The US Stock Market and the New York Stock Exchange - Term Paper Example

THE US STOCK MARKET AND THE NEW YORK STOCK EXCHANGE Introduction Everyone living in the United s is made aware of the important role of stock markets in their lives and in the lives of many others who cannot avoid witnessing the consequences of stock price movements on their economic fortunes. The stock market is also a good barometer or indicator of the overall health of the economy. This paper will discuss the stock market in general terms and specific, and then focus on the institutions that carry out this important economic function in our free market system, particularly the New York Stock Exchange. Stocks are a form of part-ownership of a business evidenced by a stock certificate. Shares are originally sold whenever a company needs money for business development or expansion. While a small business may not need shareholders from outside the owners family, an expansion strategic decision may require that he sell shares to the public. This is done through an initial public offering. The buyers and owners of shares of stock can subsequently sell their shares in the stock exchange where the stock is normally traded. While stocks may be kept as investment, often it does not imply participation in the running of the business for one can sell his shares at any time when it has appreciated in value to earn a profit or when he needs cash. The stock exchange is the place where individuals trade stocks. In the United States the three most important places where to trade stocks are the New York Stock Excange, the American Stock Excange and the Nasdaq. One can buy or sell stocks in these exchanges through stock brokers or indirectly through mutual fund companies or company dividend reinvestment plans. Wall Street is a term one often hears to refer to a marketplace for stocks. Physically it is street, an address in New York city, but as a market it is where merchants, agents and customers of finance meet to buy and sell stocks or bonds (Little and Rhodes, 1991). Thus it is composed of “all the the individual marketplaces and the totral community of interests that maintains them and is regulated closely by the Securities and Exchange Commission (ibid).” The name Wall Street comprises the two major exchanges and the regional stock exchanges, but it may also include the nationwide network of brokers/dealers known as the over-the-counter (OTC) market, the brokerage firms and their employees, and all investors, whether individual or institutional. Wall Street can also be divided into two major functions: the provision of a primary market and secondary market. The primary market is where corporations sell their stocks and bonds directly to the public, thereby obtaining money needed for expansion. The proces of bringing a stock issue to the public for he first time is called “going public,” or more commonly nowadays, as “an initial public offering. “ A company that has gone public can have its shares traded in the secondary market, which provides investors with an opportunity to buy or sell the shares they own but without the involvement of the primary issuer. Prices of stocks are determined by the economic law of supply and demand. Investors in the stock market participate in the trading of stocks actuated by the profit motive. The buyer expects to buy low and sell high. Profits can be earned either through dividends received or through an increase in the price of his holdings, or both. A seller may try to release his stocks because he needs the money for other purposes or because he has achieved his investment objective. The activities of buyers and sellers in the market makes for the creation of new industries, employment, and a higher standard of living for the membes of society. The New York Stock Exchange The New York Stock Exchange occupies the a 36,000 square feet trading floor on 11 Wall Street, New York City, where it serves as venue for the trading of more than 3,000 listed stocks through 27 specialist firms members of the exchange. A specialist hired by each firm manages up to 10 stocks, and each stock is represented by only one specialist. Companies get their stock listed in the NYSE if they are able to meet the listing requirements. Today that means that the company must have a market value of at least $100 million, has had three years of continuous profits, a minimum of 2,000 stockholders, and 1.1 million shares outstanding. Despite advances in electronic technology, the exchange continues to conduct trading in an auction-like setting where buy and sell orders meet in a central location called a trading post occupied by a specialist. There are 17 trading posts where each specialist conducts his business, and each trading post, fitted with dozens of computer screens, can handle 150 different securities. Exchange member firms and independent brokers own and run some 1,400 trading booths found along the perimeter of the exchange floor. Seats or “memberships” are purchased and owned by such investment banking firms as Merrill Lynch and Goldman Sachs, giving them the privilege of doing business in the exchange. At the end of 2001 the exchange had 1,366 members whose seats can be bought and sold. Each seat during that year was worth $2.2 million, but the price per seat can vary depending on the stock market conditions. Alternaively members may purchase physical or electronic access rather than seats. Membership is divided amolng three types of people: floor specialists; house brokers, who are employed by giant investment and brokerage firms such as Merrill Lynch and Morgan Stanley, to execute their own trades; and two-dollar brokers, who handle trades for institttional investors such as mutual funds and smaller brokerage firms. The latter got their name from the commission fee of $2 per 100 shares that member firms used to charge one another. There are 480 specialists and 400 independent brokers in the exchange and they make up the majority. Thus the floor brokers employee by major firms belong to the minority. The question that is often asked is : Why does the NYSE refuse to use computers to match trades instead of using human labor? The answer is that while it