Securities Markets - Securities Regulation

Securities Markets

1. Markets and Investors

   1. The Structure of the Trading Markets

      1. Securities not listed on an exchange are a part of the over-the-counter market

      2. Exchanges

         • Can be either National or Regional

           • National: NYSE is the largest U.S. equity market followed by the Nasdaq

             • BUT approximately 60% of the orders for NYSE stocks are executed on regional exchanges or Electronic Communications Networks (ECNs) of which are outside of the exchange

           • Regional: There are six regional exchanges

         • Exchanges are Self-Regulated

      3. Over-the-Counter Market

         • Securities not listed on an exchange are referred to as over-the-counter securities

         • The core of the over-the-counter market is the "market-maker"

           • A broker who does not own the security the investor requests can purchase the security from a market-maker

           • The market-maker is an individual who maintains an inventory in the traded security

         • FINRA operates an electronic filing bulletin board (the OTCBB) for non-Nasdaq over-the-counter stocks

           • Price quotes are available

         • Where a stock is not listed on the OTCBB, the stock is traded in a paper-base market called the "Pink Sheet Market"

      4. How Exchanges Function (The Order Process)

         • Market Order: Where the customer instructs his broker to purchase or sell a security at the best available market price OR

         • Limit Order: Where the customer instructs his broker to purchase the security at a particular price.

         • The broker will first try to match the order with that of another customer in the firm

           • If not, the order will be routed to a Floor Broker who represents buyers and sellers in the crowd.

           • If the Floor Broker cannot fulfill the order, he will invoke the services of a Specialist, who can trade for his own account

             • The Specialist intervenes in order to smooth imbalances between the supply and demand for a particular security.

             • The NYSE rules require specialists to address short-term imbalances between buy and sell orders by using their own capital or inventory to fill gaps that might arise.

             • An alternative function of the Specialist is to maintain a limit order book in which unfulfilled orders are recorded and later filled by the specialist as market conditions permit.

             • Specialists make their money because of the spread between the buy price and the selling price

         • BUT Today, much of the matching of buyers and sellers is done by computers

      5. Block Trading: Trades of 10,000 or more shares customarily occurring directly between institutional investors without the use of brokers

      6. Bond Markets

         • Bond markets are almost totally dealer markets.

         • Bond dealers are linked by computers, and most of the liquidity of the bond markets is provided by a few of the trading desks of large investment banking firms.

         • Bond markets are almost exclusively an institutional investor medium.

   2. Globalization

      1. There is a major trend towards the globalization of securities markets

   3. Institutionalization

      1. Fifty years ago, individuals held 90% of U.S. equities.

      2. As of 2005, institutional investors held 61.2% of total U.S. equities

   4. Derivative Markets

      1. Derivative: A financial instrument whose value depends on the price of some underlying instrument

      2. Types of Derivatives:

         • Stock Options: Rights to buy or sell securities from or to another at some predetermined price and date

           • Call Options: The right to buy

           • Put Options: The right to sell

         • Futures: Contracts that call for future delivery of some commodity at a fixed price and date

           • BUT Financial Futures

             • Created to protect against and bet on market price movement of currency and "baskets" of securities

             • Settlements of financial futures are in cash, rather than actual delivery of the underlying commodity

             • E.g. Index Futures: One can buy or sell an index (e.g. S & P 500) for "delivery" at some future date.

         • Exclusive jurisdiction over futures is given to the Commodities Futures Trading Commission (CFTC)

         • Credit-Default Swaps

         • Most derivatives are over-the-counter derivates and thus not subject to government regulation

2. The Efficient Market Hypothesis

   1. Three different forms of the Efficient Market Hypothesis:

      1. (1) Strong Form

         • The strong form of market efficiency occurs when security prices reflect all information, whether that information is publicly available or not.

      2. (2) Semi-String Form

         • The semi-strong form of market efficiency exists if security prices reflect all publicly available information.

         • The true fight today is whether securities markets are efficient in the semi-strong form.

      3. (3) Weak Form

         • The weak form exists when security...