Ims Cfa Reading 52

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Organization and Functioning

of Securities Market

Reading - 52

Quantitative Methods
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Learning Objective Statements (LOS)

a. What is Market

b. Facts about Market

c. Characteristics of Good market

d. Types of Market

e. Primary Capital Market

f. Secondary Financial Market

g. U.S. Secondary Equity Markets

h. Requirements for listing in Nasdaq National Market

i. Regional Stock Exchanges

j. Other Markets

k. Exchange Markets

l. Margin Transactions

m. New Trading Systems


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Market

Buyer Seller

Buy

goods & service

Sell goods &

service

Market


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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 on the volume and prices of past transactionsand current outstanding bids and offers are must for buyers and sellers.

Timely and accurateinformation

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 nonew information).

Liquidity

There should not be a substantial change in price from one transaction to next

until there is a vital information in the market.Price Continuity

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.Depth

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

the volume of transaction.Transaction Cost

Market price should adequately reflect all the information available regardingsupply and demand factors.Informational Efficiency


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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

Treasury Bills

maturity of 1year or less.

Treasury

Notes

maturity of 2to 10 years.

Treasury

Bonds

maturity ofmore than 10

years.

Government

Bond Issues

Government Bond Issues Municipal Bond Issues

Methods of Selling

MunicipalBond Issue

CompetitiveBid

NegotiatedSales

PrivatePlacements

Corporate Stock Issues

CorporateStockIssues

Seasoned

EquityIssues

New

Issues

InitialPublic

Offerings



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.



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



U.S. Secondary Equity Markets



Requirements for listing in Nasdaq National Market



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.



Other Markets

Third Market:

As per the name, dealers and brokers trade shares that are listedon an exchange, away from the exchange. Trading of well knownblue 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 thebuy and sell orders via computer mainly for retail and smallinstitutional trading.

o Electronic Crossing Systems (ECSs): It acts as a broker to matchlarge buy and sell orders.



Exchange Markets

Types of members:1. Specialists: They are the market makers who perform two

major functions namely:

o They serve as the brokers to match buy and sell orders.

o They act as dealer to maintain fair and orderly market byproviding liquidity to the market.

2. Commission Brokers: These are the employees of the firmwho buy and sell for the customers of the firm.

3. Floor Brokers: These are independent members of anexchange who act as brokers for other members.

4. Registered Traders: They have their own membership andthey buy and sell stocks for themselves.



Exchange Markets

Types ofOrders

MarketOrders

Limit Orders Short SalesSpecialOrders

Stop LossOrders

Stop BuyOrder

MarginTransactions



Margin Transactions

Example:Ram has acquired 100 share of ABC Ltd. for a price ofRs.25/share. A 50% margin requirement allowed Ram to borrowRs.1250 which makes the initial investment of Ram to Rs.1250against which he take an exposure of Rs.2500. Now, if the stock

price rises by 30%, what would be the return on investment forRam?

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



Margin Transactions

Current Value of 100 shares = Rs.32.5 x 100 = 3250Income 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 ofRs.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%

Effect of Using

Margin

Transaction


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New Trading Systems


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Ims Cfa Reading 52

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