would cut costs for all concerned, it would reduce the role and profits of the middlemen. It would make the specialists and floor brokers expendable and redundant, and the middlemen would have to vote in favor of that change, and of course they would not. Also, as many as 2/3 of all seats are leased from retired or absentee NYSE members who retain the right to vote and would be unwilling to forgo a lucrative source of income. (See Leavitt, 2003) Floor brokers are individuals who trade on the floor communicating with specialists. Brokers who are not on the trading floor communicate with specialists through what is called the Super-Dot, the electronic order-handling system of the exchange.There are also independent floor brokers, known as “free agents,” who represent nonmember brokers/dealers. A word on Super-|Dot. It means “Super Designated Order Turnaround System,” a facility set up in 1976 to link member firms directly to the specialists, and used primarily for smaller orders, or orders of less than 2,100 shares. The Super-Dot handles 80 per cent of all orders but only 40 percent of all shares traded on the NYSE. The specialist is responsible for matching buy orders with sell orders, and if he cannot find a matching trade, he can trade for his or his firms account. This means he has control over the price of his stock. He can even put a halt to trading in a particular stock he handles when there is an unusual news event that can have major impact, and he may resume trading only after he has sorted out the event and arrived at a reasonable price (Bentley, 2000). How does one participate in stock trading? One has to open an account with a brokerage firm by filling out forms, the same way that one would open a bank account. This will enable the individual to buy or sell stocks through any exchange or in the over-the-counter market with which he broker deals. If one wants to buy shares in IBM, for example, the person who has opened an account can go to his broker and instruct him to buy 100 shares of IBM (a round lot is composed of 100 shares), using a market order. A market order is an instruction to buy a stock at the best price as soon as possible. Lets assume that another person places a market order to sell the same number of shares of IBM stock. The orders are then promptly sent to the trading departments of the respective firms and then transmitted directly to the floor of the NYSE. The firms floor brokers on the stock exchange floor receive the orders and immediately proceed to the trading post where the stock is bought and sold. The specialist handles the trade at the trading post. The specialist ensures a fair and orderly market in each assigned stock by matching trades or by buying and selling for his own or his firms account in the absence of competing bids and offers for the same stock. When the specialist trades for his own account, he expects to earn his margin from the “spread” between bid and offer prices. He acts as a dealer, who by definition is a principal in the transaction, buying from and selling to a customer. He is different from a broker, who represents a customer as agent or middleman. The Super-Dot, mentioned earlier in this paper, is an electronic routing sytem that allows members to transmit orders directly to the specialist post. Before the opening of the trading day, the Super-Dot continuously matches buy and sell orders and presents to the specialist the pre-opening balance which would enable him to determine the opening price. Using a computer, the specialist just touches the electronic dislay screen to arrange voluminous transactions which can be done quickly and efficiently in little time. The specialist would act as dealer in the case of odd-lot deals (1 to 99 shares). An odd-lot order with a price limit is processed by the cmputer and processed automatically at the next odd-lot price struck at his post. Odd-lot orders without price limit, on the other hand, are immediately executed on the bid and offer prices without the charge normally exacted from those with price limits. If one wants to buy 100 shares of OTC stock rather than an exchange-listed stock, the order would have to be sent to the firms OTC trading post instead of the normal specialists tradng post. The over-the-counter (OTC) market is the oldest and largest securities market in the United Sttes. OTC brokers and dealers are connected by computer of the Nasdaq system because they do not meet in one central marketplace. The products traded in the OTC market are almost all federal, state and municipal and corporate bonds; almost all new issues; most mutual funds; foreign stocks; and nearly 30,000 domestic stocks. The aggregate dollar volume of the OTC market exceeds that of all stock exchanges combined. Conclusion The stock market of he United Stgates is a very huge organization that caters to the needs of investors, traders, exchange members, and other participants and stakeholders. It would require a book to make a comprehensive discussion of the mechanisms and intricacies involved and the various factors that have bearing on the market. It would perhaps suffice to state that the US stock market serves a major function in the functioning of the democratic capitalist system here and abroad. Many securities, both domestic and foreign, are traded in our exchanges, making it possible for wealth to change hands quickly and efficiently for those who avail themselves of the facilities that it offers. REFERENCES Bentley, K. (2000). Getting started in online trading. New York: John Wiley & Sons Dunnan, N. (2006). Dun and Bradstreet Guide to Your Investments. New York: Harper & Row Fabozzi, F.J., Modigliani, F. & Ferri, M.G. (1998). Foundations of financial markets and institutions (2nd edn). Upper Saddle River, NJ: Prentice-Hall, Kaufman, G.G. (1995) The US financial systems: Money, markets and institutions, (6th edn). Englewood Cliffs, NJ: Prentice Hall, Leavitt, A. (2003). Take on the street. New York: Random House Little J.B. & Rhodes, L. (1991) Understanding Wall Street. (3rd. ed.). New York: McGraw Hill Morris, R.M. & Siegel, A.M. (1993). The Wall Street Journal Guide to understanding money and investing. New York: Lightbulb Press. Read More