1. Chapter 3 The Trading Industry

2. Terminology  Agency vs. proprietary traders (trading) Brokers are agency traders  Long vs. short positions Short covering  Buy vs. sell side Liquidity demanders vs. liquidity providers

3.  People and institutions who use market services are on the buy-side.  Those who provide market services are on the sell-side.  These sides have nothing to do with whether you are a buyer or seller of a specific security.

4. Buy-side players - Investors  Individuals  Corporate pension fund sponsors  Charitable trusts  Legal trusts  Endowments => Stocks and bonds  Investment managers  Corporate investment funds  Governmental funds

5. Buy-side players – Borrowers and Hedgers  Homeowners  Students  Corporations => Mortgages, Bonds, Notes  Farmers  Manufacturers  Miners  Shippers  Financial Institutions => Forwards, Futures, Swaps, and Options

6. Sell-side players  Dealers trade for their own accounts. Day traders Market makers Floor traders  Brokers trade for other people’s accounts. Retail and institutional Full-service and discount  Broker-dealers do both. Specialists Wire houses

7. Sell-side trade facilitators  Exchanges provide systems that help traders arrange their trades.  Clearing houses help settle trades and guarantee that traders will perform.  Depositories and custodians hold securities.

8. A typical set of relationships  A sponsor owns funds.  An investment manager makes portfolio decisions.  A broker implements trades.  A dealer supplies liquidity.  A clearing house guarantees trades.  A depository holds the security.  Consultants advise everyone.

9. Primary vs. secondary security sales  Primary New issue Key factor: issuer receives the proceeds from the sale.  Secondary Existing owner sells to another party. Issuing firm doesn’t receive proceeds and is not directly involved.

10. Primary markets: Public offerings  Public offerings: registered with the SEC and sale is made to the investing public. Shelf registration (Rule 415, since 1982)  Initial Public Offerings (IPOs) Evidence of underpricing Performance

11. US primary listing market  New York Stock Exchange (N)  American Stock Exchange (A)  NASDAQ (Q)  Over-the-Counter (OTC) Nasdaq small cap (S) OTCBB(U) Pink Sheets

12. Primary markets: Private placements  Private placement: sale to a limited number of sophisticated investors not requiring the protection of registration.  Dominated by institutions.  Very active market for debt securities.  Not active for stock offerings.

13. Organization of secondary markets  Organized exchanges  OTC market  Third market  Fourth market

14. Organized Exchanges  Auction markets with centralized order flow.  Dealership function: can be competitive or assigned by the exchange (Specialists).  Securities: stock, futures contracts, options, and to a lesser extent, bonds.  Examples: NYSE, AMEX, Regionals, CBOE.

15. NYSE  The NYSE is a hybrid market. It has: floor traders (like a futures pit) an electronic limit order book (like Euronext) a designated dealer (the specialist) to maintain liquidity and otherwise coordinate trading.  This mix is the outcome of political, technological and economic forces over the last 200 years.

16. NYSE NYSE’s MarkeTrac: http://marketrac.nyse.com/mt/http://marketrac.nyse.com/mt/

18. NYSE  The NYSE was first a floor market (loosely resembling the futures pits).  Many of the trading rules reflect the “floor” aspect of the market.  The NYSE next evolved strong central dealers (late 1800’s).  The specialist, in the sense of a trader who specializes in a particular stock.

19. NYSE  Beginning in the 1980’s, electronic order entry has come to play an increasing role. The exchange has always permitted limit orders, but the book has become more important over time.  The basic reading for this material is the NYSE Floor Official Manual, abbreviated FOM.

20. What does the NYSE do?  Trading and trading services.  The NYSE charges (directly and indirectly) for trades that occur and for software supplied to its members.  Listing  To be listed on the NYSE, a corporation must meet/maintain certain financial standards and pay listing fees.  http://www.nasdaq.com/about/appa.pdf http://www.nasdaq.com/about/appa.pdf

21. US regional exchanges  Pacific Exchange / Archipelago(P)  Chicago (formerly Midwestern) Stock Exchange (M)  Boston Stock Exchange (B)  Philadelphia Stock Exchange (X)  Cincinnati Stock Exchange (C)

22. Third markets  Trading of listed securities away from the exchange.  Institutional market: to facilitate trades of larger blocks of securities.  Involves services of dealers and brokers

23. Fourth Market  Trading in exchange-listed stocks within Alternative Trading Systems (ATS), such as ECNs (Instinet, Island, Archipelago)  Institutions trading directly with institutions  No middleman involved in the transaction

24. Major international stock markets  Europe London Stock Exchange (LSE) EuroNext (Paris/Netherlands/Belgium) Deutsche Borse (DB) Milan Stock Exchange Swiss Stock Exchange Stockholm/Copenhagen/Helsinki/Oslo (OM)  Toronto Stock Exchange (TSX)

25.  Asia Tokyo Stock Exchange (TSE) Taiwan Stock Exchange Korean Stock Exchange (KSE) Australian Stock Exchange (ASX) Hong Kong Stock Exchange

26. International market structures  London Stock Exchange Dealer market similar to NASDAQ Stock Exchange Automated Quotation Greater Anonymity  Tokyo Stock Exchange No market making service Sartori provides bookkeeping service Feature a floor and electronic trading

27. KSE http://www.kse.or.kr/

28. The regulators  Securities and Exchange Commission (SEC) Securities markets, equity options markets, and cash-settled equity index options markets  Commodity Futures Trading Commission (CFTC) Commodity spot, forward, and futures markets