Organisation and Function of Securities Markets

Organization and Functioning
of Securities Markets
Chapter 2
What is a Market?
A market is the means through which buyers and sellers are brought together to aid in the
transfer of goods and/or services.
 A market need not have a physical location

 The market does not necessarily own the goods or services involved
 A market can deal with any variety of goods and services
2
Characteristics of a good market
 Timely and accurate information
 Liquidity– the ability to sell an asset at a known price

– Price continuity– price does not changes much from one transaction to another.
– Continuous market
– Depth
 Internal Efficiency
» Low transaction costs
 External Efficiency
» Also called informational efficiency
» Ability to price in information quickly
3
Pricing in Securities Market
 Decimal Pricing
» Common stocks were previously quoted in fractions
» Stocks are now priced in decimals, so that minimum spreads can be in cents
» The reason for this switch was:

– Ease of investor to understand and compare prices
– Saving of investors’ money
– It made US markets more competitive and comparable
 Pricing in PSX
» Pricing at PSX is also done in decimal system
4
Organization of the securities market
 Securities market is divided into two main classes

» Primary Market– where new securities are sold
» Secondary Market– where outstanding securities are bought and sold
5
Primary Capital Market
The primary market is where new issues of bonds, preferred stocks, or common stocks are sold by
government units, municipalities, or companies to acquire new capital
 Government Bond Issues
» Treasury bills– negotiable, non-interest bearing, with original maturity of < 1 year
» Treasury Notes– with maturity of 2 to 10 years
» Treasury Bonds– with maturity of more than 10 years
 Government uses auctions to sell these securities
6
Primary Capital Market (Continued)
 Corporate Bond Issues
» These are almost done through a negotiated arrangement with an investment banker
» The origination function is becoming more important, which involve security in terms of
characteristics & currency
» Investment bankers compete by creating new instruments, hence cost of capital of issuer is
reduced
» An underwriting syndicate is put together to other underwriters or sellers for the issue’s
distribution
7
Primary Capital Market (Continued)
 Corporate Stock Issues
» New stock issues are divided into two groups

– Seasoned equity issues– new shares offered by firm that already have stock outstanding
– Initial public offerings– involve a firm selling its common stock to the public for first time
» New issues (either seasoned or IPO)– typically underwritten by Investment Bankers, who
acquire the total issue from the firm & sell to investors
» Therefore, investment banker/ under-writer provides three services to the issuer:

– Origination
– Risk bearing
– Distribution
8
Secondary Financial Markets
 Why Secondary Markets are Important
» It provides liquidity to individuals who acquire these securities
» Price discovery is facilitated
9
 Secondary Bond Market
» Government & Municipal Bond Market
– Treasury issues are sold through primary dealers
– Municipal issues are sold through banks and investment firms
» Secondary Corporate Bond Market

– They are traded over-the-counter by dealers
– Major dealers are usually large investment banking firms
10
 Secondary Equity Markets
» Basic Trading System
– Only qualified stocks can be traded by individuals who are member of the exchange
– There are two major trading systems:
– Pure auction market/ Price-driven Market
– Dealer Market/ Order-driven Market
» Call versus Continuous Markets

– Call => all bids & ask are gathered at a specific point in time and attempt to arrive at a single price
– Continuous Market => trade occurs at any time, the stocks are priced either by auction process or
dealers bid-ask quotes
11
Classification of secondary Markets
 Primary Listing Methods
» Primary listing markets are formal exchanges or markets where a corporate stock is
primarily or formally listed.
» There were three exchanges in Pakistan earlier:
– Karachi Stock Exchanges
– Lahore Stock Exchanges
– Islamabad Stock Exchange
» Now all three markets have been integrated into Pakistan Stock Exchange (PSX)
12
Classification of US secondary Markets
 The Third Market
» It involves dealers and brokers who trade shares that are listed on an exchange away
from the exchange
» Although most transactions in listed stocks do take place on an exchange, an
investment firm that is not a member of an exchange can make a market in listed
stocks away from the exchange
 The Fourth Market

» Direct exchange of securities between investors without using intermediary to save
cost
» Markets have developed alternative trading systems (ATS)
13
Detailed Analysis of Exchange Markets
 Exchange Membership
» Stock exchanges typically have 4 categories of membership
– Specialist => controls limit order books and trades for his own account
– Commission Broker => are employees of a member brokerage firm who buy & sell
securities for the customers of the firm
– Floor Broker => are independent/ freelance members of an exchange who act as brokers
for other member brokers
– Registered Trader => use their memberships to buy & sell for their own accounts
14
Analysis of Exchange Markets
 Types of Order
» Market Orders – to buy & sell a stock at best current price

» Limit Orders– an individual placing a limit order specifies the buy & sell price
» Short Sales– it is the sale of stock that you do not own with the intent of purchasing it back
later at a lower price
» Special Orders
– A stop loss
– Stop buy order
» Short sell
– To sell securities that seller does not own
– This is done when the seller expects a downturn in the market/ stock price
– The seller keeps a portion of the sales amount with the broker as deposit
15
Detailed Analysis of Exchange Markets
 Exchange Market Makers
» Most exchanges do not have a single market maker but have competing dealers
» Functions of specialist
– Brokers—match buy & sell orders; & handle special limit orders
– Dealers– maintain a fair & orderly market by providing liquidity
– They can enter either side of market & ensure price changes in an orderly fashion, which depends on:
– Current Inventory position
– Position of limit-order book
– Specialist income– driven from broker dealer function
16
Margin Transactions
 Margin transaction involve buying securities with borrowed money
 Return on margin transactions are higher (in both directions)
 Initial margin requirements

» The initial margin requirement is currently 50%
 Maintenance Margin
» It is related to the required equity position in the account (at 25%)
 Margin Call
» Trigger price (buy) = P(1-initial margin/1-maintenance margin)
» Trigger price (sell) = P(1+initial margin/1+maintenance margin)
17
Effects of the institutionalization
 Effects of the institutionalization of securities market
» Commissions
» Block Trading
» Stock Price Volatility
» National Market System
18
Players of the securities market
 Investors
 Speculators
 Institutional Investors
 Retail Investors
19

Organisation and Function of Securities Markets

Uploaded by

Copyright:

Available Formats

Organisation and Function of Securities Markets

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Organisation and Function of Securities Markets

Uploaded by

Copyright:

Available Formats

Organization and Functioning

 A market need not have a physical location

 Timely and accurate information

 Liquidity– the ability to sell an asset at a known price

» The reason for this switch was:

 Securities market is divided into two main classes

 Government uses auctions to sell these securities

» New stock issues are divided into two groups

» Therefore, investment banker/ under-writer provides three services to the issuer:

» It provides liquidity to individuals who acquire these securities

» Price discovery is facilitated

» Secondary Corporate Bond Market

» Call versus Continuous Markets

 The Fourth Market

» Stock exchanges typically have 4 categories of membership

» Market Orders – to buy & sell a stock at best current price

 Return on margin transactions are higher (in both directions)

 Initial margin requirements

» Stock Price Volatility

» National Market System

You might also like