Copyright 2014 Diane Scott Docking1 The Stock Market- Secondary Market

Copyright 2014 Diane Scott Docking 1

The Stock Market-Secondary Market

Copyright 2014 by Diane Scott Docking 2

Learning Objectives

Describe the major secondary markets. Examine the process by which a trade takes place in the

secondary stock market. Understand the role of brokers, dealers, specialists, and

market makers Understand a stock quote. Recognize the major stock market indices Understand the difference between a long position and a short

position in the stock market

3

Copyright 2014 by Diane Scott Docking

Secondary Stock Markets

Secondary stock markets the markets in which stocks, once issued, are traded

among investors The U.S. has two major stock market exchanges

New York Stock Exchange Euronext (NYSE Euronext) the American Stock Exchange (AMEX) was purchased

by NYSE Euronext on October 1, 2008 National Association of Securities Dealers

Automated Quotation (NASDAQ)

Secondary stock markets the markets in which stocks, once issued, are traded

among investors The U.S. has two major stock market exchanges

New York Stock Exchange Euronext (NYSE Euronext) the American Stock Exchange (AMEX) was purchased

by NYSE Euronext on October 1, 2008 National Association of Securities Dealers

Automated Quotation (NASDAQ)

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NYSE Euronext (aka: Big Board)

Created by the merger of NYSE Group, Inc. and Euronext N.V. on April 4, 2007 to become the first truly global stock market

As of April 2014, over 2,800 different stocks trade on NYSE Euronext, with a market capitalization of over $18 trillion.

Trading occurs at a specific place on the floor of the exchange called a trading post

Each stock has a special market maker called a specialist that maintains liquidity for the stock at all times http://www.nyse.com

Created by the merger of NYSE Group, Inc. and Euronext N.V. on April 4, 2007 to become the first truly global stock market

As of April 2014, over 2,800 different stocks trade on NYSE Euronext, with a market capitalization of over $18 trillion.

Trading occurs at a specific place on the floor of the exchange called a trading post

Each stock has a special market maker called a specialist that maintains liquidity for the stock at all times http://www.nyse.com

http://www.nyse.com/

http://www.nyse.com/

5 Copyright 2014 Diane Scott Docking

NASDAQ and OTC Markets

NASDAQ is the world’s first electronic market and has no physical trading floor

Provides continuous trading for the most active stocks traded over the counter (OTC)

Primarily a dealer market in which often more than 20 dealers act as market makers

A small order execution system (SOES) provides automatic order execution for orders of less than or equal to 1,000 shares

The NASD maintains an electronic “OTC bulletin board” and “pink sheets” for small firms that are not part of the NASDAQ

http://www.nasdaq.com

NASDAQ is the world’s first electronic market and has no physical trading floor

Provides continuous trading for the most active stocks traded over the counter (OTC)

Primarily a dealer market in which often more than 20 dealers act as market makers

A small order execution system (SOES) provides automatic order execution for orders of less than or equal to 1,000 shares

The NASD maintains an electronic “OTC bulletin board” and “pink sheets” for small firms that are not part of the NASDAQ

http://www.nasdaq.com

http://www.nasdaq.com/

http://www.nasdaq.com/

6


NYSE Euronext Characteristics

Extensive listing requirements E.g..: firm market value and trading volume NASDAQ requirements are less demanding

Annual Fees for listing* NYSE range from $42,000 - $500,000 (function of shares outstanding) NASDAQ range from $32,000 - $99,500 (function of shares outstanding

and global or non-global market)

Extensive listing requirements E.g..: firm market value and trading volume NASDAQ requirements are less demanding

Annual Fees for listing* NYSE range from $42,000 - $500,000 (function of shares outstanding) NASDAQ range from $32,000 - $99,500 (function of shares outstanding

and global or non-global market)

Listing Requirements* NYSE NASDAQ

Round-lot (100 shares) shareholders 400 450

Number of public shares (millions) 1.1 1.25

Market value of public shares ($ millions) $100 $45

Pre-tax income ($ millions) $2.00 $1.00

*As of 4/22/14

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NYSE Euronext Characteristics (cont.)

