THE MARKETPLACE
CHAPTER THREE
Practical Investment Management
Robert A,Strong
3 - 2Strong C3 – The Marketplace
An exchange serves three principal functions.
The Role of the Capital Markets
? Continuous Pricing Function
? Fair Pricing Function
? Economic Function
3 - 3Strong C3 – The Marketplace
Capital markets facilitate the flow of
capital from savers to borrowers.
Capital
Savers Borrowers
Capital Market
Economic Function
3 - 4Strong C3 – The Marketplace
Bank
Banks offer home
mortgages so that home
buyers who are short of
cash can borrow money
to buy houses.
$
$
Mortgage
Home Seller
Home Buyer
Home
Ownership
Economic Function,An Example
3 - 5Strong C3 – The Marketplace
$
$
Mortgage
Mortgage-
backed
securities
Bank
Investors
Gov’t
Agency
Facilitated by
government agencies
such as the Federal National
Mortgage Association,banks
sell the mortgages to
investors with surplus cash.
Economic Function,An Example
3 - 6Strong C3 – The Marketplace
The primary market is the,new
securities” market where securities
are sold to the public for the first
time.
The secondary market is the,used securities”
market,where previously issued securities
are traded among security holders.
Economic Function
3 - 7Strong C3 – The Marketplace
Dollar Holdings
Investor Group (billions) % of Total
Household sector $6,579 38.70%
State/local governments 115 0.68
Rest of world 1,712 10.07
Bank trusts/estates 315 1.85
Life insurance companies 938 5.52
Other insurance companies 179 1.05
Private pension funds 1,999 11.76
State/local retirement funds 1,937 11.39
Mutual funds 3,226 18.98
Total $17,000 100.00
Economic Function
3 - 8Strong C3 – The Marketplace
Capital markets enable market participants to
get accurate,up-to-date price information.
Continuous Pricing Function
3 - 9Strong C3 – The Marketplace
Capital markets remove the fear that people
have of buying or selling at a rip-off price.
The greater the number of participants and
the more formal the marketplace,the
“fairer” the price.
Fair Pricing Function
3 - 10Strong C3 – The Marketplace
Functions of the Capital Markets
?Fair price function
?Continuous pricing function
?Economic function
The Role of the Capital Markets
United States
National Exchanges
New York Stock Exchange (NYSE)
American Stock Exchange (till 1999)
Regional Exchanges
e.g,Philadelphia Stock Exchange
International
Exchanges
e.g,England,
France,
Japan,
Thailand
The Exchanges
3 - 12Strong C3 – The Marketplace
Trading Systems
? Specialists are charged with making a fair
and orderly market in one or more
assigned securities at posts on the
exchange floor.
? SuperDot and NYSE Direct+ are electronic
systems enabling NYSE firms to send
market and limit orders directly to the
specialists’ posts.
? Marketmakers are groups of competing
individuals who maintain a fair and orderly
market through open outcry trading in pits
on the exchange floor.
3 - 13Strong C3 – The Marketplace
Both trading curbs and circuit
breakers are designed to reduce
temporary volatility in the market.
At the NYSE,when the Dow Jones Industrial
Average fluctuates by more than 2%,the
circuit breaker is activated and computerized
trading becomes restricted.
When a trading curb is triggered,all trading at
the exchange is halted.
Circuit Breakers and Trading Curbs
3 - 14Strong C3 – The Marketplace
? The Nasdaq (National Association of
Securities Dealers Automated Quotations)
market is a worldwide computerized linkup
of brokerage firms,investment houses and
large commercial banks.
? The Nasdaq market is sometimes still
erroneously called the over-the-counter
(OTC) market.
The Nasdaq Stock Market
3 - 15Strong C3 – The Marketplace
The Nasdaq Stock Market
? In Nasdaq trading,bids and offers for
securities ranging from small unfamiliar
firms to some of the largest companies in
the world are posted to an electronic
bulletin board.
? Trades of up to 1,000 shares can be
executed in less than one minute via the
Small Order Execution System (SOES).
3 - 16Strong C3 – The Marketplace
? The Nasdaq stock market comprises two
distinct markets:
?The Nasdaq National Market,The largest
and most established firms in the
Nasdaq market are the national market
issues.
?The Nasdaq Small Cap Market,These
small-cap issues have a low level of
capitalization.
