BUS 171A Test #3

A secondary market

is one where existing or outstanding assets are traded among investors.

sealed bid/ask auction

auction where the bid price/ask price and the quantities a participant is willing to transact are submitted

operationally (or internally) efficient market

market where investors can obtain transaction services as cheaply as possible, given the costs associated with furnishing those services; this is distinct from a

standby fee

fee the issuing corporation pays to the investment banking firm

completely segmented market

market where investors in one country are not permitted to invest in the securities issued by an entity in another country

OTC market

market where non-exchange-traded products are traded

continuous order-drive market

market where prices are determined continuously throughout the trading day as buyers and sellers submit orders, so prices may vary with the pattern of orders reaching the market and not because of any change in the basic situation of supply and demand

primary market

financial markets dealing with financial claims that are newly issued

secondary market

financial markets for exchanging financial claims previously issued, also called the market for seasoned securities

perfect market

for a financial asset: the ideal characteristics of secondary markets

order-driven market (or auction market)

market where all of the participants in the trade are natural buyers and natural sellers, thus no dealer is acting as an intermediary

completely integrated market

market with no restrictions preventing investors from investing in securities issued in any capital market throughout the world

Secondary markets

may be continuous or call markets or a combination of the two

information-motivated trades

occur when investors believe they possess pertinent information not currently reflected in the security's price

base rate

one factor of the cost of debt; the interest rate on a U.S. Treasure security with the same maturity or some other low-risk security

natural buyers

potential party to trade; take position for their own portfolio

natural sellers

potential party to trade; take position for their own portfolio

selling short

practice of selling securities that are not owned at the time of sale

In a call market

prices are determined by executions of batched or grouped orders to buy and sell at a specific time (or times) in the trading day

auctioneer

provides order and fairness in the operations market; in some market structures, the dealer acts as the auctioneer

The secondary market

provides the issuer with regular information about the value of its outstanding stocks or bonds, and it encourages investors to buy securities from issuers, because it offers them an ongoing opportunity for liquidating their investments in securities.

pricing efficiency

refers to a market where prices at all times fully reflect all available information that is relevant to the valuation of securities

Privatization

the process of offering securities of government-owned companies to private investors

subscription price:

the price at which new shares can be purchased

long position

carrying inventory of a security

Opportunity costs

arise when a desired trade fails to be executed

broker

third party in a trade that acts on behalf of a buyer or seller who wishes to execute an order

mildly segmented market (or mildly integrated market)

): real-world capital markets tend to be a mix of segmented and integrated markets, which implies that world capital markets offer opportunities to raise funds at a lower cost outside the local capital market

spread:

:second factor of the cost of debt; reflects the greater risks that investors perceive as being associated with the issue or issuer

in a theoretical sense, only if it meets many conditions regarding number of participants, flow of information, freedom from regulation, and freedom from costs that hinder trading.

A market can be perfect

reasonably priced services related to buying and selling.

A market is operationally efficient if it offers investors

prices fully reflect all available information that is relevant to the valuation of securities

A market is price efficient if at all times

selling that security short.

An investor who expects that the price of a security to decline can benefit by

collecting and transmitting orders to the market, bringing willing buyers and sellers together, negotiating prices, and executing orders; the fee for these services is the broker's commission

Brokers assist investors by

selling assets at higher prices than the prices at which they purchased them.

Dealers buy for their own account and maintain inventories of assets, and their profits come from

the execution price of a security and the price that would have existed in the absence of the trade; these costs arise out of the demand for immediate execution through both the demand for liquidity and the trading activity on the trade date.

Execution costs represent the difference between

A private placement is different from the public offering of securities in terms of the regulatory requirements that must be satisfied by the issuer

Certain provisions in federal securities law allow issuers to be exempt from registering a new issue with the SEC.

1) they provide the opportunity for investors to trade immediately rather than waiting for the arrival of sufficient orders on the other side of the trade (immediacy), and they do this while maintaining short-run price stability (continuity); (2) they offer price information to market participants; and (3) in certain market structures, dealers serve as auctioneers by bringing order and fairness to a market.

Dealers perform three functions in markets

full and fair disclosure of the character of securities sold in interstate and foreign commerce and through the mails.

Disclosure information is accomplished by the issuance of a prospectus that provides

to comply with that country's securities laws.

Entities seeking to raise funds in every developed country are required

active strategies pursued will not consistently produce superior returns after adjusting for risk and transactions costs

In a price-efficient market

(1) how a "security" is defined, (2) disclosure requirements when securities are issued, and (3) the solicitation of funds.

In all countries, securities laws dealing with the primary market cover three critical issues

¡the Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act).

In the United States, there are two principal pieces of federal legislation regarding securities:

exchange markets and over-the-counter (OTC) markets

Markets are classified as

which include commissions, fees, and execution costs.

Some key frictions are transactions costs

on the relevant information set: weak form, semi-strong form, and strong form.

Three forms of pricing efficiency are based

1) the disclosure of information about the securities that an entity is planning to issue and (2) the prevention of the sale of securities as a result of deceit, misrepresentation, and other fraud.

There are typically two basic objectives of the securities laws in countries

¡10 report; 10-Q report; 8-K report; proxy statement; Forms 3, 4, and 5; and Schedule 13D and Schedule 13G reports.

Unless an exemption is allowed, an issuer of a new security must file certain documents with regulators. In the United States, the following documents must be filed with the SEC

¡the bought deal for the underwriting of bonds and seasoned equity offerings, the auction process, and preemptive rights offering for underwriting common stock.

