ventually need to offer 24-hour global markets and platforms that allow trading of differ-ent security types, for example, both stocks and derivatives. Finally, companies want to be able to go beyond national borders when they wish to raise capital. These pressures have resulted in a broad trend toward market consolidation. In the last decade, most of the mergers were “local,” that is, involving exchanges operating on the same continent. In the U.S., the NYSE merged with the Archipelago ECN in 2006, and in 2008 acquired the American Stock Exchange. NASDAQ acquired Instinet (which operated another major ECN, INET) in 2005 and the Boston Stock Exchange in 2007. In the derivatives market, the Chicago Mercantile Exchange acquired the Chicago Board of Trade in 2007 and the New York Mercantile Exchange in 2008, thus moving almost all futures trading in the U.S. onto one exchange. In Europe, Euronext was formed by the merger of the Paris, Brussels, Lisbon, and Amsterdam exchanges and shortly thereafter purchased Liffe, the derivatives exchange based in London. The LSE merged in 2007 with Borsa Italiana, which operates the Milan exchange. There has also been a wave of intercontinental consolidation. The NYSE Group and Euronext merged in 2007. Germany’s Deutsche Börse and the NYSE Euronext agreed to merge in late 2011. The merged firm would be able to support trading in virtually every type of investment. However, in early 2012, the proposed merger ran aground when European Union antitrust regulators recommended that the combination be blocked. Still, the attempt at the merger indicates the thrust of market pressures, and other combinations 8,00012,00010,000$ Billions6,0004,0002,000NYSE-Euronext (US)NASDAQ-OMXLondonTokyoEuronext (Europe)ShanghaiHong KongBrazilTorontoAustraliaDeutsche BörseBME (Spanish)India0Figure 3.8 The biggest stock markets in the world by domestic market capitalization in 2012Source: World Federation of Exchanges, 2012. 76 PART IIntroductioncontinue to develop. The NYSE and the Tokyo stock exchange have announced their intention to link their networks to give customers of each access to both markets. In 2007, the NASDAQ Stock Market merged with OMX, which operates seven Nordic and Baltic stock exchanges, to form NASDAQ OMX Group. In 2008, Eurex took over International Securities Exchange (ISE), to form a major options exchange. 3.7 Trading Costs Part of the cost of trading a security is obvious and explicit. Your broker must be paid a commission. Individuals may choose from two kinds of brokers: full-service or discount brokers. Full-service brokers who provide a variety of services often are referred to as account executives or financial consultants. Besides carrying out the basic services of executing orders, holding securities for safe-keeping, extending margin loans, and facilitating short sales, brokers routinely provide information and advice relating to investment alternatives. Full-service brokers usually depend on a research staff that prepares analyses and forecasts of general economic as well as industry and company conditions and often makes specific buy or sell recommendations. Some customers take the ultimate leap of faith and allow a full-service broker to make buy and sell decisions for them by establishing a discretionary account.In this account, the broker can buy and sell prespecified securi-ties whenever deemed fit. (The broker cannot withdraw any funds, though.) This action requires an unusual degree of trust on the part of the customer, for an unscrupulous broker can “churn” an account, that is, trade securities excessively with the sole purpose of gen-erating commissions. Discount brokers, on the other hand, provide “no-frills” services. They buy and sell securities, hold them for safekeeping, offer margin loans, facilitate short sales, and that is all. The only information they provide about the securities they handle is price quota-tions. Discount brokerage services have become increasingly available in recent years. Many banks, thrift institutions, and mutual fund management companies now offer such services to the investing public as part of a general trend toward the creation of one-stop “financial supermarkets.” Stock trading fees have fallen steadily over the last decade, and discount brokerage firms such as Schwab, E*Trade, or TD Ameritrade now offer commis-sions below $10. In addition to the explicit part of trading costs—the broker’s commission—there is an implicit part—the dealer’s bid–ask spread. Sometimes the broker is also a dealer in the security being traded and charges no commission but instead collects the fee entirely in the form of the bid–ask spread. Another implicit cost of trading that some observers would distinguish is the price concession an investor may be forced to make for trading in quanti-ties greater than those associated with the posted bid or ask price. 3.8 Buying on Margin When purchasing securities, investors have easy access to a source of debt financing called broker’s call loans.The act of taking advantage of broker’s call loans is called buying on margin.Purchasing stocks on margin means the investor borrows part of the purchase price of the stock from a broker. The marginin the account is the portion of the purchase price CHAPTER 3How Securities Are Traded 77The percentage margin is defined as the ratio of the net worth, or the “equity value,” of the account to the market value of the securities. To demonstrate, suppose an investor initially pays $6,000 toward the purchase of $10,000 worth of stock (100 shares at $100 per share), borrowing the remaining $4,000 from a broker. The initial balance sheet looks like this: Assets Liabilities and Owners’ EquityValue of stock $10,000 Loan from broker $4,000Equity $6,000The initial percentage margin is Margin5Equity in accountValue of stock5$6,000$10,0005.60, or 60%If the price declines to $70 per share, the account balance becomes: Assets Liabilities and Owners’ EquityValue of stock $7,000 Loan from broker $4,000Equity $3,000The assets in the account fall by the full decrease in the stock value, as does the equity. The percentage margin is nowMargin5Equity in accountValue of stock5$3,000$7,0005.43, or 43%Example 3.1 Margin contributed by the investor; the remainder is borrowed from the broker. The brokers in turn borrow money from banks at the call money rate to finance these purchases; they then charge their clients that rate (defined in Chapter 2), plus a service charge for the loan. All securities purchased on margin must be maintained with the brokerage firm in street name, for the securities are collateral for the loan. The Board of Governors of the Federal Reserve System limits the extent to which stock purchases can be financed using margin loans. The current initial margin requirement is 50%, meaning that at least 50% of the purchase price must be paid for in cash, with the
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