1. Lecture 6 Other Equity Markets; Markets in other securities.

2. Markets Around the World Other equity markets: London Stock Exchange, Euronext Tokyo Others

3. Market Capitalization ($ Trillions) MarketJune 2004June 2005 NYSE11.612.9 NASDAQ2.93.4 Tokyo3.4 London2.52.7 Euronext2.12.3 Frankfurt1.1

4. London Stock Exchange 1698 - Stock dealers are expelled from the Royal Exchange for rowdiness. Operate in the coffee houses. 1720 - “South Sea Bubble” bursts. 1761 - A group of brokers forms to buy and sell shares. 1801 - The Stock Exchange becomes formal membership 1812 - The first codified rule book is created. 1845 - “Railway mania”. 1914 - The Exchange is closed July till January. 1923 - receives its own Coat of Arms: motto - My Word is My Bond.

5. London Stock Exchange 1939 - The Exchange is closed for 7 days during the war; 1986 - “Big Bang”: Minimal commissions are abolished; Market floor is abolished for computer trading; The Exchange becomes a private limited company under the Companies Act 1985. 1995 - AIM – market for growth companies; 1997 - SETS (Stock Electronic Trading Service). 2000 - Shareholders vote to become a public limited company: London Stock Exchange plc. lists on itself.

6. Average Daily Volume Year Shares (Mln.) £ (000's) Trade Size (£) Trades per Day 1968-35,4791,71620,674 1978-76,2484,65216,389 1988143,2081,286,91345,85928,062 1998259,3714,115,62163,71864,592 2003820,3077,418,663.640,661182,453 LSE Statistics

7. Trading formats on LSE SETS is the format for UK blue chips. SETS is an electronic order book that can execute hundreds of trades a second. Securities traded on SETS include all the FTSE 100 constituents reserves, the most liquid FTSE 250 securities. SEAQ is the format for mid-cap securities and the most liquid AIM securities. Continuous quotes offered by competing market makers. Prices are displayed on more than 100,000 terminals around the world. Additional hybrid formats, see: http://www.londonstockexchange.com/en-gb/products/membershiptrading/tradingservices /

8. Euronext In 2000 Paris, Amsterdam, and Brussels Exchanges merge to form Euronext – a Dutch Company. 2002 - acquisition of LIFFE (London International Financial Futures and Options Exchange) and the merger with the Portuguese Exchange. Integrated platforms for trading across countries. In 2004, 1,333 companies were listed with the total market cap of 1,796 Bln. Euro. The trading volume in cash markets was 1,543 Bln. Euro.

9. Trading format at Euronext Liquid stocks – continuous trading with two call auctions. Less liquid – the same plus market makers. The latter are retained by the issuing firm. Illiquid stocks – two call auctions per day.

10. Tokyo Stock Exchange Bond trading started in 1870, stock trading – in 1878. In March 1943, Stock Exchange became a war-time controlled institution, unifying 11 stock exchanges throughout Japan into a quasi-public corporation. In 1947 it was dissolved, and The Securities and Exchange Law was enacted in March of 1947, and entirely revised in April of 1948. Today Japan has five stock exchanges, of which Tokyo is by far the largest. It has 2,276 listed companies.

11. Other Markets Too numerous to present – we will choose several examples to focus on. Bonds Options FX Futures Options

12. US Markets by Security Class Source: Larry Harris, Trading and Exchanges

13. Debt Markets Markets for debt instruments Instruments differ based on Issuer Corporations Governments Underlying risks Issuer quality Interest rate risk Others Collateral Debt seniority Maturity Very short-term - Treasury Bills / Commercial Paper Short-term – Treasury Notes Long-term – Treasury Bonds

14. Level of Outstanding Debt

15. Treasury Securities Debt securities issued by US Treasury Federal tax on interest income, but no state/local taxes Two types Discount (maturity < 1 year) Bills Coupon (maturity >= 2 year) Notes (Maturity: 2-10 years) Bond (Maturity: > 10 years) Treasury inflation protection securities (TIPS) Investor is assured of a fixed “real” interest rate Yield curve reflects yields on Treasury securities with different maturities

16. Market for Treasuries Primary Market Treasury auctions Competitive bidding on yields Uniform pricing rule (price is the yield of the marginal investor). Primary dealers Salomon Brothers scandal of the 1980s. Secondary Market When-issued market (from the date of announcement to the date of issue). On-the-run and off-the-run issues. Traded OTC through inter-dealer brokers. Growth of electronic trading. Daily trading volume exceeds $100 billion.

