Week 11

Common stock market KEY TAKEAWAYS

Common stock market is  Common stock is a security that represents
the market for trading equities, not including  ownership in a corporation.
preferred stock.  In a liquidation, common stockholders
receive whatever assets remain after
Common Stock Market creditors, bondholders, and preferred
1. A stock market on which only common stockholders are paid.
shares are traded.  There are different varieties of stocks traded
in the market. For example, value stocks are
2. The supply and demand for common shares, wh stocks that are lower in price in relation to
ether of a single company, sector, or a whole econo their fundamentals. Growth stocks are
my. companies that tend to increase in value due
to growing earnings.
What Is Common Stock?  Investors should diversify their portfolio by
Common stock is a security that represents putting money into different securities based
ownership in a corporation. Holders of common on their appetite for risk.
stock elect the board of directors and vote on
corporate policies. This form of equity ownership Common stocks are shares of ownership in a
typically yields higher rates of return long term. corporation that afford their holders voting
However, in the event of liquidation, common rights. They vary from preferred stocks in two key
shareholders have rights to a company's assets only ways. Shareholders who own preferred stocks
after bondholders, preferred shareholders, and other receive dividend payments before shareholders of
debt holders are paid in full. Common stock is common stocks, but preferred stocks do not come
reported in the stockholder's equity section of a with voting rights.1 (Kimberly Amadeo)
company's balance sheet.
What Is Common Stock?
Understanding Common Stock
Stocks are traded on stock markets. In the
With common stock, if a company goes U.S., the most common of these are the New York
bankrupt, the common stockholders do not receive Stock Exchange and the Nasdaq Stock Market. That
their money until the creditors, bondholders, and makes stocks liquid as well as easy to price. As a
preferred shareholders have received their result, they are excellent indicators of the
respective share. This makes common stock riskier underlying value of the assets.
than debt or preferred shares. The upside to
common shares is they usually outperform bonds Common stocks allow shareholders to vote
and preferred shares in the long run. Many on corporate issues, such as the board of directors
companies issue all three types of securities. For and accepting takeover bids. Most of the time,
example, Wells Fargo & Company has several stockholders receive one vote per share.
bonds available on the secondary market. It also has Stockholders also receive a copy of the
preferred stock, such as its Series L (NYSE: WFC- corporation's annual report.
L), and common stock (NYSE: WFC).
Many corporations also give stockholders
Larger US-based stocks are traded on a dividend payouts. These dividend payouts will
public exchange, such as the New York Stock change based on how profitable the company is.
Exchange (NYSE) or NASDAQ. As of 2019, the
former has 2800 stocks listed on its bourses, while How Common Stock Works
the latter has 3300 stocks listed. NYSE had a
market capitalization of $28.5 trillion in June 2018, Stocks are bought and sold throughout the
making it the biggest stock exchange in the world day on stock exchanges, and the price of a share of
by market cap. a stock goes up or down depending on the demand.
Individual stock prices are affected by corporate
earnings and public relations announcements. All The term "over-the-counter" typically refers to the
stocks are affected by the health of the U.S. trading of securities that are not listed on widely-
economy overall. recognized exchanges such as the New York Stock
Exchange (NYSE). These securities are instead
You earn money from stocks in two ways: traded through a broker-dealer network, as the
from dividend payments or by selling the stock securities don't meet the listing requirements of a
when its price goes up. Of course, you also can lose centralized exchange. In the case of the third
your entire investment if the stock price plummets. market, the securities are exchange-listed, but they
are not being traded through the exchange.
Expected earnings drive demand for a stock.
If investors think a company's earnings will rise, KEY TAKEAWAYS
they will bid up the price of its stock, especially if  With a third market, exchange-listed
the current price is low compared to the company's securities are traded by investors operating
earnings, as measured by the price to earnings ratio. outside a centralized exchange through a
network of broker-dealers and institutional
Expected growth of revenue also impacts the investors.
price, even if the earnings aren't there yet. This can  Institutional investors, such as investment
happen with a new company that has a lot of firms and pension plans, tend to participate
promise. in the third market, as do traders in the over-
the-counter markets.
