Securities Markets Chapter 4 Charles P. Jones, Investments: Analysis and Management, Twelfth Edition, John Wiley & Sons

The Role of Financial Markets Channel funds from savers to borrowers Help firms and governments raise cash by selling securities (financial claims on issuer) Provide a place where investors can earn a return 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 offerings versus seasoned new issues Average investors do not often benefit much from IPOs Issue facilitated by investment banker Intermediaries between issuer and investor Buy securities from issuer at a discount, sell them to investors Difference between two amounts is spread

Investment Banking Client advice includes type and features of security, offer price, and timing of sale Underwriting services By purchasing securities, investment bankers assume risk of selling securities to investors May form syndicates to reduce risk Coordinates marketing by helping issuer register securities, issue prospectus, and sell securities

Issuer Originating investment banker Underwriting syndicate (group) of investment bankers Selling group of underwriting syndicate + selected retail brokerage houses Investors

Investment Banking Automatic Shelf Registration allows certain issuers to sell new securities over time after filing a single registration Private placement means new securities are sold directly to investors, bypassing the open market Registration not required Can be cheaper and faster for issuer Can lead to higher costs, restrictions

Secondary Markets Markets where investors trade previously issued securities Allow for trading of stocks, bonds, derivatives New York Stock Exchange/Euronext and NASDAQ are major US exchanges Investors are represented by brokers who facilitate trades between buyers and sellers for a fee

Stock Exchanges NYSE NASDAQ Has physical location in New York City Recently acquired the American Stock Exchange, now called NYSE Amex, which focuses on small companies NASDAQ Electronic market of dealers (“market makers”) who trade directly with each other and customers Gathers and consolidates quotes and orders from participants

Other Secondary Markets Over-the-Counter (OTC) Not organized marketplace or exchange Forum for securities not listed on a U.S. exchange Better Alternative Trading System (BATS) Appeals to hedge funds, others who want speed Electronic Communication Networks (ECNs) Offer automation, lower costs, anonymity

Foreign Markets US equity markets account for a decreasing share of world’s stock market capitalization Foreign markets include developed and emerging markets Emerging markets Often offer large potential for profits and large risks Illiquidity, lack of information, political uncertainty China and Brazil have grown and attracted investor attention

Stock Market Indexes Measure only the change in prices of a defined group of stocks over a period of time Do not include dividends and therefore generally understate total returns However, price changes are primary way to describe the performance of equity markets

Stock Market Indexes Dow Jones Industrial Average Composed of 30 “blue-chip” stocks Only major market index that is price weighted Weights high-priced stocks more than low-priced stocks Oldest, most well-known measure Percentage change in index matters: the level of the index does not

Stock Market Indexes Standard & Poor’s 500 Composite Index Accounts for about 75% of U.S. stock-market value Expressed as index number relative to a base index value of 10 (1941-43) Capitalization-weighted index: Prices and shares outstanding considered NASDAQ Indexes Russell 1000 Index Wilshire 5000 Total Market Index 4-13

Stock Market Indexes The “correct” index depends on the investor’s purpose DJIA and S&P 500 best for measuring performance of large stocks NASDAQ indexes best for measuring performance of NASDAQ stocks Wilshire 5000 best for measuring performance of U.S. stocks in the broadest sense 4-14

Foreign Stock Market Indicators MSCI EAFE Index Essentially a non-American world index (without Brazil or India) Dow Jones World Stock Index Capitalization-weighted (unlike the DJIA) Represents about 80% of world’s stock markets Global Dow Index Euro STOXX 50 and Euro STOXX 600 4-15

Bond and Derivatives Markets Secondary bond markets Necessary or investors might avoid bonds Primarily an over-the-counter network of dealers Bond brokers often buy for their own accounts and resell Derivatives Options trade on exchanges Futures markets mostly electronic

Market Globalization Electronic trading systems allow for after- hours trading Stock prices can change even when exchanges are closed Bonds also being traded around the clock Individual investors can benefit from globalization Can trade in foreign markets and in foreign currencies

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