The Stock Market

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5. The Stock Market. Learning Objectives. How firms raise capital The difference between primary and secondary stock markets. The workings of the New York Stock Exchange. How NASDAQ operates. How to calculate index returns. - PowerPoint PPT Presentation

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<ul><li><p>5The Stock Market</p></li><li><p>Learning ObjectivesHow firms raise capitalThe difference between primary and secondary stock markets.The workings of the New York Stock Exchange.How NASDAQ operates.How to calculate index returns. How to read and understand the stock market information reported in the financial press.</p></li><li><p>How do firms raise capital?Private FundingPrivate equity Venture capitalFirst Stage or Ground Floor Second Stage or Mezzanine </p><p>Public FundingPrimary versus Secondary marketsInvestment banking firms</p></li><li><p>Private Equity and Venture CapitalPrivate Equity = equity financing for nonpublic companies.Target firms typically:Have no assets other than an ideaAre run by fledgling entrepreneurs with no track record.Venture capital (VC) = important part of the private equity market</p></li><li><p>Venture Capital, IVenture Capital = financing new, often high-risk, start-ups.Individual venture capitalists invest their own money.Venture capital firms pool funds from various sources, likeIndividualsPension fundsInsurance companiesStart-ups that succeed can provide enormous profits. Large corporations University endowments</p></li><li><p>Venture Capital, IITo limit their risk:Venture capitalists generally provide financing in stages.Venture capitalists actively help run the company.At each stage, enough money is invested to reach the next stage.Ground-floor financingMezzanine Level financing</p></li><li><p>Venture Capital, IIAt each stage of financing:The value of the founders stake grows The probability of success risesIf goals are not met, the venture capitalists withhold further financing.If a start-up succeeds:Big payoff = sale or IPOEither way, investment bankers often involved.</p></li><li><p>Public FundingEquity OfferingsIPOsSeasoned Equity OfferingsInvestment banking firmsUnderwriting Dutch Auction Underwriting</p></li><li><p>The Primary and Secondary Stock MarketsPrimary market Where investors purchase newly issued securitiesInitial public offering (IPO): When a company offers stock for sale to the public for the first timeSecondary market Where investors trade previously issued securities. An investor can trade:Directly with other investors.Indirectly through a broker Directly with a dealer</p></li><li><p>Initial Public Offering</p><p>Sheet1</p><p>COMPANYINVESTMENT BANKER</p><p>Select Investment banker</p><p>Design the stock issue</p><p>Arrange underwriting</p><p>Prepare preliminary prospectus (red herring)</p><p>Submit prospectus to SEC</p><p>Circulate prospectus</p><p>SEC approves preliminary prospectus</p><p>Finalize prospectus</p><p>Tombstones placed</p><p>Sell shares</p><p>Sheet2</p><p>Sheet3</p></li><li><p>IPO Tombstone</p></li><li><p>Dutch or Uniform Price AuctionBuyers:Bid a price and number of sharesSeller: Work down the list of biddersDetermine the highest price at which they can sell the desired number of shares</p><p>All successful bidders pay the same price per share.</p></li><li><p>Dutch Price Auction ExampleThe company wants to sell 1,500 shares of stock.The firm will sell 1,500 shares at $15 per share.Bidders A, B, C, and D will get shares.</p><p>NY NQ</p><p>NYSE vs NASDAQ</p><p>NSYENASDAQ</p><p>Founding dateMay 17, 17921971</p><p>Physical location/trading floorYesNo; computer network</p><p>Typcially referred to as:"The listed market""The over-the-counter market"</p><p>BrokersYes; specialistsNo</p><p>DealersYes; specialistsYes; market makers</p><p>Market maker per stock1 specialistMultiple market makers</p><p>Electronic tradingSuperDOT SystemAll electronic</p><p>Signature IndexNYSE CompositeNASDAQ 100</p><p>Listing requirementsYesNMS - Yes</p><p>NY NQ 2</p><p>NYSE vs NASDAQ</p><p>NSYENASDAQ</p><p>Founding dateMay 17, 17921971</p><p>Physical locationYesNo; computer network</p><p>Typcially referred to as:"The listed market""The over-the-counter market"</p><p>BrokersYes; specialistsNo</p><p>DealersYes; specialistsYes; market