1. Chapter 4 Securities Markets

2. Learning Objectives Compare primary and secondary markets.
Equity markets - organization and operations
Define third and fourth markets.
Major stock market indicators.
Bond and derivatives markets.
Change in the securities markets 2

3. Importance of Financial Markets
Financing government and firm projects
Channel funds from savers to borrowers
Provide a place where investors can act on their beliefs
Help allocate cash to where it is most productive
Help lower the cost of exchange 2

4. Primary Markets New securities are issued in a primary market
Initial public offering (IPO) versus “seasoned” new issue
IPO – Common stock shares of a company being sold for the first time
Issue facilitated by investment dealers
Specialists in advice, design, and sales
Intermediaries between issuer and investor 3

5. Investment Dealers
Client advice includes type and features of security, offer price, and timing of sale
Underwriting services: Risk of selling to investors assumed from issuer
Coordinate marketing by helping issuer register securities, issue prospectus, and sell securities 4

6. Underwriting Process
The issuing company sell the securities to the financing group which consists of one or two firms
The financial group sells the securities to the marketing group at a “draw down” price
The securities are distributed for sale to the public

7. Issuance of Securities
Prompt Offering Qualification (POP) System allows senior reporting issuers to sell new securities over time via “short form” prospectuses
Reduces issuance cost
Listing process
Global security issues
A private placement means new securities are sold to a small group of institutional investors
Registration not required 5

8. Secondary Markets
Markets where investors trade previously issued securities
Auction markets involve bidding in a specific physical location
Brokers represent investors for a fee
Others trade for their own account
Negotiated markets consist of decentralized dealer network 6

9. Stock Exchanges
Toronto Stock Exchange (TSX) is a secondary auction market for equity securities
Largest Canadian stock market
Listing requirements for traded firms
TSX Venture Exchange is Canada’s “junior” stock market
New York Stock Exchange (NYSE) is the largest secondary market in the world 7

10. Stock Exchanges
Formal organizations approved and regulated by the SEC (or the provincial securities commissions such as the OSC in Canada)
Members
Can only trade listed stocks
Must buy a seat on the exchange
Listing requirements
minimum capitalization, shareholder equity, average closing share price, etc.

11. NYSE Centralized continuous auction market Exchange participants
single specialist
commission brokers
independent floor brokers
registered traders
SuperDot
Major roles of NYSE specialist
Dealer
Agent
Catalyst
Auctioneer
Commissions
deregulated in 1975

12. Over-the-Counter (OTC) Markets
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
Canadian OTC stocks are trading on the TSX Venture Exchange
US OTC Market: NASDAQ 8

13. Over-the-Counter (OTC) Markets
Trading unlisted stocks
Listing requirements
Nasdaq stock market
Nasdaq market tiers
Nasdaq National Market (3,600 co.’s)
Small Capitalization Market (850 co.’s)
Nasdaq market makers
Other OTC markets (8,000 co.’s)
OTC Bulletin Board
Pink Sheets

14. Third and Fourth Markets
Third Market: Over-the-counter transactions in securities listed on organized exchanges
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 9

15. Trading
After-Hours Trading: Electronic Communications Networks (ECNs) allow investors to trade after exchange hours (4 to 8 P.M. EST, and sometimes early in the morning)
In-House Trading: this new trend has significant implications for the NYSE

16. International Equity Markets
Toronto Stock Exchange is the eighth-largest stock exchange in the world
Many different equity markets exist
Emerging markets
Generally less regulation and standardization of trading activity
Risks: Illiquidity, lack of information, political uncertainty 10

17. Equity Market Indicators
Provide a composite report of market behavior on a given day
S&P/TSX Composite Index
Market value weighted
In 2004, comprised of 223 companies representing almost 70 per cent of the market capitalization
S&P/TSX 60 Index
Designed to mimic the performance of the S&P/TSX composite Index 11

18. Equity Market Indicators
Dow Jones Industrial Average (DJIA)
Composed of 30 “blue-chip” stocks
Price weighted
S&P 500 Composite Index
Composed of 500 “large” firm stocks
Market value weighted
Nikkei 225 Average
Price weighted index of 225 actively-traded stocks on the Tokyo Stock Exchange 12

19. Bond Markets
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 14

20. Market Developments Growth of institutional trading
Block trading of stocks (transactions of at least 10,000 shares)
Affects market structure and operation
Negotiated, not fixed, commissions
Globalization of securities markets
24-hour trading
Instinet 15

21. Stock Market Indexes S&P/TSX Composite Index
Dow Jones Industrial Average

22. Price Weighted
 Arithmetic average of current prices
 Assumes you purchase an equal number shares of each stock represented in the index
 e.g., DJIA, Nikkei 225
Problems:
 Must adjust denominator downward for splits
 Stocks with higher prices have greater influence
PWI = [  of stock prices ] / [number of stocks in index]

23. Value Weighted  Total value (mkt. cap.) of all stocks in the index
 Assumes you make a proportionate market value investment in each company in the index
 e.g., S&P 500/ NYSE indexes
Problem:  Market Cap.,  impact on index
MVW = [ (Price today) (number of shares) /
(Price base) (number of Shares)] (Index Value BEG)

24. Equal Weighted
 Unweighted index (e.g. Value-Line Composite Average, Financial Times Index – LSE)
 Assumed the investor makes an equal dollar investment in each stock in the index
 Geometric average or arithmetic average
Problem:
 GA leads to downward bias since GA<AA