Chapter 4

Charles P. Jones and Gerald R. Jensen,

Investments: Analysis and Management,
13th Edition, John Wiley & Sons

4-1
 Channel funds from savers to borrowers
 Help firms and governments raise cash by
selling securities (financial claims on issuer)
 Provide a place where investors can earn a
return
 Help allocate cash to where it is most
productive
 Help lower the cost of exchange

4-2
Primary Market
 Securities are issued in the primary market
◦ Initial public offerings (IPOs)
 Average investors generally benefit little from
IPOs
◦ Seasoned offerings
 Issuance is facilitated by investment banks
◦ Buy securities from issuer at a discount and
resell to investors
 Difference between two amounts is spread

4-3
1. Determine issue features - $'s required, type of
security, security features, etc.

2. File registration statement with the Securities

and Exchange Commission (SEC)
 Distribute red herring prospectus

3. After SEC approval, distribute prospectus with

issue price

4. Form underwriting syndicate and selling group

5. Distribute securities
6. Maintain secondary market (IPO's)

 Shelf Registration - allows large firms to

issue securities more quickly by updating a
master registration filed with the SEC

 Many IPO’s are underpriced

Why?
 Issuer

Originating investment banker

Underwriting syndicate (group) of investment bankers

Selling group of underwriting syndicate + selected retail brokerage houses

Investors

4-5
 Private (direct) placement - new securities
are sold directly to investors, bypassing the
open market
◦ SEC registration not required

◦ Can be cheaper and faster for issuer

◦ Can lead to higher interest rates, restrictions

4-7
 Market where investors trade previously
issued securities
 Allow for trading of stocks, bonds,
derivatives
 NYSE, NASDAQ, and BATS are major U.S.
exchanges
 Investors are represented by brokers who
facilitate trades between buyers and sellers
for a fee

4-8
Other Secondary Markets

 Over-the-Counter (OTC)
◦ Not an organized marketplace or
exchange
◦ Forum for securities not listed on a U.S.
exchange
◦ Many firms are small and/or financially
distressed
◦ May trade via Pink Sheets or OTC Bulletin
Board

4-9
 Offers low transactions costs

 Offers an open order book

 Provides anonymity

 Best ECN offers are posted on NASDAQ

 Allow traders to sequence offers

 US equity markets account for a decreasing
share of world’s stock market capitalization
◦ Foreign markets include developed and emerging
markets
 Emerging markets
◦ Offer large potential for profits and large risks
 Illiquidity, lack of information, political
uncertainty
◦ BRIC markets have grown and attracted investor
attention

4-11
 Stock index levels do not incorporate dividends
Three Index Weighting Methods
 Equal or un-weighted: good indicator for
investors that invest equal $’s in each member
 Price-weighted: good indicator for investors
that purchase the same number of shares in
each stock
 Value-weighted: best indicator of overall
market movement
Foreign Stock Market Indicators
 MSCI EAFE Index
◦ A non-American developed market index
 Dow Jones World Stock Index
◦ Capitalization-weighted, represents about
80% of world’s stock markets
 Euro STOXX 600
◦ Covers 18 European countries
 S & P Asia 50 (major Asia countries) and
Nikkei 225 (largest Japanese firms)

4-13
Bond and Derivatives Markets
 Secondary bond markets
◦ Necessary or investors might avoid bonds
◦ Primarily an over-the-counter network of
dealers
◦ Bond brokers often buy for their own
accounts and resell
 Derivatives
◦ Options trade on exchanges
◦ Futures markets mostly electronic

4-14
 Bond universe is broader - T-bonds to D
 Bond universe is constantly changing: bonds
mature, are converted, or are retired
 Volatility changes constantly with duration
 Bond prices are less reliable
 Bond index values incorporate total returns
 High yield bonds have equity characteristics
 Foreign bond indexes are primarily govt.
Market Globalization
 Electronic trading systems allow for after-
hours trading
 Stock prices can change even when
exchanges are closed
 Bonds also being traded around the clock
 Individual investors can benefit from
globalization
◦ Can trade in foreign markets and in foreign
currencies

4-16