Secondary Markets
Financial institutions play a key role in matching primary market players who need
money with those who have extra funds, but the vast majority of trading actually
occurs in the secondary markets.Although there are many secondary markets for a
wide variety of securities, we can classify their trading procedures along two dimen-
sions. First, the secondary market can be either a physical location exchangeor a
computer/telephone network.For example, the New York Stock Exchange, the
American Stock Exchange (AMEX), the Chicago Board of Trade (the CBOT trades
futures and options), and the Tokyo Stock Exchange are all physical location ex-
changes. In other words, the traders actually meet and trade in a specific part of a spe-
cific building. In contrast, Nasdaq, which trades U.S. stocks, is a network of linked
computers. Other examples are the markets for U.S. Treasury bonds and foreign ex-
change, which are conducted via telephone and/or computer networks. In these elec-
tronic markets, the traders never see one another.
The second dimension is the way orders from sellers and buyers are matched. This
can occur through an open outcry auctionsystem, through dealers, or by automated
order matching. An example of an outcry auction is the CBOT, where traders actually
meet in a pit and sellers and buyers communicate with one another through shouts
and hand signals.
In a dealer market, there are “market makers” who keep an inventory of the stock
(or other financial instrument) in much the same way that any merchant keeps an in-
ventory. These dealers list bid and ask quotes, which are the prices at which they are
22 CHAPTER 1 An Overview of Corporate Finance and the Financial Environment
Online Trading Systems
The forces that led to online trading have also promoted on-
line trading systems that bypass the traditional exchanges.
These systems, known as electronic communications net-
works (ECNs), use technology to bring buyers and sellers
together electronically. Bob Mazzarella, president of Fi-
delity Brokerage Services Inc., estimates that ECNs have al-
ready captured 20 to 35 percent of Nasdaq’s trading volume.
Instinet, the first and largest ECN, has a stake with Gold-
man Sachs, J. P. Morgan, and E*Trade in another network,
Archipelago, which recently announced plans to form its
own exchange. Likewise, Charles Schwab recently an-
nounced plans to join with Fidelity Investments, Donaldson,
Lufkin & Jenrette, and Spear, Leeds & Kellogg to develop
another ECN.
ECNs are accelerating the move toward 24-hour trading.
Large clients who want to trade after the other markets have
closed may utilize an ECN, bypassing the NYSE and
Nasdaq.
In fact, Eurex, a Swiss-German ECN for trading futures
contracts, has virtually eliminated futures activity on the
trading floors of Paris, London, and Frankfurt. Moreover, it
recently passed the Chicago Board of Trade (CBOT) to be-
come the world’s leader in futures trading volume. The
threat of a similar ECN in the United States has undoubt-
edly contributed to the recent 50 percent decline in the price
of a seat on the CBOT.
The move toward faster, cheaper, 24-hour trading obvi-
ously benefits investors, but it also presents regulators, who
try to ensure that all investors have access to a “level playing
field,” with a number of headaches.
Because of the threat from ECNs and the need to raise
capital and increase flexibility, both the NYSE and Nasdaq
plan to convert from privately held, member-owned busi-
nesses to stockholder-owned, for-profit corporations. This
suggests that the financial landscape will continue to un-
dergo dramatic changes in the upcoming years.
Sources:Katrina Brooker, “Online Investing: It’s Not Just for Geeks Any-
more,” Fortune,December 21, 1998, 89–98; “Fidelity, Schwab Part of Deal to
Create Nasdaq Challenger,” The Milwaukee Journal Sentinel,July 22, 1999, 1.
20 An Overview of Corporate Finance and the Financial Environment