The Nasdaq Stock Market
3 - 17Strong C3 – The Marketplace
The Over-the-Counter Market
? Today,the term OTC equity security refers
to an equity security that is not traded on
Nasdaq or a national or regional exchange.
? OTC securities trade in two ways:
?The OTC Bulletin Board (OTCBB) is a
regulated quotation service providing
real-time information.
?Data on the smallest and often most
speculative pink sheet stocks can be
accessed via the Internet.
3 - 18Strong C3 – The Marketplace
The Over-the-Counter Market
Insert Figure 3-5 here.
3 - 19Strong C3 – The Marketplace
Third and Fourth Markets
? The trading of listed securities in the
Nasdaq market is known as the third
market.
? Direct trades between large institutional
investors comprise the fourth market.
3 - 20Strong C3 – The Marketplace
Regulation
? The Exchanges have rules regarding…
? the financial capacity of members
serving as stock specialists
? the financial & market activity of listed
firms
? the disclosure & annual reporting of
listed firms
3 - 21Strong C3 – The Marketplace
? The Securities and Exchange Commission
(SEC) was established …
? to ensure that investors have adequate
information to make an informed investment
decision
? to help prevent price manipulations and abuses
like the Ponzi scheme
? Two primary acts influencing the
investment industry today are the
Securities Act of 1933 and the Securities
Exchange Act of 1934.
Regulation
3 - 22Strong C3 – The Marketplace
? The National Association of Security
Dealers (NASD) is a self-regulatory body
that licenses brokers and generally
oversees the trading practices of OTC
securities.
? The Securities Investor Protection
Corporation (SIPC) protects investors from
loss due to brokerage firm failure,fraud,
natural disaster,or theft.
Regulation
3 - 23Strong C3 – The Marketplace
Ethics
? A wide range of investment activities may
be legal but carry substantial ethical
baggage.
? The Chartered Financial Analyst (CFA)
program promotes investment education
and ethical behavior among those involved
in the investment business.
? The program is administered by the
Association for Investment Management
and Research (AIMR).
3 - 24Strong C3 – The Marketplace
? To earn a CFA designation,candidates
must pass three separate exams taken at
least a year apart.
? Persons who have earned the CFA
designation must subscribe to the AIMR
standards of professional conduct.
Ethics
CHAPTER THREE
Practical Investment Management
Robert A,Strong
3 - 2Strong C3 – The Marketplace
An exchange serves three principal functions.
The Role of the Capital Markets
? Continuous Pricing Function
? Fair Pricing Function
? Economic Function
3 - 3Strong C3 – The Marketplace
Capital markets facilitate the flow of
capital from savers to borrowers.
Capital
Savers Borrowers
Capital Market
Economic Function
3 - 4Strong C3 – The Marketplace
Bank
Banks offer home
mortgages so that home
buyers who are short of
cash can borrow money
to buy houses.
$
$
Mortgage
Home Seller
Home Buyer
Home
Ownership
Economic Function,An Example
3 - 5Strong C3 – The Marketplace
$
$
Mortgage
Mortgage-
backed
securities
Bank
Investors
Gov’t
Agency
Facilitated by
government agencies
such as the Federal National
Mortgage Association,banks
sell the mortgages to
investors with surplus cash.
Economic Function,An Example
3 - 6Strong C3 – The Marketplace
The primary market is the,new
securities” market where securities
are sold to the public for the first
time.
The secondary market is the,used securities”
market,where previously issued securities
are traded among security holders.
Economic Function
3 - 7Strong C3 – The Marketplace
Dollar Holdings
Investor Group (billions) % of Total
Household sector $6,579 38.70%
State/local governments 115 0.68
Rest of world 1,712 10.07
Bank trusts/estates 315 1.85
Life insurance companies 938 5.52
Other insurance companies 179 1.05
Private pension funds 1,999 11.76
State/local retirement funds 1,937 11.39
Mutual funds 3,226 18.98
Total $17,000 100.00
Economic Function
3 - 8Strong C3 – The Marketplace
Capital markets enable market participants to
get accurate,up-to-date price information.
Continuous Pricing Function
3 - 9Strong C3 – The Marketplace
Capital markets remove the fear that people
have of buying or selling at a rip-off price.
The greater the number of participants and
the more formal the marketplace,the
“fairer” the price.
