Chapter 3Chapter 3

Equities MarketsEquities MarketsEquities MarketsEquities Markets

3-3-22

CHAPTER 3 OVERVIEWCHAPTER 3 OVERVIEW

3.13.1 Major U.S. Securities ExchangesMajor U.S. Securities Exchanges

3.2 3.2 Over-the-Counter (OTC) MarketsOver-the-Counter (OTC) Markets

3.33.3 Large-Company Stock IndexesLarge-Company Stock Indexes

3.43.4 Medium-Size Company Stock IndexesMedium-Size Company Stock Indexes

3.53.5 Small-Company Stock IndexesSmall-Company Stock Indexes

3.63.6 Global Stock IndexesGlobal Stock Indexes

3.7 3.7 Securities Market RegulationSecurities Market Regulation

3-3-33

KEY TERMSMarkets

KEY TERMSMarkets

NYSENYSE

agency auctionagency auction

specialistspecialist

round lotround lot

NASDNASD

AMEXAMEX

public floatpublic float

CBOECBOE

CBOTCBOT

Nasdaq Stock MarketNasdaq Stock Market

negotiated market negotiated market

market makersmarket makers

customer order flowcustomer order flow

market maker spreadmarket maker spread

inside market inside market

Nasdaq SmallCap MarketNasdaq SmallCap Market

penny stockpenny stock

OTCBBOTCBB

ADR (American Depositary ADR (American Depositary Receipts)Receipts)

3-3-44

Major U.S. Securities Exchanges

Major U.S. Securities Exchanges

New York Stock Exchange--founded 1817New York Stock Exchange--founded 1817

Home to 3,025 companiesHome to 3,025 companies

As of 12/99, 280.9 billion shares listed and available for tradingAs of 12/99, 280.9 billion shares listed and available for trading——worth $12.3 trillionworth $12.3 trillion

Private partnership that provides agency auction marketPrivate partnership that provides agency auction market——brokers brokers represent buyers and sellers; prices set by supply and demandrepresent buyers and sellers; prices set by supply and demand

Largest exchange in terms of market capitalization: 3700 issues listedLargest exchange in terms of market capitalization: 3700 issues listed

Specialists manage markets for individual stocks, providing liquidity to Specialists manage markets for individual stocks, providing liquidity to buyers and sellersbuyers and sellers

Liquidity:Liquidity:The ease with which the securities can be bought or sold without The ease with which the securities can be bought or sold without wide price fluctuation assuming that no significant information has arrived wide price fluctuation assuming that no significant information has arrived since the previous trade.since the previous trade.

Trades 80% of total trading volume (One billion shares per day)Trades 80% of total trading volume (One billion shares per day)

3-3-55

NYSE Listing Requirements & Fees

NYSE Listing Requirements & Fees

RequirementsRequirements

Minimum firm sizeMinimum firm size

Minimum number of round Minimum number of round lot holders/distributionlot holders/distribution

Company position/stability Company position/stability within industrieswithin industries

Minimum earnings, cash Minimum earnings, cash flow, global market flow, global market capitalizationcapitalization

FeesFees

Listing fees formulaListing fees formula

Continuing annual fee Continuing annual fee formula; $500,000 formula; $500,000 maximum yearly feemaximum yearly fee

Attracts largest and Attracts largest and most desirable U.S. most desirable U.S. and foreign firmsand foreign firms

http:// http:// www.www.nysenyse.com.com for more informationfor more information

3-3-66

Quick QuizQuick Quiz

T or FT or F Roughly 37,000 issues from more than 30,000 companies are Roughly 37,000 issues from more than 30,000 companies are

listed on the NYSE.listed on the NYSE.

T or FT or F In the stock market, a round lot is 100 shares.In the stock market, a round lot is 100 shares.

T or FT or F Listing on NYSE is open only to U.S. companies.Listing on NYSE is open only to U.S. companies.

T or FT or F At the NYSE, each listed stock is assigned to a single post, At the NYSE, each listed stock is assigned to a single post,

where the auction process is managed by a floor trader. where the auction process is managed by a floor trader.

