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Principles of Investing FIN 330

Principles of Investing FIN 330. Chapter 2 Security Markets. Student Learning Objectives. Primary functions of security markets Primary, Secondary and Electronic Markets Regulation of Security Markets. Primary Markets Functions . Fair, open, and orderly trading

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Principles of Investing FIN 330

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  1. Principles of InvestingFIN 330 Chapter 2 Security Markets

  2. Student Learning Objectives • Primary functions of security markets • Primary, Secondary and Electronic Markets • Regulation of Security Markets

  3. Primary Markets Functions • Fair, open, and orderly trading • [Instant] Liquidity (low transaction costs) • Price (and Volume) information readily available • Market Efficiency: prices reflect all available information

  4. Primary Markets • Investors buy new issues directly from sellers • At offering prices • By sealed bid (treasuries) • Investment Bankers • Financial intermediaries who get providers and demanders of capital together (for a fee) • Help in pricing and issuing new securities • Bear risk of selling new securities (underwriting) • Distributes issue to the public (selling) • Investment Banking Functions • Advising: Timing, Pricing, Terms and Features • Underwriting: Full, Best Efforts • Distribution: Selling syndicate

  5. Primary Markets • Investment Banking • Initial Public Offerings (IPOs) • The first sale of common stock to the public • Private Placements • Private sale of securities directly to investors (Lettered stock) • Reduced liquidity - no secondary market • Secondary registration required to sell to public • Avoids underwriting discount (concession) • Avoids registration costs with SEC

  6. Secondary Markets • Trade seasoned securities • Provide liquidity • Cost of liquidity services = bid-ask spread • Bid: the price # will pay to buy security • Ask: the price # will take to sell security • Participants: Market makers, Specialists, other traders (customers) • Spread size a function of risk and activity • Provide current price information

  7. Types of Secondary Markets • Registered Exchanges • NYSE, AMEX, Regional exchanges • Trading by [open] auction or electronic • Over-the-Counter (OTC) markets • NASDAQ is primary player • Liquidity services more costly • Trading by computer (versus auction) • Most bonds traded OTC (Corps, Gov’ts, Muni's)

  8. Types of Secondary Markets C. Electronic Communication Networks (ECN) • Computerized systems that automatically match buy and sell orders • Larger ECN’s owned the larger exchange systems: i.e., Archipelago acquired by NYSE

  9. Registered Exchanges • New York Stock Exchange (NYSE): The “Big Board” • Stocks must meet listing requirements • Auction market • Only members can trade on the floor • More than 3000 issues actively traded • American Stock Exchange (AMEX) • Less stringent listing requirements • Smaller issues, Lower volumes • Less than 1000 issues actively traded. • Recently acquired by Nasdaq

  10. Registered Exchanges C. Regional Exchanges • Five Major Regional Exchanges • Boston, Philadelphia, Cincinnati (NMS), Midwest, Pacific • Dual listing (regional & national exchanges) • Typically lower transaction costs than OTC • Different trading hours than NYSE, AMEX

  11. Over-The-Counter Market • The NASDAQ Stock Market • National Association of Securities Dealers Automated Quotation system • Computer based system to serve OTC market for stocks • Gathers market makers together • Must have at least two market makers • Provides better pricing information • Less restrictive listing requirement

  12. Regulation • SEC is primary regulatory agency • Securities Exchange Act of 1933: “information (prospectus) & registration (w/ FTC - SEC)” requirements, penalties for misrepresentation • Securities Exchange Act of 1934: Required reports, insider trading activity, Fed control of margin requirements • Securities Exchange Act of 1975: end of fixed commissions, established NMS • Securities Act of 1940: Investment company act – defining a mutual fund • Securities Act of 1970: Establish Securities Investor Protection Corporation [SIPC] • Insures brokerage accounts up to $500,000 • Does not cover market losses

  13. Regulation • NASD is a self-regulatory body for exchanges and broker/dealers • Some Recent Innovations • Circuit Breakers (1989): manage volatile markets • Program Trading: computer generated buy and sell points

  14. Homework • Discussion Questions: 3, 4, 10, 12, 14

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