1. CHAPTER THREE THE MARKETPLACE © 2001 South-Western College Publishing

2. 2 Outline  The Role of the Capital Markets  Economic Function  Continuous Pricing Function  Fair Pricing Function  The Exchanges  National Exchanges  Regional Exchanges  Trading Systems  Circuit Breakers and Trading Curbs

3. 3  The Nasdaq Stock Market  The National Market System  Tiers of the Nasdaq Market  Third and Fourth Markets  Regulation  The Exchanges  The SEC  The NASD  SIPC  Ethics  Illegal vs. Unethical  The Chartered Financial Analyst Program  AIMR Standards of Professional Conduct Outline

4. 4 The Role of the Capital Markets  Economic Function  Continuous Pricing Function  Fair Pricing Function An exchange serves three principal functions.

5. 5 Economic Function Capital markets facilitate the flow of capital from savers to borrowers. Capital SaversBorrowers Capital Market

6. 6 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

7. 7 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.

8. 8 Economic Function: An Example $ $ $ $ Mortgage Mortgage- backed securities Home Seller Home Buyer Bank Investors Gov’t Agency Home Ownership Cyclic Flow of Capital

9. 9 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.

10. 10 Continuous Pricing Function Capital markets enable market participants to get accurate, up-to-date price information.

11. 11 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.

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

13. 13 Trading Systems  Specialists are charged with making a fair and orderly market in one or more assigned securities at posts on the exchange floor.  Marketmakers are groups of competing individuals who maintain a fair and orderly market by open outcry trading in pits on the exchange floor.  SuperDot is an electronic system enabling NYSE firms to send orders directly to the specialists’ posts.

14. 14 Circuit Breakers and Trading Curbs Both trading curbs and circuit breakers are designed to reduce temporary volatility in the market. At the NYSE, when the Dow Jones Industrial Average fluctuates by more than 2%, the circuit breaker is activated and computerized trading becomes restricted. Trading curbs halt all trading at the exchange.

15. 15 The Nasdaq Stock Market  The Nasdaq (National Association of Securities Dealers Automated Quotations) stock market is sometimes called the over-the-counter (OTC) market.  It is a worldwide computerized linkup of brokerage firms, investment houses and large commercial banks.  Bids and offers are posted to an electronic bulletin board called the National Market System.

16. 16 The Nasdaq Stock Market  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 Nasdaq stocks  The trading of listed securities in the Nasdaq market is known as the third market.  Direct trades between large institutional investors comprise the fourth market.

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

18. 18 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

19. 19 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

20. 20 Ethics  Illegal vs. 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

21. 21 Review  The Role of the Capital Markets  Economic Function  Continuous Pricing Function  Fair Pricing Function  The Exchanges  National Exchanges  Regional Exchanges  Trading Systems  Circuit Breakers and Trading Curbs

22. 22 Review  The Nasdaq Stock Market  The National Market System  Tiers of the Nasdaq Market  Third and Fourth Markets  Regulation  The Exchanges  The SEC  The NASD  SIPC  Ethics  Illegal vs. Unethical  The Chartered Financial Analyst Program  AIMR Standards of Professional Conduct