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Zaky Zaljuhdi

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SECURITIES MARKETS

3.1 How Firms Issue Securities

The term primary market refers to the market where new securities are issued and sold. The key
characteristic of this market is that the issuer receives the proceeds from the sale. In the secondary
market existing securities are traded among investors. The issuing firm doesn’t receive any proceeds
and is not directly involved.

If a primary market offering is made to the general public (a public offering) it must be registered
with the Securities Exchange Commission or SEC. SEC approval indicates the issuer has divulged
sufficient information for the public to evaluate the offering. Private offerings are not registered, and
may be sold to only a limited number of investors, with restrictions on resale.

• Primary

– New issue is created and sold

– Key factor: issuer receives the proceeds from the sale

– Public offerings: registered with the SEC and sale is made to the investing public

– Private offerings: not registered, and sold to only a limited number of investors,
with restrictions on resale

• Underwritten vs. “Best Efforts”

– Underwritten: banker makes a firm commitment on proceeds to the issuing


firm

– Best Efforts: banker(s) helps sell but makes no firm commitment

• Negotiated vs. Competitive Bid

– Negotiated: issuing firm negotiates terms with investment banker


– Competitive bid: issuer structures the offering and secures bids

3.2 How Securities Are Traded

Functions of Financial Markets

Overall purpose: facilitate low cost investment


1. Bring together buyers and sellers at low cost

2. Provide adequate liquidity by minimizing time and cost to trade and promoting price
continuity.

3. Set & update prices of financial assets

4. Reduces information costs associated with investing

Types Of Markets

• Direct Search Markets

– Buyers and sellers locate one another on their own

• Brokered Markets

– 3rd party assistance in location buyer or seller

• Dealer Markets

– 3rd party acts as intermediate buyer/seller

• Auction Markets

– Brokers & dealers trade in one location, trading is more or less continuous

Types Of Orders

• Market order: execute immediately at the best price

• Limit order: Order to buy or sell at a specified price or better

– On the exchange the limit order is placed in a limit order book kept by an
exchange official or computer

3.3 The Rise Of Electronic Trading

Nasdaq and NYSE both now are primarily electronic markets. These changes were driven by an
interaction of new technologies and new regulations. New regulations allowed brokers to compete for
business, broke the hold that dealers once had on information about best-available bid and ask prices,
forced integration of markets, and allowed securities to trade in ever-smaller price increments (called
tick sizes ). Technology made it possible for traders to rapidly compare prices across markets and direct
their trades to the markets with the best prices.
Electronic trading networks and the integration of markets in the wake of Reg NMS made it much
easier for exchanges around the world to compete; the NYSE lost its effective monopoly in trading its
own listed stocks, and by the end of the decade, its share in the trading of NYSE-listed stocks fell from
about 75% to 25%. While specialists still exist, trading today is overwhelmingly electronic, at least for
stocks.

3.4 U.S markets

• Nasdaq : largest organized stock market for OTC trading; information system for
individuals, brokers and dealers.

• Organized Exchanges
o Auction markets are markets with centralized order flow
o Dealership function: can be competitive or assigned by the exchange
(Specialists)

– New York Stock Exchange

– American Stock Exchange

– Regionals

• Electronic Communication Networks (ECNs), And National Market System

3.5 New Trading Strategies

Algorithmic trading delegates trading decisions to computer programs.

High-frequency trading is a special class of algorithmic trading in which computer programs initiate
orders in tiny fractions of a second, far faster than any human could process the information driving the
trade.It is a type of algorithmic trading characterized by high speeds, high turnover rates, and high
order-to-trade ratios that leverages high-frequency financial data and electronic trading tools.

Dark Pools is a private forum for trading securities, derivatives, and other financial instruments.

Bond Trading is a financial market where participants can issue new debt, known as the primary
market, or buy and sell debt securities, known as the secondary market. This is usually in the form of
bonds, but it may include notes, bills, and so on.

3.6 Globalization Of Stock Markets

Securities markets have come under increasing pressure in recent years to make international
alliances or mergers. Much of this pressure is due to the impact of electronic trading. To a growing
extent, traders view stock markets as networks that link them to other traders, and there are
increasingly fewer limits on the securities around the world that they can trade.
3.7 Trading Cost

Part of the cost of trading a security is obvious and explicit. Your broker must be paid a commission.
Individuals may choose from two kinds of brokers:

 full-service brokers
– provide a variety of services often are referred to as account executives or financial
consultants.
– Besides carrying out the basic services of executing orders, holding securities for
safekeeping, extending margin loans, and facilitating short sales, brokers routinely
provide information and advice relating to investment alternatives.
 discount brokers
– Discount brokers provide “no-frills” services. They buy and sell securities, hold them for
safekeeping, offer margin loans, facilitate short sales, and that is all. The only
information they provide about the securities they handle is price quotations.

3.8 Buying on Margin

 borrowing money to purchase stock.

When purchasing securities, investors have easy access to a source of debt financing called broker’s
call loans. The act of taking advantage of broker’s call loans is called buying on margin. Purchasing
stocks on margin means the investor borrows part of the purchase price of the stock from a broker. The
margin in the account is the portion of the purchase price contributed by the investor; the remainder is
borrowed from the broker.

3.9 Short Sales

The sale of shares not owned by the investor but borrowed through a broker and later purchased to
replace the loan. A short sale allows investors to profit from a decline in a security’s price. An investor
borrows a share of stock from a broker and sells it.

3.10 Regulation Of Security Markets

• Securities Acts of 1933

• Requires full disclosure of information by issuers of new securities

• Securities Acts of 1934

• Established the SEC and require periodic disclosure of relevant financial information for
firms with publicly traded securities

• Gives authority to regulate exchanges and OTC trading/traders to the SEC


• CFTC retains authority over commodity futures and Federal Reserve sets margin
requirements.

• Securities Investor Protection Act of 1970

• Protects investors from losses if a brokerage firm fails (up to $500,000 per customer).

• Self-Regulation

• Financial Industry Regulatory Authority (FINRA)

• Formed in 2007 by consolidating regulatory arms of the NASD and the NYSE.

• Examines securities firms, promulgates trading practice rules and administers a


dispute resolution forum for investors and firms.

• The Sarbanes-Oxley Act

 The scandals of 2000–2002 centered largely on three broad practices: allocations of


shares in initial public offerings, tainted securities research and recommendations put
out to the public, and, probably most important, misleading financial statements and
accounting practices.

• Insider Trading

 It is illegal for anyone to transact in securities to profit from inside information, that is,
private information held by officers, directors, or major stockholders that has not yet
been divulged to the public. But the definition of insiders can be ambiguous.

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