LESSON # 3
INTRODUCTION OF MARKET PLACE
Contd…
CIRCUIT BREAKERS AND TRADING
CURBS:
In listening to market reports, you will sometimes hear that
trading curbs are in effect or that a circuit breaker kicked in”.
While both trading curbs and circuit breakers are designed to
reduce temporary volatility in the market, they are slightly
different. At the NYSE, anytime the Dow Jones industrial
average moves up or down more than 2%, computerized
trading via the SuperDot system is restricted. This happened
366 times on 277 separate trading days in 1998. Non
computerized trading continues despite the circuit breaker
having been activated.
Trading curbs halt all the trading at the exchange, not just
computerized trades. If the Dow Jones industrial average drops
10%, trading stops for an hour or for 30 minutes if the drop was
between 2:00 pm and 2:30 pm. After 2:30 pm, trading is not
halted. A 20% drop halts trading for two hours if it is before 1:00
pm; for one hour if between 1:00pm and 2:00 pm; and for the
rest of the trading day if after 2:00 pm. A 30% drop halts trading
for the remainder of the day.
Trading has only been halted once because of there provisions.
On October 27, 1997 the DJIA was down 350 points at 2:35 pm
and down 550 points by 3:30 pm. This shut down trading for the
remainder of the day.
THE NASDAQ STOCK MARKET:
Once a stepchild of the marketplace, the
NASDAQ stock market, still sometimes called the
over the counter market, is now an important
part of the investment arena. Securities trading
in this market range from small, unknown firms
to some of the largest companies in the world.
THE NASDAQ NATIONAL MARKET:
Unlike the national and regional stock exchanges, no actual place
is called the over the counter market. Rather, it is a worldwide
computerized linkup brokerage firms, investment houses, and large
commercial banks. The headquarters of the computer system is in
Trumbull, Connecticut, with a backup system in Rockville,
Maryland. Bids and offers for individual securities are posted to an
electronic bulletin board. These prices appear in the financial press
under a heading including the term NASDAQ, shorthand for
national association of securities dealer’s automated quotations.
NASDAQ price quotations first appeared February 5, 1971
TIERS OF THE NASDAQ MARKET:
The largest and most established firms in the NASDAQ market are called
national market issues. These securities, which number about 4000, include
firms such as Intel and Microsoft. Information about national market issues
is usually readily available and normally covered the popular reference
sources found in most public libraries.
Other NASDAQ securities are small-cap issues, meaning they have a low
level of capitalization. There are abut 1250 of these securities, but detailed
information about them is substantially more difficult to gather quickly.
These firms receive limited coverage in the financial press. Most pay no
dividend; many are too new to have any earning from which to pay the
dividend. The newspaper listing for small-cap issues is abbreviated;
generally only trading volume and closing price appears.
THE OVER THE COUNTER MARKET:
Some investors view the terms NASDAQ and OTC synonymously.
This may have been accurate at one time, but not any more.
Today the term OTC equity security refer to an equity security
that is not listed or traded on NASDAQ or national securities
exchange. On NASDAQ, there are listing standards, automated
trade executions, formal corporate relationships with the
underlying firms, and substantial market maker obligations. This
is not true of over-the-counter securities. These trade two ways,
either via the OTC bulletin board or via the pink sheets.
OVER-THE-COUNTER BULLETIN BOARD
(OTCBB):
The OTC bulletin board is a regulated quotation service
providing real-time information on OTC equity securities.
The OTCBB came about largely because of the penny
stock reform act of 1990, which required the SEC to
establish a system facilitating widespread dissemination of
piece quotation on OTC equities. Since December 1993
firms have been required to report trades in these
securities within 90 seconds of the transaction.
PINK SHEETS STOCKS:
The smallest and often most speculative OTC stocks are the pink sheet issues.
Information on these securities comes from the NOB, which begin providing
the data in 1913. Roger Babson, founder of Babson College was largely
responsibly for its origination. The name comes from the fact that historically
the pricing informed appeared on narrow strips of pink paper and hung from a
clipboard in brokers’ offices.
The information was often limited to a dealer’s name, telephone number, a bid
price, and an offer price. As technology advanced and investors became
accustomed to current price data on demand, the pink sheets have changed,
too. Stale pricing data is not longer acceptable. Now subscribers can access
real time data on pink sheet stocks via the internet at www.otcquote.com .
THIRD AND FOURTH MARKETS:
Listed securities can be traded in the NASDAQ market. General
electric, for instance, trades on New York stock exchange. A
brokerage firm could offer to sell 1000 shares of GE through the
NASDAQ system. In essence, they post a for-sale advertisement
on the inter market trading system (ITS). GE is the widely traded
stock and odds are extremely goo that someone will bid on it. The
trading of listed securities in the NASDAQ market is known as the
third market. The third market may offer greater trading flexibility
than the exchanges, particularly with regard to trading rules and
fees.
