CHAPTER III

SECURITIES MARKETS

TOPICS:
1. Fundamentals of Securities Markets
2. Components of Securities Markets
3. Organization of Securities Markets
4. Distribution and trading of Securities Markets
5. Ways in profiting in Stock Exchange

LEARNING OUTCOMES:
After this Chapter, you should be able to:
1. Describe the fundamentals of securities markets.
2. Identify the components of securities markets.
3. Determine the different markets that comprised the organization of securities
markets.
4. Have a perspective knowledge in the distribution and marketing securities.

LECTURE PROPER
FUNDAMENTALS OF SECURITIES MARKET
What is Securities Market?
Securities Market is a platform for securities where investors can buy and sale the shares.
Securities market encompasses equity markets, bonds markets and derivatives market where
prices can be determined and participants can meet.

Characteristics of a good Securities Market

1. Growth capital
Issuing stocks is the important factor of capital formation for the Company. The
stock market provides a way for the company to issue stocks to the investing public.
2. Liquidity
Liquidity results in narrow bid-ask spreads, which means small differences
between what the buyers are offering and what the sellers are asking for stocks.
3. Transparency
Trading maintains transparency in financial institutions. All securities traded on
the market are known to all the participants.
4. Organization
The stock market provides a degree of protection to investors through oversight
by SEC and other legal regulatory bodies that serve to create an organized group of stock
exchanges and stock trading platforms; and
5. Regulated risk/reward
Stock market serves as a way for investors who seek large returns on their
investments to access organized, liquid, regulated and transparent risk investing.

COMPONENTS OF SECURITIES MARKET

The securities markets may be classified into the following:
1. The auction-type markets where buyers of securities make their bids and the sellers to
make their offers. Bids and offers stipulate both the price and volume and are handled by
the trader and the agent of auction market.
Offers are ranked from the lowest price up; bids from the highest price down; bids
and offers are matched with one another. If there is match, the trading is consummated.
Buyers and sellers do not directly trade with one another, but through a dealer.
The Philippine Stocks Exchange (PSE) is an example of auction market.
2. The negotiation market
 When buyers and sellers of securities negotiate with each other regarding the
price and volume, either directly or through a broker or dealer. Securities that are not
frequently traded in the auction market is engaged in negotiation market.
Distribution of securities through direct placement, over-the-counter, or through
dealers or brokers are examples of negotiation market.

ORGANIZATIONS OF SECURITIES MARKET

The following are the organization of securities market:
1. Primary Market (First Market)
2. Secondary Market (Second Market)
3. Over-the-Counter (Third Market)
4. Derivatives Market (Fourth Market)
The Primary Market
Primary Markets are markets in which users of funds raise through new issue of financial
instruments, such as stocks and bonds referred to as primary securities. Through primary market
can raise funds for the issuing company, which acts as a borrower by increasing its capital stock
when it issues stocks, or outstanding liabilities when it issue bonds. Primary distribution is mostly
done via investment bankers, private placement, or direct sale by the company to individual
investors.
First time issues for the public are called Initial Public Offering (IPO). If shares are offered
only to particular person or corporate investor, is called a private placement.

