BUS614 Study Guide

Unit 4: Equity Markets

4a. Describe the role of stock exchanges in capital markets

  • Is there any difference between stock markets and stock exchanges?
  • What are the types of stock market transactions?

Stock exchanges allow investors to trade with securities. The trade (buying and selling) of securities is thus facilitated through stock exchanges. It is where real-time information about securities is available to traders. Stock exchanges form part of the stock markets, which are a collection of markets and exchanges that allow buyers and sellers to meet and trade with securities. For example, the NYSE and NASDAQ are collectively regarded as stock markets and other exchanges in the United States. Stock markets are thus where companies are listed, and stock exchanges are where these listed companies’ shares are traded.

Stock market transactions include Initial Public Offering (IPO), Secondary Offering, Stock Buybacks, and Private Placement. When a company wishes to issue stocks for the first time to raise capital, they do an Initial Public Offering (IPO). On the other hand, a secondary market offering happens when the stocks of a particular company are held by investors who then sell this block of stock to other investors for profit maximization. In such a transaction, the proceeds of sale do not go to the issuing company but to the investor who sold the block of shares. Here, no new shares were created. Unlike IPOs, which take place in primary markets, such transactions occur in secondary markets.

Alternatively, companies may opt for private placement, which typically takes place in primary markets where companies raise funds from pre-selected investors. Finally, a company may buy back the shares it has already issued from investors. This is referred to as stock buyback or stock repurchase.

To review, see Stocks and Stock Markets.

 

4b. Analyze the efficient market hypothesis and its importance in equity markets 

  • Why is the Efficient Market Hypothesis (EMH) important in Equity Markets?

EMH relates to information about the stock being traded. Based on the information about a particular stock, EMH could be either strong, weak, or semi-strong. Strong market efficiency means share prices reflect all information, public and private, and no one can earn excess returns. Weak market efficiency takes place when prices on traded stocks and other assets already reflect all past publicly available information. Semi-strong efficiency claims that prices reflect all publicly available information and that prices instantly change to reflect new public information. The importance of EMH lies in the fact that it allows investors to make informed decisions on the investments they wish to undertake.

To review, see Market Efficiency.

 

4c. Compare primary and secondary markets by examining how stocks are issued in each 

  • How are stocks issued in primary and secondary markets?

Generally, primary markets deal with stocks a company issues for the first time. These come in the form of IPOs, private placement, rights issue, and preferred allotment. Also, bonds can be issued for the first time in primary markets.

On the other hand, secondary markets trade with already-issued bonds and shares. In secondary markets, owners of shares and interested buyers meet and trade with these shares. Here, the shares are not owned by the issuing organization anymore but rather by private investors. Some known examples of secondary markets include the New York Stock Exchange, the London Stock Exchange, the Frankfurt Stock Exchange, and NASDAQ, among others.

Secondary markets are divided into two broad categories: Broker Markets and Dealer Markets. Both markets are further divided into different markets. For example, Broker Markets can either be National Exchanges or Regional Exchanges, whereas Dealer Markets (which are typically decentralized) include Over-the-Counter Markets and NASDAQ.

To review, see Buying and Selling at Securities Exchanges.

 

Unit 4 Vocabulary

This vocabulary list includes the terms that you will need to know to successfully complete the final exam.

  • Stock Markets
    • The stock market is the collection of markets and exchanges where trading (buying and selling) of stocks, bonds, and other securities occur.
  • Stock Exchanges
    • Stock exchanges are trading floors where buyers and sellers of securities meet to trade.
  • Initial Public Offering
    • An initial public offering is a public offering where shares of stock in a company are sold to the general public on a securities exchange for the first time.
  • Secondary Offering
    • A secondary market offering is a registered offering of a large block of a security that has been previously issued to the public.
  • Stock Repurchase
    • Stock repurchase, also known as stock buyback, is the reacquisition by a company of its stock.
  • Private Placement
    • Private placement is the funding of securities sold to a small number of pre-selected investors, not through a private offering.
  • Dealer Market
    • Dealer markets are markets that do not operate on centralized trading floors but instead use sophisticated telecommunications networks that link dealers on a national level.
  • Broker Market
    • The broker market consists of national and regional securities exchanges that bring buyers and sellers together through brokers on a centralized trading floor.
  • Efficient Market Hypothesis
    • EMH is information about the security being traded that helps form an opinion on the price of the traded security.
  • Strong Market Hypothesis
    • Strong market efficiency means share prices reflect all information, public and private, and no one can earn excess returns.
  • Weak Market Hypothesis
    • Weak market efficiency takes place when prices on traded stocks and other assets already reflect all past publicly available information.
  • Semi-Strong Market Hypothesis
    • Semi-strong efficiency claims that prices reflect all publicly available information and that prices instantly change to reflect new public information.