REGULATION:
Another globally envied characteristic of the US
exchanges in their oversight and consequent safety.
While nothing can keep market prices from
responding to economic and psychological events,
effective regulation can reduce the possibilities that
investors will be missed by the unscrupulous.
THE EXCHANGES:
The exchanges established regarding the financial capacity of
members serving as stock specialists. Rule 104.20 of NYSE
constitution and rules requires each specialist firm to continually
carry sufficient capital to assume a position of 15000 shares in
each common stock in which they are registered. At the American
stock exchange, rule 171 of AMEX constitution and rules require
each specialist to have sufficient capital to assume 6000 shares or
$600,000 whichever is greater.
THE SEC:
Background:
Congress established the Securities and Exchange
Commission SEC in 1934. The purpose of the SEC is to
promote honest and open securities market. In particular,
the SEC is to ensure full and fair disclosure of relevant
corporate information to potential and current investors in
the firm.
Some people believe congress created the SEC in response to the
great crash of 1929. Actually, attempts to regulate the US securities
industry date back to the late nineteenth century. As capital markets
grew during the industrial revolution, so did the instances of price
manipulation and other abuses. One of the most notable instances of
abuse is the infamous Ponzi scheme. In a ponzi scheme someone
returns part of the investors’ principal, claiming it as profit.
THE PRIMARY PURPOSE OF THE SEC IS TO
ENSURE THAT INVESTORS HAVE ADEQUATE
INFORMATION TO MAKE AN INFORMED
INVESTMENT DECISION.
PRIMARY ACTS:
Perhaps the two most important security acts as
influencing the investment industry today are
the securities act 1933 and the securities
exchange act of 1934. Both acts were part of
President Roosevelt’s new deal legislation.
THE NASD:
The National Association of Securities Dealers (NASD) is a self-
regulatory body that licenses brokers and generally oversees
trading practices. Congress provided for the creation of such a
national securities association in a 1938 amendment to the
Securities Exchange Act of 1934. The NASD is the owner and
proponent of the NASDAQ price quotation system. The SEC
specifically overseas the trading of listed securities, while the
NASD overseas all trading. The SEC also oversees the NASD. A
central theme of the 1938 amendment is the promotion of a
voluntary code of business ethics.
SIPC:
In 1970 Congress passed the Securities Investor Protection Act, which
established the Securities Investor Protection Corporation SIPC. This
organization protects investors from loss due to brokerage firm
failure, fraud, natural disaster, or theft. Since its inception, the SIPC
has liquidated more than 200 firms and distributed nearly $1 billion
in claims to more than 200,000 investors. It does no provide
protection against loss due to bad investors, however. Brokerage
firms provide a minimum of $500000 protection to each of their
customers. For an added insurance premium, firms can increase their
protection level. The division of market regulation of the Securities
and Exchange Commission supervises the SIPC.
ETHICS:
One characteristic of the marketplace that should be
mentioned in the discussion is the growing sensitivity to the
importance of ethical behavior of those who can deal with
the public’s money. Much of the regulatory history of the
markets stems from attempts to curtail questionable or
downright corked behavior on the part of unscrupulous
characters who seek to take advantage of those who are
financially unsophisticated
ILLEGAL VS. UNETHICAL:
A wide range of investment activities may be legal, but these activities carry
substantial ethical baggage. Suppose, for instance, someone asks a finance
professor about the potential of Gillette common stock. “I think it is a great
investment’ the company’s sales will go up forever” may be the professor’s
opinion, which is not illegal to express. From an ethical perspective, however,
an important aspect is the basis for the opinion. If the professor knows
nothing about the company but is simply stating a preference for the
company’ razors, then the opinion is quite different from one formed from
careful company’s analysis. It might not be illegal for the professor to like
Gillette or to state a personal opinion, but many people would consider it
unethical to give the impression that such an opinion is the result of careful
analytical study.
Suppose the professor likes Gillette after reading a research report
in which an analyst recommended the stock. Does this make the
opinion more reasoned, and therefore give the response more
ethical credibility? Take for instance, another consideration with
ethical overtones. Suppose the professor has researched Gillette
and does believe it as a common stock with above average
potential. Can the professor now comfortably recommend Gillette
when someone asks about it? Even now the answer is not clear cut.
Who is asking? 30 years old professional earning $75000 per year or
a 75 years old widow was living on a fixed income? It is not possible
to discuss the merits of a particular investment without knowing the
context in which the potential investor is asking the question.