makers</p><p>Market maker per stock1 specialistMultiple market makers</p><p>Electronic tradingSuperDOT SystemAll electronic</p><p>Signature IndexNYSE CompositeNASDAQ 100</p><p>Listing requirementsYesNMS - Yes</p><p>Dutch Auction</p><p>BidderQuantityBid</p><p>A500$20500</p><p>B40018900</p><p>C250161150</p><p>D350151500</p><p>E200121700</p><p>NY NQ</p><p>NYSE vs NASDAQ</p><p>NSYENASDAQ</p><p>Founding dateMay 17, 17921971</p><p>Physical location/trading floorYesNo; computer network</p><p>Typcially referred to as:"The listed market""The over-the-counter market"</p><p>BrokersYes; specialistsNo</p><p>DealersYes; specialistsYes; market makers</p><p>Market maker per stock1 specialistMultiple market makers</p><p>Electronic tradingSuperDOT SystemAll electronic</p><p>Signature IndexNYSE CompositeNASDAQ 100</p><p>Listing requirementsYesNMS - Yes</p><p>NY NQ 2</p><p>NYSE vs NASDAQ</p><p>NSYENASDAQ</p><p>Founding dateMay 17, 17921971</p><p>Physical locationYesNo; computer network</p><p>Typcially referred to as:"The listed market""The over-the-counter market"</p><p>BrokersYes; specialistsNo</p><p>DealersYes; specialistsYes; market makers</p><p>Market maker per stock1 specialistMultiple market makers</p><p>Electronic tradingSuperDOT SystemAll electronic</p><p>Signature IndexNYSE CompositeNASDAQ 100</p><p>Listing requirementsYesNMS - Yes</p><p>Dutch Auction</p><p>BidderQuantityBid</p><p>A500$20500</p><p>B40018900</p><p>C250161150</p><p>D350151500</p><p>E200121700</p><p>Dutch Auction (2)</p><p>BidderQuantityBid</p><p>A500$20500</p><p>B40018900</p><p>C250161150</p><p>D350151500</p><p>E200121700</p></li><li><p>The Secondary Market for Common Stock Organized Exchanges &amp; MarketsNYSE (1792)NASDAQ (1971)The Regional ExchangesAmerican Stock Exchange (1842; NYSE-Euronext, 2008)Boston Stock Exchange (1834; Nasdaq, 2007)Chicago Stock Exchange (1882)Cincinnati Stock Exchange (1885; NSX, 2003)Pacific Stock Exchange (1882; Arca, 2005; NYSE,2006)Philadelphia Stock Exchange (1790; Nasdaq acquired 2008)Electronic Communications Networks (ECNs)</p></li><li><p>Brokers vs. DealersBrokerBrings buyers and sellers together to tradeDoes not hold inventoryThink Real Estate Broker</p><p>DealerMaintains an inventoryStands ready to buy or sell based on published quotesThink Used Car Dealer</p></li><li><p>Bid and Ask QuotesBid price:The price a dealer is willing to pay investors for a securityAsk price:The price at which a dealer is willing to sell a securityBid-ask spread, or spread:Difference between the bid and ask prices Inside Quotes:Highest Bid, Lowest Ask</p></li><li><p>The New York Stock ExchangeNYSE = The Big BoardPhysical location exchangeHistory:Founded in 1792 as a not-for-profit corporationIn current Wall Street building since early 1900sFor-profit, public NY state corporation in 2006Merged with Euronext N.V. in 2007 Launched NYSE Euronext, the largest stock exchange in the world</p></li><li><p>NYSE Seats and Trading LicensesHistorically, the NYSE had 1,366 exchange members. These members:Were said to own seats on the exchange.Collectively owned the exchangeProfessionals managed the exchange.Regularly bought and sold seats Record seat price: $3 million in 2005Seat holders could buy and sell securities on the exchange floor without paying commissions.</p></li><li><p>NYSE Seats and Trading LicensesIn 2006, NYSE went publicInstead of purchasing seats, exchange members purchase trading licenses:Number limited to 1,500In 2007, a license would set you back a cool $55,000per year. Having a license entitles the holder to buy and sell securities on the floor of the exchange.</p></li><li><p>NYSE-Listed Stocks2006 Listings:Global market value = $25 trillion</p><p>Minimum Listing RequirementsNumber of shareholdersTrading activityNumber and value of shares held in public handsAnnual earnings</p><p>Listing Fees:Initial listing fee and annual listing feesBased on the number of shares</p></li><li><p>Operation of the NYSEThe fundamental business of the NYSE is to attract and process order flow.In 2007, the average trading volume on the NYSE was over 2 billion shares a day.Volume breakdown: About one-third from individual investors.Almost half from institutional investors. The remainder represents NYSE-member trading, mostly from specialists acting as market makers.