1、1Overview of Market StructureThe Securities and Exchange Commission (SEC) was created in 1934. Stock exchanges are regulated by the SEC, but they are considered self-regulatory organizations (SROs) with considerable latitude. The major national stock exchanges are the New York Stock Exchange (NYSE)

2、and the American Stock Exchange (AMEX). In 1998, the National Association of Security Dealers (NASD) acquired the AMEX. It then sold the AMEX in 2003 to a private equity group for only $110 million.The NASD regulates an electronic trading network called the NASDAQ (NASD Automated Quote System). The

3、NASD went public in 2001, trades under the symbol NDAQ and is now called the Nasdaq Stock Market Incorporated. A funny name for an exchange that is not a stock market (at least according to the SEC).2The New York Stock ExchangeStock markets like the New York Stock Exchange provide strict criteria fo

4、r shares to be traded on their exchange. For this reason, they are still called listed securities.NYSE Facts and Figures:U.S. listing requirementsDaily trading volumeMarket capitalization10 Largest Companies3The NYSE Trading FloorVirtual tour4NYSE ParticipantsTo gain access to the floor, you must bu

5、y a seat. The number of seats has remained at 1,366 since 1953. They currently sell for about $1.5 million. Each stock listed on the NYSE is allocated to a specialist, a market maker who trades only in specific stocks at a designated location. All buying and selling of a stock occurs at that locatio

6、n, called a trading post. Buyers and sellers -represented by the floor brokers - meet openly to find the best price for a security. 5The NYSE Auction ProcessSpecialists organize the auction process on the trading floor. They provide information about the current state of the market, the price at whi

7、ch shares can be bought (bid) or sold (offer or ask) and the quantity of shares available at each price, called depth. The difference between the bid and offer is called the spread. In 2001, all U.S. equity markets went to decimals with a minimum spread of $0.01. 6The Specialist Agent & Principa

8、l Specialists act as agents, executing orders entrusted to them by the public.In instances when there is a temporary shortage of buyers or sellers, NYSE specialists act as agents, buying or selling for their own accounts. The specialist has an affirmative obligation to stabilize markets during sever

9、e market downturns, like the market crash of October 19, 1987. The vast majority (77%) of NYSE volume is a result of public order meeting public order - individuals, institutions and member firms interacting directly with each other. Non-specialists handle 14% and specialists 10%.Note: There can be

10、a conflict between the specialist acting as both principal and agent.7NYSE Specialist FirmsThe largest NYSE specialist firm is LaBranche and Co. which handles more than 500 stocks. Spear, Leeds and Kellog (acquired by Goldman Sachs in 2000 for $6.5 billion) and Fleet Meehan are second and third with

11、 493 and 428 stocks. Together, these 3 firms trade about 2/3 of the daily volume.You can find a complete list on the here.8NYSE Order Book9Types Of Orders - NYSEThese are four kinds or orders: market orders: an order to buy or sell a fixed quantity at the current market price; limit orders: an order

12、 to buy or sell a fixed quantity at a designated price; stop order: an order to buy or sell once a designated “stop” price has been hit.stop-limit orders: a combination of a limit and a stop order On the NYSE, stop orders become market orders once a trade has been executed at the stop price.10NYSE A

13、utomated Execution SystemsSuperDOTADotNYSE Direct+Large institutional investors can also trade in what is known as the upstairs market.11Regulation NMS(1) Trade through rule(2) Access rule(3) Sub-penny ruleThe overriding principal of a national market system is to enable traders to get the best pric

14、es independent of trading venue.12Specialist InvestigationsBackground: Since decimals and with the decline in trading volume following the bubble, specialist profits have declined.The stock price of publicly traded specialist firm LaBranche (LAB) confirms this.LAB and others bottomed out in early 20

15、04 when the 5 major specialist firms were fined $240 million.Calpers (among many others) has sued the NYSE to recover investor money.Criminal cases are pending.13Example Of InterpositioningBidDepthAskDepth41.04541.10441.03241.121241.003641.131This was the state of the limit order book in on January