Stocks are first issued in a company's initial  With over-the-counter markets, securities
public offering. Before an IPO, companies typically that are not qualified for listing on
are privately held. By going public, such companies traditional exchanges are bought and sold
can generate expand by generating capital received through a network of broker-dealers.
in an IPO.  Securities can often be purchased at lower
prices in the third market because there are
Common Stock vs. Preferred Stock no broker fees.
Shareholders who own preferred stock do
not have voting rights, but they do receive set Understanding the Third Market
dividends that do not change before a corporation The third market supports the primary and
calculates how much to spend on common stock secondary markets. The primary market describes
dividends. the issuance of new securities. The secondary
market is traditionally where seasoned securities are
If a company goes out of business or is exchanged among market participants. And now,
restructured in a bankruptcy, the assets are the third market is ancillary to the secondary
distributed to bondholders first. Preferred market, with an emphasis on OTC markets and
stockholders are next, and common stockholders are institutional investors.
last. In most cases, common stockholders will How the Third Market Works
receive nothing.
Before selling exchange-listed securities to a
non-member in a third market transaction,
THIRD MARKET a member firm must fill all limit orders on the
specialist's book at the same price or higher. Typical
What Is the Third Market? (WILL KENTON) institutional investors who take part in the third
A third market consists of trading conducted market include investment firms and pension plans.
by non-exchange member broker-dealers The third market brings together large investors
and institutional investors of exchange-listed stocks. willing and able to purchase and sell their own
In other words, the third market involves exchange- securities holdings for cash and immediate delivery.
listed securities that are being traded over-the- Securities can be purchased at lower prices in the
counter between broker-dealers and large third market because of the absence of broker's
institutional investors. commissions. 
Third-party trading systems bypass traditional
brokers and allow large and possibly rival STOCK EXCHANGE
institutions' block orders to "cross" with each other.
Anonymity rules prevent either side from knowing What is a Stock Exchange?
the identity of the counter-party. There are A stock exchange is a marketplace where
additional rules and logics built into flow securities, such as stocks and bonds, are bought and
management interfaces, but there is sold. Bonds are typically traded Over-the-Counter
some information that cannot be shared with the (OTC), but some corporate bonds can be traded on
public, which gives the transaction sufficient stock exchanges. Stock exchanges allow companies
anonymity. to raise capital and investors to make informed
decisions using real-time price information.
Exchanges can be a physical location or an
electronic trading platform. Though people are
FOURTH MARKET typically familiar with the image of the trading
floor, many exchanges now use electronic trading.
Fourth market trading is direct institution-
to-institution trading without using the service Purpose of Stock Exchanges
of broker-dealers, thus avoiding both commissions, Stock exchanges act as an agent for the
[1]
 and the bid-ask spread.[2] Trades are usually done economy by facilitating trade and disseminating
in blocks. It is impossible to estimate the volume of information. Below are some of the ways exchanges
fourth market activity because trades are not subject contribute:
to reporting requirements. Studies have suggested  
that several million shares are traded per day. 1. Raising Capital
Through initial public offerings (IPO) or
Refers to the practice of institutional investors issuing of new shares, companies are able to raise
trading large blocks of securities directly to avoid br capital to fund operations and expansion projects.
okerage commissions.  This provides companies with avenues to increase
growth.
The over-the-counter market for the sale of listed  
securities between institutional 2. Corporate Governance
investors. For example, if a mutual Companies that are publicly listed on a stock
fund sells stock in Google to a hedge exchange must conform to reporting standards that
fund without going through an exchange, the transa are set by regulating bodies. This includes having to
ction is said to occur on the fourth market.  regularly and publicly report their financial
statements and earnings to their shareholders.
