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The Over-the-Counter Market
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There is also an “over-the-counter market”. The over-the-counter market is quite different from the organized securities exchanges such as the NYSE or Amex. Stocks listed in the over-the-counter market are bought and sold by securities dealers operating from their own offices, and typically supplying shares from inventories of shares they hold themselves. Shares on the over-the-counter market less widely held than the shares sold on the exchanges and hence are less liquid.
The commission charged for buying or selling shares on the over-the-counter market is higher than that charged for shares traded on the exchanges. The over-the-counter listing shows the name of the company, the annual dividend rate per share, and bid and offer quotations as of 9.00A.M. in terms of dollars per share. Thus, Acme Electric, which pays a 24 cents dividend per share could be bought for roughly $7.25 per share and could be sold for roughly $6.50 per share. The phrase “roughly” is to indicate that the quoted bid and asked figures can change quite quickly on the basis of just a few transactions, because the market any share is quite “thin” (few shares trade hands; few buyers and few sellers). However, the bid and asked quotations are indicative of the current state of the market, much as the price of the last sale of the day is for the organized exchanges.
In addition to information on stock prices, most financial pages also present information on bond prices, and on the selling prices of mutual funds, using much the same terminology as that employed in the stock lists.
We can distinguish between different kinds of traders on these markets.
Speculators are individuals who buy or sell with the object of making a profit in the future on the basis of change in the price of the good.
Bears buy shares expecting the market to rise.
Bulls are speculators who expect share prices to fall.
Stags buy new issues of shares hoping to sell them quickly as a profit.
Hedgers- individuals who negotiate purchases or sales today in order to avoid risks of price fluctuations in the future. Thus a wheat farmer might contract in April to sell the wheat crop (which will be harvested in August) for some fixed price, thus eliminating the risk that wheat prices will fall between the time of planting and the time of harvesting.
Arbitragers are traders who buy and sell in one market in order to make profit by performing an opposite transaction in some other market.Thus, if one dollar sells for 225 yen in New York, while one dollar sells for 230 yen in Tokyo, the arbitrager can take one dollar and buy 230 dollars yen in Tokyo, at the same time contracting to sell his 230 yen in New York for 230/225 dollars, or about
$ 1.022.This might not seem like much of the profit, but what if an arbitrager invests $1million in the Tokyo market. The transaction would then net about $22,000 and is close to being completely risk-free. Arbitragers are important, because their actions have the effect of bringing all markets in a good into line with one another, after taking into account the costs of transporting goods (including insurance and so forth) between markets.
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Text 4
Capital Markets
The following list of capital markets, although not comprehensive, identifies the differences among markets and the assets traded in them:
1. Equity, or stock, markets. The stock exchange is the main ‘secondary’market for shares in corporations – i.e. limited liability companies. It is a secondary market in the sense that the shares are already in existence, so that trade takes place between investors and need not directly involve the corporations themselves.
The ‘primary’ market involves the issue of new shares by corporations. There are various categories of shares (e.g. ordinary shares, preference shares) but the distinctions among them are neglected here, being peripheral to the basic principles of price determination.
The pattern of share prices is normally summarized by reference to particular well- known stock price averages or indexes, such as the Dow-Jones Industrial Average, Standard and Poor’s 500 index, or the Financial Times Stock Exchange 100 index.
2. Bond markets. These are markets for long-term securities such as government debt (known as gilt-edged securities in Britain) or corporate bonds. Bonds are usually regarded as less risky than shares because bonds normally oblige the issuer to promise to take specific actions at definite dates in the future.
The distinction is not quite as clear as it might first seem because bond contracts can include clauses that provide for different actions in a multitude of different contingencies. Also, it is possible that the issuer of the bond will default with respect to some clause in the agreement. Even so, a typical bond is a promise to pay (a) a sequence of coupons (commonly twice a year) and (b) a lump sum maturity value (or face value) at a specified date in the future.
If there is any distinction between ‘stocks’ and ‘shares’, it is not one of any significance here. A company’s ‘stock’ could refer to the whole value of its equity, while ‘shares’ could refer to the ownership of a portion of that stock.
Bonds are commonly traded on stock exchanges in much the same way as shares. A feature of medium-term and long-term bonds is that, like shares, much of the trade is amongst investors, without the direct involvement of the issuer (government or company).
3. Money markets. Money markets exist to facilitate the exchange of securities such as treasury bills (commonly, three-month or six-month government debt) or other loans with a short time to maturity. Although such securities are traded in markets, any holder does not have to wait long before the issuer is obliged to redeem the debt in compliance with the terms of the contract.
4. Commodity markets. Markets of some form exist for almost every commodity, though financial studies are usually confined to highly organized markets for a fairly narrow range of commodities, including precious metals (gold, silver, platinum), industrial metals (such as lead, tin and copper), petrochemicals or agricultural commodities (such as cereals, soya beans, sugar and coffee). This list is not exhaustive but it does suggest that the commodities in question need to have certain physical characteristics: namely, that they can be graded according to well-defined attributes, that they are divisible into precisely defined units, and that they are storable (though often subject to deterioration over time). Most organized commodity markets involve trading in contracts for the delivery of the stated commodity at a future date, though perhaps one very near to the present.
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5. Physical asset markets, such as for real estate. In this case, the relevant asset for financial analysis is often a security (e.g. a mortgage) constructed to have a well defined relationship with the physical asset (e.g. a mortgage being a loan secured against the equity of the property). It is not uncommon for mortgages to be securitized by financial intermediaries that issue bonds backed by (and with payoffs defined by) bundles of mortgages.
6. Foreign exchange markets – ‘FOREX’ or ‘FX’ markets. These are markets for one currency against another. Governments often intervene in such markets – not infrequently with disastrous consequences – to fix, or at least influence, exchange rates among currencies. Two notable features of FX markets are (a) the vast turnover of funds (often about $1.5 trillion each day in mid-2001) and (b) round-the-clock trading.
7. Derivatives markets. Corresponding to most of the above categories are derivative, or synthetic securities. They are ‘derivative’ in the sense that their payoffs are defined in terms of the payoffs on an underlying asset or assets. The underlying asset could itself be a derivative, so that a whole hierarchy of such instruments emerges. Almost all derivatives are variants of two generic contracts.
(a) Forward agreements. These are contracts in which the parties agree to execute an action (typically, the exchange of a specified amount of money for a specified amount of some ‘good’) at a stipulated location and date in the future. For example, a forward contract might specify the delivery of 5000 bushels of domestic feed wheat to a grain elevator in Chicago, six months from the date of the agreement, at a price equal to $3.50 per bushel. A futures contract is a special type of forward contract designed to allow for trading in the contract itself. Repo contracts are combinations of loans and forward agreements. Swaps are sequences of forward contracts packaged together.
(b) Options are contracts for which the holder has the right, but not the obligation, to execute a specified action at an agreed date, or over a range of dates. For example, an option might stipulate that its owner can purchase 100 IBM ordinary shares for $220 per share at any time prior to the following 30 September. Many sorts of option contracts are traded. For example, options on futures are options to purchase or sell futures contracts; swaptions are options on swap contracts. Exotic options encompass a variety of contracts involving non-standard terms for their execution.
Many financial exchanges started life as mutually owned organizations. Examples include the LSE, the NYSE, NASDAQ, the CBOT, the London Metal Exchange (LME) and the International Petroleum Exchange (IPE).
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