Chapter # 5

The Structure and

Performance of Securities
Market

Professor Dr. Md. Abu

Sina
 Functions of Securities Market
1. Providing Continuous and ready market for
securities: Stock exchange provides a ready and
continuous market for purchase and sale of
securities. It provides ready outlet for buying and
selling of securities. Stock exchange also acts as an
outlet/counter for the sale of listed securities.
2. Facilitating evaluation of securities: Stock
exchange is useful for the evaluation of industrial
securities. This enables investors to know the true
worth of their holdings at any time. Comparison of
companies in the same industry is possible through
stock exchange quotations (i.e price list).
3. Encouraging capital formation: Stock exchange
accelerates the process of capital formation. It
creates the habit of saving, investing and risk taking
among the investing class and converts their
savings into profitable investment. It acts as an
instrument of capital formation. In addition, it also
acts as a channel for right (safe and profitable)
investment.
4. Providing safety and security in dealings: Stock
exchange provides safety, security and equity
(justice) in dealings as transactions are conducted
as per well defined rules and regulations. The
managing body of the exchange keeps control on
the members. Fraudulent practices are also
checked effectively. Due to various rules and
regulations, stock exchange functions as the
custodian of funds of genuine investors.
5. Regulates company management: Listed
companies have to comply with rules and
regulations of concerned stock exchange and work
under the vigilance (i.e supervision) of stock
exchange authorities.
6. Facilitates public borrowing: Stock exchange
serves as a platform for marketing Government
securities. It enables government to raise public
debt easily and quickly.
7. Provides clearing house facility: Stock exchange
provides a clearing house facility to members. It
settles the transactions among the members quickly
and with ease. The members have to pay or receive
only the net dues (balance amounts) because of the
clearing house facility.
8. Facilitating healthy speculation: Healthy
speculation, keeps the exchange active. Normal
speculation is not dangerous but provides more
business to the exchange. However, excessive
speculation is undesirable as it is dangerous to
investors & the growth of corporate sector.
9. Serving as Economic Barometer: Stock
exchange indicates the state of health of
companies and the national economy. It acts as a
barometer of the economic situation / conditions.
10. Facilitating Bank Lending: Banks easily know
the prices of quoted securities. They offer loans to
customers against corporate securities. This gives
convenience to the owners of securities.
 What is Primary Market?
The Primary market refers to the market where new
securities are issued for the purpose of obtaining
capital. Firms and public or government institutions
can raise funds from the primary market through
making a new issue of stock (to obtain equity
financing) or bonds (to obtain debt financing). When
a corporation is making a new issue, it is called an
Initial Public Offering (IPO), and the process is
referred to as the ‘underwriting’ of the share issue.
In the primary market, the securities are issued by
the company that wishes to obtain capital and is
sold directly to the investor. In exchange for the
funds that the share holder contributes, a certificate
is issued to represent the interest held in the
company.
 What is Secondary Market?
The secondary market refers to the market where
securities that have already been issued are traded.
Instruments that are usually traded on the
secondary market include stocks, bonds, options
and futures. Certain mortgage loans can also be
sold to investors on the secondary market. Once a
security has been purchased for the first time by an
investor on the primary market, the same security
can be sold to another investor in the secondary
market, which may be at a higher or lower price
depending on the performance of the security
during its period of trading. There are many
secondary markets worldwide, and famous few
include the New York Stock Exchange, The
NASDAQ, the London Stock exchange, the Tokyo
stock exchange and the Shanghai Stock Exchange.
 Differentiation
Primary Secondary
1. The Primary market refers 1. The secondary market
to the market where new refers to the market where
securities are issued by securities that have
the company that wishes already been issued are
to obtain capital and is traded.
sold directly to the investor 2. Secondary markets assist
2. Primary markets assist corporations obtain capital
corporations obtain capital funding from one investor
funding from investors to to another investor.
the company (or 3. In the secondary market,
representative). the company has no
3. In the primary market, the involvement since the
company is directly transactions occur
involved in the transaction. between investors.
 Primary Secondary
4. Here the functions are 4. Here financial assets can be
limited to first issuance. traded and re-traded over
5. In the primary market, the and over again.
money earned from selling 5. In the secondary market,
a security goes to the the money earned from
company directly. selling a security does not
6. In general, primary market go to the company. The
trading is considered money thus earned goes
underwriting. to the investor who sells
the security.
7. Primary issues are used by
companies for the purpose 6. Generally in secondary
of setting up new business market, trading is not
or for expanding or considered underwriting.
modernizing the existing 7. In the secondary market
business. there is no such type of
8. In it, the financial assets sold task.
can only be redeemed by 8. In this market, the financial
the original holder. assets sold can not be
redeemed by the original
holder.
 Equity Trading
Equity trading is the buying and selling of company
stock/shares. Stocks in smaller public companies
are bought and sold in over-the-counter (OTC)
markets. Equity trading specifically eliminates debt
trading.
Equity trading can be performed by the owner of the
shares, or by an agent authorized to buy and sell
on behalf of the share's owner.
Proprietary trading is buying and selling for the
trader's own profit or loss. In this case, the principal
is the owner of the shares.
Agency trading is buying and selling by an agent,
usually a stockbroker, on behalf of a client. Agents
are paid a commission for performing the trade.
Fixed income trading involves buying and selling debt
securities with regular fixed payments of interest and the
repayment of principal at the end of the maturity period. Only
a few of these securities can be traded by individual
investors.
Types of Fixed Income Securities
There are three types of fixed income securities: debt
obligations issued by governments, local authorities or
companies are bonds and notes, stocks that pay fixed
dividends but don't include voting rights are known as
preferred stock, and mortgage- or asset-backed securities.
Traders
Individual investors can relatively easy trade in bonds and
