CHAPTER THREE

SECURITY MARKETS

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 TYPES OF SECURITY MARKETS

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

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 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

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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

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 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

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 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

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 TRADING HALTS

• THE EXCHANGE MAY IMPOSE

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

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 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.”

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 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.

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 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
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 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

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 PLACING AN ORDER

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

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 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

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 OTHER EXCHANGES

• THE AMERICAN STOCK EXCHANGE:

– Lists stocks of smaller-sized companies

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 OTHER EXCHANGES

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

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 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

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 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 (NASDA) to clear
transactions
• a nationwide communication network allows instant
access to all major dealers

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 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

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 OVER-THE-COUNTER MARKET

• SMALL ORDER EXECUTION SYSTEM

– electronic order-routing system
• limit: 100 shares

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 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

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 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

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 OTHER METHODS OF ORDERING

• THE GROSSING SYSTEM

• PREFERENCING
• INTERNALIZATION

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 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

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 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

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 FOREIGN MARKETS

• TORONTO STOCK EXCHANGE:

– Uses CATS (Computer-Assisted Trading
System)
– Similar to IYATOSE trading in Tokyo

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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

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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.

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 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

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 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

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 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)

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

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 REGULATION OF SECURITIES
MARKETS
– Provisions of the Investment Advisors Act of
1940

• required registration of those providing advice

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