Securities market From Wikipedia, the free encyclopedia

Securities market is an economic institute within which take place sale and purchase transactions of securities between subjects of economy on the base of demand and supply. Also we can say that securities market is a system of interconnection between all participants (professional and nonprofessional) that provides effective conditions: to buy and sell securities, to attract new capital by means of issuance new security (securitization of debt), to transfer real asset into financial asset, to invest money for short or long term periods with the aim of deriving profit.Contents [hide] [edit] Functions of securities market

The common market functions of securities market: commercial function (to derive profit from operation on this market) Price determination (Demand and Supply balancing, the continuous process of prices movements guarantees to state correct price for each security (So, the market corrects mispriced securities) Informative function (market provides all participants with market information about participants and traded instruments) Regulation function (securities market creates the rules of trade, contention ( priorities determination) ) regulation,

Specific functions of the securities market Transfer of ownership (securities markets transfer existing stocks and bonds from owners who no longer desire to maintain their investments to buyers who wish to increase those specific investments. There is no net change in the number of securities in existence, for there is only a transfer of ownership. The role of securities market is to facilitate ( ) this transfer of ownership. This transfer of securities is extremely important, for securities holders know that a secondary market exists in which they may sell their securities holdings. The ease with which securities may be sold and converted into cash increases the willingness of people to hold stocks and bonds and thus increases the ability of firms to issue securities)

Insurance (hedging) of operations though securities market (options, futures, ) [edit] Levels of securities market [edit] Primary market

The primary market is that part of the capital markets that deals with the issue of new securities. Companies, governments or public sector institutions can obtain funding through the sale of a new stock or bond issue. This is typically done through a syndicate of securities dealers. The process of selling new issues to investors is called underwriting. In the case of a new stock issue, this sale is an initial public offering (IPO). Dealers earn a commission that is built into the price of the security offering, though it can be found in the prospectus. Primary markets creates long term instruments through which corporate entities borrow from capital market.

Features of primary markets are: This is the market for new long term equity capital. The primary market is the market where the securities are sold for the first time. Therefore it is also called the new issue market (NIM). In a primary issue, the securities are issued by the company directly to investors. The company receives the money and issues new security certificates to the investors. Primary issues are used by companies for the purpose of setting up new business or for expanding or modernizing the existing business. The primary market performs the crucial function of facilitating capital formation in the economy. The new issue market does not include certain other sources of new long term external finance, such as loans from financial institutions. Borrowers in the new issue market may be raising capital for converting private capital into public capital; this is known as "going public." The financial assets sold can only be redeemed by the original holder.

Methods of issuing securities in the primary market are: Initial public offering;

Rights issue (for existing companies); Preferential issue. [edit] Secondary Market

The secondary market, also known as the aftermarket, is the financial market where previously issued securities and financial instruments such as stock, bonds, options, and futures are bought and sold. The term "secondary market" is also used to refer to the market for any used goods or assets, or an alternative use for an existing product or asset where the customer base is the second market (for example, corn has been traditionally used primarily for food production and feedstock, but a "second" or "third" market has developed for use in ethanol production). Stock exchange and over the counter markets.

With primary issuances of securities or financial instruments, or the primary market, investors purchase these securities directly from issuers such as corporations issuing shares in an IPO or private placement, or directly from the federal government in the case of treasuries. After the initial issuance, investors can purchase from other investors in the secondary market.

The secondary market for a variety of assets can vary from loans to stocks, from fragmented to centralized, and from illiquid to very liquid. The major stock exchanges are the most visible example of liquid secondary markets - in this case, for stocks of publicly traded companies. Exchanges such as the New York Stock Exchange, Nasdaq and the American Stock Exchange provide a centralized, liquid secondary market for the investors who own stocks that trade on those exchanges. Most bonds and structured products trade over the counter, or by phoning the bond desk of one s broker-dealer. Loans sometimes trade online using a Loan Exchange. [edit] Over-the-counter market

