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Securities Markets
Source: Encyclopedia of Banking & Finance (9h Edition) by Charles J Woelfel
(We recommend this as work of authority.)

Security transactions take place in either the primary market or the secondary market.  In the primary market, the purchaser gives the original issuer of the security cash in exchange for the security.  In a primary market, the original security issuer receives cash; the public now holds a security that did not previously exist.  Weekly T-bill offerings by the U.S. Treasury and municipal bond sales by a city occur in the primary market.  Following the primary offering of a security, the security is said to trade in the secondary markets between members of the public.  The NEW YORK STOCK EXCHANGE, the AMERICAN STOCK EXCHANGE, and the OVER-THE-COUNTER market are considered secondary markets.

Investment bankers specialize in the creation and placement of securities in the primary market.  These organizations provide advice, underwriting, and distribution services to their clients.  The advice provided by investment bankers usually relates to the type of security offering (debt or equity), the timing of the offering, the legal characteristics of the issue, and the price at which the security can be sold.

Underwriting refers to the investment bankers' practice of absorbing the price risks the issuer is unwilling to accept.  Underwriting takes various forms:

1.   Firm commitment:  The underwriter commits to purchase the full amount of the issue from the seller at an agreed-upon price.  The banker then re-offers the security to the public.  The underwriter's spread represents compensation to the underwriter.  The investment banker frequently forms a purchase group consisting of other investment bankers who participate in the purchase of the securities.  The lead underwriter is primarily responsible for negotiating the agreement with the issuer and maintaining the record.

2.   Standby agreement:  The underwriter agrees to help sell the new issue for a given period of time.  After this period passes (often 30 days), the underwriter is required to purchase any unsold securities at a predetermined price.  Standby agreements are frequently used in stock sales that utilize a rights offering.

3.   Best-effort basis:  The banker acts as a broker and returns unsold securities to the issuer.  The banker assumes no risk for unsold securities.  Best-effort underwriting is often used when the issuer is confident the issue can be sold or when the issuer is relatively small and un-established.

Securities are distributed by various methods.  Some issuers market their issues directly to the public (for example, the U.S. government).  Common stock offerings using rights can often be marketed directly by the issuer.  Syndicates consisting of investment bankers are often formed to assist in the distribution of securities.  Members of the purchase syndicate frequently develop a selling group that actively distributes the securities to their clients.  The selling group usually consists of members of the purchase group and various retail brokerage houses.  A selling group agreement establishes the term of the agreement; the division of the underwriter spread among the manager, the purchase group, and the selling group; and the accounting procedures.  The agreement requires that no member will sell beneath the offering price.  During the early days of the offering to the public, the managing underwriter may stabilize the market by purchasing the security at a fixed price - a form of legal price manipulation.

Private placements refer to the distribution of securities to fewer than 25 private buyers.  Private placements do not require registration with the SEC.  Bond issues are frequently distributed through private placements.

The established stock exchanges and the over-the-counter market represent the secondary markets.  On the New York Stock Exchange, members are classified as:

1.   Commission brokers:  partners in a brokerage firm who execute orders for their clients on the floor of the exchange.

2.   Floor brokers:  commission brokers who handle overflow transactions with the commission brokers.

3.   Floor traders:  members who buy and sell solely for their own account.

4.   Specialists:  members who are assigned a number of stocks in which they act as brokers by maintaining a limit book and as dealers by selling and buying shares in which they specialize.  Specialists provide a continuous and liquid market in securities.

Stock and bond transactions that are not handled on one of the organized exchanges are traded in the over-the-counter (OTC) market.  This market is not centrally located but consists of a network of brokers and dealers who communicate by telephone or computer terminals.  Mutual fund shares, many bank and finance stock, most corporate bonds, and U.S. government and municipal obligations are traded in the OTC market.

A third market in securities refers to OTC transactions in a security that is also traded on an organized exchange.  Institutional investors often trade large blocks of stock in this market.  Negotiated fees are typical in this market.

A fourth market in securities refers to transactions that occur directly between a buyer and a seller of a large block of securities.  In the fourth market, brokers and dealers are eliminated.  A wire network provides current information subscribers are willing to buy or sell at specified prices.

Securities commissions have been negotiated rates since May 1, 1975 .  However, brokerage firms establish firm-wide rates for various types of transactions and classes of customers.  Discount brokerage firms offer low commissions but provide little, if any, investment counselling and advice.  

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