

18. Trading on Exchanges and ECNs
Any limit order is a bid-ask price
Any broker can post a limit order
market buy & stop buy orders executed at
lowest ask (effective ask price)
market sell & stop-loss orders executed at
highest bid (effective bid price)

19. Bid-Ask and Exchanges/ECNs
Lowest Limit Sell: 45.60
Highest Limit Buy: 45.50
Ask: Bid: 45.50
Market Buy
Buy at 45.60
Market Sell
Sell at 45.50

20. Bid-Ask and Exchanges/ECNs
Ask: Bid: 45.50
Limit Buy at 45.55
Order not executed. The lowest price at which you can currently buy is
Order is entered in the limit order book.
New bid price becomes 45.55, highest limit order buy.
Limit Sell at 45.55
Order not executed. The highest price at which you can sell is
New ask price becomes 45.55, lowest limit order sell.
If these trades were both submitted by different investors, the specialist would “cross these trades” and take them off the limit order book.

21. Bid-Ask and Exchanges/ECNs
Ask: Bid: 45.50
Stop Buy at 45.55
Order executed immediately. Buy price (45.60) is above the threshold (45.55)
Stop Sell (Stop Loss) at 45.55
Order executed immediately. Sell price (45.50) is below the threshold (45.55)
All stop buy orders are still executed at the ask
All stop sell orders are executed at the bid

22. Mutual Funds

23. Advantages record keeping and administration diversification
professional management
lower transaction costs

24. Mutual Funds Open-end funds
You buy or sell shares directly through the mutual fund
Shares are purchased at NAV per share
NAV is calculated every day at 4:00pm
All orders placed before 4:00pm buy at this NAV
Fund companies adjust the number of shares according to the demand by investors
Market value of assets - Liabilities
Net asset value (NAV) =
Shares outstanding

25. Mutual Funds Open-end funds
You buy or sell shares directly through the mutual fund
Shares are purchased at NAV per share
NAV is calculated every day at 4:00pm
All orders placed before 4:00pm buy at this NAV
Fund companies adjust the number of shares according to the demand by investors

26. Open-End Fund Example Fund ABC 4:00pm Monday:
Total Assets = 36 billion
Total Liabilities = 1 billion
Shares Outstanding = 900 million
NAV = 35B/900M = $38.89
Throughout day on Tuesday
Asset Value increases by 1%
New flows of $500,000

27. Open-End Fund Example 4:00pm on Tuesday New Flows of $500,000
Asset value is now 36B(1.01)=36.36B
NAV = 35.36B/900M=39.29
New Flows of $500,000
500,000/39.29 = 12,726 shares
New investors buy these shares at per share
Total shares outstanding = 900M + 12,726
Total Assets = 36.36B + 500,000

28. Open-End Example
In this example, there are no fees, and no distributions (dividends or capital gains)
Return from owning fund

29. How Funds are Sold
Fund “underwriter” has exclusive rights to distribute shares of the fund.
Funds are sold to public by underwriter, or indirectly through brokers who act in behalf of underwriter.
Financial Supermarkets
Example: Charles Schwab