Extensive member requirements (Rule 300 and 301) Current fee http://www.nyse.com/pdfs/Trading_License_Client_Notice_053111.pdf

Qualifications http://www.nyse.com/equities/nyseequities/1167954368134.html

Legal age Provide personal business history Medical examination Recommendation letters Fingerprinting & background check Appearance before board Must pass Exchange trading qualifying exam Brokerage licenses Continuing education Training sessions

Extensive member requirements (Rule 300 and 301) Current fee http://www.nyse.com/pdfs/Trading_License_Client_Notice_053111.pdf

Qualifications http://www.nyse.com/equities/nyseequities/1167954368134.html

Legal age Provide personal business history Medical examination Recommendation letters Fingerprinting & background check Appearance before board Must pass Exchange trading qualifying exam Brokerage licenses Continuing education Training sessions

http://www.nyse.com/pdfs/Trading_License_Client_Notice_053111.pdf

http://www.nyse.com/equities/nyseequities/1167954368134.html

http://www.nyse.com/pdfs/Trading_License_Client_Notice_053111.pdf

http://www.nyse.com/equities/nyseequities/1167954368134.html

8



Electronic communication networks (ECNs) normal trading occurs between 9:30 a.m. and 4:00 p.m. eastern

standard time extended-hours trading occurs through computerized

alternative trading systems (ATSs) a.k.a. ECNs Online trading via the internet is available

Electronic communication networks (ECNs) normal trading occurs between 9:30 a.m. and 4:00 p.m. eastern

standard time extended-hours trading occurs through computerized

alternative trading systems (ATSs) a.k.a. ECNs Online trading via the internet is available

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Program trading the simultaneous buying and selling of a portfolio of at least 15

different stocks valued at more than $1 million using computer programs to initiate the trades

Circuit breakers Rule 80B Temporarily halts trading to give investors time to make

informed choices during periods of high market volatility

Program trading the simultaneous buying and selling of a portfolio of at least 15

different stocks valued at more than $1 million using computer programs to initiate the trades

Circuit breakers Rule 80B Temporarily halts trading to give investors time to make

informed choices during periods of high market volatility

10



Circuit breakers Rule 80B

(a) The Exchange shall halt trading in all stocks and shall not reopen for the time periods specified in this Rule if there is a Level 1, 2, or 3 Market Decline.

(i) For purposes of this Rule, a Market Decline means a decline in price of the S&P 500® Index between 9:30 a.m. and 4:00 p.m. on a trading day as compared to the closing price of the S&P 500® Index for the immediately preceding trading day. The Level 1, Level 2, and Level 3 Market Declines that will be applicable for the trading day will be publicly disseminated before 9:30 a.m.

(ii) A "Level 1 Market Decline" means a Market Decline of 7%.

(iii) A "Level 2 Market Decline" means a Market Decline of 13%.

(iv) A "Level 3 Market Decline" means a Market Decline of 20%.

Circuit breakers Rule 80B

(a) The Exchange shall halt trading in all stocks and shall not reopen for the time periods specified in this Rule if there is a Level 1, 2, or 3 Market Decline.

(i) For purposes of this Rule, a Market Decline means a decline in price of the S&P 500® Index between 9:30 a.m. and 4:00 p.m. on a trading day as compared to the closing price of the S&P 500® Index for the immediately preceding trading day. The Level 1, Level 2, and Level 3 Market Declines that will be applicable for the trading day will be publicly disseminated before 9:30 a.m.

(ii) A "Level 1 Market Decline" means a Market Decline of 7%.

(iii) A "Level 2 Market Decline" means a Market Decline of 13%.