16、3, 2003 at 11:04 AM. The stock is VZ and Spear Leads and Kellogg (SLKS) was the specialist.The book also included market orders to buy 3,300 shares and market orders to sell 2,100 shares.The specialist could have paired off the market buy and sell orders and satisfied the remaining order from his ac

17、count or against the limit orders at 41.10 and 41.12.Instead, the specialist shorted 3,300 shares at 41.10, 400 shares at 41.04, 200 shares at 41.03, bringing the spread to 41.00 X 41.10. At that price, he covered 2,100 shares from the market sell orders, earning a riskless profit on that portion of

18、 the trade.14Grassos CompensationDuring his tenure as chairman and CEO of the NYSE, Richard Grasso, who had started out as a clerk of the floor, received nearly $160 million in compensation.The Webb report has all the details.Eliot Spitzer has sued Grasso to recover some of his pay package.The botto

19、m line: the specialist stocks are down, trading volume is down, electronic exchanges are eroding NYSE market share, NYSE seat prices are down to $1 million from a 1999 peak of $2.5 million. Mutual funds like Fidelity are actively exploring alternatives to the NYSE.Grasso was essentially being paid h

20、ush money to protect the specialists.My speculation: The NYSE is the only remaining large floor based trading system in the world. 5 years from now, it, like London, may no longer exist. Nonetheless, the power of this institution is huge and it will fight to protect its monopoly.15NYSE Goes PublicIn

21、 the Spring of 2005, the NYSE made two bold moves that are the most radical in its history:NYSE ends its partnership structure and will go public.(2) NYSE will acquire an electronic exchange called Archipelago.NYSE comments.(1) Archipelago comments.16Winners and LosersWinners:Archipelago their share

22、s jump 70% on news of the merger.NYSE seat holders. Merger estimates value their seats at $3.5 millionSome seat holders are still disgruntled.Goldman: ex-partner Thain now runs NYSE, owns Spear, Leeds & Kellog NYSE specialist firm, one of the top 3 Nasdaq market makers, and owns 15% of Archipela

23、go.Losers:Nasdaq and InstinetSpecialist firms like LAB.17Overview of NASDAQThe National Association of Securities Dealers Automated Quote (NASDAQ), pronounced “naz-daq,” system is an interdealer market represented by over 600 securities dealers trading more than 15,000 different issues. These trader

24、s are called market makers. Nasdaq operates what it calls the National Market (NNM) for larger capitalization stocks and a smaller cap market called the Nasdaq SmallCap market. There is an over the counter service called the “OTC Bulletin Board (OTCBB).” OTCBB has no formal relationship with the Nas

25、daq.18NASDAQ OwnershipNasdaq was owned until 2001 entirely by its member firms. Nasdaq issued stock that to its members that has been gradually acquired by an independent body called the Nasdaq Stock Market, Inc. which now trades on the NNM under the symbol NDAQ. The NASD has re-organized as a priva

26、te, not for profit regulatory body. It has so far been more diligent than the NYSE in oversight of its members.VolumeFacts and Figures:3,271 listingsListing requirementsNasdaq 100 by market cap19NASDAQ ParticipantsApproximately 600 market makers ranging from large investment banks like Goldman Sachs

27、 (GSCO), to retail oriented operations like Knight Trimark (NITE) to small firms like Glen Rauch Securities (GRSI). There are now just 3 ECNs: Nasdaq+BRUT, INET, and ARCA20Nasdaq Merger with InstinetNasdaq has responded to ECN competition and the NYSEs move into electronic trading by trying to grab

28、market share.They acquire the BRUT ECN in 2004.They also proposed a merger with Instinet in the Spring of 2005.Instinet had merged with a popular day trading ECN called Island in 2003.Instinet will give Nasdaq the ability to trade NYSE stocks. For the first time, there is a direct competitor to NYSE