3-3-77

Major U.S. Securities ExchangesNASD-AMEX Market Group (1998)

Major U.S. Securities ExchangesNASD-AMEX Market Group (1998)

National Association of National Association of Securities Dealers, Inc.—Securities Dealers, Inc.—industry self-regulationindustry self-regulation

AMEXAMEX——nation’s second nation’s second largest floor-based stock largest floor-based stock exchangeexchange

Market capitalization of over Market capitalization of over $100 billion$100 billion

Develops new investment Develops new investment products and innovative products and innovative servicesservices

NASD-AMEX Minimum listing NASD-AMEX Minimum listing requirements:requirements:

pretax income of $750,000pretax income of $750,000

public float of $3 millionpublic float of $3 million Public float: the market value of Public float: the market value of

common stock held by common stock held by unaffiliated institutional and unaffiliated institutional and individual investorsindividual investors

share price of $3share price of $3

three year operating historythree year operating history

stockholders’ equity of $4 stockholders’ equity of $4 millionmillion

500,000 to 1 million shares 500,000 to 1 million shares available for tradingavailable for trading

3-3-88

OPTIONSOPTIONS

Right to buy or sell a given amount or value of a Right to buy or sell a given amount or value of a particular asset at a fixed price until a given particular asset at a fixed price until a given expiration dateexpiration date

Call Option:Call Option: right to buy right to buy or call from the marketor call from the market

Put Option:Put Option: right to sell right to sell or put on the marketor put on the market

3-3-99

OPTIONS EXCHANGESOPTIONS EXCHANGES

Chicago Board Options Exchange (CBOE)Chicago Board Options Exchange (CBOE) Created standardized listed stock optionsCreated standardized listed stock options Became the country’s 2nd largest securities exchangeBecame the country’s 2nd largest securities exchange

World’s largest option exchangeWorld’s largest option exchange Options now traded on 5 U.S. Options now traded on 5 U.S.

exchangesexchanges Options on 1200 widely traded Options on 1200 widely traded

stocks plus broad indexesstocks plus broad indexes

3-3-1010

AUCTION MARKETS Futures Exchanges

AUCTION MARKETS Futures Exchanges

Futures:Futures: Financially secured binding agreement Financially secured binding agreement to buy or sell a commodity at a future timeto buy or sell a commodity at a future time

Seven futures exchanges for agricultural, Seven futures exchanges for agricultural, financial, and raw material productsfinancial, and raw material products

Largest 3 account for 90% of volume:Largest 3 account for 90% of volume: Chicago Board of TradeChicago Board of Trade——ag commoditiesag commodities Chicago Mercantile ExchangeChicago Mercantile Exchange——forexforex New York Mercantile ExchangeNew York Mercantile Exchange——oil products, oil products,

precious metalsprecious metals

3-3-1111

QUICK QUIZQUICK QUIZ

T or FT or F U.S. futures and futures option trading is U.S. futures and futures option trading is

concentrated on seven major exchanges. Among concentrated on seven major exchanges. Among these seven futures exchanges, the CBOT, CME these seven futures exchanges, the CBOT, CME and the New York Board of Trade are and the New York Board of Trade are commonly regarded as the “big three.” commonly regarded as the “big three.”

T or FT or F The CBOE is a forum for trading stocks.The CBOE is a forum for trading stocks.

3-3-1212

OVER-THE-COUNTER (OTC) MARKETS

OVER-THE-COUNTER (OTC) MARKETS

Negotiated marketsNegotiated markets——price determined through price determined through bargaining, often electronicallybargaining, often electronically

Nasdaq ranks second among world’s security Nasdaq ranks second among world’s security markets in terms of total dollar volumemarkets in terms of total dollar volume

Features market makersFeatures market makers——500 NASD member 500 NASD member firms who represent stocks and compete to buy and firms who represent stocks and compete to buy and sell stocks to customerssell stocks to customers

3-3-1313

NEGOTIATED VS. AUCTION MARKETSNEGOTIATED VS.

AUCTION MARKETS

Nasdaq market makers compete for customer order Nasdaq market makers compete for customer order flowflow——each stock usually has 10 market makerseach stock usually has 10 market makers

Customer order flow:Customer order flow: customer sell/buy activity customer sell/buy activity

BidBid:: offer to buy at a particular priceoffer to buy at a particular price

AskAsk:: offer to sell at a particular priceoffer to sell at a particular price

Spread:Spread: difference between bid and ask prices; difference between bid and ask prices; represent market makers’ profits represent market makers’ profits

Inside market is narrowest spreadInside market is narrowest spread——highest bid and highest bid and lowest offer priceslowest offer prices

3-3-1414

QUICK QUIZQUICK QUIZ

At the NYSE, the auction process for each listed At the NYSE, the auction process for each listed stock is assigned to a:stock is assigned to a:

a.a. BrokerBroker

b.b. Market MakerMarket Maker

c.c. DealerDealer

d.d. SpecialistSpecialist

a.a. BrokerBroker

b.b. Market MakerMarket Maker

c.c. DealerDealer

d.d. SpecialistSpecialist

3-3-1515

NASDAQListing Requirements

NASDAQListing Requirements

Significant net tangible assets or operating Significant net tangible assets or operating incomeincome

