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CHAPTER 4
SECURITIES MARKETS AND THE ECONOMY
I. What is a Market?
A. A market is a means through which buyers and sellers are brought together to aid in the
transfer of goods and/or services.
B. Characteristics of a Good Market
1. Timely and accurate information on volume and prices of past transactions and all
currently outstanding bids and offers
2. Liquidity (ability to buy or sell quickly at a price close to prior price)
C. Organization of the Securities Market
1. Primary markets are those where new securities are sold and funds go to issuing unit
2. Secondary markets are those where outstanding securities are bought and sold by
investors. The issuer does not receive any funds in a secondary market transaction
II. Primary Capital Markets
A. Government Bond Issues
1. Treasury Bills – negotiable, non-interest bearing securities with original maturities of
B. Corporate Bond Issues
1. Almost always sold through a negotiated arrangement with an investment banking
firm that maintains a relationship with the issuing firm
C. Corporate Stock Issues
1. Types of new issues
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D. Relationship with Investment Bankers
1. Negotiated arrangement
E. Underwriting function – the investment banker purchases the entire issue from the issuer
and resells the security to the investing public. The firm charges a commission for
providing this service.
This function can involve three services: origination, risk-bearing, and distribution.
a. Origination – involves the design of the bond issue and initial planning
III. Secondary Financial Markets
A. Importance of Secondary Markets – enhances liquidity of the securities
B. Secondary Bond Markets
1. OTC (over-the-counter market)
2. Government issues – market makers are often banks and investment firms
C. Financial Futures Markets
IV. Classification of Secondary Equity Markets
A. Primary Listing Markets
1. Toronto Stock Exchange (TSX)
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4. Global Stock Exchanges
a. Consolidations in Developed Markets driven by economies of scale and
technology
b. Global Twenty-Four-Hour Market – made possible by advances in technology
5. Regional Stock Exchanges
6. The Third Market – OTC trading of shares listed on an exchange
V. Detailed Analysis of the Exchange Market
A. Types of Orders
1. Market orders
B. Exchange Market Makers
Specialists or Designated Market Maker (DMM)
1. Functions of the specialist
a. broker for limit orders and special orders
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VI. Uses of Security Market Indices
A. As benchmarks to evaluate the performance of professional money managers
B. To create and monitor an index fund
VII. Differentiating Factors in Constructing Market Indicator
A. The Sample – should be representative of the total population
Size
Breadth
Source
B. Weighting of Sample Members
Price-weighted series
VIII. Stock-Market Indices
A. Price Weighted Index
1. Dow Jones Industrial Average – oldest and best-known of the stock market indices
a. Computation of DJIA – sum of the prices of 30 blue-chips stocks divided by
adjusted divisor
b. Criticisms of DJIA
Limited to 30 non-randomly selected stocks, mostly large, mature
2. Nikkei-Dow Jones Average (Nikkei Stock Average Index)
a. 225 stocks on the First Section of the TSE
b. Criticisms of Nikkei-Dow
A price-weighted series -suffers from the same shortcomings of the DJIA
B. Value Weighted Index
1. Generated by deriving the initial total market value of all stocks used in the index
2. Example of a Computation of a Value-Weighted Index (See Exhibit 4.5)
3. Automatic adjustment for stock split
C. Unweighted Price Indicator Series
1. General computational procedure – all stocks in an unweighted index carry equal
weight regardless of their price or market value
D. Style Indices
1. Small-cap growth
2. Midcap growth
E. Global Equity Indices
IX. Bond-Market Index
1. Investment-Grade Bond Indices
2. High-Yield Bond Indices
3. Global Government Bond Market Indices
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B. Correlations between Bond Indices
1. Low correlations between investment-grade bonds and high-yield bonds