INVESTMENTS | BODIE, KANE, MARCUSCopyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinCHAPTER 3How Securities are TradedINVESTMENTS | BODIE, KANE, MARCUSHow Firms Issue Securities Primary Market Firms issue new securities through underwriter to public Investors get new securities; firm gets funding Secondary Market Investors trade previously issued securities among themselves2INVESTMENTS | BODIE, KANE, MARCUSHow Firms Issue Securities (Ctd.) Stocks IPO Seasoned offering Bonds Public offering Private placement3INVESTMENTS | BODIE, KANE, MARCUSInvestment Banking Underwriting: Investment bank helps the firm to issue and market new securities Prospectus: Describes the issue and the prospects of the company. Red herring4INVESTMENTS | BODIE, KANE, MARCUSFigure 3.1 Relationship Among a Firm Issuing Securities, the Underwriters, and the Public5INVESTMENTS | BODIE, KANE, MARCUSInvestment Banking Firm commitment investment bank purchases securities from the issuing company and then resells them to the public. Shelf Registration SEC Rule 415: Allows firms to register securities and gradually sell them to the public for two years6INVESTMENTS | BODIE, KANE, MARCUSInvestment Banking (Ctd.) Private placements Firm uses underwriter to sell securities to a small group of institutional or wealthy investors. Cheaper than public offerings Private placements not traded in secondary markets7INVESTMENTS | BODIE, KANE, MARCUSInitial Public Offerings Process Road shows to publicize new offeringBookbuilding to determine demand for the new issueDegree of investor interest in the new offering provides valuable pricing information8INVESTMENTS | BODIE, KANE, MARCUSFigure 3.3 Long-term Relative Performance of Initial Public Offerings9INVESTMENTS | BODIE, KANE, MARCUSHow Securities are TradedTypes of Markets: Direct search Buyers and sellers seek each other Brokered markets Brokers search out buyers and sellers10INVESTMENTS | BODIE, KANE, MARCUSHow Securities are TradedTypes of Markets: Dealer markets Dealers have inventories of assets from which they buy and sell Auction markets traders converge at one place to trade11INVESTMENTS | BODIE, KANE, MARCUSBid and Asked PricesBid Price Bids are offers to buy. In dealer markets, the bid price is the price at which the dealer is willing to buy. Investors “sell to the bid”. Bid-Asked spread is the profit for making a market in a security.Ask Price Asked prices represent offers to sell. In dealer markets, the asked price is the price at which the dealer is willing to sell. Investors must pay the asked price to buy the security.12INVESTMENTS | BODIE, KANE, MARCUSTypes of Orders Market Order: Executed immediatelyTrader receives current market price Price-contingent Order: Traders specify buying or selling price A large order may be filled at multiple prices13INVESTMENTS | BODIE, KANE, MARCUSFigure 3.5 Price-Contingent Orders14INVESTMENTS | BODIE, KANE, MARCUSTrading Mechanisms Dealer markets Electronic communication networks (ECNs) True trading systems that can automatically execute orders Specialists markets maintain a “fair and orderly market”15INVESTMENTS | BODIE, KANE, MARCUSNASDAQ Lists about 3,200 firms Originally, NASDAQ was primarily a dealer market with a price quotation system Today, NASDAQs Market Center offers a sophisticated electronic trading platform with automatic trade execution. Large orders may still be negotiated through brokers and dealers16INVESTMENTS | BODIE, KANE, MARCUSTable 3.1 Partial Requirements for Listing on NASDAQ Markets17INVESTMENTS | BODIE, KANE, MARCUSNew York Stock Exchange Lists about 2,800 firms Automatic electronic trading runs side- by-side with traditional broker/specialist system SuperDot : electronic order-routing system DirectPlus: fully automated execution for small orders Specialists: Handle large orders and maintain orderly trading18INVESTMENTS | BODIE, KANE, MARCUSTable 3.2 Some Initial Listing Requirements for the NYSE19INVESTMENTS | BODIE, KANE, MARCUSElectronic Communication Networks ECNs: Private computer networks that directly link buyers with sellers for automated order execution Major ECNs include NASDAQs Market Center, ArcaEx, Direct Edge, BATS, and LavaFlow. “Flash Trading”: Computer programs look for even the smallest mispricing opportunity and execute trades in tiny fractions of a second. 20INVESTMENTS | BODIE, KANE, MARCUSBond Trading Most bond trading takes place in the OTC market among bond dealers. Market for many bond issues is “thin”. NYSE is expanding its bond-trading system. NYSE Bonds is the largest centralized bond market of any U.S. exchange21INVESTMENTS | BODIE, KANE, MARCUSMarket Structure in Other Countries London - predominately electronic trading Euronext market formed by combination of the Paris, Amsterdam and Brussels exchanges, then merged