Capital Market | Types of Capital Market

Capital Market

The hallmark of the capitalized system is called the capital market. It is a market where the trading of securities, like bonds and stocks are held freely. The basic aim of the capital market is the use of idle funds into productive activities. Following are the main 4 types of capital market.

Types

Mainly capital market is split into two categories i.e. Primary and Secondary. Furthermore, the types of capital market are discussed below:

• Exchanges
• The NASDAQ Stock Market
• The Over-the-Counter Market
• Third & Fourth Markets

The Exchanges

Exchanges are the old version of the stock market and the oldest stock exchange is the Amsterdam bourse where East Indies Trading Company’s shares were traded. At Osaka Rice Exchange future contracts were traded in 1954. The US exchanges are highly effective on the basis of its quality of trading, oversight of trading mechanisms and members of securities traded.

National Exchanges

In the past, there were two national exchanges in the United States which are New York Stock Exchange and The American Stock Exchange. NYSE was located on Wall Street while the other was located on trinity place. The AMEX was merged with the NASDAQ stock market in early 1999. The NYSE was created in 1972 when 24 merchants started gathering for exchanging shares of stocks daily under buttonwood trees. The bank of New York is recognized as the first corporate stock traded on the exchange.

The official opening of NYSE happened in 1817 in tontine’s coffee house having membership cost of $25. Only 70 stocks were listed in 1825. Trading is also carried on in the area of curb exchange near buttonwood trees. That curb exchange was later converted into AMEX in the 1950s.

The trade on the exchange floor is made only by the exchange members. Membership is generally referred to as seat. Most people are not members and they hire the members of exchange to carry out the trade in the shape of buying of securities. Such a representative person is called a broker who receives commission for his efforts. In recent years, stocks of approximately $40 billion are traded on NYSE on an average daily basis.

Regional Exchanges

The regional exchange of Philadelphia Stock Exchange was established two years before the NYSE. Philly along with 13 other smaller exchanges are called regional exchanges by the investors. There are many securities that are listed on national exchanges as well as one or more regional exchanges. For example Coca Cola is traded on New York, Cincinnati, Chicago, Boston, Pacific and Philly stock exchanges. It is also traded on the Germany, Zurich, Switzerland and Frankfurt exchanges. Throughout more than 50 countries there are approximately 150 stock exchanges worldwide. London Stock Exchange is the oldest continuous stock exchange which is continuously running since 1773.

Trading Systems

Securities are purchased and sold by people through different mechanisms either through a matchmaker system, specialist system or electronically.

The Specialist System

The distinctive feature of the NYSE and AMEX is the specialist system. The member of exchange known as specialist oversees the trade in particular security. The specialist ensures the orderly & fair market in one or more kinds of securities. There are about 460 specialists and most of them deal with 5 to 10 specified stocks. If a specialist does not perform properly then he is charged with certain fines.

SuperDot

The NYSE member firms use the SuperDot electronic trading system in which certain orders are sent directly to the specialist’s posts on the floor of exchange without employing the human runner for delivery of order. The trade is confirmed back to the member firms by specialists by using the SuperDot system. More than 75% of the trading volume on certain days on the NYSE stock exchange occurs through the SuperDot system.        

Marketmakers

In the market maker system, a fair & orderly market is maintained by a group of competing individuals. It is used by the futures exchanges and Chicago Board Exchange.

Circuit Breakers and Trading Curbs

In order to reduce temporary volatility in the market, both trading curbs & circuit breakers are used. Both of these are slightly different from one another. When the Dow Jones Industrial Average moves down or up more than 2% at NYSE, computerized trading through SuperDot system is prohibited through application of circuit breakers. In 1998 this happened 366 times on 277 different trading days. Even though the circuit breaker has activated, the non-computerized trading still continues.

All the trading is halted through the application of trading curbs, including the non-computerized trading. If DWJI falls 10%, the trading is prevented for an hour or 30 minutes if the fall was between 2:00pm & 2:30 pm. Trading is not halted after 2:30pm. If 20% fall occurs then trading is stopped for two hours if fall occurs before 1:00pm; if between 1:00pm & 2:00pm then stopped for an hour; and after 2:00pm the halt is for the rest of the day.

NASDAQ Stock Market

The second type of the capital market is the NASDAQ stock market and is sometimes called over-the-counter market. There different types of companies range from small unfamiliar firms to some of the largest companies of the world whose securities are traded on NASDAQ stock exchange.