(iv) A "Level 3 Market Decline" means a Market Decline of 20%.


How Trades Are ExecutedFloor ______

_____________

Market-______

_______


How Trades Are Executed

Acts on behalf of an investor who wishes to execute orders. May work for a brokerage house as their agent May work for self (dealer) Broker functions:

Receives, transmits and executes orders on the trading floor Brings together buyers and sellers Negotiates prices Completes the physical trade with other floor participants

In return, the broker receives a commission.

Floor Broker



Buys and sells stocks as a principal (for self). Individual, or Firm

Firm will have brokers acting as their agents.

Will hold inventory

Dealer



Specialists serve as brokers/dealers, matching buy/sell orders in a few, specific stocks on the exchange

Serve to maintain fair and orderly market i.e., they make a market in the security Will hold inventory

Works for a specialist firm which is an independent company in the business of trading listed

securities.

Specialists



Market-maker is registered to trade in a given security on the NASDAQ Like a specialist

A few stocks Create a market

Like a dealer Holds in inventory the stock.

Dealer functions: Takes a position (long or short) in the asset Provides opportunity to trade immediately Offers price information Serves as auctioneer

Dealer profit is the bid-ask spread. No specific location as with specialists on exchanges—telecommunications link Specialists and market-makers provide continuous market liquidity

Market-Makers


How to Read a Stock Quotation


Stock Quote

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14)

Name Symbol Open High Low Close Net Chg

% Chg Volume 52 Wk High

52 Wk Low

Div Yld P/E

Walmart WMT 78.31 78.78 78.02 78.62 +0.31 +0.40 5,396,525 81.37 71.51 1.92 2.44 16.01

www.finance.yahoo.com and www.wsj.com As of April 25, 2014

http://www.finance.yahoo.com/

http://www.wsj.com/


Stock Quote

YTD %

change Hi Lo Stock Sym DIV Yld% PE Vol 100s Close Net Chg

110.3 121.88 80.06 IBM IBM .56 .6 20 71979 93.77 11.06

Year-to-date Highest Lowest Name Stock Annual Dividend Price- Trading Closing Change in the

percentage price price of stock Symbol dividend yield, which earnings volume stock stock price

change in of the of the paid per represents ratio based during the price on the previ-

stock price stock stock year the annual on the previous ous trading

in this in this dividend as prevailing trading day day from the

year year a percentage stock price close on the

of the pre- day before

vailing stock

price

52-WEEK

Round lots traded

DIV / Close =

.56 / 93.77 =

.597% = .6%


Stock Indexes

8-20 Copyright 2014 Diane Scott Docking

Stock Market Indexes

A stock market index is the composite value of a group of secondary market-traded stocks

____________-weighted index the Dow Jones Industrial Average (DJIA), composed of 30

companies, is the most widely know stock market index ____________-weighted indexes

NYSE Composite Standard & Poor’s 500 NASDAQ Composite Wilshire 5000

A stock market index is the composite value of a group of secondary market-traded stocks

____________-weighted index the Dow Jones Industrial Average (DJIA), composed of 30

companies, is the most widely know stock market index ____________-weighted indexes

NYSE Composite Standard & Poor’s 500 NASDAQ Composite Wilshire 5000


Dow Jones Industrial Average http://www.djindexes.com/ Price-weighted average (aka: equally-weighted)

30 large U.S. firms Divisor: http://online.barrons.com/public/page/9_0210-djhfhravg.html;

http://wsj.com/mdc/public/page/2_3022-djiahourly.html

n

sharePrice

IndexValue

n

1i i

divisor

sharePrice

DJIA

30

1i i

http://www.djindexes.com/jsp/index.jsp

http://online.barrons.com/public/page/9_0210-djhfhravg.html

http://wsj.com/mdc/public/page/2_3022-djiahourly.html

Copyright 2014 by Diane Scott Docking22

Example: Price-Weighted IndexE.g.: PWIt Co. Price.sh # shs. o/s

A $ 10 1,000

B $ 50 20,000

C $100 2,000

3 $160

Index = $160 / 3 companies = 53.33

33.533

160

3

1005010

n

sharePrice

PWI

n

1i it

Copyright 2014 by Diane Scott Docking23

Example: Price-Weighted Index (cont.)