29、. On the other hand, ARCA will give the NYSE the ability to trade Nasdaq issues.21The Nasdaq Limit Order BookThis is the total view display which shows multiple levels of liquidity from market participants. For example, Morgan Stanley (MSCO) is on the bid at both 19.98 and 19.97.The Level I quote is

30、 19.98 x 19.99 with depths of 21 and 10, the largest at the inside.Most of Nasdaq execution systems have been folded into SuperMontage.22SuperMontageNASDAQ SuperMontage is a fully integrated order display and execution system for all NASDAQ National Market and SmallCap securities. SuperMontage is a

31、voluntary, open-access system that accommodates diverse business models and trading preferences.SuperMontage allows market participants to enter unlimited quotes and orders at multiple price levels. Quotes and orders of all SuperMontage participants are integrated and displayed on market participant

32、s front-ends as well as via data feeds. The system displays aggregate interest five price levels deep on each side of the market on a dynamic basis and additional price levels on a non-dynamic basis. SuperMontage participants are able to access the aggregated trading interest of all other participan

33、ts.Anonymity - Offered through SuperMontages SIZE featureInternalization of orders is available but not required for quoting market participants when the participant is at the NASDAQ Best Bid and Offer (NASDAQ BBO). This allows the initial match at a price to happen against the firms own orders.23NA

34、SDAQ New RegulationsReg NMS: Adopted June 9, 2005Nasdaq likes the fact that Reg NMS will:Cap fees on ECNsPut in a penny minimum incrementThey dont like that: (a) (c) the trade through opt out will enable ECNs to take market share Reg SHO pilot implemented on January 3, 2005.This will eliminate the u

35、ptick rule on a number of Nasdaq securities24Microstructures Around The World25Global Stock Market Capitalization26How Do You Buy Foreign Stocks?ADRs, e.g. Sony on NYSE, Toronto, TokyoETFs by country, region, e.g. iShares Malaysian Fund or iShares EuropeMutual funds: e.g. Vanguard Emerging Markets.2

36、7Efficient MarketsMany economists believe that markets are efficient. This means broadly that information is incorporated into stock prices.This implies that fundamental analysis, technical analysis and other approaches to the market do not produce abnormal returns.We will present some evidence for

37、and against market efficiency. The evidence against is the bubbles and crashes we have observed in markets.The evidence for is the poor performance of profession mutual fund managers. To give this evidence some context, we first have to discuss some basic valuation models for the market.28Valuation

38、ModelsMany models assume that stock prices are a present discounted value of the future dividendsIf dividends were constant, this simplifies topd1/rg.If dividends were growing at a constant rate gThe solution here is29Bubbles?05000100001500020000250003000035000400004500005001000150020002500300035004

39、00045005000Nikkei 225 1985-1995Nasdaq Comp. Aug. 1991-Aug. 200130Peaks And CrashesThe Dow Jones average did not return to its 1929 peak until 1954.Japans Nikkei index peaked at 40,000 on January 1, 1990 and currently trades atThe Nasdaq Composite peaked at 5,000 in March of 2000 and still trades alm

40、ost 3,000 points below that level.Nonetheless, a well diversified portfolio of common stocks has returned nearly 6% in real terms over the last 200 years. Bonds have returned only 2%. This difference is called the equity premium. This argument has been promoted by Jeremy Siegel, author of Stocks for

41、 the Long Run.31Irrational Exuberance?The counter argument to Siegels view has come from Yale University professor Robert Shiller, author of Irrational Exuberance.Shiller claims that the market is overvalued compared to its historical levels.05101520253035404550190019201940196019802000Price Earnings

42、 Ratio32Real Earnings0200400600800100012001400190019201940196019802000Real EarningsReal Stock PricesAn even stronger arguments comes from comparing real earnings and real stock prices.The Shiller-Siegel debate is ongoing.33(Under) Performance of Mutual FundsMark Carhart, now at Goldman Sachs, has sh

