1. Investments Vicentiu Covrig 1 Securities Markets (chapter 6)

2. Investments Vicentiu Covrig 2 Organization of the Securities Market Primary markets - New issues Secondary markets - Outstanding securities are bought and sold

3. Investments Vicentiu Covrig 3 Primary Capital Markets Bonds (see also chapter 3) Government bonds: Treasury bills: one year maturity or less Treasury notes: maturities of two to ten years Treasury bonds: original maturities of more than ten years Municipal bonds: General obligations: backed by full taxing power Revenue: pay interest from the revenue Corporate bonds: By level of claim: secured and unsecured (debenture) By credit quality: investable and high-yield (high risk)

4. Investments Vicentiu Covrig 4 Primary Capital Markets Common Stock New issues are divided into two groups Seasoned new issues - New shares offered by firms that already have stock outstanding Initial public offerings (IPOs) - Firms selling their stock to the public for the first time

5. Investments Vicentiu Covrig 5 Relationships with Investment Bankers 1. Negotiated - Most common - Full services of underwriter 2. Competitive bids (Dutch auction, Google) - Corporation specifies securities offered, then seeks bids - Reduced costs but also reduced services of underwriter 3. Best-efforts - Investment banker acts as broker, selling all it can at a specified price

6. Investments Vicentiu Covrig 6 Why Secondary Markets Are Important?

7. Investments Vicentiu Covrig 7 Secondary Equity Markets Stock Exchanges (First Market) - Major national stock exchanges  New York, American, Tokyo, and London - Regional stock exchanges  Chicago, San Francisco Over-the-counter market (Second Market) - Stocks not listed on organized exchange Third Market Fourth Market

8. Investments Vicentiu Covrig 8 Physical location stock exchanges vs. Electronic dealer-based markets Auction market vs. Dealer market (Exchanges vs. OTC) NYSE vs. Nasdaq Differences are narrowing

9. Investments Vicentiu Covrig 9 Exchange (NYSE) Membership Four categories of membership: Specialists - Maintain an orderly market in a stock Commission brokers - Member firm employees executing orders for clients of the firm Floor brokers - Independent brokers who work for other brokers Registered traders - Members who buy and sell for their own accounts

10. Investments Vicentiu Covrig 10 Over-the-Counter (OTC) Market OTC: Not a formal organization or a single location Trading listed and unlisted issues (third market) Lenient requirements for listing on OTC The Nasdaq System National Association of Security Dealers Automated Quotation system Dealers may elect to make markets in stocks Three levels of quotations available - Level 1 shows a median representative quote - Level 2 shows quotes by all market makers - Level 3 is for OTC market makers to change their quotes shown

11. Investments Vicentiu Covrig 11 Third Market OTC trading of shares listed on an exchange: GM, IBM, AT&T, Xerox Electronic exchanges (ECNs): Instinet, Archipelago May be important to investors particularly when the exchange is closed or when trading is suspended on the exchange Fourth Market Direct trading of securities between two parties with no broker involved Both parties typically large, institutional investors making large trades Savings in transaction costs can be large for such investors to deal directly with one another

12. Investments Vicentiu Covrig 12 Major Types of Orders Market orders - Buy or sell at the best current price Limit orders - Order specifies the buy or sell price  Stop loss - Conditional order to sell stock if it drops to a given price  Stop buy order - Investor may want to limit loss if stock increases in price

13. Investments Vicentiu Covrig 13 Major Types of Orders Short sales - Sell overpriced stock that you don’t own and purchase it back later (at a lower price) - Borrow the stock from another investor (through your broker)

14. Investments Vicentiu Covrig 14 Major Types of Orders Buying on Margin: On any type order, instead of paying 100% cash, borrow a portion of the transaction, using the stock as collateral Interest rate is based on the call money rate from a bank Regulations limit proportion borrowed and the investor’s equity percentage (margin) - Margin requirements are from 50% up Maintenance margin - Required proportion of equity to stock value - Minimum requirement is at least 25% - Margin call to meet margin requirement

15. Investments Vicentiu Covrig 15 Major Types of Orders Margin Example: Buy 100 shares at $60 = $6,000 position Borrow 50%, investment of $3,000 If price increases to $70, position Value is $7,000 Less - $3,000 borrowed Leaves $4,000 equity for a $4,000/$7,000 = 57% equity position

16. Investments Vicentiu Covrig 16 Learning objectives Discuss the purpose and function of a market. Discuss the characteristics that determine the quality of a market. What is the difference between a primary and secondary market? Briefly discuss the government bond issues, municipal and corporate bonds Know what are the seasoned new issues and IPO; Discuss the relationships with investment bankers Discuss why secondary markets are important. Briefly discuss how bonds are traded in the secondary market Know what are, and the differences between the major national exchanges (NYSE), Over-the-counter markets (NASDAQ), third and fourth markets (see slides 9 to 13) Discuss the exchange membership

17. Investments Vicentiu Covrig 17 Learning objectives Discuss the two alternative trading systems: pure auction market and the dealer market Discuss what are the main features of the National Market System Know the four type of orders; and short selling; and trading on margin (including the numerical example you have it in the notes) Recommended exercises: Questions 1, 3,4,9,13; Problems 2,5