TheGlobalStockMarketChapter6Francis&Ibbotson1Chapter6:TheGlobalStockMarketBackgroundAvarietyofdifferentstockmarketsexistForinstance,Germany’smarketisover400yearsoldwhileTanzania’sbeganin1998MacedoniahasonlytwocompaniestradingonitsstockexchangewhileIndiahas5,840ThemarketcapitalizationoftheU.S.is$10trillionwhilethatofGuatemalaisonly$2billion(inU.S.dollars)ManystockmarketsalsotradeotherfinancialinstrumentsConsolidationsaremergingstockmarketsandtechnologyispullingnationalmarketstogetherFrancis&Ibbotson2Chapter6:TheGlobalStockMarketTheGlobalStockMarketAggregatemarketcapitalizationofequitysharesintheworldgrewfrom$9.6trillionin1990toover$35trillionin2000Anaveragerateof14.8%annuallyFinancialcapitalisverymobileIn1990theTokyoStockExchangewas30.5%oftheglobalmarketbutonly12.7%in1999NorthAmericaincreaseditsshareoftheworldequitymarketfrom28.0%(1990)to50.28%(1999)Francis&Ibbotson3Chapter6:TheGlobalStockMarketTheGlobalStockMarketTechnologicaladvancesareautomatingexperiencedstockexchangeemployeesoutofjobsStockmarketsareactiveineverytimezoneFrancis&Ibbotson4Chapter6:TheGlobalStockMarketBrokerageServicesBrokersSalespeople(earningacommission)employedbydealersHavenomoneyinvestedinthedealer’ssecurityinventoryHelpcreatemarketsbybuyingandsellingfromemployer’sinventoryBrokeragefirmsextendcredit(marginaccounts)toclientsEnablesclienttodomoresecuritiestradingFrancis&Ibbotson5Chapter6:TheGlobalStockMarketBrokerageServicesTypesofstockbrokerageservicesFull-serviceTakebuyandsellordersExtendmargincredittocustomersHoldclients’securitiesinsafekeepingCollectcashdividendsProvidefreeinvestmentresearchPerform‘hand-holding’servicesPleasanttelephoneconversationsInvestmentcounselingBirthdaycardsAllpaidforbyclients’tradingcommissionsRangefrom$30-$150foronecommonstocktransactionExamplesMerrillLynchGoldmanSachsPaineWebberMorganStanleyDeanWitterSalomonSmithBarneyFrancis&Ibbotson6Chapter6:TheGlobalStockMarketBrokerageServicesDiscountBrokersSimplytakeordersOfferlittleornoinvestmentadviceNo‘hand-holding’servicesprovidedLittleopportunityforchurningLowercommissionsRangefrom$20to$50ExamplesCharlesSchwab&CompanyQuick&ReillyMurielSiebertJackWhite&CompanyFidelityInvestmentsVanguardBrokerageServicesFrancis&Ibbotson7Chapter6:TheGlobalStockMarketBrokerageServicesElectronicbrokersTakebuyandsellordersviaInternetNo‘hand-holding’servicesMayprovideinvestmentresearchMayormaynotbefreeLowcommissionsRangefromalmostfreeto$35atradeExamplesDiscoverBrokerageDLJdirectE*TradeArchipelagoBloombergTradebookAccutradeAmeritradeCharlesSchwabSURETRADEWallStreetAccessCyberCFrancis&Ibbotson8Chapter6:TheGlobalStockMarketTransactingWhenmakingatrade,theinvestormustspecifyTypeoforderWhetherornotmarginwillbeinvolvedFrancis&Ibbotson9Chapter6:TheGlobalStockMarketTypesofTradingOrdersMarketorder—ordertobuyorsellASAPatthecurrentmarketpriceSimplest,mostcommonordertypeExecutedimmediatelywithvirtualcertaintyLimitorder—ordertobuyorsellwithalimitLimitastothemaximumpricepaidforabuyorderLimitastotheminimumpricereceivedforasellorderIfordercannotbeimmediatelytransacted,itisrecordedinthemarket-maker’slimitorderbookandheldforpossiblefutureexecutionOrdermayneverbeexecutediflimitpriceisnotreachedMayattachatimeframetothelimitorderFrancis&Ibbotson10Chapter6:TheGlobalStockMarketTypesofTradingOrdersStopordersTobuy(sell)arewrittenatpricesgreater(lower)thanthecurrentmarketpriceActivatedwhen(if)themarketpricereachesthestoppriceOnceactivatedbecomesamarketorderDangerswithstopordersExecutionpricecannotbeknowninadvanceInvestormaybewhip-sawedinvolatilemarketVariationonstoporderStoplimitordersWhenstoporderisactivateditbecomesalimitorderratherthanamarketorderFrancis&Ibbotson11Chapter6:TheGlobalStockMarketTypesofTradingOrdersScaleorderRequiresbuyingorsellingpartoftheorderateachpriceasmarketpriceschangeCumbersomeandnotallbrokersacceptthemFillorkill(FOK)orderSpecifiespriceatwhichordermustbefilledororderisimmediatelycanceledGoodtillcanceledorderRemainsineffectuntilcanceledDayorder——mustbefilledonthedayorderisissuedMarketoncloseorder——canonlybeexecutedattheday’sclosingpriceFrancis&Ibbotson12Chapter6:TheGlobalStockMarketTradingonMarginWhenopeninganewaccountwithabrokeragefirm,canhaveeitherCashaccountMustpaycashforsecuritiesMarginaccountOffersabilitytobuysecuritiesoncreditMoneyputforthbyinvestorservesasadownpaymentAmountinvestorsmayborrowiscontrolledbytheFederalReserveBoardofGovernorsForexample,theFedmaystipulatea60%margin,meaningtheinvestormustputforthatleast60%ofthepurchasepriceFrancis&Ibbotson13Chapter6:TheGlobalStockMarketTradingonMarginFederalReserve’smarginrequirementsforstocksVariedfrom10%(1929)to100%(1940)Inrecentyearshasbeen50%MarginrequirementsaredifferentfordifferenttypesofsecuritiesFrancis&Ibbotson14Chapter6:TheGlobalStockMarketHowMarginWorksExample:Youwishtopurchase100sharesofXYZCompanyforapriceof$100pershare.Theinitialmarginrequirementis50%.Purchasepriceis$100x100shares=$10,000Youputforth50%,or$5,000Borrowtheremaining$5,000fromyourbrokerBrokerchargesyouthebrokers’callrateforamarginloanFrancis&Ibbotson15Chapter6:TheGlobalStockMarketHowMarginWorksAssumethatthemarketvalueofthestockrisesto$150ashareYourtotalprofitwillbe$50asharetimes100shares,or$5,000,ignoringinterest(onmarginloan),taxesandcommissionsYourreturnis100%:Profitof$5,000Investmentof$5,000Ifyouhadnotusedmargin,youcouldhaveonlyafforded50shares,andyourprofitwouldonlyhavebeen$2,500Yourreturnwouldhavebeen50%:Profitof$2,500Investmentof$5,000Francis&Ibbotson16Chapter6:TheGlobalStockMarketHowMarginWorksAssumethatthemarketvalueofthestockfallsto$50ashareCurrentmarketvalueoftheinvestmentisnowonly$5,000(whichexactlyequalstheamountthatwasborrowedfromthebroker)Yourtotallosswillbe$50asharetimes100shares,or$5,000,ignoringinterest(onmarginloan),taxesandcommissionsYourreturnis-100%:Lossof$5,000Investmentof$5,000Ifyouhadnotusedmargin,youcouldhaveonlyafforded50shares,andyourlosswouldonlyhavebeen$2,500Yourreturnwouldhavebeen-50%:Lossof$2,500Investmentof$5,000Francis&Ibbotson17Chapter6:TheGlobalStockMarketMaintenanceMarginIfamarginedportfoliodecreasessufficientlyinvalue,investorwillreceiveamargincallInvestormustputupmoremarginmoneyASAPOtherwise,brokerliquidatesenoughoftheinvestor’ssecuritiestobringaccountuptotherequiredminimummarginEasyforbrokertodobecauseinvestorwithamarginedaccountmustkeepsecuritiesatthebroker’sofficeascollateralfortheirloanTheNYSEhasamaintenancemarginrequirementof25%Investor’’sequitycannotfallbelow25%oftheaccount’smarketvalueOr,investor’’sloanamountcannotexceed75%oftheaccount’smarketvalueFrancis&Ibbotson18Chapter6:TheGlobalStockMarketMaintenanceMarginContinuingtheexample,ifyouhadpurchased$10,000ofstockwitha50%margin,youwouldfaceamargincallwhenMarketvalueofstockdroppedbelow$6,666.67Becauseyourloanof$5,000cannotexceed75%ofthemarketvalueofportfolio75%××X=$5,000X=$6,666.67Somebrokerssetahighermaintenancemarginthanthe25%minimumFrancis&Ibbotson19Chapter6:TheGlobalStockMarketInvestmentBanksMakePrimaryMarketsInitialpublicofferings(IPOs)occurwhencorporationsandgovernmentsissuenewsecuritiesintotheprimarymarketSometimescorporationsandgovernmentswithexistingsecuritiesraiseadditionalcapitalbyissuinganewissueofseasonedsecuritiesInvestmentbankersfindbuyersforbothIPOsandseasonednewissuesFrancis&Ibbotson20Chapter6:TheGlobalStockMarketInvestmentBanksAfewthousandinvestmentbankingfirmsexistintheU.S.,includingMerrillLynch&Co.MorganStanleyDeanWitterLehmanBrothersCreditSuisseFirstBostonGoldman,Sachs&Co.SalomonSmithBarneyBearStearnsCos.PaineWebberFrancis&Ibbotson21Chapter6:TheGlobalStockMarketInvestmentBankers’’FunctionsEachpublicofferinghasfourstepsConsultingwiththeissuerCarryingoutadministrativedutiesUnderwritingtheissueDistributingthesecuritiestoinvestorsFrancis&Ibbotson22Chapter6:TheGlobalStockMarketConsultingTheinvestmentbankthatservesastheIPO’’soriginatormustanalyzetheclient’’sneedsandsuggestafinancingplanWhattypeofsecurityshouldbeissued?Howmuchfinancingisneeded?Whenshouldthenewsecuritiesbeissued?TheoriginatorwillalsomanageTheunderwritingsyndicateRangesfrom5to200investmentbankingfirmsthatsharethefinancingandunderwritingriskThesellinggroupInvestmentbanksandbrokeragefirmsthatsellthesecuritiestoinvestorsFrancis&Ibbotson23Chapter6:TheGlobalStockMarketAdministrationDealswithlegalissuesassociatedwithanIPOHelpsobtainnecessarygovernmentpermissionsHastheprospectusprintedMakespublicannouncementsFrancis&Ibbotson24Chapter6:TheGlobalStockMarketUnderwritingAnunderwriterguaranteestheissuerwillreceiveapre-specifiedamountofcashforthenewsecuritiesDaysorweeksfromthetimetheunderwriterbuysthesecuritiesfromtheissuertilltheysellthesecuritiestotheinvestorsareveryriskytounderwriterMarketconditionsmayfluctuateandunderwritermaylosemoneyonthesecuritiesbecausetheyhavetosellthematalowerpriceItisimportanttosetthe‘right’priceforanIPOIfpriceistoohigh,underwritersmaynotbeabletosellsecuritiesIfpriceistoolow,issuermayfinditcostlytoissuesecuritiesFrancis&Ibbotson25Chapter6:TheGlobalStockMarketDistributionInvestmentbankermaysellsecuritiestoawidegroupofinvestorsOrmayactasintermediarybetweenissuerandbuyerinaprivateplacementThedifferencebetweentheinvestmentbanker’scostandthesalepriceisknownasthespreadRangesfrom5–16%forstocksAbout4%forbondsFrancis&Ibbotson26Chapter6:TheGlobalStockMarketElectronicInvestmentBankersThereareseveralinvestmentbankingfirmsofferinginternetservicesDLJdirectFreidman,Billings,RamseyGroupE*OfferingOpenIPOE-InvestmentBankWitCapitalVaryinsizeandsophisticationFrancis&Ibbotson27Chapter6:TheGlobalStockMarketFullDisclosureInU.S.theSECrequiresmostprimaryissuesbeaccompaniedbyaprospectus10to20pagedocumentthatfullydiscloses,amongotheritemsPurposeforwhichtheproceedsoftheissuewillbespentOfferingpricetothepublicOfferingpriceforspecialgroups,inanyUnderwriter’sfeesNetproceedstotheissuerInformationontheissuer’’sproducts,historyandlocationNamesandremunerationofofficersDetailedstatementofcapitalizationDetailedfinancialstatementsDetailsaboutanypendinglitigationFrancis&Ibbotson28Chapter6:TheGlobalStockMarketFullDisclosureApprovalofaprospectusbytheSECdoesnotmeantheinvestmentisagoodvalue,butthatallthenecessaryinformationrequiredbytheSEChasbeendisclosedFulldisclosureallowsinvestorstoestimatevalueofnewsecuritiesFrancis&Ibbotson29Chapter6:TheGlobalStockMarketSecondaryMarketOncesecuritiesareissuedintheprimarymarket,theycanbegintradinginthesecondarymarketTypesofsecondarymarketsOrganizedexchangerunbydealers(NYSE)Electronicmarketinwhichdealerscompetewithoneanother(Nasdaq)ElectroniccommunicationnetworksFrancis&Ibbotson30Chapter6:TheGlobalStockMarketNYSEFrancis&Ibbotson31Chapter6:TheGlobalStockMarketNYSEEachstocktradedontheNYSEisassignedaspecialistwhomustContinuouslypostbidandaskpricesforthestocksinwhichtheymakeamarketStandatassignedpostsonthetradingfloorActasmarket-makers(dealer)Alwaysreadytobuyattheirbidpriceandsellattheirask(oroffer)priceInvesttheirowncapital(risky)butmayearnareturnExecuteordersforothers(broker)Earnthebid-askspreadoneverytransactionFrancis&Ibbotson32Chapter6:TheGlobalStockMarketDecimalizationAtickrepresentstheminimumamountbywhichapricecanchangePriorto1997thetickwas1/8butthenbecame1/16Howevertheticksizeisnow1￠￠sincetheexchangesinstituteddecimalizationExpectedtoreducethebid-askspreadandtradingcostsFrancis&Ibbotson33Chapter6:TheGlobalStockMarketNYSEListingRequirementsTobelistedontheNYSEmusthaveAminimumtaxableannualincomeof$2.5millionAminimumnettangibleassetsof$18millionAminimumof1.1millionsharesofpubliclyheldstockwithaminimummarketvalueof$18millionAminimumnumberof2,000investorsowninground-lots(100shares)OnespecialistFrancis&Ibbotson34Chapter6:TheGlobalStockMarketNYSEOperationsApproximately460specialistswithabout8stocksassignedtoeachspecialist’stradingpostAbout1,500tradingboothswithtelephonessurroundtheperimeterofthetradingfloorAllowsforordertransmissionandconfirmationbetweenbrokers’’officesandexchangefloorNYSEhas1,366memberswhomustownaseatontheexchangeAlmostallmembersareeitherspecialistsorfloorbrokersFrancis&Ibbotson35Chapter6:TheGlobalStockMarketFloorBrokersBuyandsellsecuritiesfortheclientsofbrokeragehousesorfortheirownaccountsOrderprocessBrokerreceivesorderviaphonefromthebrokerageWalkstotradingfloorandexecutestransactionatthespecialist’’spostPhonesbrokerageandprovidesconfirmationFrancis&Ibbotson36Chapter6:TheGlobalStockMarketSpecialistsAcceptsobligationtomakeafairandorderlymarketbySellingsharesoutoftheirowninventoryiftherearemorebuyordersthansellorders(orbyraisingthepriceofthesecuritytheycontrol)Buyingsharesfortheirowninventoryiftherearemoresellordersthanbuyorders(orbyloweringthepriceofthestock)Keepsalimitorderbook(LOB)foreachstockinwhichtheymakeamarketFrancis&Ibbotson37Chapter6:TheGlobalStockMarketLimitOrderBookTodayiskeptonacomputerRecordsbuyandsellordersfrompotentialtradersOutlinesthesupplyanddemandcurvesthatdeterminemarketpriceofsecurityHelpsspecialistsearntradingprofitsBID:$42and?/80/84Wentz9Mirandi3Dalton1/81Sullivan4Jacoby1/43McGovern3/82GabelliFrancis&Ibbotson38Chapter6:TheGlobalStockMarketNYSENYSEhaslaggedbehindotherorganizationsintermsoftechnologyUsesSuperDesignatedOrderTurnaround(SuperDOT)systemRoutessmallmarketordersandlimitordersdirectlyfrommemberfirmstospecialistsBypassesfloorbrokersSpecialistsusuallyletPCsexecuteSuperDOTtransactionsautomaticallyFrancis&Ibbotson39Chapter6:TheGlobalStockMarketBlockTradesAsingletransactioninvolving10,000ormoresharesIncreasedsteadilythroughoutthe1960s-1980sbutleveledoffinthe1990sSpecialistsarenotinvolvedinblocktradesthatoccuroutsidetheNYSEbyblockpositionersSpecialbrokers/dealersthatlineupmultiplebuyersforalargeblockSomelargeinvestmentbankshaveablockpositioningdepartmentHavethecapitaltocarryalargeblockforafewdaysandtheconnectionstodistributeitTheupstairsmarketEconomiesofscaleleadtosmallcommissionspershareFrancis&Ibbotson40Chapter6:TheGlobalStockMarketNasdaqMarketElectronic,over-the-counter(OTC)marketListsover15%oftheworld’sstockmarketcapitalizationOver6,400commonandpreferredstocksAbout320foreignstocksAbout140ADRsFrancis&Ibbotson41Chapter6:TheGlobalStockMarketNasdaqMarketNationalAssociationofSecuritiesDealersAutomatedQuotations(Nasdaq)isthecommunicationsnetworkthatservicestheOTCmarketAbout61,000computerterminalsareconnectedtoNasdaq’’smainframeviaphonelinesCanobtaincurrentbidandaskpricesforallNasdaqstocksUpdatedcontinuouslybyabout540competingNasdaqmarket-makers(dealers)Investor’sbrokercanaccessthesystemtofindthebestbid/askpriceforasecurityBrokerthencallsdealertoexecutetransactionastradescannotbeexecutedviaNasdaqcomputerFrancis&Ibbotson42Chapter6:TheGlobalStockMarketNasdaqMarketCentralizesageographicallydispersedmarketintoamainframecomputerWhenabrokerordealerinquiresaboutasecurity’sprice,bid-askquotesareinstantlyprovidedevenifthedealersaremanymilesapartDesignedtohandleupto20,000stocksCurrentlylistsabout6,500activelytradedstocksIn1999NasdaqmergedwithAMEXNasdaqplanstocross-liststockswithvariousinternationalexchangesPositioningitselftomoreeffectivelycompetewithNYSEFrancis&Ibbotson43Chapter6:TheGlobalStockMarketCQS,ITSandLawofOnePriceSECrequiresthattheConsolidatedQuotationSystem(CQS)reportcurrenttransactionsforNYSE,OTC,AMEX,regionalU.S.stockexchangesandthethirdmarketHelpsinvestorsfindthebestpricesCQScannotperformexecutionsSECurgedNYSEtocreatetheIntermarketTradingSystem(ITS)ElectronictradingnetworklinkingvariousU.S.marketsNasdaqsupplementedITSwithanelectroniccommunicationsnetworkcalledPrimexGivesfasteraccesstoNYSE-listedstocksCombiningCQSwithITSandPrimexallowsarbitrageurstoenforcethelawofonepriceFrancis&Ibbotson44Chapter6:TheGlobalStockMarketNon-NasdaqNationalQuotationBureau(NQB)TobeincludedinNasdaq’snationaldailylist,astockmusthaveAtleasttwomarketmakersAminimumof1,500stockholdersSignificantinvestorinterestAstocknotmeetingtheserequirementsarelistedwiththeNationalQuotationBureau(NQB)NQBlists3,600stocks,someofwhicharenotactivelytradedIncludesDomesticU.S.micro-capstocksSharesinforeigncorporationsthatcannotbelistedonanorganizedexchangeADRSandGDRsforstocksthatdonotmeettheaccountingstandardsforlistingonanorganizedexchangeFrancis&Ibbotson45Chapter6:TheGlobalStockMarketThirdU.S.MarketThirdmarket—subsetofOTCmarketwhereexchange-listedstocksaretradedCompeteswithorganizedexchangesOfferscostsavingsintheformofbetterbid-askpricesNasdaqandregionalstockexchangesarethecoreofthethirdmarketForinstance,in1999ChicagoStockExchange(CHX)tradedover90%oftheNYSE-listedstocksMajorityofCHX’’stradingvolumeisfromduallistingsCHXpaysfororderflowSpecialiststakeapennyorso(pershare)fromtheirbid-askspreadandgiveittobrokerstoencouragebrokerstoexecutetheirordersontheCHXratherthanNYSEFrancis&Ibbotson46Chapter6:TheGlobalStockMarketFourthU.S.MarketFourthmarket—anetworkofmarket-makers,blocktradersandinstitutionsBypassnormaldealerservicesandnegotiatedirectlywitheachotherInstinet(shortforInstitutionalNetwork)hasoperatedinthefourthmarketsince1970Hascomputerterminalsinover5,000subscribers’officesMillionsofsharesaretradedinsecrecydailyviaInstinetCommissionsrangefrom2￠to8￠￠ashareFrancis&Ibbotson47Chapter6:TheGlobalStockMarketOrderCrossingNetworksAnelectroniccommunicationnetworkthattriestomatchbuyandsellordersThepricemaybeThelastreportedpricefromanorganizedexchangeMidwaybetweenthecurrentbid-askpricesonanorganizedexchangeTradersmaypayafixedannualfeetousealternativemarketsystemsVariabletradingcostsarezeroRapidexecutionsarepossibleiftheotherhalfofthetransactionisalreadypresentinnetworkOffersanonymitySometimesthenetworkisnotoperatingwhenitisneededOrtheotherhalfofthetransactionisunavailableFrancis&Ibbotson48Chapter6:TheGlobalStockMarketOrderCrossingNetworksInstinetoperatestheCrossingNetworkandcompeteswithInvestmentTechnologyGroup’’s(ITG)PortfolioSystemforInstitutiionalTrading(POSIT)BloombergrunsTradebook——acontinuousmatchingsystemmainlyforNasdaqstocksIn1999Bloomberg&ITGcreatedSuperECNOffersacrossingnetworkwithalargerorderflowOthercrossingnetworksincludeInvestor’sLiquidityNetworkbyFidelityInvestorsE-CrossnetisforEuropeanstocksFrancis&Ibbotson49Chapter6:TheGlobalStockMarketElectronicOrderWorkingSystemsElectronicorderworkingsystemsScreentelecommunicationnetworks,capturecurrentmarketinformationanduseittomakeongoingtransactionsNeedsthefollowinginformationSecuritiesthataretobetradedLimitorderpricesQuantitiesavailableatdifferentpricesBindingtimelimitsMarketswherethesecuritiesaretradedAnyadditionalinformationFrancis&Ibbotson50Chapter6:TheGlobalStockMarketElectronicOrderWorkingSystemsVariousEOWSincludeQuantEXbyInvestmentTechnologyGroupOrderManagementSystembyInstinetLatticeTradingSystembyCreditSuisseFirstBostonREDIBookArchipelagoExchangeFrancis&Ibbotson51Chapter6:TheGlobalStockMarketElectronicStockExchangesArizonaStockExchange(AZX)Formedin1990inPhoenixPeriodiccallmarketAutomatedauctionprocesClientsubmitsorderasifitwerealimitorderThelimitorderbookisopentoallparticipants,butanonymityofparticipantsismaintainedEachtimeanauctionoccurs,theAZXcomputercalculatessupplyanddemandcurvesforeachsecuritybeingauctionedTheintersectionofthecurvedeterminesthesecurity’smarketclearingpriceAllsell(buy)ordersbelow(above)themarketclearingpricearematchedOnadailybasis,abouttwodozeninstitutionalinvestorsusedtheAZXsystem,tradingseveralhundredthousandsharesFrancis&Ibbotson52Chapter6:TheGlobalStockMarketElectronicStockExchangesEuropeanAssociationofSecuritiesDealersAutomatedQuotations(EASDAQ)BasedinBrusselsNasdaqacquiredEASDAQin2001Listsandtradesabout50technologystocksPrimexPatternedafterNYSETakesacustomer’’sbuyorsellordertotheNYSEandothercompetingexchangesinsearchofbestavailablepriceAllowsuserstohaggleforthebestpricesFrancis&IbbotsonChapter6:TheGlobalStockMarketElectronicStockExchangesTradepointConductsauctionsforU.K.equitiesOperateswithatransparentorderbookStockbrokerscantransactwitheachotherinover6,000EuropeanandAmericanstocksAuctionsofftherighttobethedesignatedmarket-makerforeachstockinitssystemtomemberfirmsProvidescustodyservices,etc.Francis&Ibbotson54Chapter6:TheGlobalStockMarketElectronicStockExchangesEuropeanAllianceInformalallianceofeightstockexchanges,includingLondonStockExchangeAmsterdamStockExchangeBrusselsStockExchangeRegATSExchangesSECrulethatallowsalternativetradingsystemsintheU.S.toregisterasstockexchangesExchangesmustreporttheirpricesviatheConsolidatedQuotationSystemOperateasaself-regulatingorganizationParticipateintheintermarkettradingsystemFrancis&Ibbotson55Chapter6:TheGlobalStockMarketTheTwenty-FirstCenturyIn1999NYSEandNasdaqannouncedthattheyareinterestedinreorganizingasfor-profitcorporationsWouldallowthemtoraiseoutsidecapitalinordertoobtainbettertechnologyIn2000MerrillLynchstartedanelectronicbrokeragesubsidiary——thelastfull-servicebrokerageinU.S.todosoIn2000severalcompaniessubmittedajointproposaltoSECtoestablishacentrallimitorderbookWouldreducemarketfragmentationandincreasetransparencywithinU.S.Francis&Ibbotson56Chapter6:TheGlobalStockMarketTheTwenty-FirstCenturyElectronictechnologywillcontinuetoacceleratechangeTradingvolumewillincreaseastransactioncostsfallTherewillbepressureonstockexchangesandECNstoconsolidateAglobalmarketwilleventuallyemergeFrancis&Ibbotson57Chapter6:TheGlobalStockMarketLiquidityPerfectlyliquidassetsarehighlymarketableDonotsufferfromadeclineinpriceiftheyareliquidatedquicklyForexample,theU.S.dollarisperfectlyliToquicklysellahouse,sellermustofferapricediscountRealestatebrokerscommonlyhavecommissionsof6%ofthepropertyvalueFrancis&Ibbotson58Chapter6:TheGlobalStockMarketLiquidityContinuumAssetscategorizedfrommostliquidtoleastliquidU.S.dollarbillsU.S.TreasurybondsNYSE-listedstocksandlargeNasdaqstocks(suchasMicrosoft)NasdaqstocksCorporatebondsMostmunicipalbondsMostrealestateArtobjectsandcollectiblesInvestorspayaliquiditypremiumfortheconvenienceofowningliquidassets.Francis&Ibbotson59Chapter6:TheGlobalStockMarketLiquidityinSecuritiesAliquidsecuritiesmarketpossessesthefollowingqualitiesDepth—buyAmarketlackingdepthisshallowBreadth—whenalargeamountofbuy-sellordersasdescribedaboveexistMarketslackingbreadtharecalledthinmarketsResiliency—ifnewordersoccurinresponsetopricechangesduetotemporaryorderimbalancesFrancis&Ibbotson60Chapter6:TheGlobalStockMarketTransactionCostsDirecttransactioncostsBrokers’commissionsIncometaxesTransferfeesCustodialfeesOutlaysforresearchinformationIndirecttransactioncostsBid-askspread—determinedbythecostofmarket-makingexpensessuchasInterestexpenseforfinancinginventoryofsecuritiesRiskpremiumforinvestingcapitalAdministrativecostsFrancis&Ibbotson61Chapter6:TheGlobalStockMarketTransactionCostsIndirecttransactioncostsMarketimpactBuying(selling)tendstobidup(down)thepriceofasecurityLargetransactionstendtomovepricesmorethansmallertransactionsOpportunitycost(implicit)DecayofinformationvalueofatradeincurredwhenmarketmovesagainstatraderwaitingtotradeTendstoincreasewithtimebetweendecisiontotradeandtheactualexecutionofthetradeFrancis&Ibbotson62Chapter6:TheGlobalStockMarketTransactionCostsTotaltransactionscostscanrangefromlessthan1%ofthevaluetomuchoftheinvestor’’sreturn(incountrieswithhighcapitalgainstaxes)ThecostoftransactionvariesinverselywithLargecapstocksareusuallymoreactivelytradedthansmallcapThus,smallcapstocksgenerallyhaveahighertransactioncostLargeindustrializednationsgenerallyhavelowertransactioncostsbecauseThestockmarketsaremoreactiveMorepoliticalstabilityMoreefficientlegalsystemsFrancis&Ibbotson63Chapter6:TheGlobalStockMarketTheBottomLineSmallandlargestockmarketsprovidevaryingdegreesofliquidityInstitutionalinvestorsmayuseblockpositionerstoexecutelargetradesFull-servicebrokerschargehighcommissionsDiscountbrokers,electronicbrokersorECNsofferlesscostlyservicesMosttradesaremarketorders,howeverotherordertypesexistFrancis&Ibbotson64Chapter6:TheGlobalStockMarketTheBottomLineInvestorsmaybuyonmargin—effectivelyborrowingmoneyfromtheirbrokerageMargintradingenhancesgainsandlossesInvestmentbankersassisttheirclientsinraisingmoneyintheprimarymarketOrganizingdistributionsyndicatesUnderwritingtheissueDistributingthesecuritiesFrancis&Ibbotson65Chapter6:TheGlobalStockMarketTheBottomLineNYSEisthelargeststockmarketintheworldContinuousauctionmarketSpecialistsNASDAQisalargeelectronicmarketE