</p></li><li><p>Types of NYSE MembersSpecialists, or market makers:Obligated to maintain a fair and orderly market The CrowdCommission brokers:Execute customer orders to buy and sell stocksFloor brokers, or Two-dollar brokersExecute orders when commission brokers busyLess important due to SuperDOT system (designated order turnaround)Floor traders Independently trade for their own accounts</p></li><li><p>NYSE Floor ActivityThere are a number of specialists posts, each with a roughly figure-eight shape, on the floor of the exchange. At the telephone booths, commission brokers:Receive customer orders.Walk out to specialists posts where the orders can be executed,Return to confirm order executions, and receive new customer orders. Coat colors indicate the persons job or position.</p></li><li><p>Watching Trading on the Web</p></li><li><p>The New York Stock Exchange</p><p>Sheet1</p><p>NYSE vs NASDAQ</p><p>NSYENASDAQ</p><p>Founding dateMay 17, 17921971</p><p>Physical location/trading floorYesNo; computer network</p><p>Typcially referred to as:"The listed market"; "The Big Board""The over-the-counter market"</p><p>BrokersYes; specialistsNo</p><p>DealersYes; specialistsYes; market makers</p><p>Market maker per stock1 specialistMultiple market makers</p><p>Electronic tradingSuperDOT SystemAll electronic</p><p>Signature IndexNYSE CompositeNASDAQ 100</p><p>Listing requirementsYesNMS - Yes</p><p>Sheet1 (2)</p><p>NYSE vs NASDAQ</p><p>NSYENASDAQ</p><p>Founding dateMay 17, 17921971</p><p>Physical location/trading floorYesNo; computer network</p><p>Typcially referred to as:"The listed market""The over-the-counter market"</p><p>BrokersYes; specialistsNo</p><p>DealersYes; specialistsYes; market makers</p><p>Market maker per stock1 specialistMultiple market makers</p><p>Electronic tradingSuperDOT SystemAll electronic</p><p>Signature IndexNYSE CompositeNASDAQ 100</p><p>Listing requirementsYesNMS - Yes</p></li><li><p>NASDAQNational Association of Securities Dealers Automated Quotations</p><p>2nd largest stock market in U.S. in terms of $ volumeMore companies listed than the NYSE.Volume usually exceeds NYSE volume</p><p>Computer networkDisseminates price quotes to subscribersNo trading floor or physical location</p></li><li><p>NASDAQAn Over-the-counter (OTC) market: Dealers = market makersMultiple dealers per stockCompeting market makersBuy and sell from inventory</p><p>Three separate markets:The Global Select MarketThe Global MarketThe Capital Market</p></li><li><p>The NASDAQ SystemThe NASDAQ network provides bid and ask prices as well as recent transaction information.The bid and ask prices for the NASDAQ represent inside quotes.The highest bidThe lowest askFor a small fee, you can have access to Level II quotes.Displays all bids and asksFrequently displays the market maker identity</p></li><li><p>NASDAQ</p><p>Sheet1</p><p>NYSE vs NASDAQ</p><p>NSYENASDAQ</p><p>Founding dateMay 17, 17921971</p><p>Physical location/trading floorYesNo; computer network</p><p>Typcially referred to as:"The listed market""The over-the-counter market"</p><p>BrokersYes; specialistsNo</p><p>DealersYes; specialistsYes; market makers</p><p>Market maker per stock1 specialistMultiple market makers</p><p>Electronic tradingSuperDOT SystemAll electronic</p><p>Signature IndexNYSE CompositeNASDAQ 100</p><p>Listing requirementsYesNMS - Yes</p><p>Sheet1 (2)</p><p>NYSE vs NASDAQ</p><p>NSYENASDAQ</p><p>Founding dateMay 17, 17921971</p><p>Physical location/trading floorYesNo; computer network</p><p>Typcially referred to as:"The listed market""The over-the-counter market"</p><p>BrokersYes; specialistsNo</p><p>DealersYes; specialistsYes; market makers</p><p>Market maker per stock1 specialistMultiple market makers</p><p>Electronic tradingSuperDOT SystemAll electronic</p><p>Signature IndexNYSE CompositeNASDAQ 100</p><p>Listing requirementsYesNMS - Yes</p></li><li><p>NYSE vs. NASDAQ</p><p>Sheet1</p><p>NYSE vs NASDAQ</p><p>NSYENASDAQ</p><p>Founding dateMay 17, 17921971</p><p>Physical location/trading floorYesNo; computer network</p><p>Typcially referred to as:"The listed market""The over-the-counter market"</p><p>BrokersYes; specialistsNo</p><p>DealersYes; specialistsYes; market makers</p><p>Market maker per stock1 specialistMultiple market makers</p><p>Electronic tradingSuperDOT SystemAll electronic</p><p>Signature IndexNYSE CompositeNASDAQ 