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Investment Management, Frank J. Handout on international stock exchanges and efficient market hypothesis from Houthakker and Williamson. Common stock represents ownership in a corporation and holders of the stock retain residual rights to the company in the event it is liquidated.
In the even of such a liquidation all debtors claims on the company are senior to stock holders. As such, the stocks price tends to suffer in periods of low profits as the likelihood of liquidation rises and tends to fair better in periods of high profits. Partly as a consequence of this, stock prices are more volatile than bond prices.
Holders of common stock are also entitled to stock dividends. Dividends are period cash or stock payments made to holders as a form of profit sharing. Dividends are paid to all owners of record of the stock on a certain announced by the corporation ahead of time. On a particular day, the stock begins to trade ex-dividend, that is, it trades without the dividend. Investors who purchase the stock on or after the ex-dividend date are not entitled to receive the dividend payment.
As a consequence, in theory the stock price should drop an amount exactly equal to the dividend amount on the ex-dividend date. Corporation may alter the supply of their stock in the market place in one of four ways. To understand how this is possible, it is important to note that when a company goes public, its corporate charter states the total number of shares that the corporation is authorized to issue. These shares, called authorized shares, are usually not issued all at once.
The number of shares that are issued, are called the outstanding shares. Corporations can change the number of outstanding shares in one of four ways: The total number of outstanding shares times the current market price of the stock is called its market capitalization, and represents the total market value of the stock. The above four items are discussed in How the Stock Market Works, but it is interesting to make a note about stock splits. One reason a company might institute a split is to increase demand for a stock by lowering its price.
As stocks tend to trade in even lots floor brokers trade for their own accounts shares, a lower price can make purchasing the issue more attractive to small investors. Also, some corporate boards feel that floor brokers trade for their own accounts stock split sends a positive signal to the market about the future growth prospects of the firm.
This has been tested in the finance literature: In a paper, Eugene Fama, et al, called " The Adjustment of Stock Prices to New Information" International Economic Review February, conducted what is known as an event study to test whether abnormal price moves are typical around the time of a stock split.
The results of the paper were negative. There are two primary concepts we will discuss: We will start with brokers. In the abstract, a broker is nothing more than an intermediary between buyers and floor brokers trade for their own accounts. In the case at hand we are interested in securities brokers, and here supply refers to what securities are being offered, at what volumes and what prices. Later we will talk concretely about what sorts of brokers exist and what business structures surround them, but for now, we will keep the things in the abstract.
Brokers are able to exist because there are necessarily costs associated with buying and selling securities, which include the seeking out of counterparties, the setting of prices and the determination of the credit-worthiness of the counterparty.
A broker can spread these costs out among many counterparties and thus offer lower per head search costs to individual buyers and sellers while creating profit for himself. This lowering of costs increases the pool of available investors and in turn the liquidity of securities.
This has the positive effect of increasing interest in the purchase of primary offerings as the likelihood of negotiability is floor brokers trade for their own accounts. Brokers play very concrete roles in the buying and selling that is, in the trading of securities in a variety of ways. The NYSE is a physical trading place where stocks and to a lesser extent bonds are traded. It is the largest exchange in terms of volume in the world, with record volumes in stock trading increasing every year, including a new record set in late August Year to date through Augustthe New York Stock Exchange had an average daily trading volume of over million shares, up from around million in The New York Stock Exchange is structured around a set of rules determining who may trade securities on the exchange and what securities may be traded there.
Thus rules place requirements on both individuals wishing to trade and on companies wishing to be traded. In order to trade on the New York Stock Exchange you must be a member of the exchange. Membership carries privilege and prestige. The privilege is the exclusive right floor brokers trade for their own accounts conduct business on the exchange floor. The prestige is partly due to the fact that there are at all times a limited number of memberships available on the Floor brokers trade for their own accounts. In particular, there are currently 1, active members representing only firms these numbers change!
The NYSE posts them regularly on the web at www. The number of memberships have not changed since There are four types of membership: There are also rules governing the listing of a stock on the New York Stock Exchange.