E.g.: PWIt+1 Co. Price.sh # shs. o/s

A $ 12 1,000

B $ 58 20,000

C $110 2,000

3 $180

Index = $180 / 3 companies = 60.00

% change in Index = (60.00 – 53.33)/53.33 = 12.507%

At t+1, share price changes.

00.603

180

3

1105812

n

sharePrice

PWI

n

1i i1t


24

Example: Price-Weighted Index (cont.)

E.g.: PWIt+2 Co. Price.sh # shs. o/s

A $ 12 $6 1,000 2,000

B $ 58 20,000

C $110 2,000

3 $174

Index = $174 / 2.9 = 60.00Divisor adjusts such that Index is same in PWIt+1

On t+2, A has a 2 for 1 stock split.

00.609.2

174

9.2

110586

divisor

sharePrice

PWI

n

1i i2t

Overall firm value of A did not change, so Index should not change.


DJIA ComputationAt 4/25/14:

Divisor4/25/14 = 0.15571590201117

DJIA4/25/14 = 16361.46

Components4/24/14= = $2,547.74 (see next slide)

30

1i ishare

Price

46.1636111171557159020.0

74.547,2$

divisor

sharePrice

DJIA

30

1i i4/25/14at

Components of DJIA at 4/25/14

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DJIA Components at April 24, 2014

Ticker Company 4/24/2014MMM 3M Co. 136.56AXP American Express Co. 87.03T AT&T 34.48BA Boeing Co. 128.66CAT Caterpillar Inc. 104.69CVX Chevron 123.99CSCO Cisco Systems Inc. 23.00DD E.I. DuPont de Nemours & Co. 66.66XOM Exxon Mobil 100.41GE General Electric Co. 26.60GS Goldman Sachs 158.24INTC Intel Corp. 26.26IBM International Business Machines Corp. 189.63JNJ Johnson & Johnson 99.79JPM JPMorgan Chase 55.71MCD McDonald's Corp. 100.73MRK Merck & Co. Inc. 57.24MSFT Microsoft Corp. 39.91NIKE Nike 72.70PFE Pfizer Inc. 30.75KO The Coca-Cola Co. 41.01HD The Home Depot Inc. 79.38PG The Procter & Gamble Co. 81.41TRV Travelers Cos. 88.31UTX United Technologies Corp. 117.21UNH UnitedHealth Group, Inc. 75.66VZ Verizon Communications 45.94V Visa 198.93WMT Wal-Mart Stores Inc. 78.62DIS Walt Disney Co. 78.23

2,547.74$

divide by divisor 0.15571590201117Computed DJIA 4/25/14 16361.46


27

Stock Indexes Standard and Poor’s (S&P) (1,863.40 on 4/25/14)

www.standardandpoors.com Value-weighted

S&P 500: 500 large U.S. firms S&P 400: 400 Mid-cap firms S&P 600: 600 Small-cap firms

http://finance.yahoo.com/ current index value

shares #

shares of # sharePrice

VW

n

1i i

Idivisor

n

1i i


500 P&S

http://www.standardandpoors.com/

http://finance.yahoo.com/


28

Example: Value-Weighted IndexE.g.: VWIt

Co. Price/sh x # shs. o/s = Market Value

A $ 10 1,000 $ 10,000

B $ 50 20,000 $1,000,000

C $100 2,000 $ 200,000

23,000 $1,210,000

Index = $1,210,000 / 23,000 = 52.608696

608696.52000,23

000,210,1$

shares #

shares of # share

Price

VWI

n

1i i

t


29

Example: Value-Weighted IndexE.g.: VWIt+1


A $ 12 1,000 $ 12,000

B $ 58 20,000 $1,160,000

C $110 2,000 $ 220,000

23,000 $1,392,000

Index = $1,392,000 / 23,000 = 60.521739% change in Index = (60.521739-52.608696)/52.608696 = 15.0413%

At t+1, share price changes.