Over-the-counter (OTC) or off-exchange trading is to trade financial instruments such as stocks, bonds, commodities or derivatives directly between two parties. It is contrasted with exchange trading, which occurs via facilities constructed for the purpose of trading (i.e., exchanges), such as futures exchanges or stock exchanges. In the U.S., over-the-counter trading in stock is carried out by market makers that make markets in OTCBB and Pink Sheets securities using inter-dealer quotation services such as Pink

Quote (operated by Pink OTC Markets) and the OTC Bulletin Board (OTCBB). OTC stocks are not usually listed nor traded on any stock exchanges, though exchange listed stocks can be traded OTC on the third market. Although stocks quoted on the OTCBB must comply with United States Securities and Exchange Commission (SEC) reporting requirements, other OTC stocks, such as those stocks categorized as Pink Sheets securities, have no reporting requirements, while those stocks categorized as OTCQX have met alternative disclosure guidelines through Pink OTC Markets. An over-the-counter contract is a bilateral contract in which two parties agree on how a particular trade or agreement is to be settled in the future. It is usually from an investment bank to its clients directly. Forwards and swaps are prime examples of such contracts. It is mostly done via the computer or the telephone. For derivatives, these agreements are usually governed by an International Swaps and Derivatives Association agreement.

This segment of the OTC market is occasionally referred to as the "Fourth Market."

The NYMEX has created a clearing mechanism for a slate of commonly traded OTC energy derivatives which allows counterparties of many bilateral OTC transactions to mutually agree to transfer the trade to ClearPort, the exchange's clearing house, thus eliminating credit and performance risk of the initial OTC transaction counterparts. [edit] Main financial instruments

Bond, Promissory note, Cheque a security contains requirement to make full payment to the bearer of cheque , Certificate of deposit, Bill of Lading (a Bill of Lading is a document evidencing the receipt of goods for shipment issued by a person engaged in the business of transporting or forwarding goods." ), Stock. [edit] Promissory note

A promissory note, referred to as a note payable in accounting, or commonly as just a "note", is a contract where one party (the maker or issuer) makes an unconditional promise in writing to pay a sum of money to the other (the payee), either at a fixed or determinable future time or on demand of the payee, under specific terms. They differ from IOUs in that they contain a specific promise to pay, rather than simply acknowledging that a debt exists. [edit]

Certificate of deposit

A certificate of deposit or CD is a time deposit, a financial product commonly offered to consumers by banks, thrift institutions, and credit unions. CDs are similar to savings accounts in that they are insured and thus virtually risk-free; they are "money in the bank" (CDs are insured by the FDIC for banks or by the NCUA for credit unions). They are different from savings accounts in that the CD has a specific, fixed term (often three months, six months, or one to five years), and, usually, a fixed interest rate. It is intended that the CD be held until maturity, at which time the money may be withdrawn together with the accrued interest. [edit] Bond

Bond - an issued security establishing its holder's right to receive from the issuer of the bond, within the time period specified therein, its nominal value and the interest fixed therein on this value or other property equivalent. The bond may provide for other property rights of its holder, where this is not contrary to legislation. [edit] Bill of lading

A bill of lading (sometimes referred to as a BOL,or B/L) is a document issued by a carrier to a shipper, acknowledging that specified goods have been received on board as cargo for conveyance to a named place for delivery to the consignee who is usually identified. A thorough bill of lading involves the use of at least two different modes of transport from road, rail, air, and sea. The term derives from the verb "to lade" which means to load a cargo onto a ship or other form of transportation.

A bill of lading can be used as a traded object. The standard short form bill of lading is evidence of the contract of carriage of goods and it serves a number of purposes: It is evidence that a valid contract of carriage, or a chartering contract, exists, and it may incorporate the full terms of the contract between the consignor and the carrier by reference (i.e. the short form simply

refers to the main contract as an existing document, whereas the long form of a bill of lading (connaissement intgral) issued by the carrier sets out all the terms of the contract of carriage); It is a receipt signed by the carrier confirming whether goods matching the contract description have been received in good condition (a bill will be described as clean if the goods have been received on board in apparent good condition and stowed ready for transport); and It is also a document of transfer, being freely transferable but not a negotiable instrument in the legal sense, i.e. it governs all the legal aspects of physical carriage, and, like a cheque or other negotiable instrument, it may be endorsed affecting ownership of the goods actually being carried. This matches everyday experience in that the contract a person might make with a commercial carrier like FedEx for mostly airway parcels, is separate from any contract for the sale of the goods to be carried, however it binds the carrier to its terms, irrespectively of who the actual holder of the B/L, and owner of the goods, may be at a specific moment. [edit] Stocks (shares) [edit] Common shares

