American Stock Exchange

American Stock Exchange (AMEX), market for trading stocks, bonds, and other financial instruments, based in New York City. AMEX is one of the largest markets for financial trading in the United States. In 2001 about 700 companies were listed on the exchange and the market value of their stocks totaled about $100 billion. AMEX is the third largest stock exchange in the United States, behind the New York Stock Exchange and The Nasdaq Stock Market.

Trading on AMEX is initiated by stock brokers acting on behalf of their clients. These brokers place orders with members of the exchange called specialists, who concentrate on trading specific stocks. The broker and the specialist negotiate to arrive at a price for the stock.

In addition to trading stocks and bonds, AMEX pioneered trading in derivatives, a type of investment based on the performance of an underlying asset or financial index. For example, AMEX trades Standard & Poor’s Depository Receipts (SPDRs), which are derivatives tied to the Standard & Poor’s 500 Index. This index records the ups and downs of the stock market in the United States by measuring the performance of 500 selected stocks. The SPDRs are traded like stocks, but their price fluctuates according to the value of the Standard & Poor’s 500 Index.

Nasdaq Stock Market

The Nasdaq Stock Market (Nasdaq), one of the largest markets in the world for the trading of stocks. In 2001 more than 4,800 companies were listed on Nasdaq—more than on any of the other stock exchanges in the United States, including the New York Stock Exchange (NYSE) and the American Stock Exchange (AMEX). The majority of companies listed on Nasdaq are smaller or less established than most of those on the NYSE and AMEX. Nasdaq has become known as the home of new technology companies, particularly computer and computer-related businesses.

Trading on Nasdaq is initiated by stockbrokers acting on behalf of their clients. These brokers place orders with certain Nasdaq brokers, called market makers, who concentrate on trading specific stocks. The broker and the market maker negotiate to reach a price for the stock.New York Stock Exchange (NYSE), one of the largest markets in the world for trading stocks and bonds, based in New York City. In 2001 the NYSE listed—that is, traded—the stocks of about 3,000 companies, valued at about $17 trillion. Non-U.S. stocks play an increasingly important role on the NYSE. More than 400 non-U.S. companies were listed on the NYSE in 2001, more than triple the number five years ago. Trading at the NYSE is initiated by stockbrokers acting on behalf of their clients. These brokers place orders with certain members of the exchange called specialists, who concentrate on trading specific stocks. The broker and the specialist negotiate to arrive at a price for the stock. See also Stock Exchange.

The NYSE began in 1792, when a group of stock and bond brokers gathered in a park in downtown New York City and agreed to meet daily at that location to trade financial instruments, such as stocks and bonds. By 1794 the exchange had moved indoors to the Tontine Coffee House, on the corner of Wall and Water Streets. In 1817 the exchange moved closer to its present Wall Street location, drew up a formal constitution, and named itself the New York Stock and Exchange Board. As New York City became the financial center of the United States during the 19th century, the New York Stock and Exchange Board became one of the most important financial trading centers. By 1863, when it changed its name to the New York Stock Exchange, the exchange was trading the stocks and bonds of the major industrial and railroad corporations of the day. Today, the NYSE is often referred to as the big board because it lists more major corporations than any other exchange in the United States.



Unlike other stock exchanges, Nasdaq has no central location where trading takes place. Instead, its market makers are located all over the country and make trades by telephone and via the Internet. Because brokers and market makers trade stocks directly instead of on the floor of a stock exchange, Nasdaq is called an over-the-counter market. The term over-the-counter refers to the direct nature of the trading, as in a store where goods are handed over a counter.

The National Association of Securities Dealers started the National Association of Securities Dealers Automated Quotation (NASDAQ) system in 1971 to organize the over-the-counter market. Until then the over-the-counter market had few regulations, and traders often took unfair advantage of individual investors. In 1990 the Association formally changed the NASDAQ’s name to The Nasdaq Stock Market. In 1998 the National Association of Securities Dealers, the organization that manages the Nasdaq, merged operations with the American Stock Exchange to form the Nasdaq-AMEX Market Group. The new management organization maintains Nasdaq and AMEX as separate stock exchanges.

THE IMPORTANCE OF STOCK EXCHANGES

Stock exchanges perform important roles in national economies. Most importantly, they encourage investment by providing places for buyers and sellers to trade securities. This investment, in turn, enables corporations to obtain funds to expand their businesses.

Corporations issue new securities in what is known as the primary market, usually with the help of investment bankers . The investment bank acquires the initial issue of the new securities from the corporation at a negotiated price and then makes the securities available for its clients and other investors in an initial public offering (IPO). In this primary market, corporations receive the proceeds of security sales. After this initial offering the securities are bought and sold in the secondary market. The corporation is not usually involved in the trading of its stock in the secondary market. Stock exchanges essentially function as secondary markets. By providing investors the opportunity to trade financial instruments, the stock exchanges support the performance of the primary markets. This arrangement makes it easier for corporations to raise the funds that they need to build and expand their businesses.