Minimum public float of 500,000 sharesMinimum public float of 500,000 shares At least 400 shareholdersAt least 400 shareholders Bid price of at least $5Bid price of at least $5 Nasdaq competes with AMEX and NYSE for Nasdaq competes with AMEX and NYSE for

company listingscompany listings

3-3-1616

Nasdaq SmallCap Market

Nasdaq SmallCap Market

1400 smaller companies that 1400 smaller companies that trade prior to listings on trade prior to listings on Nasdaq properNasdaq proper

No penny stocksNo penny stocks——minimum share price $1minimum share price $1

Lower requirements, but Lower requirements, but safeguards for market safeguards for market credibilitycredibility

3-3-1717

QUICK QUIZQUICK QUIZ

T or FT or F

Nasdaq is an agency auction market.Nasdaq is an agency auction market.

T or FT or F

On Nasdaq, each listed stock is assigned to a single post, where On Nasdaq, each listed stock is assigned to a single post, where the specialist manages the auction process.the specialist manages the auction process.

T or FT or F

The difference between the price at which a market maker is The difference between the price at which a market maker is willing to buy a security and the price which the firm is willing to buy a security and the price which the firm is willing to sell is called customer order flow.willing to sell is called customer order flow.

T or FT or F

The spread,The spread, difference between bid and ask prices, in a Nasdaq difference between bid and ask prices, in a Nasdaq security is the inside market.security is the inside market.

3-3-1818

Over-the-Counter Bulletin Board (OTCBB)

Over-the-Counter Bulletin Board (OTCBB)

Regulated quotation service that displays real-time Regulated quotation service that displays real-time quotes,last-sale prices, and volume info in OTC quotes,last-sale prices, and volume info in OTC securitiessecurities

Established as part of Penny Stock Reform Act of 1990 Established as part of Penny Stock Reform Act of 1990 to prevent manipulation and fraudto prevent manipulation and fraud

Monitored by online market surveillance systemsMonitored by online market surveillance systems

More information: http:// More information: http:// www.www.nasdaqnasdaq--amexamex.com.com

3-3-1919

QUICK QUIZQUICK QUIZ

T or FT or F

The OTCBB is an unregulated quotation The OTCBB is an unregulated quotation service that displays real-time quotes, last service that displays real-time quotes, last sale prices, and volume information in sale prices, and volume information in OTC equity securities. OTC equity securities.

3-3-2020

KEY TERMSIndexes

KEY TERMSIndexes

DJIADJIA DJIA divisorDJIA divisor S&P 500 IndexS&P 500 Index equity benchmarkequity benchmark Russell 3000 IndexRussell 3000 Index Russell 1000 IndexRussell 1000 Index Wilshire 5000 Equity IndexWilshire 5000 Equity Index Nasdaq Composite IndexNasdaq Composite Index Nasdaq 100 IndexNasdaq 100 Index S&P Midcap 400 IndexS&P Midcap 400 Index

Wilshire 4500 IndexWilshire 4500 Index Russell 2000 IndexRussell 2000 Index S&P SmallCap 600 IndexS&P SmallCap 600 Index FTSE-100FTSE-100 Nikkei 225 IndexNikkei 225 Index TSE-35TSE-35 Hang Seng IndexHang Seng Index EAFE IndexEAFE Index Emerging Markets vs. Emerging Markets vs.

Developed MarketsDeveloped Markets

3-3-2121

INDEXESDJIA

INDEXESDJIA

Way to track stock market at a glanceWay to track stock market at a glance

Started as simple averages of stock pricesStarted as simple averages of stock prices

First was the Dow Jones Industrial Average, which is now a First was the Dow Jones Industrial Average, which is now a price-weighted average of 30 large industrial companies’ price-weighted average of 30 large industrial companies’ stock pricesstock prices

Now uses the DJIA divisor, an adjustment factor to account Now uses the DJIA divisor, an adjustment factor to account for splits and substitutionsfor splits and substitutions

Formula: TextbookFormula: Textbook

3-3-2222

DJIA-ProblemDJIA-Problem

•DJIA Divisor: 0.20142568•(a)               A $1 rise in any component stock would cause the DJIA to rise by ______ points.•(b)               A 10% rise in a DJIA stock selling for $100 results in a ______ -point rise in the DJIA. A 10% rise in a DJIA stock selling for $200 results in a ______ -point rise in the DJIA •a.       A 10% change in the value of a high-priced DJIA stock would have a much (larger, smaller) on the index than a similar percentage change in the value of a low-priced component.•b.      (T, F) Higher-priced stocks tend to affect the index more than do the lower-priced stocks.•(c)               A 1-point rise in the DJIA reflects an average increase in the price of each component stock of _________.•(d)               DJIA = 11,000. One share of all 30 component companies costs roughly __________.