mortgage-backed securities. U.S. Treasury bonds are the
most popular and easily tradable through cash purchase.
While offering federal-tax breaks, municipal bonds are less
popular because of their lower yields. Corporate bonds,
which carry a slightly higher risk of default, are tradeable by
anyone with a brokerage account.
Things to Consider
Investors in government bonds need to be aware of things like
the political situation in and macroeconomic policies of the
country whose bonds they trade in, while corporate bond
traders should know performance results of the companies
whose bonds they own and keep track of important changes
in the relevant industrial sectors. Most importantly, investors
need to know government or corporate credit ratings.
Where Does Equity Trading Take Place?
Trading equities usually takes place in public markets, both
domestic and overseas. Equity trades can take place at
almost any time of the day or night. Trading securities not on
a listed exchange involves cost inefficiencies due to lack of
liquidity. It is possible to trade equities through the futures
markets.
The Electronic Market
Equity trading now involves the electronic matching of buy and
sell orders. This is true for almost all exchanges.
Bid and Offer Price
Equity markets provide a bid and offer price for every
trade. The difference, or spread, is earned by
market makers that make trading profits from the
constant buying and selling of stocks by the
investing public.
The Many Forms of Equity
Common stock refers to the proportionate ownership
of a company. Preferred stock has both equity and
debt-like components. Equity trading also refers to
options, warrants and convertible preferred stock.
Trading Techniques
Equities may be traded for short-term and long-term
profits. Equities can be traded as part of a technique
combining the value of options and stocks. This is
called arbitrage. Stocks bought to capture stock
dividends is another popular strategy.
 Secondary Mortgage Market
The secondary mortgage market is the
market for the sale of securities or bonds
collaterized by the value of mortgage loans.
The mortgage lender, commercial banks, or
specialized financial institutions will group
together many loans and sell grouped loans as
securities called collateralized mortgage
obligations (CMOs). The ris of the individual
loans is reduced by that aggregation process.
These securities are collateralized debt
obligations (CDOs), also known as
mortgage-backed securities (MBS).
 Investment pool participation
A public entity may enter into an
agreement with other public entities to
form and manage an investment pool
under which funds of the participating
public entities are administered and
invested jointly. A public entity, by itself
or with other public entities, may form a
nonprofit corporation for the purpose of
managing an investment pool.
 Government Investment Pool and
Participants
A government investment pool (GIP) is a
government pool offered to public entities for the
investment of public funds. These pools are
important investments tools. GIP managers are
vested with a public trust that the pool will maintain
liquidity, diversity, and follow the investment pool’s
guidelines.
Participants in a government investment pool may
include state or local municipalities, counties, school
districts, utility districts, and local government units.
Govt. laws or GIP rules and procedures govern the
types of participants that can invest in a GIP.
 Some Definitions
1. Securities: The definition of 'Securities' as per the
Securities Contracts Regulation Act (SCRA), 1956 of
the USA, includes instruments such as shares, bonds,
stocks or other marketable securities of similar nature in
or of any incorporate company or body corporate,
government securities, derivatives of securities, units of
collective investment scheme, interest and rights in
securities, security receipt or any other instruments so
declared by the Government.
2. What is the function of Securities Market?
Securities Markets is a place where buyers and sellers
of securities can enter into transactions to purchase and
sell shares, bonds, debentures etc. Securities markets
provide channels for reallocation of savings to
investments and entrepreneurship. Savings are linked to
investments by a variety of intermediaries, through a
range of financial products, called 'Securities'.
3. Who are the participants in the Securities Market?
The securities market essentially has three categories of
participants, namely, the issuers of securities, investors
in securities and the intermediaries, such as merchant
bankers, brokers etc. While the corporates and
government raise resources from the securities market
to meet their obligations, it is households that invest their
savings in the securities market.
4. Is it necessary to transact through an
intermediary?
It is advisable to conduct transactions through an
intermediary. For example you need to transact through
a trading member of a stock exchange if you intend to
buy or sell any security on stock exchanges. You need
to maintain an account with a depository. You need to
deposit money with a banker to an issue if you are
subscribing to public issues. You get guidance if you are
transacting through an intermediary. Chose a registered
intermediary, as he is accountable for its activities. The
list of registered intermediaries is available with SEC.
5. What are the segments of Securities Market?
The securities market has two interdependent segments:
the primary (new issues) market and the secondary
market. The primary market provides the channel for
sale of new securities while the secondary market deals
in securities previously issued.
6. What is the role of the 'Primary Market'?
The primary market provides the channel for sale of new
securities. Primary market provides opportunity to
issuers of securities; Government as well as corporates,
to raise resources to meet their requirements of
investment and/or discharge some obligation. They may
issue the securities at face value, or at a
discount/premium and these securities may take a
variety of forms such as equity, debt etc. They may
issue the securities in domestic market and/or
international market.
7. What is meant by Face Value of a
share/debenture?
The nominal or stated amount (in Tk.) assigned to a
security by the issuer is called face value of a share.
share
For shares,
shares it is the original cost of the stock shown on
the certificate; for bonds,
bonds it is the amount paid to the
holder at maturity. Also known as par value or simply
par.
For an equity share,
share the face value is usually a very
small amount (Tk. 5, Tk. 10) and does not have much
bearing on the price of the share, which may quote
higher in the market, at Tk. 100 or Tk. 1,000 or any
other price.
For a debt security,
security face value is the amount repaid to
the investor when the bond matures (usually,
Government securities and corporate bonds have a
face value of Tk. 100). The price at which the security
trades depends on the fluctuations in the interest rates
in the economy.
8. What do you mean by the term Premium and Discount in

