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ChapterMcGraw-Hill/IrwinCopyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.The Stock Market5-2The Stock Market• Our goal in this chapter is to provide a “big picture”overview of:– Who owns stocks– How a stock exchange works, and– How to read and understand the stock market information reported in the financial press.5-3The Primary and Secondary Stock Markets•ThePrimary market is the market where investors purchase newly issued securities.– Initial public offering (IPO): An initial public offer occurs when a company offers stock for sale to the public for the first time.•TheSecondary market is the market where investors trade previously issued securities. An investor can trade:– Directly with other investors.– Indirectly through a broker who arranges transactions for others.– Directly with a dealer who buys and sells securities from inventory.5-4The Primary Market for Common Stock• An IPO involves several steps.– Company appoints investment banking firm to arrange financing.– Investment banker designs the stock issue and arranges for fixed commitment or best effort underwriting.– Company prepares a prospectus (usually with outside help) and submits it to the Securities and Exchange Commission (SEC) for approval. Investment banker circulates preliminary prospectus (red herring).• Upon obtaining SEC approval, company finalizes prospectus. • Underwriters place announcements (tombstones) in newspapers and begin selling shares.5-5IPO Tombstone5-6The Secondary Market for Common Stock, I.•The bid price:– The price dealers pay investors.– The price investors receive from dealers •The ask price:– The price dealers receive from investors.– The price investors pay dealers. • The difference between the bid and ask prices is called the bid-ask spread, or simply spread.5-7The Secondary Market for Common Stock, II.• Most common stock trading is directed through an organized stock exchange or trading network.• Whether a stock exchange or trading network, the goal is to match investors wishing to buy stocks with investors wishing to sell stocks.5-8The New York Stock Exchange• The New York Stock Exchange (NYSE), popularly known as the Big Board, celebrated its bicentennial in 1992.• The NYSE has occupied its current building on Wall Street since the early 1900’s.• Today, the NYSE is a not-for-profit New York State corporation.5-9NYSE Membership• The NYSE has 1,366 exchange members. The exchange members– Are said to own “seats” on the exchange.– Collectively own the exchange, although it is managed by a professional staff.• The seats are regularly bought and sold. – In 2005, a seat sold at a record price, $3 million. – Seats can be leased, too.– Both prospective buyers and leaseholders are closely scrutinized.• Seat holders can buy and sell securities on the exchange floor without paying commissions.5-10Types of NYSE Members, I.• Over 500 NYSE members are commission brokers. • Commission brokers execute customer orders to buy and sell stocks.• Almost 500 NYSE members are specialists, or market makers. • Market makers are obligated to maintain a “fair and orderly market”for the securities assigned to them.5-11Types of NYSE Members, II.• When commission brokers are too busy, they may delegate some orders to floor brokers, or two-dollar brokers, for execution.– Floor brokers have become less important because of the efficient SuperDOT system (designated order turnaround), – SuperDOT allows orders to be transmitted electronically directly to the specialist.• A small number of NYSE members are floor traders, who independently trade for their own accounts.5-12NYSE-Listed Stocks• In 2005, stocks from about 2,800 companies were listed, with a collective market value of about $13 trillion.• An initial listing fee, as well as annual listing fees, is charged based on the number of shares.• To apply for listing, companies have to meet certain minimum requirements with respect to– The number of shareholders– Trading activity– The number and value of shares held in public hands– Annual earnings5-13Operation of the New York Stock Exchange• The fundamental business of the NYSE is to attract and process order flow.• In 2005, the average stock trading volume on the NYSE was just over 1 billion shares a day.• Volume breakdown: – About one-third from individual investors– Almost half from institutional investors. – The remainder represents NYSE-member trading, mostly from specialists acting as market makers.5-14NYSE Floor Activity• There are a number of specialist’s posts, each with a roughly figure-eight shape, on the floor of the exchange.• At the telephone booths, commission brokers:– Receive customer orders– Walk out to specialist’s posts where the orders can be executed,– Return to confirm order executions, and receive new customer orders.• Coat colors indicate the person’s job or position.5-15Stock Market Order Types5-16NASDAQ, I.• The name “NASDAQ” is derived from the acronym NASDAQ, which stands for National Association of Securities Dealers Automated Quotations system.• NASDAQ is now a proper name in its own right.• Introduced in 1971, the NASDAQ market is a computer network of securities dealers who disseminate timely security price quotes to Nasdaq subscribers.• The NASDAQ has more companies listed than the NYSE.• On most days, volume on the NASDAQ exceeds the NYSE volume.5-17NASDAQ, II.• Nasdaq is an Over-the-counter (OTC) market: trading is almost exclusively done through dealers who buy and sell securities for their own inventories.• NASDAQ is actually made up of two separate markets, the NASDAQ National Market (NNM) and the NASDAQ SmallCap Market.•There are two key differences between the NYSE and NASDAQ:• NASDAQ is a computer network and has no physical location where trading takes place.• NASDAQ has a multiple market maker system rather than a specialist system.• Like NYSE specialists, NASDAQ market makers use their inventory as a buffer to absorb buy and sell order imbalances.5-18NASDAQ, III.• In 2005, there were about 500 competing NASDAQ dealers (market makers), which amounts to about 15 or so stocks per dealer.• In the late 1990s, the NASDAQ system was opened to Electronic Communications Networks (ECNs)• ECNs are basically websites that allow investors to trade directly with one another.• Buy and


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UCSC ECON 80H - The Stock Market

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