3-3-2323

DJIA-ProblemDJIA-Problem

**DJIA Divisor = 0,15 DJIA = 12000. A round lot of all 30 component stocks has an investment cost of _______.**DJIA Divisor = 0.15, a 100-point rise in the DJIA reflects an average increase in the price of each component stock of ______.

3-3-2424

LARGE-CAP INDEXES Largest & Most Stable CompaniesLARGE-CAP INDEXES

Largest & Most Stable Companies

S&P 500:S&P 500: value-weighted average market index value-weighted average market index Most popular equity benchmark for institutional Most popular equity benchmark for institutional

investorsinvestors——97% of money managers use it97% of money managers use it Broad cross-section of representative American Broad cross-section of representative American

companiescompanies——75% of U.S.total market capitalization75% of U.S.total market capitalization Uses 1941-43 as base yearUses 1941-43 as base year Formula: TextbookFormula: Textbook

3-3-2525

S&P 500-ProblemS&P 500-Problem

•(a) On September 28, 2000, the ratio of the closing market values of the S&P 500 composite stocks to the 1941-1943 base-period closing market values was 145.829 which results in an index value of ______.•(b)               September 28, 2000 S&P 500 Index = 1458.29 The lowest S&P 500 Index in the preceding 365-day period = 1247.41. It represented an increase of ____% in the market values of the stocks in the index.•(c)               MSFT comprises roughly 4% of the market value of stocks included in the S&P 500 Index. On a day that MSFT stock rises by 2%, it causes a rise in the S&P 500 of ______%.

3-3-2626

LARGE-CAP INDEXES Largest & Most Stable CompaniesLARGE-CAP INDEXES

Largest & Most Stable Companies

Russell 3000 and 1000:Russell 3000 and 1000: tracks largest companies in tracks largest companies in terms of total market capitalizationterms of total market capitalization

Wilshire 5000 Equity Index:Wilshire 5000 Equity Index: tracks total dollar tracks total dollar value of the US equity market by weighted stock value of the US equity market by weighted stock valuesvalues——broadest equity coverage.broadest equity coverage.

3-3-2727

U.S. MIDCAP INDEXESOpportunities for Stable Growth?U.S. MIDCAP INDEXESOpportunities for Stable Growth?

Nasdaq Composite Index:Nasdaq Composite Index: market-value market-value weighted index of 5,000 Nasdaq stocksweighted index of 5,000 Nasdaq stocks

Nasdaq 100:Nasdaq 100: largest Nasdaq issues across largest Nasdaq issues across industry groupsindustry groups

S&P MidCap 400 Index:S&P MidCap 400 Index: 400 companies with 400 companies with total market cap between $1.5 and $10 milliontotal market cap between $1.5 and $10 million

Wilshire 4500:Wilshire 4500: 6,700 companies’ stocks; 6,700 companies’ stocks; excludes S&P 500. Accounts for about 25% of excludes S&P 500. Accounts for about 25% of U.S. total market capitalizationU.S. total market capitalization

3-3-2828

SMALL CAP INDEXESReady to Break Out?

SMALL CAP INDEXESReady to Break Out?

Small Caps:Small Caps: publicly traded corporations with less than publicly traded corporations with less than $1.5 billion in market capitalization$1.5 billion in market capitalization

Russell 2000:Russell 2000: smallest companies, about 8% of total smallest companies, about 8% of total capitalizationcapitalization

Usually young and growing firms; list changes Usually young and growing firms; list changes annuallyannually

S&P SmallCap 600 Index:S&P SmallCap 600 Index: value weighted index of value weighted index of 600 domestic stocks chosen for market size, liquidity, 600 domestic stocks chosen for market size, liquidity, and industry group; index is popular due to lower and industry group; index is popular due to lower turnoverturnover

3-3-2929

GLOBAL STOCK INDEXES

GLOBAL STOCK INDEXES

Nikkei 225 Index:Nikkei 225 Index: Japan is second largest national Japan is second largest national stock market; index measures performance of 225 most stock market; index measures performance of 225 most liquid issues on Tokyo Stock Exchangeliquid issues on Tokyo Stock Exchange

FTSE 100:FTSE 100: capitalization-weighted index of 100 top capitalization-weighted index of 100 top market cap companies in 27 industriesmarket cap companies in 27 industries

