Glossary of Important Cincinnati Stock Exchange Terms
by Cheryl McDonald and Emily Keough
“One of the best known axioms, and in many respects one of the truest, holds that. A Bull can make money on wall street. A bear can make money on wall street. But a Hog Never can.” -William B. Huckabee of the New York Stock Exchange
William B. Huckabee, spokesman for the New York Stock Exchange, cautions that get-rich schemes aren’t the foundations of Wall Street. “There’s just no such animal. If there were, brokers would be so busy making money for themselves they’d have no time for customers.” Fortunately though, there are income and profit potentials in buying and selling securities.
“The main function of all securities is to raise capital for the issuer—there the general characterization ends,” according to a 1967 NYSE lecture.
Securities are used in corporations for raising capital above and beyond their earnings. There are two common means for raising this money: Corporations can sell or borrow part-ownership in a company, or they can raise an abundance of money by selling new issues of securities to bankers. When you buy an outstanding security, you are buying from another individual. And, when you sell, another person is the buyer. Service Manager for Fidelity Investments Patrick McShay explains that an outstanding securities are realistically called outstanding shares within a publically traded company. Essentially it’s debt that’s outstanding to the company.”
Because there is a broad collection of securities readily available in the market today, they are distributed from various sources. Businesses and industrial corporations can issue securities to the public. Financial institutions, along with federal, state, county and municipal governments, can all issue securities. “We sell them in the sense that investors can purchase securities through us,” says McShay of Fidelity. “We are not original issuers, but we will help clients buy and sell their holdings, their securities.”
The two basic kinds of securities are bonds and stocks. Huckabee says bonds “represent debt–the bondholder being the lender and the issuer the borrower.” He defines the main category of stocks as “representing part-ownership of a business.”
Huckabee also notes that it’s important to note that each security in its category differs from another, including its “degree of safety as an investment, degree of possible return and appreciation, its market price and stability and its place in the portfolio.” Bonds typically offer higher safety, but lower return than stocks. The NYSE lecture on “Investors’ Information states, “The latter may offer better income and profit possibilities with less safety than the former—however the reverse can be true.””
The difference between listed and unlisted securities is that listed securities are traded on the floor of the exchange, while unlisted securities are traded in the over-the-counter market. With listed securities, you are given the current market price from the ticker on Wall Street (or any financial ticker), online or in other forms of media. Companies are required to disclose this significant information. Unlisted securities, on the other hand, account for many bank, insurance and government establishments. These corporate securities aren’t listed because the business doesn’t want to adhere to regulations or can’t meet the exchanges requirements.
Stocks are often classified in two general ways, preferred and common. Preferred stock is a hybrid; it floats between common stock and bonds. Its name comes from “certain preferential treatment.” Like a bond, it has a fixed rate of return and almost always pays regular dividends as long as the company is profiting from operating. Comparing it to a common stock, it signifies equity and ownership in a business. Preferred stockalso has the right to “receive a fixed dividend ahead of any common dividend.” However, owners of preferred stock typically can’t expect increased dividends, even when the company prospers.
Common stocks are the largest category in the securities family. This type of stock is “the best known and most widely owned.” Common stock has the biggest management control but receives the last claim on earnings, but it also offers a greater chance of return and appreciation. The most significant thing about a common stock is that all corporations issue them. They represent part ownership of a company and the dividends are based on the company’s prosperity. If the corporation is doing well, then so are the dividends, and if the business is doing poorly, then the dividends decrease.
The shortest possible definition of a primary market? It is a market that offers new securities to an exchange. Or, the market for new securities issued. The primary market is also often referred to as the new issues market. Companies and governments receive funding through the sales of new stock or bonds through a collection of securities dealers. The primary market is where securities are sold. What makes the market primary is the fact that the profits of the sales go to the issuer of the securities.
The method of selling new securities to investors is often called underwriting. It is what investment bankers do. They figure out the risk involved with the securities and declare successful distribution of the issue. Each exchange goes through an underwriting or purchase group. Fidelity Investments’ McShay informs us that, “Underwriting can sometimes be easily confused with, what we call in the financial world, a registered secondary offering. People confuse the two commonly because they are practically similar, minus the fact that the earnings are passed along to the seller, not the issuer.”
Once the security is on the public market it is considered an initial public offering. Basically, this is when commission is earned by the price being built into the security. Individuals are allowed to view this information in a prospectus.
One way to share with you how to differentiate the primary market from any other term on the stock exchange is to reiterate a few key aspects:
-ONLY first time securities are sold here. Hence the “new market” name.