The market for securities in which large inve The actions of a company’s management are
stors bypass exchanges and dealers in order constantly under public scrutiny and directly affect
to trade directly among themselves. Compare secon the value of the company. Public reporting helps
dary market, third market.  ensure that management will make decisions that
benefit the goals of the company and its
Institutional investors, including mutual fun shareholders, thereby acting efficiently.
d companies and pension funds, who trade   
large blocks of securities among themselves are ope 3. Economic Efficiency
rating in what's called the fourth market. In addition to encouraging management
Usually, the transactions are handled through electr efficiency, exchanges also facilitate economic
onic communications networks (ECNs). efficiency through the allocation of capital. Stock
Among the appeals of using an ECN are reduced tra exchanges provide an avenue for individuals to
ding costs, the ability to trade after hours,  invest their cash, as opposed to merely saving these
and the fact that offers to buy and sell are matched a funds. This means that the capital that would
nonymously. otherwise be untouched is utilized towards
economic benefits, resulting in a more efficient
economy.
 In addition, exchanges also provide are traded. It includes both exchanges and OTC
liquidity, as it is relatively easy to sell one’s market. Exchange refers to the formally established
holdings. By providing liquidity and real-time price stock exchange wherein securities are traded and
information on company shares, the stock exchange they have a defined set of rules for the participants.
also encourages an efficient market by allowing When the trading is performed through the
investors to actively decide the value of companies exchange, it is under the supervision of the
through supply and demand. exchange and so it ensures that all the rules and
  regulations are duly complied with.
OVER THE COUNTER (OTC) Conversely, Over the Counter, shortly known
as OTC is a dealer oriented market of securities,
What does over the counter (OTC) mean? which is a decentralized and unorganized market
OTC stands for over-the-counter. In trading where trading happens by way of phone, emails, etc.
terms, over-the-counter means trading through The difference between OTC and Exchange are
decentralised dealer networks. A decentralised discussed below in detail.
market is simply a market structure consisting of
various technical devices. This structure allows Comparison Chart
investors to create a marketplace without a central
location. The opposite of OTC trading is
exchange trading, which takes place via a BASIS FOR OTC (OVER THE
EXCHANGE
centralised exchange. COMPARISON COUNTER)
An example of OTC trading is a
security, currency, or other financial product Meaning Over the Counter or Exchange is an
being bought through a dealer, either by OTC is a organized and
telephone or electronically. Business is decentralized dealer regulated market,
typically conducted by telephone, email and market wherein wherein trading of
dedicated computer networks. The OTC market brokers and dealers stocks takes place
is arranged through brokers and dealers who transact directly via between buyers and
negotiate directly. An advantage of the OTC computer networks sellers in a safe,
market is that non-standard quantities of stock and phone. transparent and
can be traded. systematic manner.

The OTC market often includes smaller Market maker Dealer Exchange itself
securities. It consists of stocks that do not need
to meet market capitalisation requirements. Used by Small companies Well established
OTC markets could also involve companies that companies
cannot keep their stock above a certain price per
Physical Location No Yes
share, or who are in bankruptcy filings. These
types of companies are not able to trade on an
Trading hours 24×7 Exchange hours
exchange, but can trade on the OTC markets.
Stocks Unlisted Stocks Listed Stocks
Difference between OTC and Exchange
Transparency Low Comparatively high
Secondary market refers to a market
wherein already issued securities and financial Contracts Customized Standardized
instruments are traded. It includes both
exchanges and OTC market. Exchange refers to the
formally established stock exchange wherein
securities are traded and they have a defined set of
rules for the participants.
Definition of OTC
Secondary market refers to a market wherein
already issued securities and financial instruments
 OTC or Over the counter market is a
decentralised market for unlisted securities, not Features of an Exchange
having a specific physical location, rather the  Trading of Securities: The first and
firms/persons involved in trading directly negotiate foremost function of a stock exchange is to
over a communication network such as telephone provide a formal platform for trading of
lines, emails, computer terminals, etc. Trading Over securities and liquidating them whenever an
the counter is also called off-exchange trading, investor needs to encash them, at the
because of the absence of a formal exchange. prevailing market price. Moreover, it
In general, those companies which do not provides the flexibility to the investor to
fulfil the prerequisites of the stock exchange for change their portfolio whenever required.
