Trading Locations
Stock Exchanges trading floors auction system central auction specialist system
Over-The-Counter Market no trading floor negotiated system multiple market maker system
Independent Electronic Trading Systems
Stock Exchanges in The US
Major National Stock Exchanges NYSE or Big Board AMEX or ASE or Curb
Regional Stock Exchanges Boston, Chicago,
Cincinnati, San Francisco, Philadelphia
OTC Market NASDAQ NASD
Types of Markets
First Market trading on exchanges of stocks listed on an exchange
Second Market trading in OTC market of stocks not listed on an
exchange
Third Market trading in OTC market of stocks listed on an
exchange
Fourth Market private transactions between institutional investors
International Stock Exchanges
Japan – Tokyo plus 7 othersUnited Kingdom – LondonGermany – FrankfurtFrance – ParisHong KongCanada – Toronto
Functions of Brokers
Receive and track ordersFind other partiesNegotiate pricesServer as focal point tradingExecute orders
Functions of Dealers (Market Makers)
Smooth out temporary supply/demand imbalances Supplies “immediacy”
Provide better price information Privileged access to order flow and limit
order informationAct as auctioneer
Short Selling
A way to “bet” that a security will fall in value Borrow the security and sell it
Economic value of short selling Limit upward bias
Limits on short selling “Tick” rules
Margin Transactions
Borrow funds using securities as collateral
Margin Requirements Initial margin Maintenance margin Margin call
Transactions Costs
Commissions Other Fees
Custodial fees Transfer fees
Execution Costs market impact market timing
Opportunity Costs
Trading Arrangements for Institutional Investors
Block TradingTrades of 10,000 shares or more of a given stock or trades with a market value of $200,000 or more.
Program TradingSimultaneous purchase or sale of shares in a large number of different stocks, which is computer-assisted.
Price Limits and Collars
Put in Place after the Stock Market
Crash of 1987
Trading or Price Limits
Rule 80B or Circuit Breakers
Rule 80A or Trading Collar
US Stock Market Indices
Dow Jones Industrial AverageS&P 500NYSE CompositeAMEXNASDAQ CompositeValue Line Composite Average
Major International Indices
World Morgan Stanley (EAFE)
Country Japan – Nikkei 225, Nikkei 300, Topix UK – FTSE 100, FTSE 250 Germany – DAX France – CAC Hong Kong – Hang Seng Canada – Toronto 300 Composite
Stock Market Indices
Issues in Construction Universe of stocks in index Relative weights
Price weightedEqually-weightedMarket value weighted
Averaging methodArithmeticGeometric
Efficient Market Hypothesis: Summary
Three forms of market efficiency• Weak form (random walk)
• Current prices reflect past prices and volume
• Technical analysis is useless
• Semi-strong form• Prices reflect all public information
• Most financial analysis is useless
• Strong form• Prices reflect all that is knowable
• Nobody consistently makes superior profits
Relationship among Three Different Information Sets
Informationset of
past prices
Information setof publicly available
information
All informationrelevant to a stock
Market Efficiency “Nuclear Weapons”
Argument for Efficiency: Performance of mutual funds – actively
managed mutual funds don’t beat the market
Argument against Efficiency Asset bubbles – Prices depart from
fundamental value on the high side for an extended period
Efficient Market Hypothesis: Summary
Does Not Say:• Prices are uncaused• Investors are foolish and too stupid to be in the
market• All shares of stock have the same expected returns• Investors should throw darts to select stocks• There is no upward trend in stock prices
Does Say• Prices reflect underlying value• Financial managers cannot time stock and bond sales• Sales of stock and bonds will not depress prices• You cannot cook the books
Market Anomalies
Small firmPrice to book (earnings)Neglected firmCalendar effects
January Turn of the month Weekend
Weather
Efficient Market Hypothesis: Summary
Why Doesn’t Everyone Believe It?• There are optical illusions, mirages and
apparent patterns in charts of stock and market returns
• The truth is less interesting• There is some evidence against efficiency
• Seasonality• Small vs large stocks• Value vs growth stocks
• Tests of market efficiency are weak
Pricing Efficiency of the Stock Market
Forms of Efficiency Weak form Semistrong form Strong form
Implications for Investing in Common Stock Active strategies Passive strategies
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