Common shares represent ownership in a company and a claim (dividends) on a portion of profits. Investors get one vote per share to elect the board members, who oversee the major decisions made by management.Over the long term, common stock, by means of capital growth, yields higher returns than almost every other investment. This higher return comes at a cost since common stocks entail the most risk. If a company goes bankrupt and liquidates, the common shareholders will not receive money until the creditors, bondholders, and preferred shareholders are paid. [edit] Preferred stock

Preferred stock represents some degree of ownership in a company but usually doesn't come with the same voting rights. (This may vary depending on the company.) With preferred shares investors are usually guaranteed a fixed dividend forever. This is different than common stock, which has variable dividends that are never guaranteed. Another advantage is that in the event of liquidation preferred shareholders are paid off before the common shareholder (but still after debt holders). Preferred stock may also be callable, meaning that the company has the option to purchase the shares from shareholders at anytime for any reason (usually for a premium). Some people consider preferred stock to be more like debt than equity.

[edit] Professional participants

Professional participants in the securities market - legal persons, including credit organizations, and also citizens registered as business persons who conduct the following types of activity: Brokerage shall be deemed performance of civil-law transactions with securities as agent or commission agent acting under a contract of agency or commission, and also under a power (letter) of attorney for the performance of such transactions in the absence of indication of the powers of agent or commission agent in the contract. Dealer activity shall be deemed performance of transactions in the purchase and sale of securities in one's own name and for one's own account through the public announcement of the prices of purchase and/or sale of certain securities, with an obligation of the purchase and/or sale of these securities at the prices announced by the person pursuing such activity. Activity in the management of securities shall be deemed performance by a legal person or individual business person, in his own name, for a remuneration, during a stated period, of trust management of the following conveyed into his possession and belonging to another person, in the interests of this person or of third parties designated by this person:

1)securities;

2)monies intended for investment in securities;

3)monies and securities received in the process of securities management. Clearing activity shall be deemed activity in determining mutual obligations (collection, collation and correction of information on security deals and

preparation of bookkeeping documents thereon) and in offsetting these obligations in deliveries of securities Depositary activity shall be deemed the rendering of services in the safekeeping of certificates of securities and/or recording and transfer of rights to securities

Activity in the keeping of a register of owners of securities shall be deemed collection, fixing, processing, storage and provision of data constituting a system of keeping the register of security owners Provision of services directly promoting conclusion of civil-law transactions with securities between participants in the securities market shall be deemed activity in the arrangement of trading on the securities market. Information asymmetry From Wikipedia, the free encyclopedia

In economics and contract theory, information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other. This creates an imbalance of power in transactions which can sometimes cause the transactions to go awry. Examples of this problem are adverse selection and moral hazard. Most commonly, information asymmetries are studied in the context of principal-agent problems.

In 2001, the Nobel Prize in Economics was awarded to George Akerlof, Michael Spence, and Joseph E. Stiglitz "for their analyses of markets with asymmetric information."[1]Contents [hide]

[edit] Information asymmetry models

Information asymmetry models assume that at least one party to a transaction has relevant information whereas the other(s) do not. Some asymmetric information models can also be used in situations where at least one party can enforce, or effectively retaliate for breaches of, certain parts of an agreement whereas the other(s) cannot.