-The COMPANY receives the profit and in return issues new security certificates to investors.
-Used by businesses to establish new companies or expand existing ones.
-Doesn’t cover loans.
-The financial assets sold can only be redeemed by the original holder.
The main difference between the primary market and the secondary market is that, in the primary market the issuer buys the securities directly from the seller. The secondary market is also for used goods instead of first time securities. This is where formerly issued bonds and shares, as well as certificates of deposit and bills of exchange, are bought and sold. It provides a means of resale for all over-the counter markets, commodity and stock exchanges that serve as secondary markets. These secondary markets help maintain liquidity, as well as lower the risk of investment.
As we have already learned, the primary market is where securities are created. After this market, they move to the secondary market. A present day example of this would be the NYSE, where all stocks and other securities are secondary. McShay says that, “Any major company, Procter & Gamble or General Electric for example, are going to trade on the secondary, because any stock that’s traded is traded on the secondary market. When a private company goes public, they go through the process of an initial public offering. The IPO is done on the primary market because it’s coming from the original issuer. Say I own 100 shares of Procter & Gamble; since the company has gone public, I can now go and sell as an individual investor, creating that secondary market.”
There are other securities in secondary markets, such as investment banks, funds or, “entities like Fannie Mae.” And no, Fannie Mae is not a person or a nickname. It is an acronym for the Federal National Mortgage Association. The government defines it as, a publicly traded company, working to assure that mortgage money is readily available for existing and potential homeowners in the United States. It is also the largest non-banking financial services company in the world.
The secondary market develops an efficient capital market by linking investors’ fondness for liquidity (how much stocks or bonds can be bought or sold in the market without affecting the asset’s price) with the highest users’ hope of using their money longer. For instance, in a partnership, one partner may not access the other partner’s investment. If they end up breaking apart their mutual ownership of the equity, they will in return sell their own portions to a different investor. This is only recognizable in the secondary market.
Final factoids: In any secondary market, the capital will go to an investor instead of directly to the company; also, only basic forces like supply and demand determine the price of the security, where are in the primary market prices are often set beforehand.
Over The Counter Trading
Over-the-counter trading not handled at an actual exchange. This is because it cannot meet the listing requirements for the market. McShay, of Fidelity Investments, says these securities are not able to meet these requirements because they’re not yet a big enough company or there isn’t enough information about them. “Because of this, OTC was created for companies that went bankrupt,” says McShay. “Their stock was delisted off NYSE and was then traded OTC.”
However, U.S. government securities, corporate bonds, mortgage backed securities, asset-backed securities and municipal securities also are traded over-the-counter. For instance, bank stocks are traded OTC, even though many are listed on major exchanges and regional stock exchanges. OTC can also be referred to as “unlisted.”
OTC stocks are known to be very risky stocks because they’re not considered big enough or stable enough to trade on a major exchange. These securities are different from the others because they’re traded by broker-dealers that negotiate with each other either by phone or over computer networks, which are monitored by the National Association of Securities Dealer.
The National Association of Securities Dealers Automated Quotations (which is a part of NASD) is the largest stock exchange. It also operates as a dealer network. But, Because Nasdaq is considered a stock exchange, they’re not normally labeled as OTC. Because of this, OTC stocks are commonly unlisted and trade on the Over the Counter Bulletin Board (OTCBB) or on “pink sheets.” OTCBB is an electronic trading service showing, last-sale prices, real-time quotes and volume information for OTC securities. OTCBB stocks are normally offered to companies with bad credit scores and are generally referred to as penny stocks.
Intermarket Trading System (ITS)
The Intermarket Trading System (ITS) began in 1978 so specialists and brokers from different exchanges could communicate. Nick Niehoff, former president of the Cincinnati Stock Exchange (CSE), explains its beginnings.
“The Intermarket Trading System was one of the important first steps in consolidating the exchanges into what was envisioned as the National Market System,” Niehoff says.
Display screens showed the best bid and offer for a stock in the system. Specialists typed messages indicating whether they wanted to buy or sell stocks from another participating exchange. Once the order was received, the sender had to wait 60 seconds to receive confirmation via the system that the offer or bid was accepted. If too much time elapsed with no response, the offer would expire. By the end of September 1979, “some 630 dually or multiply traded listed stocks” would be traded in the ITS, according to the National Market System Five Year Status Report. (See complete document on the Sources page.)