100</p><p>Listing requirementsYesNMS - Yes</p><p>Sheet1 (2)</p><p>NYSE vs NASDAQ</p><p>NSYENASDAQ</p><p>Founding dateMay 17, 17921971</p><p>Physical locationYesNo; computer network</p><p>Typcially referred to as:"The listed market""The over-the-counter market"</p><p>BrokersYes; specialistsNo</p><p>DealersYes; specialistsYes; market makers</p><p>Market maker per stock1 specialistMultiple market makers</p><p>Electronic tradingSuperDOT SystemAll electronic</p><p>Signature IndexNYSE CompositeNASDAQ 100</p><p>Listing requirementsYesNMS - Yes</p></li><li><p>Other Market VenuesThe Third MarketOff-exchange trading of exchange-listed securities The Fourth MarketDirect trading of both NYSE and NASDAQ stocks among investors. ECNs provide an avenue for fourth market trading.ECNs Electronic Communications NetworksThe Regional Exchanges Chicago, Cincinnati (NSX) Dually-listed stocks</p></li><li><p>NASDAQ, II.In the late 1990s, the NASDAQ system opened to electronic communications networks (ECNs)ECNs are basically websites that allow investors to trade directly with one another. </p></li><li><p>Stock Market Order Types</p></li><li><p>Market and Limit OrdersMarket Order: Buy 100 shares of IBM at the marketSell 200 shares of GE at the marketLimit Order:Buy 100 shares of IBM at $100 or betterSell 200 shares of GE at $35 or better</p><p>NY NQ</p><p>NYSE vs NASDAQ</p><p>NSYENASDAQ</p><p>Founding dateMay 17, 17921971</p><p>Physical location/trading floorYesNo; computer network</p><p>Typcially referred to as:"The listed market""The over-the-counter market"</p><p>BrokersYes; specialistsNo</p><p>DealersYes; specialistsYes; market makers</p><p>Market maker per stock1 specialistMultiple market makers</p><p>Electronic tradingSuperDOT SystemAll electronic</p><p>Signature IndexNYSE CompositeNASDAQ 100</p><p>Listing requirementsYesNMS - Yes</p><p>NY NQ 2</p><p>NYSE vs NASDAQ</p><p>NSYENASDAQ</p><p>Founding dateMay 17, 17921971</p><p>Physical locationYesNo; computer network</p><p>Typcially referred to as:"The listed market""The over-the-counter market"</p><p>BrokersYes; specialistsNo</p><p>DealersYes; specialistsYes; market makers</p><p>Market maker per stock1 specialistMultiple market makers</p><p>Electronic tradingSuperDOT SystemAll electronic</p><p>Signature IndexNYSE CompositeNASDAQ 100</p><p>Listing requirementsYesNMS - Yes</p><p>Dutch Auction</p><p>BidderQuantityBid</p><p>A500$20500</p><p>B40018900</p><p>C250161150</p><p>D350151500</p><p>E200121700</p><p>Dutch Auction (2)</p><p>BidderQuantityBid</p><p>A500$20500</p><p>B40018900</p><p>C250161150</p><p>D350151500</p><p>E200121700</p><p>Orders</p><p>MarketLimit</p><p>BuyPriceBest price availableBest price; not &gt; limit</p><p>ExecutionImmediateOnly if limit met</p><p>SellPriceBest price availableBest price; not &lt; limit</p><p>ExecutionImmediateOnly if limit met</p></li><li><p>Stock Market InformationThe most widely followed barometer of day-to-day stock market activity is the Dow Jones Industrial Average (DJIA), or Dow for short.</p><p>The DJIA is an index of the stock prices of 30 large companies representative of American industry.</p></li><li><p>The Dow Jones Industrial Average</p></li><li><p>Yields on DJIA Component Stocks</p></li><li><p>Stock Market IndexesDistinguishing features:Market coveredTypes of stocks includedNumber of stocks includedIndex calculation techniquePrice-weightedValue-weighted</p></li><li><p>Index WeightingPrice-WeightedStocks held in proportion to their share priceHigher priced stock = higher weightDJIA (3/08/2008: DJIA divisor = 0.122834016)Adjusted for stock splitsValue-WeightedStocks held in proportion to their total company market valuesCompany with larger market value = higher weightS&amp;P 500</p></li><li><p>Stock Market Indexes, III.</p></li><li><p>Price- vs. Value-WeightedThe Price-Weighted Index = Average share priceThe Value-Weighted Index = Total Market Value (# shares x Price)</p><p>NY NQ</p><p>NYSE vs NASDAQ</p><p>NSYENASDAQ</p><p>Founding dateMay 17, 17921971</p><p>Physical location/trading floorYesNo; computer network</p><p>Typcially referred to as:"The listed market""The over-the-counter market"</p><p>BrokersYes; specialistsNo</p><p>DealersYes; specialistsYes; market makers</p><p>Market maker per stock1 specialistMultiple market makers</p><p>Electronic tradin...</p></li></ul>