Understanding Stock Markets and Trading: A Comprehensive Guide
Understanding Stock Markets and Trading
1. Primary vs. Secondary Markets
If Sue buys 300 newly issued shares of High Color Detergent on NASDAQ, the trade occurs in the primary market.
When Wilson buys 500 outstanding shares of GE, the trade occurs in the secondary market.
2. Initial Public Offerings (IPOs)
Hi-Tek Shoes, a private firm going public, will be conducting an initial public offering (IPO).
3. Investment Banking
Firms specializing in arranging financing for companies are called investment banking firms.
4. Underwriting
The process of buying newly issued shares from the issuer and reselling them to the public is called underwriting.
5. Venture Capital
Financing for high-risk new ventures is referred to as venture capital.
6. Seasoned Equity Offering
Marco Painting Supplies issuing additional shares is a seasoned equity offering.
7. General Cash Offer
Under a general cash offer, shares are offered to the general public on a “first-come” basis.
8. Rights Offer
A public offering where shares are offered first to current shareholders is a rights offer.
9. Spread
The difference between the underwriter’s purchase price and offering price is the spread.
10. Syndicate
A group of underwriters working together to sell a new issue is a syndicate.
11. Types of Underwriting
- Firm Commitment: Underwriters buy the entire issue and accept the risk of unsold shares.
- Best Efforts: The issuer assumes the risk of unsold shares.
- Dutch Auction: The price is determined by competitive bidding.
12. Securities and Exchange Commission (SEC)
The Securities and Exchange Commission (SEC) regulates U.S. financial markets.
13. Prospectus and Red Herring
A prospectus is required for stock offering approval. A red herring is a preliminary document for interested investors.
14. Brokers and Dealers
A securities dealer trades from their inventory. A broker arranges trades between buyers and sellers.
15. Bid and Ask Prices
Investors sell at the bid price and buy at the ask price.
16. Private Equity Funds
Private equity funds invest in private companies and manage their operations.
17. New York Stock Exchange (NYSE)
An owner of a trading license on the NYSE is a member.
18. Designated Market Maker (DMM)
A designated market maker (DMM) maintains an orderly market for specific securities.
19. Trading Floor Broker
A trading floor broker executes orders for commission brokers.
20. NYSE Super Display Book
The NYSE’s Super Display Book is based on its ARCA electronic trading engine.
21. Floor Trader
An NYSE member trading only for their own account is a floor trader.
22. Specialist’s Post
The location where a security trades on the exchange floor is the specialist’s post.
23. Types of Orders
- Market Order: Buy or sell at the current market price.
- Limit Order: Buy or sell at a specific price or better.
- Stop Order: Becomes a market order after a trigger price is reached.
24. Over-the-Counter (OTC) Market
An OTC market is centered on dealers trading from their inventories.
25. Electronic Communication Network (ECN)
An ECN allows investors to trade directly with each other.
26. Inside Quotes
Inside quotes are the highest bid and lowest ask prices from dealers.
27. Third and Fourth Markets
The third market is for off-exchange trading of listed securities. The fourth market is for direct trading between investors.
28. Types of Indexes
- Price-Weighted Index: Stocks are weighted by their price per share.
- Value-Weighted Index: Stocks are weighted by their market value.
29. Index Staleness
Index staleness occurs when some stocks haven’t traded recently.
30. Venture Capital Sources
Common sources of venture capital include private individuals, university endowment funds, and insurance companies.
31. IPO Lock-Up Period
The IPO lock-up period is typically six months.
32. SEC IPO Approval
SEC approval of an IPO registration ensures full disclosure of information.
33. Primary Market Transactions
The sale of newly issued shares by the issuer is a primary market transaction.
34. Securities Dealer
Trevor, buying and selling shares for his own account, is a securities dealer.
35. NYSE Structure
The NYSE is currently a publicly traded corporation.
36. NYSE Merger
In 2007, NYSE Holdings merged with Euronext, N.V.
37. NYSE Trading License
To trade on the NYSE floor, members must purchase a trading license.
38. Liquidity Provider
The designated market maker has the greatest duty to provide liquidity.
39. SuperDOT System
The SuperDOT system has lessened the role of floor brokers.
40. NYSE Hybrid Market
In the NYSE Hybrid market, floor brokers operate both electronically and in person.
41. NYSE Listing Requirements
To be listed on the NYSE, a firm must have at least $10 million in pre-tax aggregate earnings over the previous 3 years.
42. Specialist’s Role
A specialist can “stop” a stock, agreeing to purchase shares if no other buyer is available.
43. Specialist’s Duties
A specialist’s duties include maintaining an orderly market and providing liquidity.
44. Market Order
A market order is immediately executed at the current market price.
45. Limit Order
A limit order may never execute if the price limit is not reached.
46. Stop Order
A stop order becomes a market order after the trigger price is reached.
47. Stop-Buy Order
A stop-buy order is often used to limit losses from a short sale.
48. Stop Limit Order
A stop limit order becomes a limit order after the trigger price is reached.
49. NYSE Uptick Rule
The NYSE uptick rule restricts short-selling except after an uptick.
50. NASDAQ Characteristics
NASDAQ is a computer network with multiple market makers.
51. NASDAQ Listings
There are more companies listed on NASDAQ than on NYSE.
52. NASDAQ Orders
Orders on NASDAQ are placed by market makers and individuals on ECNs.
53. Dual Listings
Stocks listed on the NYSE can also be listed on NASDAQ.
54. Pink Sheets
Stocks on the Pink Sheets do not have to file financial statements with the SEC.
55. OTCBB Market
The OTCBB market is characterized by low stock prices and high percentage price changes.
56. Dow Jones Industrial Average (DJIA)
The DJIA is an index of 30 large publicly owned companies based in the United States.
57. Stock Market Indexes
Stock market indexes vary in the types of stocks included.
58. Price-Weighted Index Flaw
A price-weighted index is affected by price per share, not company size.
59. Value-Weighted Index
The S&P 500 is a value-weighted index.
Calculations and Examples
The remaining content (questions 78-103) involves calculations and examples related to IPOs, underwriter fees, Dutch auctions, price-weighted and value-weighted index calculations, and order book execution. These require specific formulas and data provided in the original text to solve.