TSE-35:TSE-35: market basket of 35 blue-chip Canadian market basket of 35 blue-chip Canadian stocks listed on the Toronto Stock Exchangestocks listed on the Toronto Stock Exchange

Hang Seng Index:Hang Seng Index: 33 largest companies from 10 33 largest companies from 10 industries listed on Hong Kong marketindustries listed on Hong Kong market

3-3-3030

Morgan Stanley Capital International Indexes

Morgan Stanley Capital International Indexes

Global equity benchmarks for international and Global equity benchmarks for international and regional marketsregional markets

Most widely used benchmark by international Most widely used benchmark by international portfolio managersportfolio managers

EAFE IndexEAFE Index——tracks investment returns of 21 tracks investment returns of 21 developed countries outside of North Americadeveloped countries outside of North America

Emerging vs. developed marketsEmerging vs. developed markets

3-3-3131

KEY TERMSRegulation

KEY TERMSRegulation

Securities and Exchange Securities and Exchange Commission (SEC)Commission (SEC)

Self-regulatory Self-regulatory organizations (SROs)organizations (SROs) NASDNASD NYSENYSE AMEXAMEX CBOECBOE Municipal Securities Municipal Securities

Rulemaking BoardRulemaking Board

Stock WatchStock Watch Intermarket Surveillance Intermarket Surveillance

GroupGroup Securities arbitrationSecurities arbitration Circuit breakers and Circuit breakers and

trading limitstrading limits

3-3-3232

SECURITIES MARKET REGULATIONLegislation Important to Investors,

Issuers of Securities, and Brokers/Dealers

SECURITIES MARKET REGULATIONLegislation Important to Investors,

Issuers of Securities, and Brokers/Dealers

Securities Act of 1933Securities Act of 1933 Applies to firms going publicApplies to firms going public

—issuing new securities—issuing new securities Requires firms to register with Requires firms to register with

government government Requires firms to provide Requires firms to provide

investors with financial and investors with financial and material information material information

Exempts private placements Exempts private placements and small issuesand small issues

Securities Exchange Act of Securities Exchange Act of 19341934 Focuses on securities Focuses on securities

tradingtrading Creates and authorizes Creates and authorizes

Securities and Exchange Securities and Exchange Commission (SEC) to Commission (SEC) to enforce statutes, rules, and enforce statutes, rules, and regulationsregulations

Protects investors against Protects investors against fraudfraud

3-3-3333

WALL STREET WISDOM

WALL STREET WISDOM

Current competition for regulatory controlCurrent competition for regulatory control

Federal Reserve, Comptroller of Currency, and Federal Reserve, Comptroller of Currency, and Federal Deposit Insurance Corporation each lay Federal Deposit Insurance Corporation each lay claim to authorityclaim to authority

1999: Repeal of Glass-Steagall Act1999: Repeal of Glass-Steagall Act

Among the questions: who protects federally Among the questions: who protects federally insured bank deposits in new landscape?insured bank deposits in new landscape?

3-3-3434

Self-Regulatory Organizations (SROs)

Self-Regulatory Organizations (SROs)

SEC delegates regulatory authoritySEC delegates regulatory authority National Association of Securities Dealers (NASD)National Association of Securities Dealers (NASD)

Regulates Nasdaq and OTCRegulates Nasdaq and OTC Monitors sales practicesMonitors sales practices Administers tests and licenses for individualsAdministers tests and licenses for individuals Ensures accurate sales informationEnsures accurate sales information

NYSE, AMEX, CBOE--business practices and market NYSE, AMEX, CBOE--business practices and market operationsoperations

Municipal Securities Rulemaking BoardMunicipal Securities Rulemaking Board BanksBanks——Fed Reserve, Comptroller of Currency, FDICFed Reserve, Comptroller of Currency, FDIC

3-3-3535

MARKET SURVEILLANCE

MARKET SURVEILLANCE

NYSE’s Stock WatchNYSE’s Stock Watch Flags unusual volume or price changesFlags unusual volume or price changes Investigates questionable tradesInvestigates questionable trades

Intermarket Surveillance GroupIntermarket Surveillance Group Shares information and coordinates efforts to Shares information and coordinates efforts to

detect manipulationdetect manipulation

Securities ArbitrationSecurities Arbitration Circuit Breakers and Trading LimitsCircuit Breakers and Trading Limits

3-3-3636

Qualifying As Securities Professional

Qualifying As Securities Professional

Register with NASD Register with NASD and othersand others

Clear FBI screeningClear FBI screening

Challenging examsChallenging exams

Series 7 (stock brokers)Series 7 (stock brokers)

Series 3 (commodities)Series 3 (commodities)

State examsState exams