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Chapter 4
Organization and Functioning of Securities
Markets
What are the national exchanges and how are
the major security markets becoming linked
(what is meant by passing the book)?
What are the regional stock exchanges and
the over-the-counter (OTC) market?
What are the alternative market-making
arrangements available on the exchanges and
the OCT market?
Chapter 4
Organization and Functioning of Securities
Markets
What are the major types of orders available
to investors and market makers?
What is a market?
Brings buyers and sellers together to aid in the
transfer of goods and services
Does not require a physical location
Both buyers and sellers benefit from the
market
Liquidity
marketability
price continuity
depth
Secondary markets
Market where outstanding securities are bought
and sold by investors. The issuing unit does not
receive any funds in a secondary market
transaction
Trading Systems
Pure auction market
Buyers and sellers are matched by a broker at a
central location
Price-driven market
Dealer market
Dealers provide liquidity by buying and selling
shares
Dealers may compete against other dealers
Third Market
OTC trading of shares listed on an
exchange
Mostly well known stocks
GM, IBM, AT&T, Xerox
Fourth Market
Direct trading of securities between two
parties with no broker intermediary
Usually both parties are institutions
Can save transaction costs
No data are available regarding its specific
size and growth
Detailed Analysis of
Exchange Markets
Exchange Membership
Major Types of Orders
Exchange Market Makers
Exchange Membership
Specialist
Commission brokers
Employees of a member firm who buy or sell
for the customers of the firm
Floor brokers
Independent members of an exchange who act
as broker for other members
Registered traders
Use their membership to buy and sell for their
own accounts
Limit orders
Order specifies the buy or sell price
Time specifications for order may vary
Instantaneous - fill or kill, part of a day, a full
day, several days, a week, a month, or good until
canceled (GTC)
Margin Transactions
On any type order, instead of paying 100%
cash, borrow a portion of the transaction,
using the stock as collateral
Interest rate on margin credit may be below
prime rate
Regulations limit proportion borrowed
Margin requirements are from 50% up
Margin Transactions
Buy 200 shares at $50 = $10,000 position
Borrow 50%, investment of $5,000
If price increases to $60, position
Value is $12,000
Less
- $5,000 borrowed
Leaves $7,000 equity for a
$7,000/$12,000 = 58% equity position
Margin Transactions
Buy 200 shares at $50 = $10,000 position
Borrow 50%, investment of $5,000
If price decreases to $40, position
Value is $8,000
Less
- $5,000 borrowed
Leaves $3,000 equity for a
$3,000/$8,000 = 37.5% equity position
Margin Transactions
Initial margin requirement at least 50%. Set up by
the Fed.
Maintenance margin
Requirement proportion of equity to stock
Protects broker if stock price declines
Minimum requirement is 25%
Margin call on undermargined account to meet
margin requirement
If margin call not met, stock will be sold to pay off the
loan