1. © 2009 McGraw-Hill Ryerson Limited 6-1 Chapter 6 The Stock Market The primary and secondary stock markets The primary and secondary stock markets The New York Stock Exchange The New York Stock Exchange The Toronto Stock Exchange and TSX Venture Exchange The Toronto Stock Exchange and TSX Venture Exchange Nasdaq Nasdaq Third and Fourth Market Third and Fourth Market Stock Market Information Stock Market Information

2. © 2009 McGraw-Hill Ryerson Limited 6-2 The Stock Market Our goal in this chapter is to get a “big picture” overview of: Our goal in this chapter is to get a “big picture” overview of: Who owns stocks Who owns stocks How a stock exchange works, and How a stock exchange works, and How to read and understand the stock market information reported in the financial press. How to read and understand the stock market information reported in the financial press.

3. © 2009 McGraw-Hill Ryerson Limited 6-3 The Primary Stock Markets The Primary market is the market where investors purchase newly issued securities. The Primary market is the market where investors purchase newly issued securities. Initial public offering (IPO): An initial public offer occurs when a company offers stock for sale to the public for the first time. Initial public offering (IPO): An initial public offer occurs when a company offers stock for sale to the public for the first time. The Secondary Stock Markets The Secondary market is the market where investors trade previously issued securities. An investor can trade: The Secondary market is the market where investors trade previously issued securities. An investor can trade: Directly with other investors. Directly with other investors. Indirectly through a broker who arranges transactions for others. Indirectly through a broker who arranges transactions for others. Directly with a dealer who buys and sells securities from inventory. Directly with a dealer who buys and sells securities from inventory.

4. © 2009 McGraw-Hill Ryerson Limited 6-4 The Primary Market for Common Stock An IPO involves several steps. Company appoints investment banking firm to arrange financing. An IPO involves several steps. Company appoints investment banking firm to arrange financing. Investment banker designs the stock issue and arranges for fixed commitment or best effort underwriting. Investment banker designs the stock issue and arranges for fixed commitment or best effort underwriting. Company prepares a prospectus (usually with outside help) and submits it to securities and exchange commissions for approval. Company prepares a prospectus (usually with outside help) and submits it to securities and exchange commissions for approval. Investment banker circulates preliminary prospectus (red herring). Investment banker circulates preliminary prospectus (red herring). Upon obtaining approval, company finalizes prospectus. Upon obtaining approval, company finalizes prospectus. Underwriters place announcements (tombstones) in newspapers and begin selling shares. Underwriters place announcements (tombstones) in newspapers and begin selling shares.

5. © 2009 McGraw-Hill Ryerson Limited 6-5 Short Form Prospectus Figure 6.1

6. © 2009 McGraw-Hill Ryerson Limited 6-6 The Secondary Market The bid price: The bid price: The price dealers pay investors. The price dealers pay investors. The ask price: The ask price: The price dealers receive from investors. The price dealers receive from investors. The difference between the bid and ask prices is called the bid-ask spread, or simply spread. The difference between the bid and ask prices is called the bid-ask spread, or simply spread. Most common stock trading is directed through an organized stock exchange or trading network. Most common stock trading is directed through an organized stock exchange or trading network. Whether a stock exchange or trading network, the goal is to match investors wishing to buy stocks with investors wishing to sell stocks. Whether a stock exchange or trading network, the goal is to match investors wishing to buy stocks with investors wishing to sell stocks.

7. © 2009 McGraw-Hill Ryerson Limited 6-7

8. © 2009 McGraw-Hill Ryerson Limited 6-8 The New York Stock Exchange The New York Stock Exchange (NYSE), popularly known as the Big Board, celebrated its bicentennial in 1992. The New York Stock Exchange (NYSE), popularly known as the Big Board, celebrated its bicentennial in 1992. The NYSE has occupied its current building on Wall Street since the turn of the century The NYSE has occupied its current building on Wall Street since the turn of the century The NYSE has 1,366 exchange members. The NYSE has 1,366 exchange members. In 2003, stocks from about 2,800 companies were listed, with a collective market value of about $15 trillion. In 2003, stocks from about 2,800 companies were listed, with a collective market value of about $15 trillion. An initial listing fee, as well as annual listing fees, is charged based on the number of shares. An initial listing fee, as well as annual listing fees, is charged based on the number of shares. In 2003, the average stock trading volume on the NYSE was just over 1 billion shares a day. In 2003, the average stock trading volume on the NYSE was just over 1 billion shares a day.