The NASDAQ National 

The over-the-counter market does not have any actual physical place. In fact different brokerage firms, Investment houses and larger commercial banks are connected with worldwide computer networks. The headquarters of the computer system is in Trumbull, Connecticut and its backup is present in Rockville. There is an electronic Bulletin Board on which the bids and offers of individual securities are posted. The prices of these securities are mentioned in a financial press under a heading that contains the term NASDAQ which is an abbreviation of National Association of Securities Dealer’s Automated Quotation. On February 5, 1971, the NASDAQ price quotation first appeared.

The trading on NYSE outnumbered trading on NASDAQ two to one in 1980. However in the current year the numbers of trading shares are almost equal in both these systems. There are certain larger companies that are traded on the NASDAQ exchange like Oracle, Microsoft, Microsystems, Intel and MCI communication. Besides these larger companies there are also a number of smaller firms listed on the NASDAQ stock exchange.

Through the Small Order Execution System, trades of up to 100 shares can be executed in less than one minute. An order for buying or selling of 1000 shares of actively traded NASDAQ stock can be placed by an investor and he is assured that his order will be executed with the best prevailing price in the market. The rule of 100 shares is no longer absolute in recent days. When a bid of 400 shares is posted by a market maker then he is obliged to bid for extra 600 shares. However getting 1000 shares of liquid actively traded stock at a single price is the general norm.

Tiers of NASDAQ 

National Market issues are considered as the largest and most established firms in the NASDAQ market. Intel and Microsoft are the firms that contain 4000 securities. Generally there is readily availability of information about national market issues. There are other small-cap issues that contain other NASDAQ securities which have low levels of capitalization. The information about these 1250 securities is relatively difficult to obtain quickly.

The Over The Counter Market

In certain cases NASDAQ and OTC are viewed as synonymous terms. But it is accurate only at a particular time. In recent days, the OTC equity security is considered equity security which is not traded or listed on the NASDAQ or national stock exchanges. There are listing standards, substantial market maker obligations, automated trade executions and formal corporate relationships with the specified firms on the NASDAQ. For over-the-counter securities, this is not true. The trading in this capital market is made in two different ways either through OTC Bulletin Board or through Pink Sheets.

Over-the-Counter Bulletin Board (OTCBB)

The real-time information on OTC equity securities is provided by a regulated quotation service provider named OTC Bulletin Board. The penny stock act of 1990 provides the basis for establishment of OTCBB by forcing the SEC to develop a system that assists the widespread distribution of price quotation of OTC equities. The firms are required to report trade in these securities within 90 seconds of the transaction since December 1993.

There are about 400 firms and 5500 OTCBB securities markets. One important point to understand is that the price information is provided through the means of OTCBB and the listing service is not offered by it. The market makers on OTCBB determine how much to buy or sell of certain security so there is no guarantee that the new shares of the company are sold at an initial price.

Pink Sheet Stocks

Pink Sheet Issues are the smallest and often most speculative OTC stocks. NOB has been providing information on these securities since 1913. The origin of NOB is largely made by Roger Babson who is the founder of Babson College. The name of pink sheets emerged from the fact that in the old days the information about the prices was highlighted on the pink paper that was hung in broker’s offices on clipboards.  

The information about bid price, offer price, dealer name & telephone no was only provided. In recent years the real-time information about the pink sheet can be accessed through the internet.

There are certain pink sheet stocks that have no assets virtually. There may be only a rented office as corporate headquarters having only telephone, mailbox and desk. The others contain real revenue and assets but are held closely with no consideration in exchange listing.

Third and Fourth Markets

In the NASDAQ market, listed securities can be traded. For example, on the New York Stock Exchange, General Electric is traded. 1000 shares of GE can be offered for sale by a brokerage firm through the NASDAQ system. A for-sale advertisement is posted on the Inter market Trading System (ITS) by them. GE is considered as a widely traded stock with extremely good odds that someone that makes a bid on it can be made by someone. The third market is referred to as the trading of listed securities on the NASDAQ market. The greater trading flexibility, especially in trading fee and rules, is offered by the third market than the exchanges.

In certain cases the large companies bypass the NASDAQ and exchanges at trade and make direct trade with each other. Such direct trade between large institutions is referred to as the fourth market. The reduced trading fees is the motivation for fourth market trading. These trading can be done either through telephone or face to face or through an institutional network called Instinet. Commission of about 25% of the full service brokerage rate is paid by the users of Instinet. These users also receive a proprietary fee. The Instinet offers access to only financial institutions and brokers. Instinet maintained price data on many thousand popular stocks on 16 various stock exchanges. Best price is searched by the system for a particular trade electronically.