CHAPTER FOUR

Securities Markets

CHAPTER FOUR

Securities Markets

Cleary / Jones Investments: Analysis and

Management

Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

To distinguish between primary To distinguish between primary and secondary marketsand secondary markets

To describe how the equity To describe how the equity markets are organized and how markets are organized and how they operatethey operate

To explain what we mean by the To explain what we mean by the third and fourth marketsthird and fourth markets

Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

To state the major stock market To state the major stock market indicatorsindicators

To briefly describe the bond and To briefly describe the bond and derivatives marketsderivatives markets

To discuss the factors behind rapid To discuss the factors behind rapid change in the securities marketschange in the securities markets

The Role of Financial The Role of Financial MarketsMarkets

The Role of Financial The Role of Financial MarketsMarkets

Help firms and governments raise cash Help firms and governments raise cash by selling securitiesby selling securities

Channel funds from savers to borrowersChannel funds from savers to borrowers Provide a place where investors can act Provide a place where investors can act

on their beliefson their beliefs Help allocate cash to where it is most Help allocate cash to where it is most

productiveproductive Help lower the cost of exchangeHelp lower the cost of exchange

Primary MarketsPrimary MarketsPrimary MarketsPrimary Markets

New securities are issued in a New securities are issued in a primary marketprimary market– Initial public offering (IPO) versus Initial public offering (IPO) versus

“seasoned” new issue“seasoned” new issue Issue facilitated by investment Issue facilitated by investment

dealersdealers– Specialists in advice, design, and salesSpecialists in advice, design, and sales– Intermediaries between issuer and Intermediaries between issuer and

investorinvestor

Investment DealersInvestment DealersInvestment DealersInvestment Dealers

Client advice includes type and Client advice includes type and features of security, offer price, and features of security, offer price, and timing of saletiming of sale

Underwriting services:Underwriting services: Risk of selling Risk of selling to investors assumed from issuerto investors assumed from issuer

Coordinate marketing by helping Coordinate marketing by helping issuer register securities, issue issuer register securities, issue prospectus, and sell securities prospectus, and sell securities

Issuance of SecuritiesIssuance of SecuritiesIssuance of SecuritiesIssuance of Securities

Prompt Offering Qualification (POP) Prompt Offering Qualification (POP) System allows senior reporting issuers System allows senior reporting issuers to sell new securities over time via to sell new securities over time via “short form” prospectuses“short form” prospectuses– Reduces issuance costReduces issuance cost

A private placement means new A private placement means new securities are sold to a small group of securities are sold to a small group of institutional investorsinstitutional investors– Registration not requiredRegistration not required

Secondary MarketsSecondary MarketsSecondary MarketsSecondary Markets

Markets where investors trade Markets where investors trade previously issued securitiespreviously issued securities

Auction markets involve bidding in Auction markets involve bidding in a specific physical locationa specific physical location– Brokers represent investors for a feeBrokers represent investors for a fee– Others trade for their own accountOthers trade for their own account

Negotiated markets consist of Negotiated markets consist of decentralized dealer networkdecentralized dealer network

Stock ExchangesStock ExchangesStock ExchangesStock Exchanges

Toronto Stock Exchange is a secondary Toronto Stock Exchange is a secondary auction market for equity securitiesauction market for equity securities– Largest Canadian stock marketLargest Canadian stock market– Listing requirements for traded firmsListing requirements for traded firms

Canadian Venture Exchange is Canadian Venture Exchange is Canada’s new “junior” stock marketCanada’s new “junior” stock market

New York Stock Exchange is the New York Stock Exchange is the largest secondary market in the worldlargest secondary market in the world

Over-the-Counter MarketsOver-the-Counter MarketsOver-the-Counter MarketsOver-the-Counter Markets

Network of dealers standing ready to Network of dealers standing ready to either buy or sell securities at specified either buy or sell securities at specified pricesprices– Dealers profit from spread between buy Dealers profit from spread between buy

and sell pricesand sell prices– Handle unlisted securitiesHandle unlisted securities

Canadian Over-the-Counter Automated Canadian Over-the-Counter Automated Trading System (COATS)Trading System (COATS)

NASDAQNASDAQ

Third and Fourth MarketsThird and Fourth MarketsThird and Fourth MarketsThird and Fourth Markets

Third Market:Third Market: Over-the-counter Over-the-counter transactions in securities listed on transactions in securities listed on organized exchangesorganized exchanges

Fourth market:Fourth market: Trading network Trading network among investors interested in buying among investors interested in buying and selling large blocks of stockand selling large blocks of stock– Brokers, dealers bypassed so costs are Brokers, dealers bypassed so costs are

lowlow– Electronic or telephone networkElectronic or telephone network

International Equity International Equity MarketsMarkets

International Equity International Equity MarketsMarkets

Toronto Stock Exchange is the Toronto Stock Exchange is the eighth-largest stock exchange in the eighth-largest stock exchange in the worldworld– Many different equity markets existMany different equity markets exist

Emerging marketsEmerging markets– Generally less regulation and Generally less regulation and

standardization of trading activitystandardization of trading activity– Risks: Illiquidity, lack of information, Risks: Illiquidity, lack of information,

political uncertaintypolitical uncertainty

Equity Market IndicatorsEquity Market IndicatorsEquity Market IndicatorsEquity Market Indicators

Provide a composite report of Provide a composite report of market behaviour on a given daymarket behaviour on a given day

TSE 300 Composite Index TSE 300 Composite Index – Market value weighted Market value weighted – Divided into 14 major industry groupsDivided into 14 major industry groups

S&P / TSE 60S&P / TSE 60– Designed to give index funds Designed to give index funds

sufficient diversificationsufficient diversification

Equity Market IndicatorsEquity Market IndicatorsEquity Market IndicatorsEquity Market Indicators

Dow Jones Industrial AverageDow Jones Industrial Average– Composed of 30 “blue-chip” stocksComposed of 30 “blue-chip” stocks– Price weightedPrice weighted

S&P 500 Composite IndexS&P 500 Composite Index– Composed of 500 “large” firm stocksComposed of 500 “large” firm stocks– Market value weighted Market value weighted

Nikkei 225 AverageNikkei 225 Average– Price weighted index of 225 actively-traded Price weighted index of 225 actively-traded

stocks on the Tokyo Stock Exchangestocks on the Tokyo Stock Exchange

Bond MarketsBond MarketsBond MarketsBond Markets

Secondary bond market is Secondary bond market is primarily an over-the-counter primarily an over-the-counter network of dealersnetwork of dealers

– Government of Canada bonds actively Government of Canada bonds actively trade in dealer marketstrade in dealer markets

– Corporate bonds are not as actively Corporate bonds are not as actively traded as government issuestraded as government issues

Market DevelopmentsMarket DevelopmentsMarket DevelopmentsMarket Developments

Growth of institutional tradingGrowth of institutional trading– Block trading of stocks (transactions Block trading of stocks (transactions

of at least 10,000 shares)of at least 10,000 shares) Affects market structure and operationAffects market structure and operation

– Negotiated, not fixed, commissionsNegotiated, not fixed, commissions Globalization of securities marketsGlobalization of securities markets

– 24-hour trading24-hour trading– InstinetInstinet