Financial Markets 1

Financial Markets

1. Registered Exchanges

To be successful, investors must understand the functions and operations of financial markets. These markets bring together buyers and sellers of securities to create more efficient transactions. They allow businesses to obtain capital from individual investors to finance their operations and growth. While main street often distrusts Wall Street, these efficient markets have contributed greatly to the United States economic growth and prosperity.

There are two types of exchanges, the registered exchanges and the over-the-counter market, or OTC.

The registered exchanges include the New York Stock Exchange (NYSE), American Stock Exchange (AMEX), regional exchanges (listed below in section on stock tickers) and the overseas exchanges. The U.S. registered exchanges are registered with the Securities and Exchange Commission (SEC) and fall under SEC regulations.

You can purchase many NYSE and AMEX-listed stocks on regional exchanges, though you may pay slightly higher prices because of spreads between bid and ask (buy and sell) prices, different commission schedules and other factors. Check with your broker before buying on a regional exchange.

Many shares trade 24 hours a day on overseas exchanges, the most important being London and Tokyo. Events on those markets can have a major influence on the U.S. exchanges. When American investors arrive at work in the morning, most Wall Street firms check the wires from London and Tokyo overnight to see how those market events may affect the U.S. market. The rapid globalization of markets will continue in the future and should offer more opportunities for investors and for companies to raise capital.

2. Over-the-Counter Markets

The OTC market is self-regulated by members belonging to the National Association of Securities Dealers (NASD). The market consists of hundreds of brokers and dealers tied together by the National Association of Securities Dealers Automated Quotation (NASDAQ) system. NASDAQ acts as a central clearing house for trades. It lists thousands of OTC stocks and some non-OTC issues that trade on so-called pink or yellow sheets. Companies not on the NASDAQ system may be closely held, good quality firms—but can also may be disaster-prone penny stock companies.

Caution! Investors should be aware of price differences between stocks on registered exchanges and stocks on the OTC. OTC stocks have two prices, the bid (purchase price) and the ask (selling price). The bid price is often as much as 10 to 15 percent higher than the ask price. This "bid/ask spread" is a commission that goes to the broker-dealer. You buy at the asked price (the higher price) and sell at the bid (the lower price). The difference goes to the broker-dealer, the market maker for the stock.

For example NOT-SO-BIG company may have a bid of 5 and ask of 4 5/8. If you bought 2000 shares, the commission would be 3/8 times 2,000, or $750! You will not see the $750 commission charge on your order but the broker or market maker is making the money on the transaction. If you were to immediately sell your 2,000 shares, the broker would pay you 2,000 x 4 5/8, or $9,250. The $750 has gone straight into your broker's pocket. But, they'll claim they didn't charge you a commission. What friends they are!

Double check before you buy. Small stocks on the OTC markets usually move up or down in price faster than larger companies. However, because of broad spreads, a trading strategy to take advantages of the price moves may generate more commissions for the broker than profits for you.

Penny stock firms usually levy outrageous commissions. For example, the SEC reported a brokerage that sold a customer $25,000 in stock and made a $12,500 commission! This was just one of many examples. The SEC will soon have a "Stock Watch" system for OTC stocks that will flag orders that have excessive spreads or commissions. Penny stocks will be discussed further later in the course.

3. Requirements for Listing on Exchanges

Not just any company can have itself listed and traded on an exchange. The following minimum requirements apply to companies that want to be listed on a particular exchange.

NYSE: Minimum number of shareholders: 2,000. Minimum number of shares: 1.1 million. Pre-tax income: $2.5 million for the previous year, or $2.0 million for the previous years.

AMEX: Number of shareholders: 800 if 500,000 shares are outstanding; or 400 if 1 million shares are outstanding. Minimum value of shares outstanding: $4 million. Pre-Tax income: $750,000 for previous year, or for 2 out of the last 3 years.

OTC (NASD): Number of shareholders: 300. Number of shares: 100,000. Total assets: $2 million. Stockholder's equity: $1 million.

If a listed company drops below the requirements, it may be delisted or moved to another exchange with less stringent requirements. Conversely, as OTC companies expand they can move up to the AMEX or NYSE that offers greater exposure to more investors and analysts. However, many companies, such as Apple Computer, Microsoft and Intel, started on the OTC and decided to stay there even after they grew larger.

Companies on the NYSE and AMEX usually have more stringent financial standards. Several OTC companies lost value after Wall Street discovered that accountants were playing with capitalization of expenses, phantom (non-existent) inventory, bogus earnings and inflated accounts receivable.

Unfortunately, a company's use of a Big Six (soon to be the Big Five, or Big Three?) accounting firm does not guarantee protection from accounting fabrications.

In 1989, a security company located in Florida, Sahlen and Associates, appeared to be a rising star in the security guard business. A Bear Stearns analyst wrote a glowing report in Fortune magazine. One of the Bass brothers bought a stake in the company. The company kept growing through acquisition of firms far larger than itself. Then one day the SEC learned from a fired employee that the accountants had greatly overstated accounts receivable. The company's accounting firm, Peat Marwick Main, had "no comment!"

Another example was Crazy Eddie's, the New York electronics retailer that counted "phantom" inventory. Other abuses have occurred. The point here is that although OTC stocks can offer greater appreciation potential, be aware that registered exchanges offer more protection to you, the individual investor.

4. Reading the Tape

"To me, the 'tape' is the final arbiter of any investment decision. I have a cardinal rule: Never fight the tape!"

—Martin Zweig

Investors often watch stock prices on television (FNN, CNN, others) or on brokerage firm "tapes." With Quotrons and other modern computer-based quotation machines, this section may seem obsolete, but many still keep up with the market by watching the ticker. In the old days, stock prices literally came across on ticker tape machines. Today, investors can check prices in a variety of ways (listed below). The main format is still the electronic ticker or price board used on TV and in many brokerage offices.

Every stock or security is listed with a ticker symbol: IBM is IBM, GM is GM, but Coca Cola is KO, Exxon is XON, Walmart is WMT, etc. As the trades are executed on the trading floor or by computer, the transactions—identified by ticker symbols—are input to a computer and the data go out to brokerages, to TV tickers and to anyone with a quote service.

As the ticker display moves across the screen the prices and trades are displayed along with the exchange the shares traded on. The table below shows the suffixes used to identify the exchanges.

Exchange	Tape Suffix Symbol (after stock symbol)
New York Stock Exchange	&N
American Stock Exchange	&A
NASDAQ	&T
Pacific Stock Exchange	&P
Philadelphia Stock Exchange	&X
Boston Stock Exchange	&B
Midwest Stock Exchange	&M
Cincinnati Stock Exchange	&C

The ticker display, "XON&N 65 1/2," means Exxon traded 100 shares at $65.50 per share on the New York Stock Exchange (&N). Unless otherwise indicated, the display always shows one-hundred-share "round lot" trades. If a trade is for other than 100 share, a number followed by "s" indicates the number of 100-share blocks traded. "AMH&A 3s25" means Amdahl Computer traded 300 shares at $25 on the American Stock Exchange. The "s" means 100 shares, so "3s" means 300 shares. "BA&A 12s25" shows a 1200-share trade of Boeing Aircraft at $25 per share on the AMEX; "150s" would mean 15,000 shares were traded.