1

CHAPTER THREE

SECURITY MARKETS

2

TYPES OF SECURITY MARKETS

• CALL MARKETS– have posted hours for trading only– “called” securities are for sale to those buyers

or sellers

3

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

4

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

5

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

6

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

7

TRADING HALTS

• THE EXCHANGE MAY IMPOSE TRADING HALTS AND CIRCUIT BREAKERS– Trading Halts:

• are temporary suspensions of trading in a listed firm’s shares

8

TRADING HALTS

– Circuit Breakers: Rule 80A• 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.”

9

TRADING HALTS

– Circuit breakers: Rule 80B• 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.

10

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

11

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

12

PLACING AN ORDER

• SMALLER ORDERS:– in the past these orders were often overlooked

in favor of larger orders

13

PLACING AN ORDER

– to correct this oversight the SuperDOT 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

14

OTHER EXCHANGES

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

15

OTHER EXCHANGES

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

16

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

17

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

18

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

19

OVER-THE-COUNTER MARKET

• SMALL ORDER EXECUTION SYSTEM– electronic order-routing system

• limit: 100 shares

20

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

21

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

22

OTHER METHODS OF ORDERING

• THE GROSSING SYSTEM

• PREFERENCING

• INTERNALIZATION

23

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

24

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

25

FOREIGN MARKETS

• TORONTO STOCK EXCHANGE:– Uses CATS (Computer-Assisted Trading

System)– Similar to IYATOSE trading in Tokyo

26

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

27

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.

28

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

29

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

30

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)

31

REGULATION OF SECURITIES MARKETS

– Provisions of the Investment Company Act of 1940

• extends disclosure and registration requirements to investment companies

32

REGULATION OF SECURITIES MARKETS

– Provisions of the Investment Advisors Act of 1940

• required registration of those providing advice