Only listed stocks may be traded on the exchange, and the listing requirements are as follows the complete listing requirements may also be looked up on the NYSE Web Page: The New York Stock Exchange trades the most volume of any exchange in the world.
In addition, it has a large turnover rate, that is, the ratio of shares traded to total shares outstanding is high as well. When an individual wants to buy or sell a stock they must communicate certain information to a broker. The broker, who usually works with brokers who trade directly on the floor of the exchange e.
The first to items floor brokers trade for their own accounts straightforward to understand, but the third needs some clarification. Because of the high volume of trading, and intra-day volatility of markets, it is not always convenient or optimal to place an order at a floor brokers trade for their own accounts price although this is certainly possible. As a consequence, there are a variety of ways of expressing how an order is to be regarded and also the amount of time the broker has to execute the order.
Here are the major types of orders: Notice that limit orders and stop orders are only executed upon floor brokers trade for their own accounts certain condition being met. As a consequence, the customer must specify ahead of time how long the order shall remain active. There are several options: This system has a particular way of handling the flow of buy and sell orders and maintaining liquidity. It is by no means the only possible system for handling a large volume of trades, and in fact floor brokers trade for their own accounts stands in opposition to another important system embodied by the NASDAQ exchange more later.
The New York Floor brokers trade for their own accounts Exchange operates as a "continuous auction" in which brokers constantly make bids to buy stocks and offers to sell stocks. Whenever a bid to buy by one broker is met by an offer to sell at the same price by another, the trade can be executed directly between the two brokers or by means of the specialist.
For example, Here is a detailed example modeled after Houthakker and Williamson, p. A client contacts his broker in order to sell shares of XYZ. The broker will first check the current market quotation: The specialist is willing to buy at least shares and sell at least shares.
The broker then calls his or her floor broker with the order. This illustrates a second important point: However, due to the possibility of simultaneous arrival of orders, it is possible to market execute orders between the bid-ask price.
There is a second way this can happen, known as hidden limit orders that we will deal with in a moment. When a stock becomes listed on the NYSE it is assigned a floor brokers trade for their own accounts. The specialists may buy and sell stock executing orders for other brokers or for their own accounts. Their stated purpose is to maintain orderly flow in the market.
But what does this mean in particular? The specialists book is closely held floor brokers trade for their own accounts its contents are only known by the specialist. An example of what a specialists book may look is as follows from Houthakker and Williamson, p. Moreover, the quote will appear with a bid size and ask size, wherein the bid size will be and the ask size will be Now suppose floor brokers trade for their own accounts market order arrives at The specialists job is to execute the order while attempting to satisfy all buy limit orders first.
This is problematic for the market because it would create the public perception that there had been a rather large move in the price over a short period of time. This in turn might create a spate selling, due to the erroneous perception that something fundamental had happened to the value of the company XYZ that would make it worth suddenly less.
In order to avoid such market disorder, the specialist is charged with meeting the temporary demands placed on the market, such as in the example above by buying or selling where appropriate to create the appearance of an orderly market whose published price fluctuations reflect the actual level of price volatility.
First, the specialist is the unique person who as access to the complete book of orders, and he knows that there is a fairly balanced set of orders above and below the market. In addition, the specialist has just bought the stock at the bid price. This is an advantage, because now if another situation arises where a market order to buy floor brokers trade for their own accounts in, the same logic is likely to allow the specialist to sell at the ask price.
If the bid-ask spread remains stable, then the specialist can "make the spread" by buying at the bid and selling at the ask. This said, we have to ask are the any risks that the specialist undertakes for the reward of buying low and selling high?
The answer is yes: In that the specialist has been assigned the duty of keeping an orderly market, there are official rules governing the trading behavior of the specialist. One class of rules ensures that the specialist will never trade ahead of customers.
That is, that all prevailing limit orders will be executed first. Another class of rules ensures the fair handling of limit orders: For example, if two limit orders of the same size are in the specialists book, there is a specific rule deciding which floor brokers trade for their own accounts will be executed first.
Clearly having privileged knowledge of the specialists book could be a large advantage to traders. The book, however, is closed to the public and only the specialist knows for sure its exact contents. The public, however, is not without some information about the specialists book.