Secondary Markets
by MaestriFinancial institutions play a key role in matching primary market players who need money with those who have extra funds, but the vast majority of trading actually occurs in the secondary markets. Although there are many secondary markets for a wide variety of securities, we can classify their trading procedures along two dimensions. First, the secondary market can be either a physical location exchange or a computer/telephone network. For example, the New York Stock Exchange, the American Stock Exchange (AMEX), the Chicago Board of Trade (the CBOT trades futures and options), and the Tokyo Stock Exchange are all physical location exchanges. In other words, the traders actually meet and trade in a speci?c part of a speci?c building. In contrast, Nasdaq, which trades U.S. stocks, is a network of linked computers. Other examples are the markets for U.S. Treasury bonds and foreign exchange, which are conducted via telephone and/or computer networks. In these electronic markets, the traders never see one another.
The second dimension is the way orders from sellers and buyers are matched. This can occur through an open outcry auction system, through dealers, or by automated order matching. An example of an outcry auction is the CBOT, where traders actually meet in a pit and sellers and buyers communicate with one another through shouts and hand signals.
In a dealer market, there are “market makers” who keep an inventory of the stock (or other ?nancial instrument) in much the same way that any merchant keeps an inventory. These dealers list bid and ask quotes, which are the prices at which they arewilling to buy or sell. Computerized quotation systems keep track of all bid and ask prices, but they don’t actually match buyers and sellers. Instead, traders must contact a speci?c dealer to complete the transaction. Nasdaq (U.S. stocks) is one such market, as are the London SEAQ (U.K. stocks) and the Neuer Market (stocks of small German companies).
The third method of matching orders is through an electronic communications network (ECN). Participants in an ECN post their orders to buy and sell, and the ECN automatically matches orders. For example, someone might place an order to buy 1,000 shares of IBM stock (this is called a “market order” since it is to buy the stock at the current market price). Suppose another participant had placed an order to sell 1,000 shares of IBM at a price of $91 per share, and this was the lowest price of any “sell” order. The ECN would automatically match these two orders, execute the trade, and notify both participants that the trade has occurred. Participants can also post “limit orders,” which might state that the participant is willing to buy 1,000 shares of IBM at $90 per share if the price falls that low during the next two hours. In other words, there are limits on the price and/or the duration of the order. The ECN will execute the limit order if the conditions are met, that is, if someone offers to sell IBM at a price of $90 or less during the next two hours. The two largest ECNs for trading
U.S. stocks are Instinet (owned by Reuters) and Island. Other large ECNs include Eurex, a Swiss-German ECN that trades futures contracts, and SETS, a U.K. ECN that trades stocks.
What are the major differences between physical location exchanges and computer/ telephone networks?
What are the differences among open outcry auctions, dealer markets, and ECNs?
Taken From : Five-Minute MBA – Corporate Finance
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