1. Copyright 2014 Diane Scott Docking1 The Stock Market- Secondary Market

2. Copyright 2014 by Diane Scott Docking 2 Learning Objectives  Describe the major secondary markets.  Examine the process by which a trade takes place in the secondary stock market.  Understand the role of brokers, dealers, specialists, and market makers  Understand a stock quote.  Recognize the major stock market indices  Understand the difference between a long position and a short position in the stock market

3. 3 Copyright 2014 by Diane Scott Docking Secondary Stock Markets  Secondary stock markets the markets in which stocks, once issued, are traded among investors  The U.S. has two major stock market exchanges New York Stock Exchange Euronext (NYSE Euronext)  the American Stock Exchange (AMEX) was purchased by NYSE Euronext on October 1, 2008 National Association of Securities Dealers Automated Quotation (NASDAQ)  Secondary stock markets the markets in which stocks, once issued, are traded among investors  The U.S. has two major stock market exchanges New York Stock Exchange Euronext (NYSE Euronext)  the American Stock Exchange (AMEX) was purchased by NYSE Euronext on October 1, 2008 National Association of Securities Dealers Automated Quotation (NASDAQ)

4. 4 Copyright 2014 by Diane Scott Docking NYSE Euronext (aka: Big Board)  Created by the merger of NYSE Group, Inc. and Euronext N.V. on April 4, 2007 to become the first truly global stock market  As of April 2014, over 2,800 different stocks trade on NYSE Euronext, with a market capitalization of over $18 trillion.  Trading occurs at a specific place on the floor of the exchange called a trading post  Each stock has a special market maker called a specialist that maintains liquidity for the stock at all times http://www.nyse.com http://www.nyse.com  Created by the merger of NYSE Group, Inc. and Euronext N.V. on April 4, 2007 to become the first truly global stock market  As of April 2014, over 2,800 different stocks trade on NYSE Euronext, with a market capitalization of over $18 trillion.  Trading occurs at a specific place on the floor of the exchange called a trading post  Each stock has a special market maker called a specialist that maintains liquidity for the stock at all times http://www.nyse.com http://www.nyse.com

5. 5Copyright 2014 Diane Scott Docking NASDAQ and OTC Markets  NASDAQ is the world’s first electronic market and has no physical trading floor  Provides continuous trading for the most active stocks traded over the counter (OTC)  Primarily a dealer market in which often more than 20 dealers act as market makers  A small order execution system (SOES) provides automatic order execution for orders of less than or equal to 1,000 shares  The NASD maintains an electronic “OTC bulletin board” and “pink sheets” for small firms that are not part of the NASDAQ http://www.nasdaq.com  NASDAQ is the world’s first electronic market and has no physical trading floor  Provides continuous trading for the most active stocks traded over the counter (OTC)  Primarily a dealer market in which often more than 20 dealers act as market makers  A small order execution system (SOES) provides automatic order execution for orders of less than or equal to 1,000 shares  The NASD maintains an electronic “OTC bulletin board” and “pink sheets” for small firms that are not part of the NASDAQ http://www.nasdaq.com

6. 6 Copyright 2014 by Diane Scott Docking NYSE Euronext Characteristics  Extensive listing requirements E.g..: firm market value and trading volume NASDAQ requirements are less demanding Annual Fees for listing*  NYSE range from $42,000 - $500,000 (function of shares outstanding)  NASDAQ range from $32,000 - $99,500 (function of shares outstanding and global or non-global market)  Extensive listing requirements E.g..: firm market value and trading volume NASDAQ requirements are less demanding Annual Fees for listing*  NYSE range from $42,000 - $500,000 (function of shares outstanding)  NASDAQ range from $32,000 - $99,500 (function of shares outstanding and global or non-global market) Listing Requirements*NYSENASDAQ Round-lot (100 shares) shareholders400450 Number of public shares (millions)1.11.25 Market value of public shares ($ millions)$100$45 Pre-tax income ($ millions)$2.00$1.00 *As of 4/22/14