Fair Pricing Function
3 - 10Strong C3 – The Marketplace
Functions of the Capital Markets
?Fair price function
?Continuous pricing function
?Economic function
The Role of the Capital Markets
United States
National Exchanges
New York Stock Exchange (NYSE)
American Stock Exchange (till 1999)
Regional Exchanges
e.g,Philadelphia Stock Exchange
International
Exchanges
e.g,England,
France,
Japan,
Thailand
The Exchanges
3 - 12Strong C3 – The Marketplace
Trading Systems
? Specialists are charged with making a fair
and orderly market in one or more
assigned securities at posts on the
exchange floor.
? SuperDot and NYSE Direct+ are electronic
systems enabling NYSE firms to send
market and limit orders directly to the
specialists’ posts.
? Marketmakers are groups of competing
individuals who maintain a fair and orderly
market through open outcry trading in pits
on the exchange floor.
3 - 13Strong C3 – The Marketplace
Both trading curbs and circuit
breakers are designed to reduce
temporary volatility in the market.
At the NYSE,when the Dow Jones Industrial
Average fluctuates by more than 2%,the
circuit breaker is activated and computerized
trading becomes restricted.
When a trading curb is triggered,all trading at
the exchange is halted.
Circuit Breakers and Trading Curbs
3 - 14Strong C3 – The Marketplace
? The Nasdaq (National Association of
Securities Dealers Automated Quotations)
market is a worldwide computerized linkup
of brokerage firms,investment houses and
large commercial banks.
? The Nasdaq market is sometimes still
erroneously called the over-the-counter
(OTC) market.
The Nasdaq Stock Market
3 - 15Strong C3 – The Marketplace
The Nasdaq Stock Market
? In Nasdaq trading,bids and offers for
securities ranging from small unfamiliar
firms to some of the largest companies in
the world are posted to an electronic
bulletin board.
? Trades of up to 1,000 shares can be
executed in less than one minute via the
Small Order Execution System (SOES).
3 - 16Strong C3 – The Marketplace
? The Nasdaq stock market comprises two
distinct markets:
?The Nasdaq National Market,The largest
and most established firms in the
Nasdaq market are the national market
issues.
?The Nasdaq Small Cap Market,These
small-cap issues have a low level of
capitalization.
The Nasdaq Stock Market
3 - 17Strong C3 – The Marketplace
The Over-the-Counter Market
? Today,the term OTC equity security refers
to an equity security that is not traded on
Nasdaq or a national or regional exchange.
? OTC securities trade in two ways:
?The OTC Bulletin Board (OTCBB) is a
regulated quotation service providing
real-time information.
?Data on the smallest and often most
speculative pink sheet stocks can be
accessed via the Internet.
3 - 18Strong C3 – The Marketplace
The Over-the-Counter Market
Insert Figure 3-5 here.
3 - 19Strong C3 – The Marketplace
Third and Fourth Markets
? The trading of listed securities in the
Nasdaq market is known as the third
market.
? Direct trades between large institutional
investors comprise the fourth market.
3 - 20Strong C3 – The Marketplace
Regulation
? The Exchanges have rules regarding…
? the financial capacity of members
serving as stock specialists
? the financial & market activity of listed
firms
? the disclosure & annual reporting of
listed firms
3 - 21Strong C3 – The Marketplace
? The Securities and Exchange Commission
(SEC) was established …
? to ensure that investors have adequate
information to make an informed investment
decision
? to help prevent price manipulations and abuses
like the Ponzi scheme
? Two primary acts influencing the
investment industry today are the
Securities Act of 1933 and the Securities
Exchange Act of 1934.
Regulation
3 - 22Strong C3 – The Marketplace
? The National Association of Security
Dealers (NASD) is a self-regulatory body
that licenses brokers and generally
oversees the trading practices of OTC
securities.
? The Securities Investor Protection
Corporation (SIPC) protects investors from
loss due to brokerage firm failure,fraud,
natural disaster,or theft.
Regulation
3 - 23Strong C3 – The Marketplace
Ethics
? A wide range of investment activities may
be legal but carry substantial ethical
baggage.
? The Chartered Financial Analyst (CFA)
program promotes investment education
and ethical behavior among those involved
in the investment business.
? The program is administered by the
Association for Investment Management
and Research (AIMR).
3 - 24Strong C3 – The Marketplace
? To earn a CFA designation,candidates
must pass three separate exams taken at
least a year apart.
? Persons who have earned the CFA
designation must subscribe to the AIMR
standards of professional conduct.
Ethics