521739.60000,23

000,392,1$

shares #


VWI

n

1i i1

t


30

Example: Value-Weighted IndexE.g.: VWIt+2


A $ 12 $6 1,000 2,000 $12,000

B $ 58 20,000 $1,160,000

C $110 2,000 $ 220,000

23,000 24,000 $1,392,000

Index = $1,392,000 / 23,000 = 60.521739Divisor adjusts such that Index is same as VWIt+1

On t+2, A has a 2 for 1 stock split.

521739.60000,23

000,392,1$shares of #

sharePrice

VWI

n

1i i2

divisort

Overall MV is same so Index should not change


S&P 500 Index

See 1950 to present (real time): http://finance.yahoo.com/echarts?s=%5EGSPC#chart1:symbol=^gspc;range=my;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;source=undefined

See last 2 years at:

http://finance.yahoo.com/echarts?s=%5EGSPC#chart1:symbol=^gspc;range=2y;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;source=undefined

http://finance.yahoo.com/echarts?s=%5EGSPC#chart1:symbol=%5Egspc;range=my;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;source=undefined



http://finance.yahoo.com/echarts?s=%5EGSPC#chart1:symbol=%5Egspc;range=2y;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;source=undefined




Types of Orders

Limit order

Stop order

Market orderOther types


Types of Orders

Market order Limit order Stop order (aka: stop-loss order)


Types of Orders

_________________ order At best available price


Types of Orders

______________order Order to buy or sell a set number of shares at a specified price or

better. Can limit length of time order can be outstanding before being canceled.

Typically cost more than market orders. Recorded in a “limit order book”

A record of unexecuted limit orders maintained by the specialist. BUY limit order – buy only at the designated price or lower

Designated price is _________ than current market price SELL limit order – sell at the designated price or higher

Designated price is _________ than current market price Beneficial because

investors get the specified purchase or sell price. useful on a low-volume or highly volatile stock.


Types of Orders

Limit order Buy limit order – buy only at the designated price or lower

Designated price is lower than current market price

PLimit_buy < PMV_current

E.g.: $19 < $20

Buy only at $19 or lower.

If short the stock, take profit and run.


Types of Orders

Limit order Sell limit order – sell at the designated price or higher

Designated price is greater than current market price

PLimit_sell > PMV_current

E.g.: $22 > $20

Sell only at $22 or higher.

If long the stock, take profit and run.


Limit Order Book for Intel on Archipelago


Types of Orders

____________ order (aka: stop-loss order) An order to buy or sell when price surpasses a particular price – at

which point the stop order becomes a market order. Not a 100% guarantee of getting the desired entry/exit price.

E.g., if a stock gaps down (up) then the stop sell (buy) order will be triggered (or filled) at a price significantly lower (higher) than expected

Stop order to BUY – order is not to be executed until the market rises to a designated price Designated price is _______ than the current market price

Stop order to SELL – order is not to be executed until the market falls to a designated price Designated price is _______ than the current market price

Beneficial because Commonly used before leaving for holidays or entering a situation

where unable to monitor their portfolio for an extended period. Ensures a greater probability of achieving a predetermined entry or exit

price, limiting the investor's loss or locking in his/her profit.


Types of Orders

Stop order (aka: stop-loss order) Stop order to buy – order is not to be executed until the

market rises to a designated price Designated price is greater than the current market price

PStop_buy > PMV_current

E.g.: $25 > $20

Buy only if price gets to $25.Idea is to buy it before price gets too high:

- Cover a short position before price gets too high, or - Go long (buy the stock) before it becomes too expensive

If price gaps up to $30 may end up buying at $30, than the expected $25; but guaranteed to own the stock.


