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CHAPTER 4 ORGANIZATION AND FUNCTIONING OF SECURITIES MARKETS Answers to Questions 1. A market is a means whereby buyers and sellers are brought together to aid in the transfer of goods and/or services. While it generally has a physical location it need not necessarily have one. Secondly, there is no requirement of ownership by those who establish and administer the market - they need only provide a cheap, smooth transfer of goods and/or services for a diverse clientele. A good market should provide accurate information on the price and volume of past transactions, and current supply and demand. Clearly, there should be rapid dissemination of this information. Adequate liquidity is desirable so that participants may buy and sell their goods and/or services rapidly, at a price reflecting the supply and demand. The costs of transferring ownership and middleman commissions should be low. Finally, the prevailing price should reflect all available information. 2. This is a good discussion question for class because you could explore with students what are some of the alternatives that are used by investors with regards to other assets such as art and antiques. Some possibilities are ads in the paper of your local community or large cities. Another obvious alternative is an auction. With an ad you would have to specify a price or be ready to negotiate with a buyer. With an auction you would be very uncertain of what you would receive. In all cases, there would be a substantial time problem. 3. Liquidity is the ability to sell an asset quickly at a price not substantially different from the current market assuming no new information is available. A share of AT&T is very liquid, while an antique would be a fairly illiquid asset. A share of AT&T is highly liquid since an investor could convert it into cash within 1/8 of a point (or less) of the current market price. An antique is illiquid since it is relatively difficult to find a buyer and then you are uncertain as to what price the prospective buyer would offer. 4. The primary market in securities is where new issues are sold by corporations to acquire new capital via the sale of bonds, preferred stock or common stock. The sale typically takes place through an investment banker. The secondary market is simply trading in outstanding securities. It involves transactions between owners after the issue has been sold to the public by the company. Consequently, the proceeds from the sale do not go to the company, as is the case with a primary offering. Thus, the price of the security is important to the buyer and seller. The functioning of the primary market would be seriously hampered in the absence of a good secondary market. A good secondary market provides liquidity to an investor if he 4 - 1
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or she wants to alter the composition of his or her portfolio from securities to other assets (i.e., house, etc.). Thus, investors would be reluctant to acquire securities in the primary
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