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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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  • 5The Stock Market

  • 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.

  • How do firms raise capital?Private FundingPrivate equity Venture capitalFirst Stage or Ground Floor Second Stage or Mezzanine

    Public FundingPrimary versus Secondary marketsInvestment banking firms

  • 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

  • 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

  • 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

  • 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.

  • Public FundingEquity OfferingsIPOsSeasoned Equity OfferingsInvestment banking firmsUnderwriting Dutch Auction Underwriting

  • 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

  • Initial Public Offering

    Sheet1

    COMPANYINVESTMENT BANKER

    Select Investment banker

    Design the stock issue

    Arrange underwriting

    Prepare preliminary prospectus (red herring)

    Submit prospectus to SEC

    Circulate prospectus

    SEC approves preliminary prospectus

    Finalize prospectus

    Tombstones placed

    Sell shares

    Sheet2

    Sheet3

  • IPO Tombstone

  • 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

    All successful bidders pay the same price per share.

  • 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.

    NY NQ

    NYSE vs NASDAQ

    NSYENASDAQ

    Founding dateMay 17, 17921971

    Physical location/trading floorYesNo; computer network

    Typcially referred to as:"The listed market""The over-the-counter market"

    BrokersYes; specialistsNo

    DealersYes; specialistsYes; market makers

    Market maker per stock1 specialistMultiple market makers

    Electronic tradingSuperDOT SystemAll electronic

    Signature IndexNYSE CompositeNASDAQ 100

    Listing requirementsYesNMS - Yes

    NY NQ 2

    NYSE vs NASDAQ

    NSYENASDAQ

    Founding dateMay 17, 17921971

    Physical locationYesNo; computer network

    Typcially referred to as:"The listed market""The over-the-counter market"

    BrokersYes; specialistsNo

    DealersYes; specialistsYes; market makers

    Market maker per stock1 specialistMultiple market makers

    Electronic tradingSuperDOT SystemAll electronic

    Signature IndexNYSE CompositeNASDAQ 100

    Listing requirementsYesNMS - Yes

    Dutch Auction

    BidderQuantityBid

    A500$20500

    B40018900

    C250161150

    D350151500

    E200121700

    NY NQ

    NYSE vs NASDAQ

    NSYENASDAQ

    Founding dateMay 17, 17921971

    Physical location/trading floorYesNo; computer network

    Typcially referred to as:"The listed market""The over-the-counter market"

    BrokersYes; specialistsNo

    DealersYes; specialistsYes; market makers

    Market maker per stock1 specialistMultiple market makers

    Electronic tradingSuperDOT SystemAll electronic

    Signature IndexNYSE CompositeNASDAQ 100

    Listing requirementsYesNMS - Yes

    NY NQ 2

    NYSE vs NASDAQ

    NSYENASDAQ

    Founding dateMay 17, 17921971

    Physical locationYesNo; computer network

    Typcially referred to as:"The listed market""The over-the-counter market"

    BrokersYes; specialistsNo

    DealersYes; specialistsYes; market makers

    Market maker per stock1 specialistMultiple market makers

    Electronic tradingSuperDOT SystemAll electronic

    Signature IndexNYSE CompositeNASDAQ 100

    Listing requirementsYesNMS - Yes

    Dutch Auction

    BidderQuantityBid

    A500$20500

    B40018900

    C250161150

    D350151500

    E200121700

    Dutch Auction (2)

    BidderQuantityBid

    A500$20500

    B40018900

    C250161150

    D350151500

    E200121700

  • The Secondary Market for Common Stock Organized Exchanges & 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)

  • Brokers vs. DealersBrokerBrings buyers and sellers together to tradeDoes not hold inventoryThink Real Estate Broker

    DealerMaintains an inventoryStands ready to buy or sell based on published quotesThink Used Car Dealer

  • 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

  • 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

  • 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.

  • 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.

  • NYSE-Listed Stocks2006 Listings:Global market value = $25 trillion

    Minimum Listing RequirementsNumber of shareholdersTrading activityNumber and value of shares held in public handsAnnual earnings

    Listing Fees:Initial listing fee and annual listing feesBased on the number of shares

  • 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.

  • 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

  • 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.

  • Watching Trading on the Web

  • The New York Stock Exchange

    Sheet1

    NYSE vs NASDAQ

    NSYENASDAQ

    Founding dateMay 17, 17921971

    Physical location/trading floorYesNo; computer network

    Typcially referred to as:"The listed market"; "The Big Board""The over-the-counter market"

    BrokersYes; specialistsNo

    DealersYes; specialistsYes; market makers

    Market maker per stock1 specialistMultiple market makers

    Electronic tradingSuperDOT SystemAll electronic

    Signature IndexNYSE CompositeNASDAQ 100

    Listing requirementsYesNMS - Yes

    Sheet1 (2)

    NYSE vs NASDAQ

    NSYENASDAQ

    Founding dateMay 17, 17921971

    Physical location/trading floorYesNo; computer network

    Typcially referred to as:"The listed market""The over-the-counter market"

    BrokersYes; specialistsNo

    DealersYes; specialistsYes; market makers

    Market maker