7. 7 Copyright 2014 by Diane Scott Docking NYSE Euronext Characteristics (cont.)  Extensive member requirements (Rule 300 and 301) Current fee http://www.nyse.com/pdfs/Trading_License_Client_Notice_053111.pdf http://www.nyse.com/pdfs/Trading_License_Client_Notice_053111.pdf Qualifications http://www.nyse.com/equities/nyseequities/1167954368134.html http://www.nyse.com/equities/nyseequities/1167954368134.html  Legal age  Provide personal business history  Medical examination  Recommendation letters  Fingerprinting & background check  Appearance before board  Must pass Exchange trading qualifying exam  Brokerage licenses  Continuing education  Training sessions  Extensive member requirements (Rule 300 and 301) Current fee http://www.nyse.com/pdfs/Trading_License_Client_Notice_053111.pdf http://www.nyse.com/pdfs/Trading_License_Client_Notice_053111.pdf Qualifications http://www.nyse.com/equities/nyseequities/1167954368134.html http://www.nyse.com/equities/nyseequities/1167954368134.html  Legal age  Provide personal business history  Medical examination  Recommendation letters  Fingerprinting & background check  Appearance before board  Must pass Exchange trading qualifying exam  Brokerage licenses  Continuing education  Training sessions

8. 8 Copyright 2014 by Diane Scott Docking NYSE Euronext Characteristics (cont.)  Electronic communication networks (ECNs) normal trading occurs between 9:30 a.m. and 4:00 p.m. eastern standard time extended-hours trading occurs through computerized alternative trading systems (ATSs) a.k.a. ECNs Online trading via the internet is available  Electronic communication networks (ECNs) normal trading occurs between 9:30 a.m. and 4:00 p.m. eastern standard time extended-hours trading occurs through computerized alternative trading systems (ATSs) a.k.a. ECNs Online trading via the internet is available

9. 9 Copyright 2014 by Diane Scott Docking NYSE Euronext Characteristics (cont.)  Program trading  the simultaneous buying and selling of a portfolio of at least 15 different stocks valued at more than $1 million using computer programs to initiate the trades  Circuit breakers Rule 80B Temporarily halts trading to give investors time to make informed choices during periods of high market volatility  Program trading  the simultaneous buying and selling of a portfolio of at least 15 different stocks valued at more than $1 million using computer programs to initiate the trades  Circuit breakers Rule 80B Temporarily halts trading to give investors time to make informed choices during periods of high market volatility

10. 10 Copyright 2014 by Diane Scott Docking NYSE Euronext Characteristics (cont.)  Circuit breakers Rule 80B (a) The Exchange shall halt trading in all stocks and shall not reopen for the time periods specified in this Rule if there is a Level 1, 2, or 3 Market Decline. (i) For purposes of this Rule, a Market Decline means a decline in price of the S&P 500® Index between 9:30 a.m. and 4:00 p.m. on a trading day as compared to the closing price of the S&P 500® Index for the immediately preceding trading day. The Level 1, Level 2, and Level 3 Market Declines that will be applicable for the trading day will be publicly disseminated before 9:30 a.m. (ii) A "Level 1 Market Decline" means a Market Decline of 7%. (iii) A "Level 2 Market Decline" means a Market Decline of 13%. (iv) A "Level 3 Market Decline" means a Market Decline of 20%.  Circuit breakers Rule 80B (a) The Exchange shall halt trading in all stocks and shall not reopen for the time periods specified in this Rule if there is a Level 1, 2, or 3 Market Decline. (i) For purposes of this Rule, a Market Decline means a decline in price of the S&P 500® Index between 9:30 a.m. and 4:00 p.m. on a trading day as compared to the closing price of the S&P 500® Index for the immediately preceding trading day. The Level 1, Level 2, and Level 3 Market Declines that will be applicable for the trading day will be publicly disseminated before 9:30 a.m. (ii) A "Level 1 Market Decline" means a Market Decline of 7%. (iii) A "Level 2 Market Decline" means a Market Decline of 13%. (iv) A "Level 3 Market Decline" means a Market Decline of 20%.

11. Copyright 2014 Diane Scott Docking11 How Trades Are Executed Floor ______ _____________ Market-______ ______ _

12. Copyright 2014 Diane Scott Docking12 How Trades Are Executed  Acts on behalf of an investor who wishes to execute orders.  May work for a brokerage house as their agent  May work for self (dealer)  Broker functions: Receives, transmits and executes orders on the trading floor Brings together buyers and sellers Negotiates prices Completes the physical trade with other floor participants  In return, the broker receives a commission. Floor Broker

13. Copyright 2014 Diane Scott Docking13 How Trades Are Executed  Buys and sells stocks as a principal (for self). Individual, or Firm  Firm will have brokers acting as their agents.  Will hold inventory Dealer

14. Copyright 2014 Diane Scott Docking14 How Trades Are Executed  Specialists serve as brokers/dealers, matching buy/sell orders in a few, specific stocks on the exchange  Serve to maintain fair and orderly market i.e., they make a market in the security Will hold inventory  Works for a specialist firm which is an independent company in the business of trading listed securities. Specialists