a Security Market?
Securities are generally issued in denominations of 5, 10 or
100. This is known as the Face Value or Par Value of the
security as discussed earlier. When a security is sold above its
face value, it is said to be issued at a Premium and if it is sold
at less than its face value, then it is said to be issued at a
Discount.
9. Why do companies need to issue shares to the public?
Most companies are usually started privately by their
promoter(s). However, the promoters' capital and the
borrowings from banks and financial institutions may not be
sufficient for setting up or running the business over a long
term. So companies invite the public to contribute towards the
equity and issue shares to individual investors. The way to
invite share capital from the public is through a 'Public Issue'.
Simply stated, a public issue is an offer to the public to
subscribe to the share capital of a company. Once this is
done, the company allots shares to the applicants as per the
prescribed rules and regulations laid down by SEC.
10. What are the different kinds of issues?
Primarily, issues can be classified as a Public, Rights
or Preferential issues (also known as private
placements).
placements While public and rights issues involve
a detailed procedure, private placements or
preferential issues are relatively simpler. The
classification of issues is illustrated below:
i) Initial Public Offering (IPO) is when an
unlisted/listed company makes either a fresh issue
of securities or an offer for sale of its existing
securities or both for the first time to the public. This
covers way for listing and trading of the issuer's
securities.
ii) A follow on public offering (Further Issue) is
when an already listed company makes either a
fresh issue of securities to the public or an offer for
sale to the public, through an offer document.
iii) Rights Issue is when a listed company which
proposes to issue fresh securities to its existing
shareholders as on a record date. The rights are
normally offered in a particular ratio to the number of
securities held prior to the issue. This route is best
suited for companies who would like to raise capital
without diluting stake of its existing shareholders.
iv) A Preferential issue is an issue of shares or of
convertible securities by listed companies to a select
group of persons under Section 81 of the Companies
Act, 1956 which is neither a rights issue nor a public
issue. This is a faster way for a company to raise
equity capital. The issuer company has to comply
with the Companies Act and the requirements
contained in the Chapter pertaining to preferential
allotment in SEBI guidelines which inter-alia include
pricing, disclosures in notice etc.
Classification of Issues
 Auction vs. Dealer Market
When you buy or sell a stock from your online
broker; you are trading in the secondary markets.
They are essential to creating efficient capital
markets through efficiency and transparency.
Transactions are being completed through one of two
methods; an auction style exchange or a dealer
exchange.
exchange
In an Auction Market,
Market buyers and sellers will meet
and place offers to buy and sell. These are
commonly known as bid and ask. ask The buyer is
“bidding” to buy a security at a certain price while the
seller is "asking" a certain price to sell their security.
The most aggressive buyer and seller have the best
chances at executing their trade.
The most popular example of an auction market is
the New York Stock Exchange where there are
traders on the floor (specialists) who are buying
and selling securities with each other,
electronically, or through the phone.
A dealer market is very similar in that the role of
this market is to create liquidity and efficiency.
Dealer markets, as readily seen on the SEC,
have market makers who keep an inventory of
the security and then transact with customers
with that inventory. Dealers will profit off of the
bid/ask spread and the commissions charged to
place the trade.