17. Auction Types – for reference; (Source: http://www.agorics.com/Library/Auctions/auction5.html)

18. Municipal Securities Debt securities issued by state and local authorities. Tax implications vary. Two types. Tax-backed debt. Secured by tax revenues. Revenue bonds. Secured by project revenues. Dedicated revenue bonds. “Tobacco settlement” bonds. Importance of ratings.

19. Market for Munis Primary market Underwritten by investment banks Secondary market Traded OTC by municipal bond dealers Muni auctions (~ 1,000 auctions totalling $1.5 trillion)

20. Primary Corporate Debt Market Private placements. Public offerings – similar to equities.

21. Secondary Corporate Debt Market Mostly traded over the counter (OTC). Flow of a typical trade. Fund contacts several broker-dealers for a price. The trading desk will provide broker with a price ( inventory?). Fund chooses a particular broker. Bond dealers provide most of the liquidity. Development of electronic trading systems Cantor’s eSpeed Transparency of trade prices is small.

22. Credit Rating Need to establish issuer quality Independent raters Typical ratings

23. Investor Protections Collateral Debt seniority. Equity stake Convertible debt. Warrants. Legal Chapter 11 (Resolution through reorganization). Set time period to resolve conflicts between debt holders resolve conflicts between debt holders and others Chapter 7 (Resolution through liquidation).

24. Eurobond Market Offshore market for bonds. Issuers of one nationality issue bonds to investors of other nationalities E.g., a US corporation issues dollar-denominated Eurobonds to European investors Features. Usually underwritten by an international syndicate Offered simultaneously to investors in a number of countries Outside the jurisdiction of any single country Not registered with any regulatory authority Mostly bearer bonds No tax withholding Most Eurobonds are dollar-denominated. London is the financial center for the Eurobond market

25. Futures Commodities Futures Physicals - Grains, precious metals etc. “Virtual” - Electricity, pollution etc. Financial Futures Stock index futures Single stock futures Interest rate futures Treasury futures Currency futures

26. Futures Contracts Highly standardized contracts. Important features: Contract size - Weight or quantity Product quality specification. Delivery details. Daily settlement to avoid the credit risk.

27. A Typical Futures Trade Flow Investor places order with a registered broker who passes it to a floor broker. Floor broker trades with another broker (representing another customer) or a ‘local’. Locals trade for their own account Each party is obligated to the exchange rather than to each other “Marking to market” Settlement: actual delivery or cash settlement.

28. Market for Financial Futures Trading in CBOT and CME Mostly open outcry trading GLOBEX (electronic system of CME). Competition from Eurex.

29. Options Stock options Standardized contracts 1 contract = 100 shares of the underlying stock Different strike prices – grid. Can exercise anytime before expiration (“American”) Expiration dates standardized. Stock index options Interest-rate options Currency options.

30. Foreign Exchange Markets The largest financial market ~150,000 transactions a day totalling $1.2 trillion (Source: Levinson (2003)) Reduction in trading in recent times Consolidation of banking industry Introduction of Euro Major players Traders Investors Speculators Governments

31. Foreign Exchange Markets Two types Spot market Immediate delivery. Use of brokers and currency dealers. Derivatives market Futures Forwards Options Swaps Standardized derivative products trade in markets such as Eurex and CME, while non-standardized products are handled by large currency brokers/dealers.

32. Trading by Currency

33. Other Issues Why exchange rates change? Real interest rate changes, Investors will push rates closer to parity. Government role Use of exchange rates to pursue monetary policies. Fixed-rate vs. Floating-rate systems. Recent case histories of bad exchange rate management.

34. Asset-backed Securities Markets Securitization of common financial assets “Loans” are typically the largest assets of financial firms Mortgages, Car loans, Student loans etc. Companies can also securitize their assets (e.g. receivables), or royalties (rock-stars). Investors in asset-backed securities receive cash flow generated by the loans Investor  Firm  Borrower. Dealer markets.

35. Summary Markets vary in terms of combination of the three basic forms, depending on the profile of the traded security, the degree of information immediacy, and the demand for immediacy. Markets evolve with technology, but the principles remain.

36. Exercise VI Find information about the Eurex trading system for Futures; describe its history, and how it operates. Find information about the CBOE option market and describe the trading procedures.