GENERAL ORGANIZATION OF SECURITIES MARKETS

GENERAL ORGANIZATION OF SECURITIES MARKETS

·         Primary Market

• Market for first hand securities


• Securities are issued in two ways;


• Private placement


• Issuing securities to less number of institution and individuals (maximum number is specified in the respective act; in case of Nepal, as provisioned by Companies Act, 2006, securities can be issued to less than 50 institutions or individual through private placement)


• Issued on negotiation through letter or telephone or personal contact 


• Public offering


• Basic three types of public offering


• Initial public offering (IPO): Issuing securities to the public for the first time by the company


• Further public offering (FPO): Another public offering after having IPO


• Rights offering: Offering securities to the existing shareholders

·         Secondary Market

• Stock exchanges


• Over-the-Counter (OTC) Markets


• Third and Fourth Markets

Stock Exchanges

·         Centralized trading system

·         Trading through member of stock exchange; (Members: Dealer and Brokers)

• Members: two types of members


• Dealers: who trade on their own account maintaining bid ask spread


• Brokers: who do not trade on their own account


• Open client account


• Collect orders from its clients


• Quote on the floor for transaction


• Report transaction

·         Standard Rules: Listing rules/fees, standard system of trading and clearing and settlement, trading commission, trading hours etc.

·         Information Disclosure System and Supervision Mechanism

·         Advantages:

• Better price discovery


• Better liquidity

·         Examples; NYSE, LISE, TSE, BSE, NEPSE etc.

Over-the-Counter (OTC) Markets

·         Stocks of companies that can not fulfill the listing criteria of stock exchanges are traded

·         Differ with stock exchange with respect to that;

• It doesn't rely on central trading place and market is made up of people in diverse locations


• Instead of brokers/dealers; there are market makers making market in particular stocks


• Members of securities dealers are allowed to trade in the OTC market


• Trading through electronic communication network; Securities Dealers Automated Quotation


• Examples: NASDAQ, JASDAQ, KOSDAQ, OTCEI (OTC Exchange of India) etc.

Informal Market Arrangements

·         Often called third and fourth markets

·         Market for large blocks of securities

·         A kind of OTC market where the stocks both listed and not listed in the stock exchanges are traded

·         Network of brokers/dealers that aggregate quotation information and provides inter-participants order routing tools, but leaves the order execution to the market participants

·         In the fourth market, trading could take place without intervention of the brokers/dealers

·         Concept of such markets developed due to fixed commission nature of stock exchanges and the OTC markets

Dealer and Auction Markets

Dealer Market:

• Market made by dealers who quote prices at which they are willing to buy and sell


• Quote driven market


• Dealers are responsible in setting the price by maintaining bid ask spread

Bid price: Purchase price

Ask/offer: Selling price

• Greater the bid ask spread, greater the profit to dealers


• Greater bid ask spread also means low liquidity


• Price control:


• Dealers change prices as new information is available


• Does not change the prices in case of liquidity imbalance, rather they absorb the imbalance by buying and selling securities


• Benefit from liquidity traders and has always threat of loss from the information traders


• Liquidity traders: traders who trades for reasons unrelated to the price of security


• Information traders: who trade to profit from discrepancies between the market price and the fair price


• Short sale the securities


• All OTC markets are dealer market and some of the exchanges also have dealer market

Auction Market:

• Market in which the orders of traders are matched


• Also called order driven market


• Trading rules usually are as follows


• The first bid or offer at a given prices has priority over any other bid or offer at the same price


• The high bid and low offer have the floor


• A new auction begins whenever all the offers or bid at a given prices exhausted


• Secret transactions are prohibited


• Bid and offer must be made in an audible voice


• Price is established by competitive bidding between brokers acting as an agent for buyers and sellers


• Price is influenced by buy orders and sell orders


• Higher the buy orders, price will go up and vice versa


• Prices of securities rises and falls in response to the new information and liquidity imbalances


• Information traders can play to stabilize the price due to liquidity imbalances


• High supply – low price -→ buy and hold and sell when imbalance passes


• Price control mechanism


• Price changes slowly than in dealer market as they are not set by the market makers so can’t change until they are changed by trading


• Price fluctuation limit and circuit breakers


• E.g., NEPSE: 5 percent from previous close and 2 percent from latest trading price (LTP) and circuit breaker in 10 percent


• Basic two types of orders


• Market Order


• to buy or sell at most profitable prices


• Execute quickly


• Limit order


• Customer specifies maximum price to buy or minimum price to sell


• Other types of orders are


• Stop order: Sell stock if price drops to specified price (to protect from rapid loss) or reach to specified price


• Stop limit order: Maximum to buy and minimum to sell


• Fill or kill: Cancel if not executed immediately


• Market if touched order: A sell order entered above the current price


• Not-held order: Market order that gives brokers to delay if they think they can get a better price.


• Specific-time order:


• At-the-opening (ATO)


• On-the-close


• Day order: (expires at the end of the day)


• Good-till-cancelled (GTC)