43、own (“On Persistence in Mutual Fund Performance,” Journal of Finance, 1997.) that over the 34-year period from 1962 to 1995, only 23% of funds outperformed the S&P 500 index. 01020304050607080901977 19781979 1980 19811982 1983 19841985 1986 1987 19881989 1990 19911992 1993 19941995 1996Y Ye ea a

44、r rP Pe er rc ce en nt t34Dont Chase Mutual Fund WinnersCarhart makes a second point which is even less well understood. Funds with high returns tend to have high returns only in the year following their outperformance. This is just the momentum result we saw in individual stocks.After one-year, the

45、ir performance is just average.Fidelity Magellan, under Peter Lynch, and Legg Mason Value, under Bill Miller, have had long periods where they outperform the index.Are they just winners in a big coin flipping competition?Recent returns for Magellan suggest that may be the case.35The Role of Security

46、 AnalystsAccording to the SEC, the role of analysts: “research analysts study publicly traded companies and make recommendations on the securities of those companies.Analysts have been in the news lately for not fulfilling their fiduciary duty to investors. If we understand their incentives, we can

47、understand the problems they have faced.Analysts are not directly revenue producers for securities firms. They are a cost center, not a profit center. Yet we know they are well paid.How do they earn their money? By attracting brokerage business to their firms.(1) Through investment banking business.

48、36Analysts And Investment BankingResearch on reveals: (1) They recommend stocks to obtain investment banking fees. According to Michaely and Womack (RFS, 1999) lead underwriter analysts issue 50% more buy recommendations. Their recommendations under perform other analyst picks by more than 25% per y

49、ear for 2 years; Anecdotal evidence from the Merrill Lynch-Henry Blodgett case(2) An overall bias towards positive ratings. In June 2001, according to First Call, only 2% of stocks had sell recommendations, despite more than a year long bear market; (3) They are de facto corporate insiders. Jack Gru

50、bman attended WorldCom board meetings and was paid consulting fees.37ReformsReg FDOn August 10, 2000, the SEC approved Regulation Fair Disclosure (Reg FD), which became effective on October 23rd of the same year. According to Eric Zitzewitz of Stanford Business School: This regulation prohibits the

51、selective disclosure of material information to financial professionals including analysts; companies with material information to disclose must now do so in a press release or conference call that is simultaneously open to all investors.”Spitzer investigationsMay 2002 settlement with Merrill Lynch.

52、Global settlement in Dec. 2002. $1.4 billion settlement was reached with Bear Stearns ($80 mn), Credit Suisse First Boston ($200 mn), Deutsche Bank ($80 mn), Goldman Sachs ($100 mn), JP Morgan Chase ($80 mn), Lehman Brothers ($80 mn), Merrill Lynch ($200 mn), Morgan Stanley ($125), Salomon Smith Bar

53、ney ($400 mn) and UBS Warburg ($80 mn). 38Conduct Remedies (1) The insulation of research analysts from investment banking pressure. No fees for banking business, no analysts on road shows.(2) A complete ban on the spinning of Initial Public Offerings (IPOs). Brokerage firms will not allocate lucrat

54、ive IPO shares to corporate executives and directors who are in the position to greatly influence investment banking decisions. (3) For a five-year period, each of the brokerage firms will be required to contract with no less than three independent research firms (4) Disclosure of analyst recommenda

55、tions. Each firm will make publicly available its ratings and price target forecasts. investment banks may simply drop research.Why was Eliot Spitzer doing the job of the federal government?39Mutual Funds40Spitzer Goes After the Mutual Fund IndustryManager trading abuses, e.g. Richard StrongMarket t

56、iming trades, particularly a problem with international fundsLate trading, e.g. Ed Stern of Canary PartnersThe bottom line: Based on Zitzewitz (2002): Taking these pieces together, the annual loss from the $364 in commission over-charges, the annual loss of 0.28% in return from market timing and the joint effect compounded by the rate of return to the S&P500, the typical middle-income American