CORPORATIONS, SHARES, AND
SHAREHOLDER RIGHTS
Common stock is the hallmark of the capitalist systems.
Millions of people directly own a portion of U.S. business
through their investment in common stock; millions more
have an indirect ownership interest through their
investments in mutual funds, insurance contracts and
retirement annuities. People own stock have an equity
interest in the organization.
CORPORATIONS:
If a business has shares of stock, it is organized as a
corporation rather than a proprietorship or a partnership.
Corporations very widely in their complexity and size
General Motors (GM NYSE) and Intel (INTC, NASDAQ) are
corporations, but so are many doctors professional
athletes and inventors. All corporations issue common
stock, but it is not always possible for the general public to
buy the shares. The stock of some corporations is closely
held, meaning the people who own the stock do not
routinely offer it for sale.
SHARES:
In the United States, those two types of stock are common
stock and preferred stock. Both are equity securities and
both represent a partial ownership interest in the firm.
Don’t be misled by the term common. It does not mean
the stock is average or routine. Common stock is really a
single term rather than an adjective and a noun. In formal
terms, common shareholders have a residual claim on the
assets of the firm after the bondholders and other
creditors.
SHAREHOLDER RIGHTS :
Investors in the shares of U.S. corporations are
entitled to standard bills of rights unless
otherwise provided in the corporate charter. A
few of these are especially important to stock
investors.
THE RIGHT TO RECEIVE DECLARED
DIVIDENDS ON A PRO RATA BASIS:
A corporation is not required to issue any kind of dividend
to its shareholders. Shareholders do not have a right to
dividends; but if a dividend is declared the dividend each
shareholders, receive must be in proportion to the
shareholder’s ownership interest in the firm. A person
owning 500 shares receives five items the dividends
received by a person owning 100 shares.
THE RIGHT TO VOTE:
Shareholders are entitled to vote on matters of interest to
the corporation, such as the election of the board of
directors, the selection of an auditor, and amendments to
the corporation charter. The usual rule is the shareholders
gets one vote for each share held.
THE RIGHT TO MAINTAIN
OWNERSHIP PERCENTAGE;
Sometimes a firm chooses to raise new capital by selling
additional shares of stock. The preemptive right gives existing
shareholders the right to maintain the same ownership
percentage before and after the new stock sale. Suppose for
instance a corporation has 10 million shares of stock outstanding
and a pension fund owns one percent of them. If the corporation
decides to issue an additional 1 million shares, the pension fund
will be entitled to purchase 10,000 (one percent) of these new
shares. If it does so after the stock issue the fund would own
110,000 of the 11 million total shares still one percent of the total.
TYPE OF DIVIDENDS:
The three types of dividends that corporations
may pay to their shareholders include cash
dividends stock dividends, and property
dividends.
1. CASH DIVIDENDS:
A cash dividend not surprisingly, is paid in cash and is the most
common type of dividend. Most firms have an established dividend
payment schedule through which a portion of the firm’s profits are
returned to the shareholders. These dividends may be received as cash
(via a check form the company) or they can sometimes be reinvested in
additional shares of stock in the firm. This latter option is accomplished
via a dividend reinvestment plan, often called a DRIP. Such a plan
virtually always provides for the purchase of fractional shares with the
reinvested check. If the current share price is $25, $30 dividend check
would buy 1.2 shares.
2. STOCK DIVIDENDS:
Stock dividends are paid in additional shares of
stock rather than in cash. Firms announce these
a as percentage such as a 10 percent stock
dividend, which means the holder of 1000
shares would receive an additional stock
certificate for 100 shares. The person who holds
100 shares would get 10 more.
3. PROPERTY DIVIDENDS:
A property dividend is the prorate distribution of a physical
asset. The asset is usually something the firms produce.
Property dividends were popular in the early days of the
capital markets when the number of shareholders in a
particular company was small and the company produced
something that could conveniently be distributed.
STOCK SPLITS:
Even though stock splits are common in the
marketplace, the typical investor may
misunderstand them. And because stock splits
are generally a natural occurrence, they clearly
are not a windfall for the recipient.
STOCK SPLIT VS. STOCK DIVIDENDS:
In practical terms, they are not different at all. From the investor’s
perspective, the impact is exactly the same. The difference between a
stock split and a stock dividend is purely an accounting phenomenon.
With a stock split the par value of the stock as carried on the firm’s
book changes by the split factor. With a stock dividend the par value is
not affected, new shares are issued. Stock par value is not a
meaningful statistics from an investment point of view, it is an
accounting curiosity.