The distribution channel for a new security issue

Corporate Issuer of
Securities

Underwriting Syndicate

Investment Banker Originating Investment Investment Banker

Bankers

Investment Banker Selling Groups

Investment Banker

Investors
Fig. 6 Distribution channel for a new security issue

The Secondary Market

Secondary Markets are markets for currently outstanding securities, referred to as
secondary securities. These securities were previously bought and owned and now being resold
either by initial investors or those who have purchased the securities in the secondary market.
Secondary markets provide liquidity for investors as they sell their financial securities when they
need cash.
All transactions after the initial issue in the primary markets are done in the secondary
markets. Outstanding shares are those issued shares of stock held by the public. Secondary
markets only transfer ownership, but do not affect the total outstanding shares or issued shares
of stocks unless the issuing firm retires the stocks that would reduce outstanding shares in the
market.
 On bonds issues, redemption of bonds decrease s total outstanding debt securities in the
market and at the same time reduces the outstanding liabilities of the issuing company.
Organized or formal market like the Philippine Stocks Exchange and other stock
exchanges around the world are referred to as secondary markets wherein seasoned or existing
securities are traded. A security is said to be seasoned when it was passed through the initial
offering and a certain degree of active trading. Disposal of securities in the secondary market is
the means by which the investor converts his security into cash. As the secondary market picks
the grounds and be a lucrative source of income, security dealers, institutional buyers and
investors purchase securities for resale or as a form of temporary investments. However,
volatility index of the markets are unpredictable, as in the case of ABS-CBN Corporation stock
price crash that tremendously affected by the non-renewal of its franchise.
Listing of security issues is only permitted when those issues have already undergone
seasoning process in the primary market. Before a security is traded on the floor of the exchange
it has to be listed. The issuer or the dealer applies for the listing of security with the stock
exchange and after process of approval (SEC), such listed securities are added to the list on the
exchange floor for actual trading.
The listing of security benefits both the issuer and the investor. The salient advantages
are:
1. It promotes the marketability of the security as the buying public is aware of the rigid
screening issue has gone through before the stock exchange and the SEC permitted the
listings.
2. Listed securities gain more values as collaterals as they inspire greater confidence among
creditors/banks.
3. Security holders are in a better position to keep track of the financial condition of the
issuer as they are furnish with financial statement.
4. The issuer is likewise favored by listing due to:
a. The wide publicity the security gains as the durations of the stock exchange are
published in daily newspapers;
b. New issues of the company with listed securities may be sold at a higher price,
with selling expenses and lower underwriting commissions; and
c. It is a public nation that a company with listed securities have been conformed to
the high standards set by the PSE and the SEC.
A Stock Exchange is a private non-profit self-governing organization which furnishes
facilities and establishes rules and regulations that strictly govern transactions on the floor.
The Over-the-Counter Market (OTC)
The Over-the-Counter Market is an intangible market usually referred to as the off-board
market or Third Market. The OTC operates refers to the trading of securities outside the stock
exchange having a broader scope than the latter. It also covers trading both in listed and unlisted
securities (new issues and seasoned securities). Unlike stock exchanges, there are no set up of
rules to follow as its operations embraces the trading through brokers or dealers in whatever
place and regardless of the methods and facilities used. Trading is predominantly carried out
through telephone calls and other forms of communication that would establish direct contacts
between broker/dealer and their various clients.
Specialization in security trading expedites transactions. The broker or dealer know when
to contact when confronted with security of a specific type industry. However, the lack of
diversification increases the risk to the specialist dealers.
OTC markets are less formal, through a well-organized networks of trading relationships
of dealers. Dealers act as market makers by quoting prices at which they will sell or buy to other
dealers and to their clients or customers. OTC markets are less transparent and operate with
fewer rules than do exchanges. All of the securities and derivatives involved in the financial
turmoil that began in 2007 breakdown in the US Mortgage Market were traded in OTC markets
(Dodd, 2016).
The Derivative Markets (The fourth market)
The Derivatives Securities Market refers to markets where derivative securities are
traded. Derivative securities are financial instruments which payoffs are linked to another
previously issued securities.
A derivative is a contract where value is tied to the value of an underlying asset (e.g.
foreign currency, share capital, debt security). Derivative can be used to reduce risk exposure.
Further, derivatives may be used to hedge a position so that unfavorable price movement on one
asset is offset by a favorable movement in another asset.
Derivatives is represented by an agreement between two parties to exchange a standard
quantity of asset or cash flow at a predetermined price at a specified date in the future. Futures,
option and forward contracts are examples of derivatives as well as swap agreements,
mortgaged-back securities, stock warrants, etc. The mortgaged-backed securities are
instruments that are secured or guaranteed by mortgages.

TRADING IN THE SECURITIES MARKET

Securities can be traded both in exchanges and the Over-the-Counter (OTC) Markets. Trading
in the stock exchange are characterized by the following:
1. Exchange transactions are carried out on the floor of the exchange by its members on
an agency basis;
2. The facilitator of exchange in the stock market is called a broker and is paid a
commission;
3. A transaction in an exchange is exposed to the public, less selling effort is required;
and
4. A complete record to transactions generally becomes available almost immediately to
members of the exchange, professional traders, and the public.
On the other hand, OTC transactions are characterized by the following:
1. The dealers who buy the securities offered for sale act as principals;
2. The facilitator of exchange in the OTC market is called a dealer and earns his income
by selling at a mark-up;
3. More selling effort is required in stimulating OTC transactions; and
4. Bid and asked price are made to interested parties.
The selling price and the sales volume are not necessarily reported. Transactions on the stock
exchange are done an “action basis” where all buyers and sellers and securities are
converged/standing together on the trading floor and securities are sold to the highest bidder.
While buyers and sellers in the OTC market, however, are not situated in a single place, but
connected by negotiation through electronics means.

WAYS IN PROFITING IN STOCK EXCHANGE

There are ways to make profit by investing in the stock exchange, such as”
1. Earn income on share investment in the form of dividends commensurate to the
volume of shareholdings.
2. Spread (mark-up) generated from stock trading, the difference of selling price over
the buying price of shares.
3. Earning from capital appreciation on the gains made on capital (principal invested)
when share price increases.