Primary Securities and Where They Are Traded

Capital Market Securities Money market securities Mature within one year or less Capital market securities Maturity dates range from 1 year to infinity Include following securities Debt Preferred stock Common stock

Money Market Securities Characteristics Types: Treasury bills Commercial papers Certificate of deposits Banker’s Acceptance Federal funds Libor market REPOS

Component of U.S. Money Market Billions of $ Outstanding Commercial Paper $715.0 Bankers Acceptances $14.0 Short-Term Treasury Securities $371.2 Term Eurodollars $149.4 Repurchase agreements $272.1 Large CDs $616.1 Small CDs $958.3 Over $200 billion are traded on average trading day.

Fixed Income Securities Include all debt issued by governments and corporations Most fixed income securities are marketable legal contracts Promise to pay interest payments periodically (usually) Promise repayment of principal at maturity May have other features Sinking funds, callable, convertible, etc

Fixed Income Securities US Government securities Non-marketable US treasury securities Marketable US treasury securities Notes and bonds Federal agency securities Government national mortgage association (Ginnie Mae) Federal national mortgage association (Fannie Mae) Zeros STRIPS – Separate Trading of Registered Interest and Principal of Securities

Fixed Income Securities Municipal bonds Corporate bonds Specifies all terms of the issue, such as Coupon payments Collateral provisions Sinking fund provisions Conversion stipulations Other protective provisions Secured vs unsecured (aka debentures)

Equity Securities Represent a claim on earnings and assets of a corporation Includes common and preferred stock Common stock is the first security issued in a corporation and the last security retired in bankruptcy Common and preferred stock have No maturity dates No claims on specific corporate assets No claims on specific sources of corporate earnings Characteristics

The Global Stock Market Aggregate market capitalization of equity shares in the world grew from $9.6 trillion in 1990 to over $35 trillion in 2000 An average rate of 14.8% annually Financial capital is very mobile In 1990 the Tokyo Stock Exchange was 30.5% of the global market but only 12.7% in 1999 North America increased its share of the world equity market from 28.0% (1990) to 50.28% (1999)

The World’s Equity Capital World’s equity capital is concentrated in North America, western and central Europe and the Pacific Rim (mostly Japan) Because market prices are rather volatile, this situation can change rapidly. For instance, from 1989-1990 Japan’s stock market was worth more than the U.S. stock market.

The World’s Bond Market

The World’s Bond Market

U.S. Market for Bonds

Brokerage Services Brokers Sales people (earning a commission) employed by dealers Have no money invested in the dealer’s security inventory Help create markets by buying and selling from employer’s inventory Brokerage firms extend credit (margin accounts) to clients Enables client to do more securities trading

Brokerage Services Types of stock brokerage services Full-service Take buy and sell orders Extend margin credit to customers Hold clients’ securities in safe keeping Collect cash dividends Provide free investment research Perform ‘hand-holding’ services Pleasant telephone conversations Investment counseling Birthday cards All paid for by clients’ trading commissions Range from $30 - $150 for one common stock transaction Examples Merrill Lynch Goldman Sachs PaineWebber Morgan Stanley Dean Witter Salomon Smith Barney

Brokerage Services Discount Brokers Simply take orders Offer little or no investment advice No ‘hand-holding’ services provided Little opportunity for churning Lower commissions Range from $20 to $50 Examples Charles Schwab & Company Quick & Reilly Muriel Siebert Jack White & Company Fidelity Investments Vanguard Brokerage Services

Brokerage Services Electronic brokers Take buy and sell orders via Internet No ‘hand-holding’ services May provide investment research May or may not be free Low commissions Range from almost free to $35 a trade Examples Discover Brokerage DLJdirect E*Trade Archipelago Bloomberg Tradebook Accutrade

Transacting When making a trade, the investor must specify Type of order Market order, limit order, stop orders, scale order, fill or kill order, good till canceled order Whether or not margin will be involved Examples: How margin and short sell work

Primary Markets Investment Banks: A few thousand investment banking firms exist in the U.S., including Merrill Lynch & Co. Morgan Stanley Dean Witter Lehman Brothers Credit Suisse First Boston Goldman, Sachs & Co. Salomon Smith Barney Bear Stearns Cos. Paine Webber

Secondary Market Once securities are issued in the primary market, they can begin trading in the secondary market Types of secondary markets Organized exchange run by dealers (TSX, ME, VSE, NYSE, AMEX, Regionals, CBOE) Electronic market in which dealers compete with one another (Nasdaq) Electronic communication networks

Third U.S. Market Third market—subset of OTC market where exchange-listed stocks are traded Competes with organized exchanges Offers cost savings in the form of better bid-ask prices Nasdaq and regional stock exchanges are the core of the third market For instance, in 1999 Chicago Stock Exchange (CHX) traded over 90% of the NYSE-listed stocks Majority of CHX’s trading volume is from dual listings CHX pays for order flow Specialists take a penny or so (per share) from their bid-ask spread and give it to brokers to encourage brokers to execute their orders on the CHX rather than NYSE

Fourth U.S. Market Fourth market—a network of market-makers, block traders and institutions Bypass normal dealer services and negotiate directly with each other Instinet (short for Institutional Network) has operated in the fourth market since 1970 Has computer terminals in over 5,000 subscribers’ offices Millions of shares are traded in secrecy daily via Instinet Commissions range from 2¢ to 8¢ a share