Although corporations do not directly benefit from secondary market transactions, the managers of a corporation closely monitor the price of the corporation’s stock in secondary markets. One reason for this concern involves the cost of raising new funds for further business expansion. The price of a company’s stock in the secondary market influences the amount of funds that can be raised by issuing additional stock in the primary market.

Corporate managers also pay attention to the price of the company’s stock in secondary markets because it affects the financial wealth of the corporation’s owners—the stockholders. If the price of the stock rises, then the stockholders become wealthier. This is likely to make them happy with the company’s management. Typically, managers own only small amounts of a corporation’s outstanding shares. If the price of the stock declines, the shareholders become less wealthy and are likely to be unhappy with management. If enough shareholders become unhappy, they may move to replace the corporation’s managers. Most corporate managers also receive options to buy company stock at a selected price, so they are motivated to increase the value of the stock in the secondary market.

Stock exchanges encourage investment by providing this secondary market. Stock exchanges also encourage investment in other ways. They protect investors by upholding rules and regulations that ensure buyers will be treated fairly and receive exactly what they pay for. Exchanges also support state-of-the-art technology and the business of brokering. This support helps traders buy and sell securities quickly and efficiently. Of course, being able to sell a security in the secondary market increases the relative safety of investing because investors can unload a stock that may be on the decline or that faces an uncertain future.

STOCK TRADING

Stocks are shares of ownership in companies. People who buy a company’s stock may receive dividends (a portion of any profits). Stockholders are entitled to any capital gains that arise through their trading activity—that is, to any gain obtained when the price at which the stock is sold is greater than the purchase price. But stockholders also face risks. One risk is that the firm may experience losses and not be able to continue the payment of dividends. Another risk involves capital losses when the stockholder sells shares at a price below the purchase price.

A company can list its stock on only one major stock exchange. However, options on its stock may be traded on another exchange. Where a stock is traded depends on both the requirements of the exchange and the decision of the corporation. Each exchange establishes requirements that a company must meet to have its stock listed. For example, to be listed on the New York Stock Exchange, a company, among other things, must have a minimum of 1.1 million shares outstanding with a market value of at least $100 million. But not all companies that satisfy NYSE requirements apply to have their stock traded on this exchange. Intel and Dell Computer, two very large and well-known corporations, satisfy NYSE requirements but choose instead to have their shares traded on the over-the-counter Nasdaq.
The different exchanges tend to attract different kinds of companies. Smaller exchanges, such as the Nasdaq, typically trade the stock of small, emerging businesses, such as high-tech companies. In the United States, the AMEX lists small to medium-sized businesses, including many oil and gas companies. The NYSE primarily lists large, established companies.

Most security trading is accomplished through brokerage firms. Persons and organizations that wish to purchase securities will call upon the brokerage firm to execute their transaction. To actually conduct the transaction on the stock exchange, the brokerage firm must have a membership, called a seat, on the exchange. Stock exchanges limit the number of available seats, and the cost of a seat on an exchange is high. During 2002 the price of a seat on the NYSE ranged from $2 million to $2.6 million. Brokerage firms that have seats not only can complete trades on the floor of the exchange but also have the right to vote on exchange policy.

Brokerage firms are willing to pay high prices for exchange seats because of the profit opportunities available from membership in an exchange. Profits can be generated from the fees charged for the execution of trades as well as from trading on the firm’s own account. There are, however, risks associated with brokerage firm activity. For example, brokerage firms can lose money if their clients default on margin loans (loans obtained to purchase securities).

A. Example of a Trade

In an example of a trade, an investor wanting to buy 200 shares—also known as two round lots, of 100 shares each—of IBM stock will telephone or e-mail the order to a brokerage firm. This communication is normally made to an individual called a stockbroker. The investor might desire to buy the shares at the market, or current, price. On the other hand, the investor may choose to pay no more than a set amount per share. The brokerage firm then contacts one of its floor brokers at the NYSE, the exchange on which IBM stock is traded. The floor broker then goes to IBM’s stock post—that is, the particular spot on the trading floor where IBM stock is traded. Here other floor brokers will be buying and selling the same stock. The activity around the post constitutes an auction market with transactions typically communicated through hand signals. The most important person at the post is a broker-dealer called a specialist. The job of the specialist is to manage the auction process. The specialist will actually execute the trade and inform the floor broker of the final price at which the trade has been executed. For this service, the investor will pay the original broker a commission, either as a flat fee or as a percentage of the purchase price.

