Chapter 3 The Trading Industry

1. Chapter 3 The Trading Industry

2. Terminology • Agency vs. proprietary traders (trading) • Brokers are agency traders • Long vs. short positions • Short covering • Buy vs. sell side • Liquidity demanders vs. liquidity providers

3. People and institutions who use market services are on the buy-side. • Those who provide market services are on the sell-side. • These sides have nothing to do with whether you are a buyer or seller of a specific security.

4. Buy-side players - Investors • Individuals • Corporate pension fund sponsors • Charitable trusts • Legal trusts • Endowments=> Stocks and bonds • Investment managers • Corporate investment funds • Governmental funds

5. Homeowners Students Corporations=> Mortgages, Bonds, Notes Farmers Manufacturers Miners Shippers Financial Institutions => Forwards, Futures, Swaps, and Options Buy-side players – Borrowers and Hedgers

6. Sell-side players • Dealers trade for their own accounts. • Day traders • Market makers • Floor traders • Brokers trade for other people’s accounts. • Retail and institutional • Full-service and discount • Broker-dealers do both. • Specialists • Wire houses

7. Sell-side trade facilitators • Exchanges provide systems that help traders arrange their trades. • Clearing houses help settle trades and guarantee that traders will perform. • Depositories and custodians hold securities.

8. A typical set of relationships • A sponsor owns funds. • An investment manager makes portfolio decisions. • A broker implements trades. • A dealer supplies liquidity. • A clearing house guarantees trades. • A depository holds the security. • Consultants advise everyone.

9. Primary vs. secondary security sales • Primary • New issue • Key factor: issuer receives the proceeds from the sale. • Secondary • Existing owner sells to another party. • Issuing firm doesn’t receive proceeds and is not directly involved.

10. Primary markets: Public offerings • Public offerings: registered with the SEC and sale is made to the investing public. • Shelf registration (Rule 415, since 1982) • Initial Public Offerings (IPOs) • Evidence of underpricing • Performance

11. US primary listing market • New York Stock Exchange (N) • American Stock Exchange (A) • NASDAQ (Q) • Over-the-Counter (OTC) • Nasdaq small cap (S) • OTCBB (U) • Pink Sheets

12. Primary markets: Private placements • Private placement: sale to a limited number of sophisticated investors not requiring the protection of registration. • Dominated by institutions. • Very active market for debt securities. • Not active for stock offerings.

13. Organization of secondary markets • Organized exchanges • OTC market • Third market • Fourth market

14. Organized Exchanges • Auction markets with centralized order flow. • Dealership function: can be competitive or assigned by the exchange (Specialists). • Securities: stock, futures contracts, options, and to a lesser extent, bonds. • Examples: NYSE, AMEX, Regionals, CBOE.

15. NYSE • The NYSE is a hybrid market. It has: • floor traders (like a futures pit) • an electronic limit order book (like Euronext) • a designated dealer (the specialist) to maintain liquidity and otherwise coordinate trading. • This mix is the outcome of political, technological and economic forces over the last 200 years.

16. NYSE NYSE’s MarkeTrac: http://marketrac.nyse.com/mt/

18. NYSE • The NYSE was first a floor market (loosely resembling the futures pits). • Many of the trading rules reflect the “floor” aspect of the market. • The NYSE next evolved strong central dealers (late 1800’s). • The specialist, in the sense of a trader who specializes in a particular stock.

19. NYSE • Beginning in the 1980’s, electronic order entry has come to play an increasing role. The exchange has always permitted limit orders, but the book has become more important over time. • The basic reading for this material is the NYSE Floor Official Manual, abbreviated FOM.

20. What does the NYSE do? • Trading and trading services. • The NYSE charges (directly and indirectly) for trades that occur and for software supplied to its members. • Listing • To be listed on the NYSE, a corporation must meet/maintain certain financial standards and pay listing fees. • http://www.nasdaq.com/about/appa.pdf

21. US regional exchanges • Pacific Exchange / Archipelago (P) • Chicago (formerly Midwestern) Stock Exchange (M) • Boston Stock Exchange (B) • Philadelphia Stock Exchange (X) • Cincinnati Stock Exchange (C)

22. Third markets • Trading of listed securities away from the exchange. • Institutional market: to facilitate trades of larger blocks of securities. • Involves services of dealers and brokers

23. Fourth Market • Trading in exchange-listed stocks within Alternative Trading Systems (ATS), such as ECNs (Instinet, Island, Archipelago) • Institutions trading directly with institutions • No middleman involved in the transaction

24. Major international stock markets • Europe • London Stock Exchange (LSE) • EuroNext (Paris/Netherlands/Belgium) • Deutsche Borse (DB) • Milan Stock Exchange • Swiss Stock Exchange Stockholm/Copenhagen/Helsinki/Oslo (OM) • Toronto Stock Exchange (TSX)

25. Asia • Tokyo Stock Exchange (TSE) • Taiwan Stock Exchange • Korean Stock Exchange (KSE) • Australian Stock Exchange (ASX) • Hong Kong Stock Exchange

26. International market structures • London Stock Exchange • Dealer market similar to NASDAQ • Stock Exchange Automated Quotation • Greater Anonymity • Tokyo Stock Exchange • No market making service • Sartori provides bookkeeping service • Feature a floor and electronic trading

27. KSE • http://www.kse.or.kr/

28. The regulators • Securities and Exchange Commission (SEC) • Securities markets, equity options markets, and cash-settled equity index options markets • Commodity Futures Trading Commission (CFTC) • Commodity spot, forward, and futures markets