CHAPTER THREE
THE MARKETPLACE
© 2001 South-Western College Publishing
Outline

The Role of the Capital Markets
 Economic
Function
 Continuous Pricing Function
 Fair Pricing Function

The Exchanges
 National
Exchanges
 Regional Exchanges
 Trading Systems
 Circuit Breakers and Trading Curbs
2
Outline

The Nasdaq Stock Market
 The
National Market System
 Tiers of the Nasdaq Market
 Third and Fourth Markets

Regulation
 The
Exchanges
 The NASD

 The
SEC
 SIPC
Ethics
 Illegal
vs. Unethical
 The Chartered Financial Analyst Program
 AIMR Standards of Professional Conduct
3
The Role of the Capital Markets
An exchange serves three principal functions.

Economic Function

Continuous Pricing Function

Fair Pricing Function
4
Economic Function
Capital markets facilitate the flow of
capital from savers to borrowers.
Capital
Savers
Borrowers
Capital Market
5
Economic Function: An Example
Mortgage
$
Banks offer home
mortgages so that home
buyers who are short of
cash can borrow money
to buy houses.
Home Buyer
Home
Ownership
Bank
$
Home Seller
6
Economic Function: An Example
Mortgage
Bank
Facilitated by
government agencies
such as the Federal National
Mortgage Association, banks
sell the mortgages to
investors with surplus cash.
$
Gov’t
Agency
$ Mortgagebacked
securities
Investors
7
Economic Function: An Example
Mortgage
Mortgage
$
Home Buyer
Home
Ownership
Bank
$
Cyclic Flow
of Capital
Gov’t
Agency
$
$ Mortgagebacked
securities
Home Seller
Investors
8
Economic Function
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.
9
Continuous Pricing Function
Capital markets enable market participants to
get accurate, up-to-date price information.
10
Fair Pricing Function
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.
11
The Exchanges
United States
National Exchanges
New York Stock Exchange (NYSE)
Nasdaq Stock Market
Regional Exchanges
e.g. Philadelphia Stock Exchange
International
Exchanges
e.g. England,
France,
Japan,
Thailand
Trading Systems

Specialists are charged with making a fair and
orderly market in one or more assigned
securities at posts on the exchange floor.

Marketmakers are groups of competing
individuals who maintain a fair and orderly
market by open outcry trading in pits on the
exchange floor.

SuperDot is an electronic system enabling
NYSE firms to send orders directly to the
specialists’ posts.
13
Circuit Breakers and Trading Curbs
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.
Trading curbs halt all trading at the exchange.
14
The Nasdaq Stock Market

The Nasdaq (National Association of Securities
Dealers Automated Quotations) stock market
is sometimes called the over-the-counter
(OTC) market.

It is a worldwide computerized linkup of
brokerage firms, investment houses and large
commercial banks.

Bids and offers are posted to an electronic
bulletin board called the National Market
System.
15
The Nasdaq Stock Market

Market Tiers
- national market issues: issues by large and
established firms e.g. Intel, Microsoft
- small-cap issues: issues with a low level of
capitalization
- pink sheet issues: the smallest and most
speculative Nasdaq stocks

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.
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The “Markets”
Primary Market
Company
via investment bankers
Public
Secondary Market
via stock exchanges or Nasdaq
Public
Public
Third Market
listed securities via Nasdaq
Public
Public
Fourth Market
via telephone or Instinet
Institution
Institution
Regulation

The Exchanges have rules regarding...
- the financial capacity of members serving as
stock specialists
- the financial & market activity, as well as the
disclosure & annual reporting of listed firms

The Securities and Exchange Commission (SEC)
was established…
- to ensure that investors have adequate
information to make an informed investment
decision
- so as to help prevent price manipulation
and abuses like the Ponzi scheme
18
Regulation

The National Association of Security Dealers
- is a self-regulatory body that licenses
brokers and generally oversees the trading
practices of OTC securities

The Securities Investor Protection Corporation
- protects investors from loss due to
brokerage firm failure, fraud, natural disaster,
or theft
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Ethics

Illegal vs. Unethical
A wide range of investment activities may be
legal, but these activities carry substantial
ethical baggage.

The Chartered Financial Analyst Program
- promotes investment education and ethical
behavior among those involved in the
investment business

AIMR Standards of Professional Conduct
- a strict set of ethical guidelines
20
Review

The Role of the Capital Markets
 Economic
Function
 Continuous Pricing Function
 Fair Pricing Function

The Exchanges
 National
Exchanges
 Regional Exchanges
 Trading Systems
 Circuit Breakers and Trading Curbs
21
Review

The Nasdaq Stock Market
 The
National Market System
 Tiers of the Nasdaq Market
 Third and Fourth Markets

Regulation
 The
Exchanges
 The NASD

 The
SEC
 SIPC
Ethics
 Illegal
vs. Unethical
 The Chartered Financial Analyst Program
 AIMR Standards of Professional Conduct
22