In adverse selection models, the ignorant party lacks information while negotiating an agreed understanding of or contract to the transaction, whereas in moral hazard the ignorant party lacks information about performance of the agreed-upon transaction or lacks the ability to retaliate for a breach of the agreement. An example of adverse selection is when people who are high risk are more likely to buy insurance, because the insurance company cannot effectively discriminate against them, usually due to lack of information about the particular individual's risk but also sometimes by force of law or other constraints. An example of moral hazard is when people are more likely to behave

recklessly after becoming insured, either because the insurer cannot observe this behavior or cannot effectively retaliate against it, for example by failing to renew the insurance. [edit] Adverse selection

The classic paper on adverse selection is George Akerlof's "The Market for Lemons" from 1970, which brought informational issues at the forefront of economic theory. It discusses two primary solutions to this problem, signaling and screening. [edit] Signaling

Michael Spence originally proposed the idea of signaling. He proposed that in a situation with information asymmetry, it is possible for people to signal their type, thus believably transferring information to the other party and resolving the asymmetry.

This idea was originally studied in the context of looking for a job. An employer is interested in hiring a new employee who is "skilled in learning." Of course, all prospective employees will claim to be "skilled at learning", but only they know if they really are. This is an information asymmetry. Skill in learning is malleable, and depends upon many factors, including diet, exercise, and money.

Spence proposes, for example, that going to college can function as a credible signal of an ability to learn. Assuming that people who are skilled in learning can finish college more easily than people who are unskilled, then by finishing college the skilled people signal their skill to prospective employers. No matter how much or how little they may have learned in college, finishing functions as a signal of their capacity for learning. However, finishing college may merely function as a signal of their ability to pay for college, it may signal the willingness of individuals to adhere to orthodox views, or it may signal a willingness to comply with authority. [edit] Screening

Joseph E. Stiglitz pioneered the theory of screening. In this way the underinformed party can induce the other party to reveal their information. They can provide a menu of choices in such a way that the choice depends on the private information of the other party.

Examples of situations where the seller usually has better information than the buyer are numerous but include used-car salespeople, mortgage brokers and loan originators, stockbrokers, Realtors, real estate agents, and life insurance transactions.

Examples of situations where the buyer usually has better information than the seller include estate sales as specified in a last will and testament, or sales of old art pieces without prior professional assessment of their value. This situation was first described by Kenneth J. Arrow in an article on health care in 1963.[2]

George Akerlof in The Market for Lemons notices that, in such a market, the average value of the commodity tends to go down, even for those of perfectly good quality. Because of information asymmetry, unscrupulous sellers can "spoof" items (like replica goods such as watches) and defraud the buyer. As a result, many people not willing to risk getting ripped off will avoid certain types of purchases, or will not spend as much for a given item. It is even possible for the market to decay to the point of nonexistence.

Although information asymmetry has recently been noted to be on the decline with the rise of the internet, which allows ignorant users to acquire hitherto unavailable information such as the costs of competing insurance policies, or the price of used cars, it is still heavily applied to human resource and personnel economics regarding incentive schemes when the employer cannot continually observe worker effort. [edit] Application of information asymmetry in research

Since the seminal contributions of Akerlof, Spence, and Stiglitz, the pervasive effects of information asymmetry in markets have been documented and studied in numerous contexts. In particular, a substantial portion of research in the field of accounting can be framed in terms of information asymmetry, since accounting involves the transmission of enterprise's information from those who have it to those who need it for decision-making. Likewise, financial economists apply information asymmetry in studies of differentially informed financial market participants (insiders, stock analysts, investors, etc).

The Market for Lemons From Wikipedia, the free encyclopedia

"The Market for Lemons: Quality Uncertainty and the Market Mechanism" is a 1970 paper by the economist George Akerlof. It discusses information asymmetry, which occurs when the seller knows more about a product than the buyer. A lemon is a slang term in America for a bad car, i.e. a "clunker". Akerlof, Michael Spence, and Joseph Stiglitz jointly received the Nobel Memorial Prize in Economic Sciences in 2001 for their research related to asymmetric information. Akerlof's paper uses the market for used cars as an example of the problem of quality uncertainty. It concludes that owners of good cars will not place their cars on the used car market. This is sometimes summarized as "the bad driving out the good" in the market.Contents [hide]

