I
Functions
1. information about the assets fair value (price discovery)
2. offer liquidity for assets
3. cost of searching and transacting
 

II
Trading location
1. Organized exchange
 Specific location (NYSE, AMEX in New York) --- floor based
2. Over the counter (OTC) --- screen based
 

III
Market Structure
1. Continuous Market
  Prices are determined continuously throughout the trading day
2. Call Market
  Orders are batched or grouped together for simultaneous execution at the same price
  Example : London Gold Bullion Market (morning fix and afternoon fix)
  Example : NYSE are both continuous and call market
         (i) mixed ( begin trading at 9:30am with a call auction)
         (ii) opening price set in call market trading proceeds in a continuous way until closing
 

IV
Trading Mechanics
A.  Type of Order
  An investor must provide information to the broker about conditions under which she will transact
 Specific securities number of shares (quantity or bonds), type of order
      1. Market Order
  Orders that are to be executed immediately at current market price
      2. Limit Order
  buy or sell at specified price or better
  specify price at which they willing to buy or sell securities
     3. Stop loss order (for selling) and stop buy order (to buy)
  similar to limit orders in that trade is not to be executed unless stock hits a price limit. However the stock is to be sold
              if its price falls below a stipulated level
  limit potential loss
     4. Time specific order
         (a) Day order : expire at the close of the day
         (b) Open or good till cancelled order : remain up to 6 months unless cancelled by customers
     5. Size related orders
         (a) round lot : 100 shares of a stock
         (b) odd lot : less than a round lot

B. Short selling
 practice of selling securities that are not owned at the time of sale
  want to benefit if the price of security decline
  the securities are purchased subsequently by the investor and return for the party that lent it (over the short position)

Stock A T=0 Stock price $50 Borrow 10 stocks $50 X 10 = $500 then price decline to $40 $40 X 10 = $400 get profit of $100

Exchange – imposed restrictions to prevent investors from destablishing the price of a stock when market price is falling
Tick test rules
     (a) uptick rule : the sale price of stock is higher than the last trade price
     (b) zero uptick : the price stay the same

C. Margin Transaction
Investors borrow cash to buy securities and use the securities themselves as collateral
Buying on margin (create financial leverage)
Broker gets the money from a bank to lend the fund to investor ? called money rate (broker loan rate)
Benefit if price rises
Worse off if price falls

Stock A Stock Price $50 Have $500 so can buy 10 shares When price goes up to $60 per share, investors get $100 profit If investors borrowed another $500 from broker on margin Then the investors can buy 20 shares instead of 10 When the price goes up to $60, the investor get $200 profit instead of $100

D. Margin Requirement
Initial margin requirement
SEA of 1934 prohibits brokers from lending more than a specified percent of the market value of the securities
Proportion of total market value (MV) of securities that the investor must pay for in cash (down payment)
Board of governors of Federal Reserve set initial margin requirement (currently 50%)
Federal also establish a maintenance margin requirement
Margin call
 

V
Roles of brokers and dealers
1. Brokers
  Middle man (agent of investors)
  Entity that acts on behalf on investors who wishes to execute order
  Gets commission
  No money involve so no risk (no capital)
2. Dealers (as market maker)
  stands ready and willing to buy and sell a financial asset for its own account (whenever the public wish to sell or buy)
  keep inventory of securities (maintain liquidity), with capital so with risk
  maintain fair and orderly market
  bid ask spread : primary source of compensation for providing liquidity to market makers
  *** market microstructure : studies or process on which how securities are traded
 

VI
Market Efficiency
1. Operational Efficiency
  In an operationally efficient market, investors can obtain transaction services as cheaply as possible ? commission bid ask
         spread smaller
2. Pricing Efficiency
  A market where prices at all times fully reflect all available information that is relevant to the valuation of securities
  FAMA in University of Chicago (efficient capital market, Journal Finance 1970)
         (a) Weak efficiency : price of the security reflects the past price and trading history of the security
         (b) Semi strong efficiency : price fully reflect all public information
         (c) Strong efficiency: price reflect all information whether or not it is publicly available. (insider information are against the
               law)
 

VII
Transaction Costs
1. Commissions
     Prior to 5/1/1975 : all brokerage houses charged same commission (fixed commission) 6%
     Now negotiable (usually 2 to 3%)
     Merrill Lynch charge high commission because it provides all information the investors need
2. Fees: custodian fees, transfer fees