15. Copyright 2014 Diane Scott Docking15 How Trades Are Executed  Market-maker is registered to trade in a given security on the NASDAQ Like a specialist  A few stocks  Create a market Like a dealer  Holds in inventory the stock.  Dealer functions: Takes a position (long or short) in the asset Provides opportunity to trade immediately Offers price information Serves as auctioneer  Dealer profit is the bid-ask spread.  No specific location as with specialists on exchanges—telecommunications link  Specialists and market-makers provide continuous market liquidity Market-Makers

16. Copyright 2014 Diane Scott Docking 16 How to Read a Stock Quotation

17. Copyright 2014 by Diane Scott Docking 17 Stock Quote a www.finance.yahoo.comwww.finance.yahoo.com and www.wsj.com As of April 25, 2014www.wsj.com

18. Copyright 2014 Diane Scott Docking18 Stock Quote a YTD % changeHiLoStockSymDIVYld%PEVol 100sCloseNet Chg 110.3121.8880.06IBM.56.6207197993.7711.06 Year-to-dateHighestLowestNameStockAnnualDividendPrice-TradingClosingChange in the percentageprice of stockSymboldividendyield, whichearningsvolumestock price change inof the paid perrepresentsratio basedduring thepriceon the previ- stock pricestock yearthe annualon thepreviousous trading in this dividend asprevailingtrading dayday from the year a percentagestock priceclose on the of the pre-day before vailing stock price 52-WEEK Round lots traded DIV / Close =.56 / 93.77 =.597% =.6%

19. Copyright 2014 Diane Scott Docking 19 Stock Indexes

20. 8-20Copyright 2014 Diane Scott Docking Stock Market Indexes  A stock market index is the composite value of a group of secondary market-traded stocks  ____________-weighted index the Dow Jones Industrial Average (DJIA), composed of 30 companies, is the most widely know stock market index  ____________-weighted indexes NYSE Composite Standard & Poor’s 500 NASDAQ Composite Wilshire 5000  A stock market index is the composite value of a group of secondary market-traded stocks  ____________-weighted index the Dow Jones Industrial Average (DJIA), composed of 30 companies, is the most widely know stock market index  ____________-weighted indexes NYSE Composite Standard & Poor’s 500 NASDAQ Composite Wilshire 5000

21. Copyright 2014 Diane Scott Docking 21 Dow Jones Industrial Average  http://www.djindexes.com/ http://www.djindexes.com/  Price-weighted average (aka: equally-weighted)  30 large U.S. firms  Divisor: http://online.barrons.com/public/page/9_0210-djhfhravg.html; http://wsj.com/mdc/public/page/2_3022-djiahourly.htmlhttp://online.barrons.com/public/page/9_0210-djhfhravg.html http://wsj.com/mdc/public/page/2_3022-djiahourly.html

22. Copyright 2014 by Diane Scott Docking 22 Example: Price-Weighted Index E.g.: PWI t Co. Price.sh# shs. o/s A$ 10 1,000 B$ 5020,000 C$100 2,000 3$160 Index = $160 / 3 companies= 53.33

23. Copyright 2014 by Diane Scott Docking 23 Example: Price-Weighted Index (cont.) E.g.: PWI t+1 Co. Price.sh# shs. o/s A$ 12 1,000 B$ 5820,000 C$110 2,000 3$180 Index = $180 / 3 companies= 60.00 % change in Index = (60.00 – 53.33)/53.33 = 12.507% At t+1, share price changes.

24. Copyright 2014 by Diane Scott Docking 24 Example: Price-Weighted Index (cont.) E.g.: PWI t+2 Co. Price.sh# shs. o/s A$ 12 $6 1,000 2,000 B$ 5820,000 C$110 2,000 3$174 Index = $174 / 2.9= 60.00 Divisor adjusts such that Index is same in PWI t+1 On t+2, A has a 2 for 1 stock split. Overall firm value of A did not change, so Index should not change.