The price of a stock depends on the market forces of supply and demand. With companies issuing only a limited number of shares, price is determined by demand. An increase in demand will raise the price whereas a decrease in demand will lower the price. Normally the demand for a particular stock depends on expectations regarding the profits of the corporation that issued the stock. The more optimistic these expectations are, the greater the demand will be and, therefore, the greater the price of the stock.


 

STOCKBROKERS

A stockbroker is an employee of a brokerage firm. The individual investor contacts his or her stockbroker and provides the stockbroker with the details of the transaction the investor wants to complete. Stockbrokers, however, are more than order takers or sales representatives for their firms; they frequently provide advice to the investor. They may have their own client list and call clients when they see transactions that will fit the client’s investment objectives. Stockbrokers almost always have certification from, or registration with, a state government agency or an exchange or both. For this reason they are sometimes referred to as registered representatives.

A. Institutional Brokers

Institutional brokers specialize in bulk purchases of securities, including bonds, for institutional investors. Institutional investors include large investors such as banks, pension funds, and mutual funds.

Institutional brokers generally charge their clients a lower fee per unit than brokers who trade for individual investors. This is the case because the total cost of both large and small transactions is much the same. When this total cost is spread over a larger number of shares, then the cost per share is lower. Given the lower per-share cost, institutional brokers can charge a lower per-share fee.

TRADING IN OTHER SECURITIES

Exchanges trade in all forms of securities. Although the general operations of exchanges apply to all securities trading, there are some differences. In particular, trades in nonstock securities, such as bonds and options, are often managed by financial intermediaries other than brokers.

A. Bonds

Bonds provide a way for companies to borrow money. Companies obtain funds when they initially issue bonds. As with the initial issue of stocks, companies use the services of investment banks in primary market transactions for bonds. Once issued the bonds are then traded in secondary markets or on exchanges and the company is no longer directly involved.

B. Options

Options are traded on many U.S. stock exchanges, as well as over the counter. Options writers offer investors the rights to buy or sell, at fixed prices and over fixed time periods, specified numbers of shares or amounts of financial or real assets. Writers give call options to people who want options to buy. A call option is the right to buy shares or amounts at a fixed price, within a fixed time span. Conversely, writers give put options to people who want options to sell. A put option is the right to sell shares or amounts at a fixed price, within a fixed time span. Buyers may or may not opt to buy, or sellers to sell, and they may profit or lose on their transactions, depending on how the market moves. In any case, options traders must pay premiums to writers for making contracts. Traders must also pay commissions to brokers for buying and selling stocks on exchanges. Options trading is also handled by options clearing corporations, or clearinghouses, which are owned by exchanges.

C. Futures

Futures contracts are also traded on certain U.S. exchanges, most of which deal in commodities such as foods or textiles. Futures trading works somewhat like options trading, but buyers and sellers instead agree to sales or purchases at fixed prices on fixed dates. After a futures contract is made, the choice to buy or sell is not optional. Instead, there is an obligation to buy or sell. Futures contracts are then traded on the exchanges. Commodities brokers handle this trading.

Futures and options traders often judge market trends by monitoring compiled indexes and averages of stocks, usually organized by industry or market ranking. Among the most closely watched U.S. indexes are the Dow Jones averages and Standard & Poor’s.

International Exchanges

Exchanges started in Western Europe and then spread to other parts of the world. Some of the older exchanges, dating back as far as the 1100s, are the Paris Bourse in France; the Amsterdam Bourse in The Netherlands; the Deutsche Stock Exchange (formerly the Börse) in Frankfurt, Germany; the London Stock Exchange (LSE) in England; and the Borsa in Milan, Italy. Other European exchanges opened in the 1600s and 1700s, including those in Belgium, Spain, Portugal, and Sweden. Because stocks were uncommon before the 1800s, all of these early exchanges traded in commodities and currencies. In 1785 Amsterdam’s Bourse was the first to formally begin trading in securities. By the mid-1800s, many countries outside of Europe traded in securities, including Canada and Australia. During the 19th and 20th centuries, major exchanges opened in Asia, Eastern Europe, and parts of Africa and Latin America.

Most of the world’s major exchanges have become highly efficient, computerized organizations. Each has a charter for regulating operations and some are integrated within regional economic unions. For instance, the EU was instrumental in organizing the EASDAQ and drafted its charter. In addition, exchanges now trade securities from companies around the world. Computerization has enabled brokers to instantaneously monitor activities on foreign exchanges. Many exchanges also list indexes and averages—such as the Nikkei 225 Stock Average of the Tokyo Stock Exchange (TSE) and the Financial Times Stock Exchange 100 of the LSE—that are closely followed by options and futures investors.