Quantitative Methods

Organization and Functioning of Securities Market

Reading - 52

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Learning Objective Statements (LOS)

a. b. c. d. e. f. g. h. i. j. k. l. m. What is Market Facts about Market Characteristics of Good market Types of Market Primary Capital Market Secondary Financial Market U.S. Secondary Equity Markets Requirements for listing in Nasdaq National Market Regional Stock Exchanges Other Markets Exchange Markets Margin Transactions New Trading Systems
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Market

Market

Buy goods & service

Sell goods & service

Buyer

Seller

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Market
Facts about Market: 1. Not necessary to have physical location or entity, only thing required is that the buyers and sellers can communicate for relevant transaction. 2. Not necessary to own the goods or services but to provide a platform for transaction of goods and service. 3. No hurdle for transaction of any type of goods or service.

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Characteristics of Good Market

Timely and accurate information Liquidity Price Continuity Depth Transaction Cost Informational Efficiency
http://proschool.imsindia.com/ Timely and accurate information on the volume and prices of past transactions and current outstanding bids and offers are must for buyers and sellers.

The ability to buy or sell an asset quickly and at a known price that not substantially different from prices of recent prior transactions (assuming no new information).

There should not be a substantial change in price from one transaction to next until there is a vital information in the market.

There should be buyers and sellers willing to trade prices above and below the current market price to maintain the balance of the market and hence preventing drastic price changes.

Lower the transaction cost as a % of the transaction amount, higher would be the volume of transaction.

Market price should adequately reflect all the information available regarding supply and demand factors.

Type of Markets
Primary Market: In this market, new issues of bonds, preferred stock, or common stock are sold by entities like government units, municipalities or companies to raise capital for growth. Secondary Market: Outstanding securities that already sold to the public are bought and sold here.

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Primary Capital Market

Government Bond Issues
Treasury Bills maturity of 1 year or less.

Municipal Bond Issues Methods of Selling

Government Bond Issues

Treasury Notes maturity of 2 to 10 years.

Municipal Bond Issue

Treasury Bonds maturity of more than 10 years.

Competitive Bid

Negotiated Sales

Private Placements

Corporate Stock Issues

Seasoned Equity Issues

Corporate Stock Issues

Initial Public Offerings

New Issues

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Secondary Financial Market

Importance of Secondary Market: o It provides liquidity to the individuals who purchase securities from the primary market. o It also helps the issuer in determining the price for seasoned securities. o New issues of outstanding stocks or bonds are based on the price and yields in the secondary market. o It also effects price volatility and market volatility. o Forthcoming IPO price are also based on comparable stocks and bonds in the secondary market.
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Secondary Financial Market

o Secondary Bond Market
Secondary Markets for U.S. Government and Municipal Bonds Secondary Corporate Bond Market

o Financial Futures o Secondary Equity Markets

Basic Trading Systems
Pure Auction Market Dealer Market

Call and Continuous Markets

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U.S. Secondary Equity Markets

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Requirements for listing in Nasdaq National Market

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Regional Stock Exchanges

Reason for existence of Regional Stock Exchanges: A. Benefit to small local companies: It provides trading facilities to local companies who cannot afford to get listed in national exchanges. B. Benefit to local brokers who are not members of national exchange as they can purchase the stock listed in national exchanges that are also listed in local exchanges. C. Regional Exchanges can also trade some stock on the NASDAQ market under unlisted trading privileges (UTP) which granted by SEC.
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Other Markets
Third Market: As per the name, dealers and brokers trade shares that are listed on an exchange, away from the exchange. Trading of well known blue chip stocks are done in third market. Success and Failure of Third Market depends on two factors: 1. Efficiency of the non-exchange market 2. Transaction cost as compare to national exchange. Alternative Trading Systems (ATSs): o Electronic Communication Networks (ECNs): It matches the buy and sell orders via computer mainly for retail and small institutional trading. o Electronic Crossing Systems (ECSs): It acts as a broker to match large buy and sell orders.
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Exchange Markets
Types of members: 1. Specialists: They are the market makers who perform two major functions namely:
o o They serve as the brokers to match buy and sell orders. They act as dealer to maintain fair and orderly market by providing liquidity to the market.

2. Commission Brokers: These are the employees of the firm who buy and sell for the customers of the firm. 3. Floor Brokers: These are independent members of an exchange who act as brokers for other members. 4. Registered Traders: They have their own membership and they buy and sell stocks for themselves.
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Exchange Markets

Types of Orders

Market Orders

Limit Orders

Short Sales

Special Orders

Margin Transactions

Stop Loss Orders

Stop Buy Order

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Margin Transactions
Example: Ram has acquired 100 share of ABC Ltd. for a price of Rs.25/share. A 50% margin requirement allowed Ram to borrow Rs.1250 which makes the initial investment of Ram to Rs.1250 against which he take an exposure of Rs.2500. Now, if the stock price rises by 30%, what would be the return on investment for Ram? Solution: Exposure = 100 share x Rs.25 = Rs.2500 Margin = 50% Investment = Rs.2500 x 50% = Rs.1250 Loan from Broker = 2500 1250 = Rs.1250 Current Market Price of share = Rs.25 x (1 + 30%) = Rs.32.5
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Margin Transactions
Current Value of 100 shares = Rs.32.5 x 100 = 3250 Income after paying off debt = Rs.3250 Rs.1250 = Rs.2000 Return on Investment = (Rs.2000 /Rs.1250) 1 = 0.6 or 60%. Hence, the return on investment for Ram on an investment of Rs.1250 by of margin transaction is 60%. Had been the total investment from Rams end, the ROI would have been:

= (Rs.3250/Rs.2500) 1 = 0.3 or 30%.

ROI with margin transaction = 60% ROI without margin transaction = 30%
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Effect of Using Margin Transaction

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New Trading Systems

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Thank You

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