9. © 2009 McGraw-Hill Ryerson Limited 6-9 The Toronto Stock Exchange The Toronto Stock Exchange started its operations in 1861 with 18 securities and 14 member firms. The Toronto Stock Exchange started its operations in 1861 with 18 securities and 14 member firms. The initial members paid $250 to purchase a seat at that time. In 1901, the price of a membership rose to $12,000 and trading volume became approximately 1 million shares per year. The initial members paid $250 to purchase a seat at that time. In 1901, the price of a membership rose to $12,000 and trading volume became approximately 1 million shares per year. To be listed on the Toronto Stock Exchange, technology companies must have at least one million free shares with total market value of $4 million or $10 million. These shares must be held by at least 300 public shareholders. To be listed on the Toronto Stock Exchange, technology companies must have at least one million free shares with total market value of $4 million or $10 million. These shares must be held by at least 300 public shareholders. In 1999, the Canadian exchanges were restructured and the Toronto Stock Exchange became the major stock exchange for trading senior equities. In 1999, the Canadian exchanges were restructured and the Toronto Stock Exchange became the major stock exchange for trading senior equities.

10. © 2009 McGraw-Hill Ryerson Limited 6-10 TSX Venture Exchange Small and emerging Canadian companies are listed at the TSX Venture Exchange. Majority of the listed companies are mining, oil and technology companies. Small and emerging Canadian companies are listed at the TSX Venture Exchange. Majority of the listed companies are mining, oil and technology companies. New companies seeking access to venture capital marketplace prefer TSX Venture Exchange. As companies get bigger they apply to be listed on senior exchanges. New companies seeking access to venture capital marketplace prefer TSX Venture Exchange. As companies get bigger they apply to be listed on senior exchanges. Companies are listed in three different tiers at TSX Venture Exchange. Each tier has different listing requirements. Companies are listed in three different tiers at TSX Venture Exchange. Each tier has different listing requirements. Firms can use the following ways to be listed on TSX Venture Exchange: 1- initial public offering, 2- reverse takeover and 3- the Capital Pool Company Program. Currently, there are more than 2500 companies listed at TSX Venture Exchange. Firms can use the following ways to be listed on TSX Venture Exchange: 1- initial public offering, 2- reverse takeover and 3- the Capital Pool Company Program. Currently, there are more than 2500 companies listed at TSX Venture Exchange.

11. © 2009 McGraw-Hill Ryerson Limited 6-11 Nasdaq The name “Nasdaq” is derived from the acronym NASDAQ, which stands for National Association of Securities Dealers Automated Quotations system. The name “Nasdaq” is derived from the acronym NASDAQ, which stands for National Association of Securities Dealers Automated Quotations system. Introduced in 1971, the Nasdaq market is a computer network of securities dealers who disseminate timely security price quotes to Nasdaq subscribers Introduced in 1971, the Nasdaq market is a computer network of securities dealers who disseminate timely security price quotes to Nasdaq subscribers There are two key differences between the NYSE and Nasdaq: There are two key differences between the NYSE and Nasdaq: Nasdaq is a computer network and has no physical location where trading takes place. Nasdaq is a computer network and has no physical location where trading takes place. Nasdaq has a multiple market maker system rather than a specialist system. Nasdaq has a multiple market maker system rather than a specialist system. Like NYSE specialists, Nasdaq market makers use their inventory as a buffer to absorb buy and sell order imbalances. Like NYSE specialists, Nasdaq market makers use their inventory as a buffer to absorb buy and sell order imbalances.

12. © 2009 McGraw-Hill Ryerson Limited 6-12 Nasdaq Nasdaq is often referred to as an an Over-the-counter (OTC) market : securities market in which trading is almost exclusively done through dealers who buy and sell for their own inventories. Nasdaq is often referred to as an an Over-the-counter (OTC) market : securities market in which trading is almost exclusively done through dealers who buy and sell for their own inventories. Nasdaq is actually made up of two separate markets, the Nasdaq National Market (NNM) and the Nasdaq SmallCap Market. Nasdaq is actually made up of two separate markets, the Nasdaq National Market (NNM) and the Nasdaq SmallCap Market. In 2010,Market value of Nasdaq firms was $3.9 trillion, compared to $13.4 trillion for the NYSE. In 2010,Market value of Nasdaq firms was $3.9 trillion, compared to $13.4 trillion for the NYSE. In 2010, there were about 1000 competing Nasdaq dealers (market makers), which amounts to about 35 or so per stock. In 2010, there were about 1000 competing Nasdaq dealers (market makers), which amounts to about 35 or so per stock. In the late 1990s, the Nasdaq system was opened to the electronic communications networks (ECNs). In the late 1990s, the Nasdaq system was opened to the electronic communications networks (ECNs). ECNs are websites that allow individual investors to trade directly with one another. ECNs are websites that allow individual investors to trade directly with one another. ECN orders are transmitted to the Nasdaq and displayed along with market maker prices. ECN orders are transmitted to the Nasdaq and displayed along with market maker prices.

