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INVESTMENTS:
Analysis and Management
Second Canadian Edition
W. Sean Cleary
Charles P. Jones
Chapter 4
Securities Markets
Learning Objectives
• Distinguish between primary and secondary
markets.
• Describe how the equity markets are organized
and how they operate.
• Explain what we mean by the third and fourth
markets.
• State the major stock market indicators.
• Describe, briefly, the bond and derivatives
markets.
• Discuss the factors behind rapid change in the
securities markets
Importance of Financial Markets
• Help firms and governments raise cash by
selling securities
• Channel funds from savers to borrowers
• Provide a place where investors can act on
their beliefs
• Help allocate cash to where it is most
productive
• Help lower the cost of exchange
Primary Markets
• New securities are issued in a primary market

Initial public offering (IPO) versus “seasoned”
new issue
•
IPO – Common stock shares of a company
being sold for the first time
• Issue facilitated by investment dealers


Specialists in advice, design, and sales
Intermediaries between issuer and investor
Investment Dealers
• Client advice includes type and features of
security, offer price, and timing of sale
• Underwriting services: Risk of selling to
investors assumed from issuer
• Coordinate marketing by helping issuer
register securities, issue prospectus, and sell
securities
Underwriting Process
•
•
•
The issuing company sell the securities to
the financing group which consists of one or
two firms
The financial group sells the securities to
the marketing group at a “draw down” price
The securities are distributed for sale to the
public
Issuance of Securities
• Prompt Offering Qualification (POP) System
allows senior reporting issuers to sell new
securities over time via “short form” prospectuses

Reduces issuance cost
• Listing process
• Global security issues
• A private placement means new securities are
sold to a small group of institutional investors

Registration not required
Secondary Markets
• Markets where investors trade previously
issued securities
• Auction markets involve bidding in a specific
physical location


Brokers represent investors for a fee
Others trade for their own account
• Negotiated markets consist of decentralized
dealer network
Stock Exchanges
• Toronto Stock Exchange (TSX) is a
secondary auction market for equity
securities


Largest Canadian stock market
Listing requirements for traded firms
• TSX Venture Exchange is Canada’s “junior”
stock market
• New York Stock Exchange (NYSE) is the
largest secondary market in the world
Stock Exchanges
• Formal organizations approved and regulated by
the SEC (or the provincial securities commissions
such as the OSC in Canada)
• Members

Can only trade listed stocks
 Must buy a seat on the exchange
• Listing requirements

minimum capitalization, shareholder equity,
average closing share price, etc.
General Exchange Initial Listing
Requirements (specifics may vary)
Standard
NYSE
Distribution
a) 2,000
round lot
holders
b) 1.1m
public
shares
Market Value
$100m
(public shares)
TSX
Nasdaq
(NM)
Nasdaq
(Sm. Cap)
a) 300 board
lot holders
b) 1m public
shares
a) 400 round
lot owners
b) 1.1m
a) 300 round
lot owners
b) 1m
$4m Cdn.
$75m
(or Total
Assets or
Total Sales >
$75m)
$50m
(or Stock
Equity >$5m
or Net Income
>$0.75m)
General Exchange Initial Listing
Requirements (cont’d)
Standard
NYSE
TSX
Nasdaq
(NM)
Nasdaq
(Sm. Cap)
Before-Tax
Earnings
from
Continuing
Operations
$6.5 m over
past 3
years:$2.5m
last year +
($2m/ $2m),
OR
$4.5m last
year and pos.
all 3 years
For Senior
Industrial
Companies:
$300,000 CDN
last year
$1m last
year (or in 2
of last 3
years)
$0.75m Net
Income
(or $5m Equity
or $50m Mkt.
Value)
Cash Flow
$25m
Operating
Cash Flow
over last 3
years
Pre-Tax CF
$0.7m last year
and prior 2-year
average
($0.5m)
N/A
N/A
New York Stock Exchange (NYSE)
• Centralized continuous auction market
• Exchange participants




single specialist
commission brokers
independent floor brokers
registered traders
• SuperDot
• Major roles of NYSE specialist