Variations in the underwriting process include

principal

a dealer commits its own capital to accommodate a trade sought by other parties, and thus acts as a principal in a trade

coupon formula

a formula according to which a coupon rate for a floating-rate security resets periodically, and which consists of a reference rate and a quoted margin

coupon security

a government-issued security that is issued with a stated rate of interest, makes interest payments periodically, and has a terminal payment equal to its principal value

discount security

a government-issued security that pays a single cash flow at the end of its life

pre-emptive rights offering

allows a corporation to issue new common stock directly to existing shareholders and allows them the right to buy some proportion of the new shares at a price below market value

dealer

an entity that acts as an intermediary in a trade by buying and selling for its own account

individual accredited investor

an individual who meets certain annual income and/or net worth thresholds

periodic call auction

another type of order-drive market where orders are batched or grouped together for simultaneous execution at preannounced times

marketing timing cost

arises when an adverse price movement of the security during the time of the transaction can be attributed in part to other activity in the security and is not the result of a particular transaction

price scan auction:

auction where an auctioneer announces tentative prices and the participants physically present respond indicating how much they would be willing to buy and sell at each tentative price

Investors get services from the secondary market

because the market supplies them with liquidity and prices for the assets they are holding or want to buy, and the market brings interested investors together, thereby reducing the costs of searching for other parties and of making trades.

Even the most developed and smoothly functioning secondary market falls short of

being perfect in the economically theoretical meaning of the term

Electronic trading (or etrading)

brings buyers and sellers together electronically, replacing personal and telephone contact in most markets

In general, secondary market structures

can be classified as order driven or quote driven, with real-world financial markets using a combination of these market structures.

Order-driven markets

can be further classified as continuous order-driven and periodic call auction markets

dealer's position

can involve either a long position or a short position

opportunity cost

cost of not transacting; may arise when a desired trade fails to be executed and represents the difference in performance between an investor's desired investment and the same investor's actual investment after adjusting for execution costs, commissions, and fees

specialists

dealers of the organized markets; their privileged positions allows them to get special information about the flow of market orders

Quote-driven markets

do not require a dealer, and the prices are determined by the interaction of natural buyers and natural sellers rather than being set by a dealer.

standby underwriting arrangement:

ed in instances where the issuing corporation uses the services of an investment banker for the distribution of common stock that is not subscribed to; such an arrangement calls for the underwriter to buy the unsubscribed shares

strong efficiency

exists in a market where the price of a security reflects all information, regardless of whether it is publicly available

institutional accredited investor

includes such entities as banks, insurance companies, mutual funds, and venture capital funds

Because of imperfections in actual markets

investors need the services of two types of market participants: dealers and brokers.

The primary market

involves the distribution to investors of newly issued securities and seasoned offerings.

A mechanism to allow investors to sell short

is critical in financial markets, because in the absence of such a mechanism, security prices will tend to be biased toward the view of more optimistic investors.

The Securities and Exchange Commission (SEC)

is the U.S. federal agency responsible for administrating federal securities laws as set forth in the Securities Act and the Exchange Act.

quote-driven market (or dealer market or dealership market)

market determined by the dealer and is based on prevailing market information, where the dealer stands ready to buy and sell a financial asset at the prices it quotes

bought deal

refers to the offering of a security (stock or bond) whereby an underwriter agrees to purchase all of the security from the issuer at a fixed price without premarketing the deal before purchasing from the issuer

execution costs:

represent the difference between the execution price of a security and the price that would have existed in the absence of the trade; further decomposed into market (or price) impact and market timing costs

informationless trades

result from either a reallocation of wealth or the implementation of an investing strategy that depends only on existing public information

Rule 415 (or the shelf registration rule)

rule approved by the SEC that permits certain issuers to file a single registration document indicating that it intends to sell a certain amount of a certain class of securities at one or more times in the next two years

exchanges

secondary markets that legally established national securities exchanges

inflation-adjusted securities

securities that adjust the payments to investors for some measure of the country's rate of inflation

floating-rate securities

securities whose interest payments change periodically according to a predetermined coupon formula

short position

selling a security that is not an in inventory

A secondary market

serves several needs of the firm or governmental unit that issues securities in the primary market.

limit orders

special orders that can be executed only if the market price of the asset changes in a specified way

market maker

special type of dealer that has a special obligation to use its capital to make an orderly market for designated financial assets in the secondary market

indexing

strategy that seeks to match the performance of some financial index

Actual markets

tend to have numerous frictions that affect prices and investors' behavior.

sovereign debt

the debt issued by the highest level of government in a particular country

bid-ask spread

the difference between the price at which a dealer is willing to offer a financial asset to investors (the ask price) and the price at which a dealer is willing to buy a financial asset from investors (the bid price)

market impact cost (or simply impact cost

the result of the bid-ask spread and a price concession extracted by dealers to mitigate their risk that an investor's demand for liquidity is information motivated

In the United States, SEC Rule 415

the shelf registration rule, permits certain issuers to file a single registration document indicating that it intends to sell a certain amount of a certain class of securities at one or more times in the next two years

In a continuous market

trading and price determination go on throughout the day as orders to buy and sell reach the market

Dutch auction

type of auction where a single price will be paid by all bidders

frictions

various costs and impediments that occur in a market; perfect markets are free of them

prospectus

what is issued for disclosure of information about the securities an entity is planning to issue, which provides "full and fair disclosure of the character of securities sold in interstate and foreign commerce and through the mails"

immediacy

when buyers and sellers do not want to wait for the arrival of sufficient orders on the other side of the trade, which would bring the price closer to the level of recent transactions

semi-strong efficiency

when the price of the security fully reflects all public information, which includes but is not limited to historical price and trading patterns

weak efficiency

when the price of the security reflects the past price and trading history of the security