[edit] The Used Cars uncertainty problem

Akerlof's paper uses the market for used cars as an example of the problem of quality uncertainty. A used car is one in which ownership is transferred from one person to another, after a period of use by its first owner and its inevitable wear and tear. There are good used cars ("cherries") and defective used cars ("lemons"), normally as a consequence of several not-always-traceable variables such as the owner's driving style, quality and frequency of maintenance and accident history. Because many important mechanical parts and other elements are hidden from view and not easily accessible for inspection, the buyer of a car does not know beforehand whether it is a cherry or a lemon. So the buyer's best guess for a given car is that the car is of average quality; accordingly, he/she will be willing to pay for it only the price of a car of known average quality. This means that the owner of a carefully maintained, never-abused, good used car will be unable to get a high enough price to make selling that car worthwhile.

Therefore, owners of good cars will not place their cars on the used car market. The withdrawal of good cars reduces the average quality of cars on the market, causing buyers to revise downward their expectations for any given car. This, in turn, motivates the owners of moderately good cars not to sell, and so on. The result is that a market in which there is asymmetrical information with respect to quality shows characteristics similar to those described by Gresham's Law: the bad drives out the good (although Gresham's Law applies to a different situation).

"Lemon market" effects have also been noted in other markets, such as used computers[citation needed] . There are also parallels in the insurance market, where, unless those least likely to need insurance (i.e., those least likely to get in accidents) are forced to buy insurance, it is those most likely to need insurance compensation who tend most to buy insurance. [edit] Statistical abstract of the problem

Suppose we can use some number, q to index the quality of used cars, where q is uniformly distributed over the interval [0,1]. The average quality of a used car which could be supplied to the market is therefore 1/2. There are a large number of buyers looking for cars who are prepared to pay their reservation price of for a car that is of quality q. There are also a large number of sellers who are prepared to sell a car of quality q for the price q. If quality were observable, the price of used cars would therefore be somewhere between q and , and the cars would be sold and everyone would be perfectly happy. If the quality of cars is not observable by the buyers, then it seems reasonable for them to estimate the quality of a car offered to market using the average quality of all cars.

Based on this estimation, the willingness to pay for any given car will therefore be , where qavg is the average quality of all the cars. Now, assume that the equilibrium price in the market is some price, p, where p > 0. At this price, all the owners of cars with quality less than p will want to offer their cars for sale. Since again, quality is uniformly distributed over the interval from 0 to this p, the average quality of the cars offered for sale at p will be worth only p/2. We know however that for an expected quality worth p/2, buyers will only be willing to pay (3/2)(p/2) = . Therefore we can conclude that no cars will be sold at p. Because p is any arbitrary positive price, it is shown that no cars will be sold at any positive price at all. The market for used cars collapses when there is asymmetric information. [edit] Asymmetric information

The paper by Akerlof describes how the interaction between quality heterogeneity and asymmetric information can lead to the disappearance of a market where guarantees are indefinite. In this model, as quality is undistinguishable beforehand by the buyer (due to the asymmetry of information), incentives exist for the seller to pass off low-quality goods as higher-quality ones. The buyer, however, takes this incentive into consideration, and takes the quality of the goods to be uncertain. Only the average quality of the goods will be considered, which in turn will have the side effect that goods that are above average in terms of quality will be driven out of the market. This mechanism is repeated until a no-trade equilibrium is reached.

As a consequence of the mechanism described in this paper, markets may fail to exist altogether in certain situations involving quality uncertainty. Examples given in Akerlof's paper include the market for used cars, the death of formal credit markets in developing countries, and the difficulties that the elderly encounter in buying health insurance. However, not all players in a given market will follow the same rules or have the same aptitude of assessing quality. So there will always be a distinct advantage for some vendors to offer low-quality goods to the less-informed segment of a market that, on the whole, appears to be of reasonable quality and have reasonable guarantees of certainty. This is part of the basis for the idiom, buyer beware.

There is no reciprocal danger of a market for a good product collapsing in this manner when the asymmetry is in favour of the buyer,[dubious discuss] that is to say, when the buyers can assess more accurately the quality of the products than the sellers. In this case, regular market forces of supply and demand will prevail, the sellers will get the highest price paid, and the trend will be to weed out products with prices in excess of their quality.

