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FIN 521 (6)
Chapter 4

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FIN 521
Eric Terry

Chapter 4: Securities Markets and the Economy*  Market: is the means through which buyers and sellers are brought together to aid in the transfer of goods and/or services - A market does not need to have a physical location - The market does not necessarily own the goods or services involved - A market can deal in any variety of goods and services  Characteristics of a good market: - Use characteristics such as strong, active, liquid, or illiquid 1. Timely and accurate information on the price and volume of past transactions 2. Liquidity, meaning an asset can be bought or sold quickly at a price close to the prices for previous transactions (has price continuity), assuming no new information has been received. In turn, price continuity requires depth. 3. Low transaction costs, including the cost of reaching the market, the actual brokerage costs, and the cost of transferring the asset. 4. Prices that rapidly adjust to new information, so the prevailing price are fair because it reflects all available information regarding the asset. [External (or informational) efficiency]  Organization of the Securities Market: - Primary markets: where new securities are sold, where new issues of bonds, preferred stocks, or common stock are sold by government units, municipalities, or companies to acquire new capital - Secondary markets: where outstanding securities are bought and sold  Government of Canada Bond Issues: - Subdivided into three segments based on their original maturities - Treasury Bills are negotiable, non-interest-bearing securities with original maturities of one year or less; medium-term bonds have 3- to 10- year maturities; and long-term bonds are typically issued with initial maturities over 10 years  Provincial and Municipal Bond Issues: - Nearly all the provinces, territories, and municipalities borrow money to finance public works and other such investments - Bonds issued by provinces and territories (including bonds issued by provincial authorizes that are guaranteed by the province) are typically called provincial bonds, while those issued by municipalities are called municipals  Corporate Bond Issues: - Almost always sold through a negotiated arrangement with an investment banking firm that maintains a relationship with the issuing firm - The expertise of the investment banker can help reduce the issuer’s cost of new capital  Corporate Stock Issues: - In addition to the ability to issue fixed-income securities to get new capital, corporations can also issue equity securities- generally, common stock - For corporations, new stock issues are typically divided into 2 groups: 1. Seasoned Equity Issues: are new shares offered by firms that already have stock outstanding 2. Initial Public Offerings (IPOs): involve a firm selling its common stock to the public for the first time - New Issues (seasoned or IPOs) are typically underwritten by investment bankers, who acquire the total issue from the company and sell the securities to interested investors o The underwriter gives advice to the corporation on the general characteristics of the issue, its pricing, and the timing of the offering o The underwriter also accepts the risk of selling the new issue after acquiring it from the corporation - Ontario Securities Commission (OSC) Short Form Prospectus Distribution (SPDF) system: allows issuers to file their annual and interim financial statements on a continuous basis, whether or not they intend on issuing securities o If the issuer needs to issue new securities, they need only provide supplementary material and the approval process then drops to a matter of days (appeals to underwriters as it reduces their pricing risk)  Private Placements: the firm designs an issue with the assistance of an investment banker and sells it to a small group of institutions - Firm enjoys lower issuing costs because it does not need to prepare the extensive registration statement required for a public offering  Secondary Financial Markets: permit trading in stocks or bonds that have already been sold to the public - The proceeds from a sale in the secondary market do not go to the issuer (the government or company), but rather to the current owner of the security - Why secondary markets are important? Because the secondary market involves the trading of securities initially sold in the primary market, it provides liquidity to the individuals who bought these securities. - Secondary Bond Markets: o In Canada, most trading in bonds occurs over-the-counter (OTC), that is, there is not formal market- just a network of dealers standing ready to buy and sell o For the government issues, many of the bonds are held as investments by the dealers as well as by large institutional investors. The corporate bond dealers do not carry extensive inventories of specific issues rather they hold a limited number of bonds desired by their clients, and when someone wants to do a trade, they work more like brokers than dealers. - Financial Futures: these contracts allow the holder to buy or sell a specified amount of a given bond issue at a stipulated price - Secondary Equity Markets: divided in three segments: national stock exchanges, regional stock exchanges, and OTC markets for stocks listed on an exchange o Basic Trading Systems: 1. Pure Auction Market (order-driven market): in which interested buyers and sellers submit bid- and-ask prices (buy and sell orders) for a given stock to a central location where the orders are matched (price-driven because shares are sold to the investor with the highest bid price and brought from the seller with the lowest offering price 2. Dealer market (quote- driven market): where individual dealers provide liquidity for investors by buying and selling the shares of stock for themselves o Call Market: the intent is to gather all the bids and asks for the stock at a point in time and attempt to arrive at a single price where the quantity demanded is as close as possible to the quantity supplied o Continuous Market: trades occur at any time the market is open wherein stocks are priced either by auction or by dealers  Classification of Secondary Equity Markets: - Primary Listing Markets: o Toronto Stock Exchange (TSX)- all trades are conducted electronically o New York Stock Exchange (NYSE)- the largest organized securities market in the US o An Aside on Global Stock Exchanges- the equity-market environment outside Canada is similar in that each country typically will have one relatively large exchange that dominates the market o The Global 24-Hour Market o The NASDAQ Market- is a dealer market, in contrast to a broker/ dealer (specialist) market as in the NYSE (second largest US secondary market in terms of number of issues traded) o Operation of the NASDAQ Market- stocks can be traded on the NASDAQ market as long as there are dealers willing to make a market by buying or selling for their own account o The NASDAQ Quotation System- automated, electronic quotation system o Listing Requirements for NASDAQ- quotes and trading volume for the NASDAQ market are reported on two lists: National Market System (NMS) list and a regular NASDAQ list o A Sample Trade o Changing Deale
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