Chapter 3The Trading Industry
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
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.
Buy-side players - Investors Individuals Corporate pension fund
sponsors Charitable trusts Legal trusts Endowments
=> Stocks and bonds
Investment managers
Corporate investment funds
Governmental funds
Buy-side players – Borrowers and Hedgers Homeowners Students Corporations
=> Mortgages, Bonds, Notes
Farmers Manufacturers Miners Shippers Financial Institutions
=> Forwards, Futures, Swaps, and Options
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
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.
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.
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.
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
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
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.
Organization of secondary markets
Organized exchanges OTC market Third market Fourth market
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.
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.
NYSE NYSE’s MarkeTrac: http://marketrac.nyse.com/mt/
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.
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.
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
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)
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
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
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)
Asia
• Tokyo Stock Exchange (TSE)• Taiwan Stock Exchange• Korean Stock Exchange (KSE)• Australian Stock Exchange (ASX)• Hong Kong Stock Exchange
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
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