25. Copyright 2014 by Diane Scott Docking 25 DJIA Computation At 4/25/14: Divisor 4/25/14 = 0.15571590201117 DJIA 4/25/14 =16361.46 Components 4/24/14 = = $2,547.74 (see next slide)

26. Components of DJIA at 4/25/14 26 Copyright 2014 by Diane Scott Docking

27. 27 Stock Indexes  Standard and Poor’s (S&P) (1,863.40 on 4/25/14) www.standardandpoors.com Value-weighted S&P 500: 500 large U.S. firms S&P 400: 400 Mid-cap firms S&P 600: 600 Small-cap firms  http://finance.yahoo.com/ current index value http://finance.yahoo.com/

28. Copyright 2014 by Diane Scott Docking 28 Example: Value-Weighted Index E.g.: VWI t Co. Price/sh x # shs. o/s = Market Value A $ 10 1,000 $ 10,000 B $ 50 20,000 $1,000,000 C $100 2,000 $ 200,000 23,000 $1,210,000 Index = $1,210,000 / 23,000= 52.608696

29. Copyright 2014 by Diane Scott Docking 29 Example: Value-Weighted Index E.g.: VWI t+1 Co. Price/sh x # shs. o/s = Market Value A $ 12 1,000 $ 12,000 B $ 58 20,000 $1,160,000 C $110 2,000 $ 220,000 23,000 $1,392,000 Index = $1,392,000 / 23,000 = 60.521739 % change in Index = (60.521739-52.608696)/52.608696 = 15.0413% At t+1, share price changes.

30. Copyright 2014 by Diane Scott Docking 30 Example: Value-Weighted Index E.g.: VWI t+2 Co. Price/sh x # shs. o/s = Market Value A $ 12 $6 1,000 2,000 $12,000 B $ 58 20,000 $1,160,000 C $110 2,000 $ 220,000 23,000 24,000 $1,392,000 Index = $1,392,000 / 23,000 = 60.521739 Divisor adjusts such that Index is same as VWI t+1 On t+2, A has a 2 for 1 stock split. Overall MV is same so Index should not change

31. Copyright 2014 Diane Scott Docking31 S&P 500 Index See 1950 to present (real time): http://finance.yahoo.com/echarts?s=%5EGSPC#chart1:symbol=^gspc;range= my;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;s ource=undefined http://finance.yahoo.com/echarts?s=%5EGSPC#chart1:symbol=^gspc;range= my;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;s ource=undefined See last 2 years at: http://finance.yahoo.com/echarts?s=%5EGSPC#chart1:symbol=^gspc;range=2 y;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;sou rce=undefined

32. Copyright 2014 Diane Scott Docking 32 Types of Orders Limit order Stop order Market order Other types

33. Copyright 2014 by Diane Scott Docking 33 Types of Orders  Market order  Limit order  Stop order (aka: stop-loss order)

34. Copyright 2014 Diane Scott Docking 34 Types of Orders  _________________ order At best available price

35. Copyright 2014 Diane Scott Docking 35 Types of Orders  ______________order Order to buy or sell a set number of shares at a specified price or better.  Can limit length of time order can be outstanding before being canceled. Typically cost more than market orders. Recorded in a “limit order book”  A record of unexecuted limit orders maintained by the specialist. BUY limit order – buy only at the designated price or lower  Designated price is _________ than current market price SELL limit order – sell at the designated price or higher  Designated price is _________ than current market price Beneficial because  investors get the specified purchase or sell price.  useful on a low-volume or highly volatile stock.

36. Copyright 2014 Diane Scott Docking 36 Types of Orders  Limit order Buy limit order – buy only at the designated price or lower  Designated price is lower than current market price P Limit_buy < P MV_current E.g.: $19 < $20 Buy only at $19 or lower. If short the stock, take profit and run.

37. Copyright 2014 Diane Scott Docking 37 Types of Orders  Limit order Sell limit order – sell at the designated price or higher  Designated price is greater than current market price P Limit_sell > P MV_current E.g.: $22 > $20 Sell only at $22 or higher. If long the stock, take profit and run.

38. Copyright 2014 Diane Scott Docking 38 Limit Order Book for Intel on Archipelago

39. Copyright 2014 Diane Scott Docking 39 Types of Orders  ____________ order (aka: stop-loss order) An order to buy or sell when price surpasses a particular price – at which point the stop order becomes a market order. Not a 100% guarantee of getting the desired entry/exit price.  E.g., if a stock gaps down (up) then the stop sell (buy) order will be triggered (or filled) at a price significantly lower (higher) than expected Stop order to BUY – order is not to be executed until the market rises to a designated price  Designated price is _______ than the current market price Stop order to SELL – order is not to be executed until the market falls to a designated price  Designated price is _______ than the current market price Beneficial because  Commonly used before leaving for holidays or entering a situation where unable to monitor their portfolio for an extended period.  Ensures a greater probability of achieving a predetermined entry or exit price, limiting the investor's loss or locking in his/her profit.