This is likely the basis for the idiom that an informed consumer is a better consumer. An example of this might be the subjective quality of fine food and wine. Individual consumers know best what they prefer to eat, and quality is almost always assessed in fine establishments by smell and taste before they pay. That is, if a customer in a fine establishment orders a lobster and the meat is not fresh, he can send the lobster back to the kitchen and refuse to pay for it. However, a definition of 'highest quality' for food eludes providers. Thus, a large variety of better quality and higher priced restaurants are supported. [edit] Critical reception

George E. Hoffer and Michael D. Pratt state that the economic literature is divided on whether a lemons market actually exists in used vehicles." The authors research supports the hypothesis that known defects provisions, used by US states (e.g., Wisconsin) to regulate used car sales have been ineffectual, because the quality of used vehicles sold in these states is not significantly better than the vehicles in neighboring states without such consumer protection legislation.[1]

Both the American Economic Review and the Review of Economic Studies rejected the paper for "triviality", while the reviewers for Journal of Political Economy rejected it as incorrect, arguing that if this paper was correct, then no goods could be traded. Only on the 4th attempt did the paper get

published in Quarterly Journal of Economics.[2] Today, the paper is one of the most-cited papers in modern economic theory (more than 8,530 citations in academic papers as of May 2011),[3] and has profoundly influenced economic thinking in virtually every field of economics, from industrial organisation and public finance to macroeconomics and contract theory. [edit] Criteria

A lemon market will be produced by the following: Asymmetry of information, in which no buyers can accurately assess the value of a product through examination before sale is made and all sellers can more accurately assess the value of a product prior to sale An incentive exists for the seller to pass off a low quality product as a higher quality one Sellers have no credible disclosure technology (sellers with a great car have no way to disclose this credibly to buyers) Either a continuum of seller qualities exists or the average seller type is sufficiently low (buyers are sufficiently pessimistic about the seller's quality) Deficiency of effective public quality assurances (by reputation or regulation and/or of effective guarantees/warranties) [edit] Impact on markets

The article draws some conclusions about the cost of dishonesty in markets in general: The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence.

[edit] Laws in the United States

Five years after Akerlof's paper was published, The United States enacted a federal "lemon law" (the Magnuson-Moss Warranty Act) that protects citizens of all states. There are also state laws regarding "lemons" which vary by state and may not necessarily cover used or leased vehicles. The rights afforded to consumers by "lemon laws" may exceed the warranties expressed in purchase contracts. These state laws provide remedies to consumers for automobiles that repeatedly fail to meet certain standards of quality and performance. "Lemon law" is the common nickname for these laws, but each state has different names for the laws and acts, which may also cover more than just automobiles. In California and federal law, "Lemon Laws" cover anything mechanical.

The federal "lemon law" also provides the warrantor may be obligated to pay your attorney fees if you prevail in a lemon law suit, as do most state lemon laws. If a car has to be repaired for the same defect four or more times and the problem is still occurring, the car may be deemed to be "a lemon." The defect must substantially hinder the vehicle's use, value or safety. Purchasers who knowingly purchase a car in "as is" condition accept the defects and void their rights under the "lemon law". [edit] Criticism

Criticism for this theory stems from the fact that it ignores the fact that consumers themselves can seek ways to assure the quality of a car and that a used-car salesman may work to maintain his reputation rather than pass off a "lemon". The issue of reputation, however, would not apply to private individual sellers who do not intend to sell another car in the near future.

Libertarians like William L. Anderson oppose the regulatory approach proposed by the authors of the paper, observing that some used-car markets haven't broken down even without lemon legislation and that the lemon problem creates entrepreneurial opportunities for alternative marketplaces or customers' knowledgeable friends.[4]

In any case, the "used car" scenario is clearly intended as an allegory, meant to clearly illustrate an idea; and not as a literal statement concerning the actual business of car sales or any real-life individuals and companies engaged in such a business.