Chapter 18

COMMON STOCK MARKETS IN THE

UNITED STATES

Characteristics of Common Stock

Equity securities = ownership share of a corporation.

Common (junior) stockholders are the residual owners: Right to income Right to assets

Preferred (senior) stockholders have preference over common stockholders: Right to fixed dividend

Trading Locations

Stock Exchanges trading floors auction system / open-outcry central auction specialist system

Over-The-Counter Market no trading floor negotiated system multiple market maker system

Independent Electronic Trading Systems

(US) Stock Exchanges

Major National Stock Exchanges NYSE or Big Board AMEX or ASE or Curb

Regional Stock Exchanges Boston, Chicago,

Cincinnati, San Francisco, Philadelphia

OTC Market NASDAQ NASD

Stocks can be dual-listed

Types of Markets

First Market trading on exchanges of stocks listed on an exchange

Second Market trade in OTC market of stocks not listed on exchange

Third Market trading in OTC market of stocks listed on an exchange

(deregulation helped: needn’t be member)

Fourth Market private transactions between institutional investors e.g. B.S.E.

Exchanges (1st mkt)

Formal organizations approved and regulated by the SEC

Members can only trade listed stocks must buy a seat on the exchange (member)

Listing requirements (initial, continued): minimum capitalization, shareholder equity,

average closing share price, etc.

NYSE

Centralized continuous auction

Exchange participants: single specialist/stock

(market maker) (commission) brokers indie floor brokers

(spill over) registered traders

SuperDotMajor roles of NYSE-

specialist Auctioneer: buy/sell

on own account at stated price

Agent / broker Dealer (own account) Catalyst: focal point

Commissions: dereg’d

OTC Market (2nd, 3rd)

Trading unlisted stocks

But: listing requirements

NASDAQ stock market (virtual, 5k)

NASDAQ market tiers NASDAQ National

Market Small Cap Market: can

graduate to NNM

NASDAQ market makers

Other OTC markets (80k) OTC Bulletin Board Pink Sheets

Fourth Market

Direct trading of stocks between two customers (no intermediary)

Commissions avoidedAlternative trading systems (ATS)

electronic communications networks (30% of NASDAQ volume; no brokers)

crossing networks (aggregate orders across institutions by computer)

Trading Mechanisms

Types of Orders market order limit order

Automatic thresholds

Short Selling Borrow #stocks, not

their price Margin Transactions

Buy on margin: use shares as collateral

initial margin maintenance margin

Transactions Costs (time trade to minimise

these) explicit costs

Fees, taxes… implicit costs

Impact: changes p Timing: if slow trade Opportunity: if trade

cancelled

Trading Arrangements for Institutional Investors

Block Trading Trades of 10,000 shares or more of a given stock

or trades with a market value of $200,000 or more. NYSE: 1961 3%; now > 50% Upstairs market: broker may avoid exchange, OTC

Program Trading Simultaneous computer-assisted buy/sale shares

in a large number of different stocks for:Rebalance portfolio (asset allocation)Index arbitrage (e.g. all S&P500 firms)

Stock Market Indicators

Dow Jones Industrial Average (30 largest NYSE ‘blue chip’)

NYSE Composite (all NYSE)NASDAQ Composite (all NASDAQ OTC)S&P 500 (500 NYSE listed + OTC)AMEXValue Line Composite Average

Pricing Efficiency of the Stock Market

Forms of Efficiency Weak form: can’t predict from market history Semistrong form: + `from public info’ Strong form: + ‘from private info’

but: insider traders often earn abnormal returns

Implications for Investing in Common Stock Active strategies: try to outperform market Passive strategies: buy market at min. cost

Stock Market Indexes

Japan Tokyo Stock Price

Index (TOPIX) Nikkei 225 Stock

Average

United Kingdom Financial Times-

Stock Exchange 100 (FTSE 100)

Germany Deutscher

Aktienindex (DAX)

France CAC 40

Others Hang Seng Index Morgan Stanley

EAFE Index