The Secondary Market
The secondary market is where previously issued securities trade between investors. Understanding the Securities Exchange Act of 1934 and the structure of various markets is crucial for Series 7 representatives.
Securities Exchange Act of 1934
The Securities Exchange Act of 1934 governs the secondary market—trading of outstanding securities. Often called the "People Act," it regulates market participants and trading practices.
Key Provisions
| Provision | Description |
|---|---|
| Created SEC | Established the Securities and Exchange Commission |
| Broker-Dealer Registration | Requires registration of broker-dealers |
| Exchange Registration | Requires registration of national securities exchanges |
| Anti-Fraud | Section 10b-5 prohibits fraud in securities trading |
| Insider Trading | Prohibits trading on material non-public information |
| Proxy Rules | Regulates shareholder voting and proxies |
| Margin Requirements | Gave Federal Reserve authority over margin |
1933 Act vs. 1934 Act
| Feature | Securities Act of 1933 | Securities Exchange Act of 1934 |
|---|---|---|
| Market | Primary (new issues) | Secondary (trading) |
| Focus | Issuers, offerings | Broker-dealers, markets |
| Key Document | Prospectus | Form 10-K, 10-Q, 8-K |
| Nickname | Paper Act | People Act |
Exchange Markets
New York Stock Exchange (NYSE)
The NYSE is the world's largest stock exchange by market capitalization. It operates as an auction market where buyers and sellers come together in a centralized location.
| Feature | Description |
|---|---|
| Market Type | Auction market |
| Location | Physical trading floor + electronic |
| Key Player | Designated Market Maker (DMM) |
| Trading System | Universal Trading Platform |
Designated Market Maker (DMM)
The DMM (formerly called "Specialist") is central to NYSE trading:
DMM Responsibilities:
- Maintain fair and orderly markets for assigned securities
- Provide liquidity when no other buyers/sellers available
- Execute orders from the order book
- Facilitate price discovery at market open/close
DMM Rules:
- One DMM per listed stock
- Must buy when no buyers (add liquidity)
- Must sell when no sellers (add liquidity)
- Acts as both agent (handling orders) and principal (trading for own account)
NASDAQ
NASDAQ (National Association of Securities Dealers Automated Quotations) is a negotiated market with multiple competing market makers.
| Feature | Description |
|---|---|
| Market Type | Negotiated/dealer market |
| Location | Electronic only (no physical floor) |
| Key Players | Multiple competing market makers |
| Trading System | NASDAQ Market Center |
NASDAQ vs. NYSE Comparison
| Feature | NYSE | NASDAQ |
|---|---|---|
| Market Structure | Auction | Negotiated |
| Market Makers | One DMM per stock | Multiple per stock |
| Physical Location | Yes | No |
| Competition | Orders compete | Dealers compete |
OTC Markets
Securities not listed on major exchanges trade in the over-the-counter (OTC) market.
OTC Market Tiers
| Tier | Description | Requirements |
|---|---|---|
| OTCQX | Best marketplace; established companies | Financial standards, disclosure |
| OTCQB | Venture market; early-stage companies | SEC reporting, minimum price |
| Pink Sheets | Speculative securities | Minimal requirements |
| Grey Market | No quotes available | Broker-priced only |
Market Makers in OTC
In OTC markets, market makers provide liquidity:
- Post bid and ask prices for securities
- Required to honor quotes up to their stated size
- Multiple market makers may compete for the same security
- Must stand ready to buy or sell at quoted prices
The Four Markets
| Market | Description |
|---|---|
| First Market | Listed securities on exchanges (NYSE) |
| Second Market | OTC market (NASDAQ, Pink Sheets) |
| Third Market | Listed securities trading OTC |
| Fourth Market | Institution-to-institution (no intermediary) |
Electronic Communication Networks (ECNs)
ECNs are electronic systems that match buy and sell orders:
- Provide after-hours trading capability
- Often offer lower costs than exchanges
- Display anonymous quotes
- Examples: Instinet, ARCA
Dark Pools
Dark pools are private exchanges where large institutional orders can be executed without displaying quotes publicly:
- Reduce market impact of large trades
- Less price transparency
- Used primarily by institutional investors
- Subject to SEC regulation
Bid, Ask, and Spread
Quote Terminology
| Term | Definition |
|---|---|
| Bid | Price dealers will pay to BUY (investors sell at bid) |
| Ask (Offer) | Price dealers will SELL at (investors buy at ask) |
| Spread | Difference between bid and ask |
| Inside Quote | Best bid and best ask (NBBO) |
Memory Aid: Investors buy at the ask, sell at the bid. Dealers do the opposite.
National Best Bid and Offer (NBBO)
The NBBO is the best available bid and ask price aggregated from all exchanges:
- Required for best execution
- Published by the Securities Information Processor (SIP)
- Broker-dealers must consider NBBO when executing orders
On the Exam
The Series 7 exam frequently tests:
- Differences between NYSE (auction) and NASDAQ (negotiated)
- DMM/Specialist functions and responsibilities
- Understanding bid, ask, and spread
- The four markets (first through fourth)
- OTC market structure and tiers
The New York Stock Exchange is classified as what type of market?
A stock is quoted at 45.50 - 45.75. An investor wanting to purchase 100 shares would pay:
Which entity maintains fair and orderly markets for assigned securities on the NYSE?
Trading of NYSE-listed securities in the over-the-counter market is known as:
11.3 Order Types and Execution
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