ch6 - The Structure and Performance of Securities Markets...

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Unformatted text preview: The Structure and Performance of Securities Markets of Chapter 6 Nature and Function of Securities Markets of All markets bring sellers and buyers together Price balances supply and demand for the Price securities by all potential market participants all Key role of markets is to provide information to Key buyers/sellers buyers/sellers Markets reduce transaction costs – – – Buyers and sellers may be unaware of each other Different locations Different times Primary vs. Secondary Markets Primary Primary Markets – Deal in newly issued securities Secondary Markets – Deal in existing securities Primary Markets Primary Investment Banks Underwritings – Underwriting spreads Tombstone Ads Trading in this market is not in a physical Trading market, but electronically or personally between the investment bankers and ultimate investors—usually large institutional investors institutional Dallas Morning News – Monday, April 19, 1999 From Start to Finish: – The seven steps of the IPO process, and how The specifically went from “bake-off” to completion. to Initial Public Offerings Initial Secondary Markets Secondary Three main types: – Auction Market – Brokered Market – Dealer Market Market orders vs. Limit orders Auction Market Auction Buyers and sellers confront each other directly Buyers to set the price to Either a single trade between all parties at a Either single price or a series of trades at different prices prices Particular rules of the auction determine exactly Particular how buyers and sellers are matched up. how All buy/sell orders are centralized so highest All bidders and lowest offers are exposed to each other other Auction Market Auction Posts—Specific locations where auctions —Specific for individual securities take place for Specialists—Individual designated by the —Individual exchange to represent buy/sell orders tendered by customers tendered NYSE AMEX Brokered Market Brokered Buyers/sellers employ services of a broker to Buyers/sellers search for information about the “other side” of the trade the Broker’s role is to provide information Brokers earn a commission Real estate brokers—provide information for —provide buyers/sellers of homes buyers/sellers Municipal bonds are traded primarily in a Municipal brokered market brokered Dealer Market Dealer Security dealers sell/buy for their own account Help to stabilize the market Commit own capital in process of bringing Commit sellers and buyers together sellers Expect to earn a profit by “buying low and selling Expect high” high” Take a risk on a change of price in the securities Take they own Dealer Markets Dealer Most securities trade in dealer markets Over-the counter (OTC) – Network of dealers linked together by Network telephone or computers telephone – Most trades take place in a partially Most automated electronic stock market called NASDAQ—National Association of Security NASDAQ—National Dealers Automated Quotation System Dealers Dealer Markets Dealer Organizational structure of a dealer Organizational market and technological information keep transaction prices as close to true equilibrium as is economically feasible equilibrium Good marketability of a security implies it Good marketability can be sold, liquidated, and turned into cash very quickly without a collapse in price price Efficiency of Secondary Market Trading Efficient markets result in a transaction price close to true equilibrium price—highly liquid close Low transaction costs-timely information Walrasian auction – Auctioneer announces the price and asks Auctioneer buyers/sellers to submit quantities they want to buy or sell sell – If not equal, auctioneer raises or lowers price until the If market clears—quantity demanded is equal to market —quantity quantity supplied quantity – Exchange occurs at single equilibrium price Efficiency of Secondary Market Trading Market Financial markets operate differently with Financial transactions occurring continuously throughout the day at different prices throughout Dealers (market makers) quote a bid quote price at which they will buy (seller’s supply curve) and an offer price at which they will sell (buyer’s demand curve) sell Efficiency of Secondary Market Trading Market Dealer’s objective is to sell inventory that Dealer’s has been purchased before the equilibrium price has an opportunity to change change Since buyers/sellers are concerned that Since equilibrium price might change before the auction occurs, they may chose to transact at dealer’s bid and offer price. transact Measure of Liquidity Measure Spread between bid and asked prices – Bid Price—What dealer is willing to pay —What – Asked Price—What sellers are willing to accept Perfectly competitive markets trade at Perfectly equilibrium price—bid and asked prices are identical. identical. Wider bid-asked spreads indicate high Wider transaction costs, lack of information and transaction prices will differ from equilibrium prices prices Measure of Liquidity Measure Dealer will quote a narrow bid-asked spread if: – – – Expected value of transactions is large Expected risk of large equilibrium price change is low Competitive pressures from other dealers Although the spread is shown as a dollar amount, Although dollar comparison with the price indicates the percentage variation variation In general, higher transaction costs for equities result in a larger spread which reflects the greater risk of price fluctuation Ability of a market to handle large trades of institutional investors trades Does a large buy/sell order shift demand/supply Does curve and significantly alter the equilibrium price curve Characteristics of a stable market—low price Characteristics stable —low volatility volatility – Depth of market—easy to uncover buy/sell orders —easy above and below current prices above – Breadth of market—orders above/below current —orders prices exist in large volume prices – Resilience of market—new orders quickly pour in —new which prices move up or down which Efficiency of Secondary Market Trading Market Thin Markets —only a small volume of trading can be absorbed without causing wide price swings swings Equilibrium price changes are part of Equilibrium everyday price movement everyday – Reflect basic changes in supply/demand – Readily available information permits traders to Readily continuously monitor prices and quickly enter the market when prices deviate from equilibrium market – Contributes to price stability and liquidity Efficient Capital Markets Efficient Current price of a security reflects all publicly Current available information available Changes in information will cause the Changes demand/supply curves to shift, resulting in a change in the expected equilibrium price change – Can individual investors earn above-average returns Can by trying to “second-guess” the market? by – Security analysts and stock-brokerage firms advertise Security they can “out-perform” the market they Securities and Exchange Act of 1934 Securities Created the Securities and Exchange Created Commission (SEC) Commission – Established to prevent fraud and promote Established equitable and fair operations in securities market market – Despite the scrutiny of the SEC, investors, Despite and traders—manipulation, fraud, misinformation, and deception still exist in the market market The Securities and Exchange Commission (SEC) Commission Require full disclosure of information that Require might be relevant for valuing a security might Ban misinformation and dissemination of Ban false or misleading reports false Prohibit the use of insider information Prohibit ...
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