13. © 2009 McGraw-Hill Ryerson Limited 6-13 Third and Fourth Market The third market is an off-exchange market for securities listed on an organized exchange. The third market is an off-exchange market for securities listed on an organized exchange. The fourth market is for exchange-listed securities in which investors trade directly with one another, usually through a computer network. The fourth market is for exchange-listed securities in which investors trade directly with one another, usually through a computer network. For dually listed stocks, regional exchanges also attract substantial trading volume. For dually listed stocks, regional exchanges also attract substantial trading volume.

14. © 2009 McGraw-Hill Ryerson Limited 6-14 Stock Market Information The most widely followed barometer of day-to-day stock market activity is the Dow Jones Industrial Average (DJIA), or “Dow” for short. The most widely followed barometer of day-to-day stock market activity is the Dow Jones Industrial Average (DJIA), or “Dow” for short. The DJIA is an index of the stock prices of 30 large companies representative of American industry. The DJIA is an index of the stock prices of 30 large companies representative of American industry. The S&P/TSX is a capitalization weighted index of 220 Canadian companies. The S&P/TSX is a capitalization weighted index of 220 Canadian companies.

15. © 2009 McGraw-Hill Ryerson Limited 6-15 S&P/TSX Composite Figure 6.3

16. © 2009 McGraw-Hill Ryerson Limited 6-16 Stock Market Indexes Indexes can be distinguished in four ways: Indexes can be distinguished in four ways: The market covered, The market covered, The types of stocks included, The types of stocks included, How many stocks are included, and How many stocks are included, and How the index is calculated (price-weighted, e.g. DJIA, versus value-weighted, e.g. S&P 500) How the index is calculated (price-weighted, e.g. DJIA, versus value-weighted, e.g. S&P 500)

17. © 2009 McGraw-Hill Ryerson Limited 6-17 Stock Market Indexes For a value-weighted index (i.e., the S&P 500), companies with larger market values have higher weights. For a value-weighted index (i.e., the S&P 500), companies with larger market values have higher weights. For a price-weighted index (i.e., the DJIA), higher priced stocks receive higher weights. For a price-weighted index (i.e., the DJIA), higher priced stocks receive higher weights. This means stock splits cause issues. This means stock splits cause issues. But, stock splits can be addressed by adjusting the index divisor. But, stock splits can be addressed by adjusting the index divisor.

18. © 2009 McGraw-Hill Ryerson Limited 6-18 Stock Market Major Indexes Figure 6.4

19. © 2009 McGraw-Hill Ryerson Limited 6-19 Example I: $1,000,000 to Invest, Price-Weighted Portfolio Note: Shares = $1,000,000 / 99.370 = 10,063

20. © 2009 McGraw-Hill Ryerson Limited 6-20 Example II: Changing the Divisor

21. © 2009 McGraw-Hill Ryerson Limited 6-21 Example III: $1,000,000 to Invest, Value-Weighted Portfolio Note: Shares to Buy = $1,000,000*Weight / Price

22. © 2009 McGraw-Hill Ryerson Limited 6-22 Example IV: How Does the Value-Weighted Index Change? (Use Index Example II.) Using the Index from Example II:

23. © 2009 McGraw-Hill Ryerson Limited 6-23 The Day 3 Index Can be Calculated in Two Ways:

24. © 2009 McGraw-Hill Ryerson Limited 6-24 Useful Internet Sites www.hoovers.com (reference for more on Initial Public Offerings, IPOs) www.hoovers.com (reference for more on Initial Public Offerings, IPOs) www.hoovers.com www.nyse.com (website for the New York Stock Exchange) www.nyse.com (website for the New York Stock Exchange) www.nyse.com www.tsx.com (website for the Toronto Stock Exchange) www.tsx.com (website for the Toronto Stock Exchange) www.tsx.com www.nasdaq.com (website for the Nasdaq) www.nasdaq.com (website for the Nasdaq) www.nasdaq.com averages.dowjones.com (reference for more information on the DJIA) averages.dowjones.com (reference for more information on the DJIA) averages.dowjones.com