Chapter 8 Security Markets and Transactions Overview of the Security Markets Classified by o Maturity money market and capital markets Money markets where short term debt securities are bought and sold Short term 1 year Capital markets where long term debt and equity securities are bought and sold Long term 1 year o Who s doing the trading and who gets the money Primary and secondary markets Primary market where firms raise capital by issuing new stock shares or debt securities to the general public o Trade is between firm and investor o Selling new security issues to the general public Public offerings IPO Initial Public Offering o Typically refers to the first time a firm s stock is publicly traded Seasoned equity offerings new stock issue of an already publicly trading firm Private placements Rights offering discussed later o Purpose raise capital for firm o IPO Procedure 1 Issuing firm gets existing shareholders approval Selects underwriter investment bank Advise promote and facilitate sale of new shares SEC Securities and Exchange Commission Prospectus part of registration filing describing the issue and the issuer o Red herring preliminary prospectus prior to SEC approval o Approves only accuracy and completeness o IPO Procedure 2 information Quiet period time when firm must limit material Material info info that could cause normal investors to change their position on the firm s stock Ex new deals signed in current quarter management changes major product service announcements major partnership changes Road show presentations to potential investors Used to gauge interest level in the IPO o Number of shares to offer o What to set the offer price at Once stock trades publicly price is determined by supply and demand o Underwriting Process 1 Lead underwriter lead investment banker Typically buys entire issue at an agreed on price o Eliminates risk to issuing firm Syndicate additional investment bankers brought in by lead to share financial underwriting risk if needed Selling group investment banks and brokerage firms responsible for selling a part of the issue Good issues usually go to their best clients Compensation usually in the form of a discount to the expected sale price of the new securities o Underwriting Process 2 Tendency to underprice amount paid to issuing firm Higher profits Easier to sell Less underwriting risk Spread difference between Gross spread amount issuing firm leaves on the table IPOs are risky investments for retail investors Generally over perform 1st day Typically underperform 3 5 years Secondary market where securities are re traded o Trade is between investors Issuing firm not involved Issuing firm earns nothing o Issuing firm cares about price Market capitalization of shares x price per share o Role of secondary markets Provide liquidity so stocks can trade Continuous pricing mechanism o How Stocks Trade Technology has changed things Distinctions have blurred Reflects market judgement of new information We re practical This is how things are now o Trading process Dealer markets Virtual linked telecommunication networks o Dealers are market makers Their buy and sell offers keep trading going Stocks that trade come from their inventories Buyers and sellers don t come together 3 parties in every trade dealer in between 2 separate trades with same or different dealer s Buyer buys from a dealer Seller sells to a dealer o Dealer profit bid ask spread how does this work Broker markets Summation o Dealers must transact orders to make money o Dealer competition keeps bid ask spread small o The bid ask spread investor transaction cost o NASDAQ and the NYSE compete head to head Buyers and sellers brought together 2 party trades o Brokers facilitate deals not actively involved Trade occurs on trading floor physical location o Best known NYSE NY Stock exchange Designated market makers o Used to be called specialists Also has many electronic platforms Basic Characteristics o Brokers individuals or firms who provide a service Facilitators find counterparties to trade No active participation in transaction Profit commission o Dealers individuals or firms Active participants in transactions Hold inventories from which they buy and sell Alternative markets Profit bid ask spread Virtual computer networks no physical location The NYSE History o Oldest exchange predates computers o Physical location original gathering place for trades o Advantages Negotiation all parties represenatitives present Better pricing than fragmented markets Centralized trading fastest and most information No specialists Designated Market Maker DMM Acknowledgement of new ways to do business Times change o Designated market maker broker dealer o Listed firms have only one DMM o Agents of specialized financial firms o Provide meeting place post on exchange floor o Required to have stock inventory Electronic trading Obligated to maintain a fair and orderly market Keep stock prices moving in small steps If not trade from inventory liquidity s lacking Negotiate large trades o Most retail trades execute automatically o Most large trades are broken into smaller trades or negotiated o Hybrid system Fully electronic platforms Human involvement o Competes on equal footing with NASDAQ Forums where security buyers and sellers are brought together to execute trades Security exchanges o Virtual or physical o Regulated by SEC o Listing standards Set by specific exchange liquidity and viability Earnings Firm size market cap market value Delisting Trading Mechanisms Over the counter OTC dealer markets o Ex NASDAQ exchange bulletin boards pink sheets o Dealer quotes bid buy and ask sell prices Investor broker dealer order execution Quotes went from recorded to computerized o National association of securities dealers NASD creates single network to link dealers o Evolves from quote display to automatic order execution o 2006 SEC designates NASDAQ an exchange o Thousands of firms not listed on NASDAQ trade OTC Exchange trading with designated market makers DMM o Ex NYSE Electronic communication networks ECNs o Type of alternative trading system ATS 1 Non exchange trading venues Most use ECNs electronic communication network o ECNs trade electronically o ECNs require subscribership Not all alternative trading systems use ECNs Crossed orders match orders by price submitted by separate parties o No broker or dealer o No bid ask spread Profit very small fee per stock share traded Mainly used by institutional
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