40. Copyright 2014 Diane Scott Docking 40 Types of Orders  Stop order (aka: stop-loss order) Stop order to buy – order is not to be executed until the market rises to a designated price  Designated price is greater than the current market price P Stop_buy > P MV_current E.g.: $25 > $20 Buy only if price gets to $25. Idea is to buy it before price gets too high: - Cover a short position before price gets too high, or - Go long (buy the stock) before it becomes too expensive If price gaps up to $30 may end up buying at $30, than the expected $25; but guaranteed to own the stock.

41. Copyright 2014 Diane Scott Docking 41 Types of Orders  Stop order (aka: stop-loss order) Stop order to SELL – order is not to be executed until the market rises to a designated price  Designated price is lower than the current market price P Stop_sell < P MV_current E.g.: $15 < $20 Sell only if price fall to $15. Idea is to sell it before price gets too low: - Get out of a long position. Take profit and run or cut losses. If price gaps down to $10 may end up selling at $10, than the expected $15; but guaranteed to sell the stock.

42. Copyright 2014 Diane Scott Docking 42 Types of Orders  Size-Related orders Round lot – 100 shares Odd lot – less than 100 shares Block trade – large trades of 10,000 or mores shares or MV ≥ $200,000

43. Copyright 2014 Diane Scott Docking 43 Short Selling

44. 44 Short Sales Note that an investor who buys and owns shares of stock is said to be “long the stock” or to have a “long position.” Short Sale is a sale in which the seller does not actually own the security that is sold. Borrow shares from someone Borrow shares from someone Sell the Shares in the market Sell the Shares in the market Buy shares From the market Buy shares From the market Return the shares Return the shares TodayIn the Future Copyright 2014 Diane Scott Docking

45. 45 Short Sales  An investor with a long position benefits from price increases. Easy to understand You buy today at $34, and sell later at $57, you profit! Buy low, sell high  An investor with a short position benefits from price decreases. Also easy to understand You sell today at $83, and buy later at $27, you profit. Sell high, buy low Copyright 2014 Diane Scott Docking

46. 46 Short Selling  In a short sale, investor borrows and sells stock  Promises to pay back stock later  Short seller hopes stock price declines to provide gain  Short seller covers dividend payments while borrowing stock  Limited gain; unlimited losses

47. 47 Example 1: Short Sales  You short 100 shares of Texas Instruments (TXN) at $30 per share. The value of stock borrowed that will be sold short is: $30 × 100 shs = $3,000 NOTE: YOU MUST PUT UP FUNDS TO SHORT A STOCK! 1) Assume in 1 year the stock has a value of $20 per share. What is your gain/loss? 2) Assume in 1 year the stock has a value of $40 per share. What is your gain/loss? Copyright 2014 Diane Scott Docking

48. 48 Example 1: Short Sales  Assume in 1 year the stock has a value of $20 per share. What is your gain/loss and return? Sell $30 Buy-$20 Gain $10 / sh. X 100 shs. = _________________ Copyright 2014 Diane Scott Docking

49. 49 Example 1: Short Sales  Assume in 1 year the stock has a value of $40 per share. What is your gain/loss and return? Sell $30 Buy-$40 Loss-$10 / sh. X 100 shs. = _______________ Copyright 2014 Diane Scott Docking

50. 50 REGULATION OF SECURITIES MARKETS

51. 51Copyright 2014 Diane Scott Docking Stock Market Regulations  The Securities and Exchange Commission (SEC) is the primary regulator of stock markets  The main emphasis of SEC regulation is on full and fair disclosure of information on securities  Securities Act of 1933/Securities Exchange Act of 1934  The SEC delegates certain regulatory responsibilities to the exchanges for the day-to-day surveillance of activity  Recently imposed regulations aim to reduce excessive price fluctuations and increase auditing oversight  The Securities and Exchange Commission (SEC) is the primary regulator of stock markets  The main emphasis of SEC regulation is on full and fair disclosure of information on securities  Securities Act of 1933/Securities Exchange Act of 1934  The SEC delegates certain regulatory responsibilities to the exchanges for the day-to-day surveillance of activity  Recently imposed regulations aim to reduce excessive price fluctuations and increase auditing oversight

52. Copyright 2014 Diane Scott Docking52 SEC Oversight of Corporate Disclosure  Regulation Fair Disclosure (FD), October, 2000 Requires corporations to disclose relevant information broadly to investors at the same time Forbade old practice of providing selected analysts new information during teleconference calls  Means of disclosing new information Company Web site—Web cast 8-k form filing News release Above simultaneously with conference call