listing their stocks, trade them over the counter. The  Ascertainment of price: An Exchange-
trade takes place between two companies or traded market is one of the best examples of
financial institutions. Financial products such as perfect competition, because of the presence
bonds, derivatives, currencies, etc. are mainly of many buyers and sellers in the market. As
traded OTC. the market is transparent, all the necessary
It is a dealer’s market, where they buy and information is available and so active
sell the financial products for their account and the bidding takes place and in this way, the price
investors can directly contact the dealers, who are is decided.
interested in selling their stocks or bonds they have  Raising funds: Stock exchange is
or they can talk to the brokers, who will find out the commonplace for the companies and
dealers offering the stocks with the best price. governments to generate funds from the
The dealers making the market for a certain market by offering securities for sale to the
securities quote the price at which they are going to general public.
pay for the stock called as the bid price and the rate  Mobilization of savings: People invest their
at which they are going to sell the stock is savings in the share market, to earn good
called ask price. Here, the bid-ask spread implies returns and make money out of their
the amount left in-between the bid and asked prices investments. In this way, the savings of the
indicating the markup of the dealer. public is mobilized and channelised by the
stock exchanges, by investing their money in
Definition of Exchange different sectors, which generate high
returns.
 Trades in second-hand securities: In an
Exchange refers to the exchange-traded exchange, only those securities are traded
market, which refers to a centralized and regulated which are previously issued by the
financial market, where securities, commodities, companies through a public offering in the
derivatives, etc. of listed companies are bought and primary market.
sold between stockbrokers and traders.
The prices of securities such as shares, Other Key Difference Between OTC and
debentures, notes, corporate bonds, etc. are decided Exchange
by the market demand and supply forces. It can be a The difference between OTC and Exchange can be
physical trading location such as premises, etc. or it drawn clearly on the following grounds:
can be an electronic platform, i.e. website.  Exchange implies a trade exchange which
It has an association of persons (registered can be an organization or institution that
or unregistered) commonly referred to as member hosts a market where stocks of listed
brokers. It is established with the aim of governing companies are traded between the buyers
the trade of securities by the general public and and sellers. On the other hand, OTC
companies, as a whole. There is a set of rules expands to over the counter, which refers to
imposed by the Exchange on the firms and brokers, a decentralised market, wherein buyers look
which participate in the trading of securities. for sellers and vice versa to communicate
with each other by way of computer
network or phone.
  In an over the counter market the dealers flexibility to change the investment portfolio at any
play the role of market makers, as they time, less risk and maintenance of fair price.
quote the price at which the securities and
other financial instruments are bought and
sold between the participants. Conversely,
in case of an exchange, the trading
exchange is the market maker, as the prices
are determined by the demand and supply
forces.
 The companies which do not follow the
guidelines and meet the requirements of the
exchange often trade their securities OTC,
which are generally small companies. As
against, big business houses usually go for
listing and trading their stocks through an
exchange.
 One of the main difference between these
two is that an exchange is physically
present, wherein the open outcry method is
used. In contrast, OTC has no physical
location, everything is phone-based or
computer-based.
 In an exchange, trading is performed during
trading hours only. On the contrary, in
OTC, trading is performed 24×7.
 When it comes to transparency, the OTC
market is not as transparent as an exchange,
where the participants have complete
information and knowledge about the
securities being traded.
 In case of an exchange only standardized
products, in terms of quality and quantity
are dealt, whereas in case of an OTC the
contracts are customized as per the
requirement.
 Due to short term imbalance between the
demand and supply, there is no mechanism
in the OTC market to stop acute highs or
lows in the security prices. However, in an
exchange, these imbalances in prices are
managed by exchange halting trading in a
particular stock, that lets the additional
participants restore market equilibrium.

Conclusion
At the end of the discussion, we can say that
an exchange is obviously a step ahead of the OTC
due to certain reasons such as it provides liquidity to
encash the securities whenever required,
transparency in terms of availability of information,