Types of Orders Stop order (aka: stop-loss order)

Stop order to SELL – order is not to be executed until the market rises to a designated price Designated price is lower than the current market price

PStop_sell < PMV_current

E.g.: $15 < $20

Sell only if price fall to $15.

Idea is to sell it before price gets too low: - Get out of a long position. Take profit and run or cut losses.

If price gaps down to $10 may end up selling at $10, than the expected $15; but guaranteed to sell the stock.


Types of Orders

Size-Related orders Round lot – 100 shares Odd lot – less than 100 shares Block trade – large trades of 10,000 or mores

shares or MV ≥ $200,000


Short Selling

44

Short Sales

Note that an investor who buys and owns shares of stock is said to be “long the stock” or to have a “long position.”

• Short Sale is a sale in which the seller does not actually own the security that is sold.

Borrowsharesfrom

someone

Borrowsharesfrom

someone

Sell theShares in the market

Sell theShares in the market

Buyshares

From themarket

Buyshares

From themarket

Returnthe

shares

Returnthe

shares

Today In the Future

Copyright 2014 Diane Scott Docking

45

Short Sales

An investor with a long position benefits from price increases. Easy to understand You buy today at $34, and sell later at $57, you profit! Buy low, sell high

An investor with a short position benefits from price decreases. Also easy to understand You sell today at $83, and buy later at $27, you profit. Sell high, buy low



Short Selling In a short sale, investor borrows and sells stock Promises to pay back stock later Short seller hopes stock price declines to provide

gain Short seller covers dividend payments while

borrowing stock Limited gain; unlimited losses

47

Example 1: Short Sales

You short 100 shares of Texas Instruments (TXN) at $30 per share. The value of stock borrowed that will be sold short is: $30 × 100 shs

= $3,000 NOTE: YOU MUST PUT UP FUNDS TO SHORT A STOCK!

1) Assume in 1 year the stock has a value of $20 per share. What is your gain/loss?

2) Assume in 1 year the stock has a value of $40 per share. What is your gain/loss?


48


Assume in 1 year the stock has a value of $20 per share. What is your gain/loss and return?

Sell $30Buy -$20Gain $10 / sh. X 100 shs. = _________________


49


Assume in 1 year the stock has a value of $40 per share. What is your gain/loss and return?

Sell $30Buy -$40Loss -$10 / sh. X 100 shs. = _______________



REGULATION OF SECURITIES MARKETS

51 Copyright 2014 Diane Scott Docking

Stock Market Regulations

The Securities and Exchange Commission (SEC) is the primary regulator of stock markets

The main emphasis of SEC regulation is on full and fair disclosure of information on securities

Securities Act of 1933/Securities Exchange Act of 1934 The SEC delegates certain regulatory responsibilities to

the exchanges for the day-to-day surveillance of activity Recently imposed regulations aim to reduce excessive

price fluctuations and increase auditing oversight

The Securities and Exchange Commission (SEC) is the primary regulator of stock markets

The main emphasis of SEC regulation is on full and fair disclosure of information on securities

Securities Act of 1933/Securities Exchange Act of 1934 The SEC delegates certain regulatory responsibilities to

the exchanges for the day-to-day surveillance of activity Recently imposed regulations aim to reduce excessive

price fluctuations and increase auditing oversight


SEC Oversight of Corporate Disclosure

Regulation Fair Disclosure (FD), October, 2000 Requires corporations to disclose relevant information

broadly to investors at the same time Forbade old practice of providing selected analysts new

information during teleconference calls Means of disclosing new information

Company Web site—Web cast 8-k form filing News release Above simultaneously with conference call

Documents

Copyright 2014 Diane Scott Docking1 The Stock Market- Secondary Market