Financial Markets

Chapter 4 Charles P. Jones, Investments: Analysis and Management, Tenth Edition, John Wiley & Sons Prepared by G.D. Koppenhaver, Iowa State University

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The Role of Financial Markets

Help firms and governments raise cash by selling claims against themselves Provide a place where investors can act on their beliefs Help allocate cash to where it is most productive Help lower the cost of exchange

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Markets in New Securities

New securities are issued in a primary market

Initial public offerings versus seasoned new issues Specialists in advice, design, and sales Intermediaries between issuer and investor

Issue facilitated by investment banker

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Investment Banking

Client advice includes type and features of security, offer price, and timing of sale Underwriting services: Risk of selling to investors assumed from issuer Coordinates marketing by helping issuer register securities, issue prospectus, and sell securities

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Investment Banking

Rule 415 (shelf rule) allows certain issuers to sell new securities over time after filing a single registration

Reduces issuance cost

A private placement means new securities are sold directly to investors, bypassing the open market

Registration not required

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Secondary Markets

Markets where investors trade previously issued securities Auction markets involve bidding in a specific physical location

Brokers represent investors for a fee Others trade for their own account

Negotiated markets consist of decentralized dealer network

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Stock Exchanges

NYSE is a secondary, auction market in equity shares

Not-for-profit organization of members Listing requirements for traded firms Specialists assigned to each traded equity to make a market in that stock

AMEX and regional exchanges list smaller firms, have less volume than NYSE
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NASDAQ

Network of competing dealers trading listed securities Automated quotation system with no fixed number of participants

NASDAQ National Market NASDAQ SmallCap Market

More firms listed than NYSE Network connects to other trading systems
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Over-the-Counter Markets

Network of dealers standing ready to either buy or sell securities at specified prices

Dealers profit from spread between buy and sell prices Handle unlisted securities

OTC Bulletin Board ECNs: Additional trading mechanism, especially after exchanges close
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Foreign Markets

US equity markets account for a decreasing share of worlds stock market capitalization

Many different equity markets exist

Emerging market: Stable political system, low regulation, low standardization in trading activity

Risks: Illiquidity, lack of information, political uncertainty

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Equity Market Indicators

Provide a composite report of market behavior on a given day Dow Jones Industrial Average

Composed of 30 blue-chip stocks Price-weighted index: Essentially adds the prices of 30 stocks, divides by 30

Adjusted for stock splits, stock dividends

Oldest, most well-known measure

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Equity Market Indicators

Standard & Poors Composite Index

Composed of 500 large firm stocks Expressed as index number relative to a base index value of 10 (1941-43) Value-weighted index: Prices and shares outstanding considered

Indicates how much the average equity value of the 500 firms in the index has increased relative to the base period

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Equity Market Indicators

NYSE and NASDAQ Composite Indices

Value-weighted indices of broad markets

Price-weighted index of 225 actively-traded stocks on the Tokyo Stock Exchange

Nikkei 225 Average

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Bond Markets

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

NYSE features an automated bond system to execute orders.

Mostly corporate bonds, thinly traded

Treasury and agency bonds actively trade in dealer markets

Municipal bonds less actively traded

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Market Developments

Growth of institutional trading associated with:

Block trading of stocks (transactions of at least 10,000 shares)

Affects market structure and operation

Negotiated, not fixed, commissions

Evolution of National Market System

Centralized system for price and activity reporting, order routing and sequencing
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