Dealer
Agent
Catalyst
Auctioneer
• Commissions

deregulated in 1975
Over-the-Counter (OTC) Markets
• Network of dealers standing ready to either buy
or sell securities at specified prices


Dealers profit from spread between buy and sell
prices
Handle unlisted securities
• Canadian OTC stocks are trading on the TSX
Venture Exchange
• US OTC Market: NASDAQ
Over-the-Counter (OTC) Markets
•
•
•
•
Trading unlisted stocks
Listing requirements
Nasdaq stock market
Nasdaq market tiers


Nasdaq National Market (3,600 co.’s)
Small Capitalization Market (850 co.’s)
• Nasdaq market makers
• Other OTC markets (8,000 co.’s)


OTC Bulletin Board
Pink Sheets
Third and Fourth Markets
• Third Market: Over-the-counter transactions in
securities listed on organized exchanges
• Fourth market: Trading network among
investors interested in buying and selling large
blocks of stock


Brokers, dealers bypassed so costs are low
Electronic or telephone network
Trading
• After-Hours Trading: Electronic
Communications Networks (ECNs) allow
investors to trade after exchange hours (4 to 8
P.M. EST, and sometimes early in the
morning)
• In-House Trading: this new trend has
significant implications for the NYSE
International Equity Markets
• Toronto Stock Exchange is the eighth-largest
stock exchange in the world

Many different equity markets exist
• Emerging markets


Generally less regulation and standardization of
trading activity
Risks: Illiquidity, lack of information, political
uncertainty
Equity Market Indicators
• Provide a composite report of market
behavior on a given day
• S&P/TSX Composite Index


Market value weighted
In 2004, comprised of 223 companies
representing almost 70 per cent of the market
capitalization
• S&P/TSX 60 Index

Designed to mimic the performance of the
S&P/TSX composite Index
Equity Market Indicators
• Dow Jones Industrial Average (DJIA)


Composed of 30 “blue-chip” stocks
Price weighted
• S&P 500 Composite Index


Composed of 500 “large” firm stocks
Market value weighted
• Nikkei 225 Average

Price weighted index of 225 actively-traded
stocks on the Tokyo Stock Exchange
Bond Markets
• Secondary bond market is primarily an overthe-counter network of dealers


Government of Canada bonds actively trade in
dealer markets
Corporate bonds are not as actively traded as
government issues
Market Developments
• Growth of institutional trading

Block trading of stocks (transactions of at least
10,000 shares)
•

Affects market structure and operation
Negotiated, not fixed, commissions
• Globalization of securities markets


24-hour trading
Instinet
Appendix 4-A
Stock Market Indexes
• S&P/TSX Composite Index
 Pit Qit
S & P / TSX 
(k )
 PibQib
• Dow Jones Industrial Average
DJIAt   Pit / n
*
Price Weighted Indexes
•
•
 Arithmetic average of current prices
 Assumes you purchase an equal number
shares of each stock represented in the index
 e.g., DJIA, Nikkei 225
Problems:
 Must adjust denominator downward for
splits
 Stocks with higher prices have greater
influence
PWI = [  of stock prices ] / [number of stocks
in index]
Value Weighted Indexes
•
•
 Total value (mkt. cap.) of all stocks in the
index
 Assumes you make a proportionate market
value investment in each company in the index
 e.g., S&P 500/ NYSE indexes
Problem:  Market Cap.,  impact on index
MVW = [ (Price today) (number of shares) /
(Price base) (number of Shares)] (Index Value
BEG)
Equal Weighted Indexes
•
 Unweighted index (e.g. Value-Line
Composite Average, Financial Times Index –
LSE)
 Assumed the investor makes an equal dollar
investment in each stock in the index
 Geometric average or arithmetic average
Problem:
 GA leads to downward bias since GA<AA
Copyright
Copyright © 2005 John Wiley & Sons Canada, Ltd. All rights
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