Chapter 4

Securities Markets
Learning Objectives
 Compare primary and secondary markets.
 Equity markets - organization and
operations
 Define third and fourth markets.
 Major stock market indicators.
 Bond and derivatives markets.
 Change in the securities markets
Importance of Financial Markets
 Financing government and firm projects
 Channel funds from savers to borrowers
 Provide a place where investors can act
on their beliefs
 Help allocate cash to where it is
most productive
 Help lower the cost of exchange
Primary Markets
 New securities are issued in a primary market
 Initial public offering (IPO) versus “seasoned”
new issue
 IPO – Common stock shares of a company being sold
for the first time
 Issue facilitated by investment dealers
 Specialists in advice, design, and sales
 Intermediaries between issuer and investor
Investment Dealers
 Client advice includes type and features
of security, offer price, and timing of sale
 Underwriting services: Risk of selling
to investors assumed from issuer
 Coordinate marketing by helping issuer
register securities, issue prospectus, and
sell securities
Underwriting Process
• The issuing company sell the securities
to the financing group which consists of
one or two firms
• The financial group sells the securities
to the marketing group at a “draw down”
price
• The securities are distributed for sale
to the public
Issuance of Securities
 Prompt Offering Qualification (POP) System
allows senior reporting issuers to sell new
securities over time via “short form”
prospectuses
 Reduces issuance cost
 Listing process
 Global security issues
 A private placement means new securities are
sold to a small group of institutional investors
 Registration not required
Secondary Markets
 Markets where investors trade previously
issued securities
 Auction markets involve bidding in
a specific physical location
 Brokers represent investors for a fee
 Others trade for their own account
 Negotiated markets consist of decentralized
dealer network
Stock Exchanges
 Toronto Stock Exchange (TSX) is a
secondary auction market for
equity securities
 Largest Canadian stock market
 Listing requirements for traded firms
 TSX Venture Exchange is Canada’s
“junior” stock market
 New York Stock Exchange (NYSE) is the
largest secondary market in the world
Stock Exchanges
 Formal organizations approved and regulated
by the SEC (or the provincial securities
commissions such as the OSC in Canada)
 Members
 Can only trade listed stocks
 Must buy a seat on the exchange
 Listing requirements
 minimum capitalization, shareholder equity,
average closing share price, etc.
NYSE
 Centralized continuous auction market
 Exchange participants
 single specialist
 commission brokers
 independent floor brokers
 registered traders
 SuperDot
 Major roles of NYSE specialist
 Dealer
 Agent
 Catalyst
 Auctioneer
 Commissions
Over-the-Counter (OTC) Markets
 Network of dealers standing ready to either
buy or sell securities at specified prices
 Dealers profit from spread between buy and
sell prices
 Handle unlisted securities
 Canadian OTC stocks are trading on the TSX
Venture Exchange
 US OTC Market: NASDAQ
Over-the-Counter (OTC) Markets
 Trading unlisted stocks
 Listing requirements
 Nasdaq stock market
 Nasdaq market tiers
 Nasdaq National Market (3,600 co.’s)
 Small Capitalization Market (850 co.’s)
 Nasdaq market makers
 Other OTC markets (8,000 co.’s)
 OTC Bulletin Board
 Pink Sheets
Third and Fourth Markets
 Third Market: Over-the-counter transactions
in securities listed on organized exchanges
 Fourth market: Trading network among
investors interested in buying and
selling large blocks of stock
 Brokers, dealers bypassed so costs are low
 Electronic or telephone network
Trading
 After-Hours Trading: Electronic
Communications Networks (ECNs) allow
investors to trade after exchange hours (4
to 8 P.M. EST, and sometimes early in the
morning)
 In-House Trading: this new trend has
significant implications for the
NYSE
International Equity Markets
 Toronto Stock Exchange is the eighth-
largest stock exchange in the world
 Many different equity markets exist
 Emerging markets
 Generally less regulation and standardization of
trading activity
 Risks: Illiquidity, lack of information, political
uncertainty
Equity Market Indicators
 Provide a composite report of
market behavior on a given day
 S&P/TSX Composite Index
 Market value weighted
 In 2004, comprised of 223 companies
representing almost 70 per cent of the market
capitalization
 S&P/TSX 60 Index
 Designed to mimic the performance of the
S&P/TSX composite Index
Equity Market Indicators
 Dow Jones Industrial Average (DJIA)
 Composed of 30 “blue-chip” stocks
 Price weighted
 S&P 500 Composite Index
 Composed of 500 “large” firm stocks
 Market value weighted
 Nikkei 225 Average
 Price weighted index of 225 actively-traded
stocks on the Tokyo Stock Exchange
Bond Markets
 Secondary bond market is primarily
an over-the-counter network of dealers
 Government of Canada bonds actively trade in
dealer markets
 Corporate bonds are not as actively traded as
government issues
Market Developments
 Growth of institutional trading
 Block trading of stocks (transactions of at least
10,000 shares)
 Affects market structure and operation
 Negotiated, not fixed, commissions
 Globalization of securities markets
 24-hour trading
 Instinet
 Stock Market Indexes

 S&P/TSX Composite Index


S & P / TSX 
Pi t Q i t
(k )
 Pi b Q i b

 Dow Jones Industrial Average

DJIA   P / n*
t it
Price Weighted
 Arithmetic average of current prices
 Assumes you purchase an equal number
shares of each stock represented in the index
 e.g., DJIA, Nikkei 225
 Problems:
 Must adjust denominator downward for
splits
 Stocks with higher prices have
greater influence
 PWI = [  of stock prices ] / [number of
stocks in index]
Value Weighted
 Total value (mkt. cap.) of all stocks in the
index
 Assumes you make a proportionate
market value investment in each company in
the index
 e.g., S&P 500/ NYSE indexes
 Problem:  Market Cap.,  impact on index
 MVW = [ (Price today) (number of shares)
/
(Price base) (number of Shares)] (Index
Equal Weighted
 Unweighted index (e.g. Value-Line
Composite Average, Financial Times Index –
LSE)
 Assumed the investor makes an equal
dollar investment in each stock in the index
 Geometric average or arithmetic
average
 Problem:
 GA leads to downward bias since
GA<AA