Security Markets Environment

This section describes the Security Markets environment.

New Securities

Firms receive funds by issuing new securities and selling them to the public. An investment bank channels money from investors to firms who need funds. Because these banks have broker units with many customers, they are able to sell the issues without the costly search a firm would have to make.

In underwriting, the bank selling the issues bears the risk present with the sale. They agree to give it their best effort to sell the issues, but do not promise an amount of money. The new issue market is very risky. Insiders may use it to sell their holdings after a lock-up period ends.

Financial Intermediaries

Another short-term source of funds, is through intermediaries. These banks were developed to help the indirect transfer of saver’s funds to borrowers. They include

  • commercial banks
  • S & L’s
  • mutual savings banks
  • credit unions
  • life insurance firms
  • pension plans
  • money market fundsSecurity Markets

Instruments include:

  • Certificates of Deposits (CD’s)
  • Commercial Paper
  • Repurchase Agreements
  • Banker’s Acceptances
  • Tax Anticipation Notes

Security Markets Makers

Securities are bought and sold every day on either a Security Markets exchanges or the informal over-the-counter Security Markets. In either case, dealers make markets in securities and help their transfer by buying and selling in their own account. They profit by pocketing the spread between bid and ask quotes.

This difference is called the spread. The size of the spread is set by

  • the number of market makers
  • volume of transactions
  • the number of shares out

The dealers not only are paid by the spread. They also

  • charge commission fees
  • earn income on their holdings
  • enjoy any rise in prices

Market makers try to quote a price which equates the supply with the demand. Although they can’t set the market price, they maintain an steady market by buying in large blocks and selling off pieces according to demand.

Security Exchanges

When a firm first offers its shares to the public, they are usually traded over the counter. The listing of a firm’s stock on a major exchange has an element of prestige.with the New York Stock Exchange being the most famous. There are also regional and virtual exchanges dealing in niches of the market. Daily transactions are reported by the press in print (becoming rare) and online.

Large blocks of listed stocks may be traded over-the-counter in what’s known as the third market. Players are usually large firms who desire secrecy. A fourth market skips the middleman and trades directly with the issuer through a computerized system.

Mechanics of Investing

You purchase stocks and bonds through brokers. They have to take tough exams but should not be called experts. There are two courses of action involved depending on your outlook for the issue. If you have a bullish view, you will purchase or go long.  If you are bearish, you would sell short the issue by borrowing shares, selling and then buying the shares back at a lower price.

Types of Orders

  • Market order- an order to buy or sell at the current market price or quote. This the only type SCM uses.
  • Limit order- an order placed with your broker to buy or sell at an exact price.
  • Day order- an order placed with your broker which is canceled at the end of the day if not filled
  • Good-Till-Canceled order- an order placed with your broker which remains in effect until it is executed by the broker or canceled by you
  • Stop order- a purchase or sell designed to limit your loss or to assure a profit on a position in a security.

You must pay for the securities as they are purchased. You can buy on margin which means you are using borrowed funds, but SCM doesn’t use this method due its riskiness. The margin requirement is the minimum percentage of the total price you must pay and is set by the Fed.

Once the shares have been purchased and paid for, the broker takes delivery electronically on your behalf and also acts as a custodian.The custodian is responsible for reporting confirmation of trades, monthly statements and all tax reporting. Your cost is for the trade is the commission and the spread. Discounted commissions are often associated with higher spreads.


The security industry is subject to a substantial degree of regulation both from the federal and state governments. The purpose is to protect the investor by ensuring honest and fair practices and providing full disclosure.Security Markets

Significant legislation:

  • The Security Act of 1933 and Security Exchange Act of 1934- hatched during the Depression and govern much of the activity today. They forbid market manipulation, deception and misrepresentation of facts and fraudulent practices. Publicly held firms are required to keep current financial information on file with the SEC.
  • The Investment Company Act of 1940- extended regulation to mutual fund and other investment companies.
  • The Securities Investor Protection Act of 1970- protects investors from brokerage firm failures and bankruptcies.

Also, visit these topics for further detail or return to the Investment Basics page:

The info on this Security Markets page and Investment Basics pages were adapted from Dave’s lecture notes for the Investments for Professionals course taught at UCLA 1998-2005 and three decades of practical experience. Also, see our Site Credits page for Security Markets reference sources.