40 Part 2 Fundamental Concepts in Financial Management
Today these markets are often referred to as dealer markets. A dealer market
includes all facilities that are needed to conduct security transactions, but the trans-
actions are not made on the physical location exchanges. The dealer market system
consists of (1) the relatively few dealers who hold inventories of these securities and
who are said to “make a market” in these securities; (2) the thousands of brokers
who act as agents in bringing the dealers together with investors; and (3) the com-
puters, terminals, and electronic networks that provide a communication link be-
tween dealers and brokers. The dealers who make a market in a particular stock
quote the price at which they will pay for the stock (the bid price) and the price at
which they will sell shares (the ask price). Each dealer’s prices, which are adjusted
as supply and demand conditions change, can be seen on computer screens across
the world. The bid-ask spread, which is the difference between bid and ask prices,
represents the dealer’s markup, or pro! t. The dealer’s risk increases when the stock
is more volatile or when the stock trades infrequently. Generally, we would expect
volatile, infrequently traded stocks to have wider spreads in order to compensate
the dealers for assuming the risk of holding them in inventory.
Brokers and dealers who participate in the OTC market are members of a self-
regulatory body known as the National Association of Securities Dealers (NASD), which
licenses brokers and oversees trading practices. The computerized network used by
the NASD is known as the NASD Automated Quotation System (Nasdaq).
Nasdaq started as just a quotation system, but it has grown to become an orga-
nized securities market with its own listing requirements. Over the past decade, the
competition between the NYSE and Nasdaq has become increasingly! erce. As noted
earlier, the Nasdaq has invested in the London Stock Exchange and other market
makers, while the NYSE merged with Euronext. Since most of the larger companies
trade on the NYSE, the market capitalization of NYSE-traded stocks is much higher
than for stocks traded on Nasdaq. However, reported volume (number of shares
traded) is often larger on Nasdaq, and more companies are listed on Nasdaq.^7
Interestingly, many high-tech companies such as Microsoft, Google, and Intel
have remained on Nasdaq even though they meet the listing requirements of the
NYSE. At the same time, however, other high-tech companies have left Nasdaq for
the NYSE. Despite these defections, Nasdaq’s growth over the past decade has
been impressive. In the years ahead, competition between Nasdaq and NYSE Eu-
ronext will no doubt remain! erce.Dealer Market
Includes all facilities that
are needed to conduct
security transactions not
conducted on the physical
location exchanges.Dealer Market
Includes all facilities that
are needed to conduct
security transactions not
conducted on the physical
location exchanges.(^7) One transaction on Nasdaq generally shows up as two separate trades (the buy and the sell). This “double
counting” makes it di" cult to compare the volume between stock markets.
SEL
F^ TEST What are the di# erences between the physical location exchanges and the
Nasdaq stock market?
What is the bid-ask spread?
2-5 THE MARKET FOR COMMON STOCK
Some companies are so small that their common stocks are not actively traded;
they are owned by relatively few people, usually the companies’ managers. These
! rms are said to be privately owned, or closely held, corporations; and their stock
is called closely held stock. In contrast, the stocks of most large companies are owned
by thousands of investors, most of whom are not active in management. These
Closely Held
Corporation
A corporation that is
owned by a few
individuals who are
typically associated with
the firm’s management.
Closely Held
Corporation
A corporation that is
owned by a few
individuals who are
typically associated with
the firm’s management.