CHAPTER THREE SECURITY MARKETS 1 TYPES OF SECURITY

CHAPTER THREE SECURITY MARKETS 1

TYPES OF SECURITY MARKETS • CALL MARKETS – have posted hours for trading only – “called” securities are for sale to those buyers or sellers 2

TYPES OF SECURITY MARKETS • CONTINUOUS MARKETS – trading may occur at any time during a regular trading day – dealers (market makers) • provide liquidity to brokers who cannot find a suitable buyer or seller • usually are temporary positions 3

MAJOR U. S. SECURITY MARKETS • THE NEW YORK STOCK EXCHANGE (NYSE) – established as a corporation, with a charter and regulations for membership – approximately 1, 366 members – Board of Directors: 26 elected 4

MAJOR U. S. SECURITY MARKETS • NYSE SEATS: – purchased from a current member – give privileges to members to execute trades – held by individuals as well as brokerage firms 5

MAJOR U. S. SECURITY MARKETS • LISTED SECURITIES: Some criteria to list – the degree of national interest – relative position and stability in the industry – prospects of maintaining its relative position 6

TRADING HALTS • THE EXCHANGE MAY IMPOSE TRADING HALTS AND CIRCUIT BREAKERS – Trading Halts: • are temporary suspensions of trading in a listed firm’s shares 7

TRADING HALTS – Circuit Breakers: Rule 80 A • rule states that if the Dow Jones Industrial Average (DJIA) moves 50 or more points from a previous closing price, all index arbitrage orders will be subject to the “tick test. ” 8

TRADING HALTS – Circuit breakers: Rule 80 B • if a 350 point change before 3 PM occurs, the NYSE shuts down for one-half hour • if a 550 point change (total) occurs after the reopen, NYSE shuts down for 1 hour. 9

PLACING AN ORDER • 4 TYPES OF NYSE MEMBERSHIPS: – commission brokers: • earn commission for their brokerage firms – floor brokers: • assist commission brokers during overload periods – floor traders: • trade only for themselves – specialists: • keep unfilled limit orders/act as market makers 10

PLACING AN ORDER • LARGE ORDERS: – Found in blocks of at least 10, 000 shares – Usually placed by institutional investors – Handled mostly by upstairs dealer market 11

PLACING AN ORDER • SMALLER ORDERS: – in the past these orders were often overlooked in favor of larger orders 12

PLACING AN ORDER – to correct this oversight the Super. DOT system was created – stands for Super Designated Order Turnaround: • handles smaller orders involving 30, 999 or fewer shares • orders sent directly to trading post specialist for immediate exposure and execution • facilitates the trading technique known as program trading 13

OTHER EXCHANGES • THE AMERICAN STOCK EXCHANGE: – Lists stocks of smaller-sized companies 14

OTHER EXCHANGES • REGIONAL EXCHANGES: – Boston – Cincinnati – Chicago – Pacific – Philadelphia 15

OTHER EXCHANGES • REGIONAL EXCHANGES: – Options • Chicago Board Options Exchange – one of the largest – Futures • The Chicago Mercantile Exchange – offers interest rate, commodities, and index futures contracts 16

OVER-THE-COUNTER MARKET • NASDAQ is an o-t-c market: – created by the National Association of Securities Dealers (NASD) – the NASD created the NASD automated quotation system (NASDAQ) to clear transactions • a nationwide communication network allows instant access to all major dealers 17

OVER-THE-COUNTER MARKET • NASDAQ CLASSIFICATION OF STOCKS: – National Market System (NMS) • stocks with larger trading volumes • stocks that are eligible for margin and short transactions • Small Cap Issues 18

OVER-THE-COUNTER MARKET • SMALL ORDER EXECUTION SYSTEM – electronic order-routing system • limit: 100 shares 19

THIRD AND FOURTH MARKETS • THIRD MARKET: – A name for a market where • any trading of NYSE security is permitted • trading hours are not fixed • trading is not bound by NYSE trading halts or circuit breakers 20

THIRD AND FOURTH MARKETS • THE FOURTH MARKET: – Direct trading in exchange-listed securities – Between investors without the benefit of a broker – Trading facilitated by an automated system: INSTINET • give quotations and executions information immediately 21

OTHER METHODS OF ORDERING • THE GROSSING SYSTEM • PREFERENCING • INTERNALIZATION 22

FOREIGN MARKETS • LONDON STOCK EXCHANGE: – Significantly changed by the “Big Bang” of 1986: • ending fixed commissions • introduced SEAQ (Stock Exchange Automated Quotations) • attracted trading in non-UK stock 23

FOREIGN MARKETS • TOKYO STOCK EXCHANGE: – Has introduced major reforms: • introduced CORES (Computer-Assisted Order Routing and Execution System) • introduced FORES (Floor Order Routing and Execution System) • Saitori System of Trading • follows IYATOSE Method at market open similar to a call marekt – Zaraba used where orders are processed continuously 24

FOREIGN MARKETS • TORONTO STOCK EXCHANGE: – Uses CATS (Computer-Assisted Trading System) – Similar to IYATOSE trading in Tokyo 25

INFORMATION- AND LIQUIDITY-MOTIVATED TRADERS • THE DEALER’S DILEMMA: Adverse Selection – Assume there are two types of traders that a dealer may confront during the trading day: • informed traders whose information and identity are unknown to the dealer • uninformed traders 26

INFORMATION- AND LIQUIDITY-MOTIVATED TRADERS • THE DILEMMA: How to quote the correct price and make a profit? – Solution: • set the bid-ask spread wide enough so that the gains from the uninformed traders offset the mistaken price quotes to the informed traders. 27

REGULATION OF SECURITIES MARKETS • THE FOUR PILLARS OF SECURITY REGULATION: – The Securities Act of 1933 – The Securities Exchange Act of 1934 – The Investment Company Act of 1940 – The Investment Advisors Act of 1940 28

REGULATION OF SECURITIES MARKETS – Provisions of the Securities Act of 1933 • • known as the “truth in securities” law requires registration of new issues disclosure of relevant information by issuer prohibits misrepresentation and fraud 29

REGULATION OF SECURITIES MARKETS – Provisions of the Securities Exchange Act of 1934 • requires national exchanges, brokers, and dealers to be registered • made possible creation of Self Regulatory Organizations (SROs) to oversee the industry • established the Securities Exchange Commission (SEC) 30

REGULATION OF SECURITIES MARKETS – Provisions of the Investment Company Act of 1940 • extends disclosure and registration requirements to investment companies 31

REGULATION OF SECURITIES MARKETS – Provisions of the Investment Advisors Act of 1940 • required registration of those providing advice 32