“The ITS was kind of a hybrid of that wire system,” says Niehoff. “It sent messages from one exchange to another from one post to another. There were no posts at the CSE. The entire system was resident in the software. This system was implemented in 1978/1979, and it survived until regulation NMS II came into effect until 2005.”
Today, it is an electronic computer system that links the trading floors of all the major American exchanges together. The system is connected to large national exchanges like the New York Stock Exchange (NYSE) as well as smaller regional exchanges like the Boston Stock Exchange. ITS gives all eligible member market-makers and brokers the ability to execute buy and/or sell orders at different exchanges when a better price quote becomes available.
In February, 2000, the U.S. Securities and Exchange Commission adopted several amendments (http://www.sec.gov/rules/final/34-42212.htm ) to the ITS Plan to expand the ITS/Computer Assisted Execution System Linkage to all listed securities.
National Market System
A National Market System (NMS) has two primary functions: 1) to facilitate trading of OTC stocks that meet a specific criterion of size, trading activity and profitability, and 2) to simultaneously post prices for securities on the NYSE and other regional stock exchanges. Both the NASD and the NASDAQ sponsor the NMS.
In 1979, during his testimony in hearings before the SEC regarding the development of an NMS, CSE’s Nick Niehoff asserted that the CSE already had what the SEC was looking for. “We believe that this System contains all the ingredients that Congress wanted in a national market system. It is economic, efficient, fair, competitive, and open… It is error free… expandable to handle more issues… Access is easy and inexpensive.”
Before the NMS, markets were fragmented. There were exchanges from Cincinnati to Boston to Philadelphia and stretching to the west coast. Congress thought that the SEC should oversee the development of a national market and eliminate these fragmented markets, and there should be a methodology allowing markets to compete and spur innovation. The CSE wanted to lead these efforts.
Niehoff pledged the commitment of the CSE to create a unified system. “We stand ready to devote further efforts to integrate our system with others to the fullest extent possible, so long as we are not required to abandon the features that make us unique.”
These Congressional hearings were a catalyst that awakened the exchanges and caused them to be more radical in their approaches to revolutionize the NMS.
SEC Chairman Arthur Levitt detailed developments in the NMS in his Jan. 8, 2001, speech, The National Market System: A Vision That Endures:
“More than twenty-five years ago, Congress established the framework for a National Market System to connect the growing number of different markets. This framework, set forth in the 1975 Amendments, has served our markets well. But today, as our markets undergo unprecedented technological and competitive changes, some question its viability. In a time when the ground beneath our markets is shifting so, it’s a fair question to consider. But as we do, look at the fundamental vision of the ’75 Amendments.”
Automated Consolidated Tape (CTA)
Before the Automated Consolidated Tape came into existence, each exchange had its own tape. It was difficult to monitor all of the prices coming from all of the different exchanges throughout the U.S. The CTA, which became active in 1975, is an electronic system that continuously reports data on the sales volume and price of exchange traded securities.
Meeting minutes from the National Association of Securities Dealers, Inc. (NASD), dated Jan. 13, 1972, state: “The advantage of consolidated tape is that it could open up all public limit orders to executions taking place in every market center, thus providing another step toward the development of a central market system.”
In addition, “a consolidated tape will tell us much more about the market… because it will report the whole market. It will improve the regulatory capabilities of the SEC, the exchanges, and the NASD.”
Niehoff explains the need and the urgency to develop a consolidated tape. “It became technologically impractical to amalgamate all of these prices so it was discovered, and Cincinnati endorsed this, that a consolidation of information in one place was the best solution,” he says. “So, what occurred was, one by one, all of the exchanges stopped displaying their own tape and consolidated it into one. Everyone could see this one tape and this consolidation was a great benefit to the securities industry. Once the consolidated tape was announced and all the exchanges had implemented the connection, it virtually happened in one day. The exchanges decided it was the proper and right thing to do and we all did it together.”
The CSE officially stopped their individual tape in 1980.
Today, CTA consists of two networks: Tape A- Network A contains market data from NYSE-listed securities from all market centers trading such securities; and Tape B- Network B contains market data from all of the other exchange-listed securities including those listed on the American Stock Exchange, NYSE Arca and regional stock exchanges. This data includes trading activity from all market centers trading these types of securities.
The CTA disseminates real-time trade and quote information (market data) in both the NYSE and the American Stock Exchange (AMEX) listed securities (stocks and bonds). The CTA is an independent, industry-wide organization that was developed under a formal “CTA Plan” filed with the SEC.
The CTA and the Consolidated Quote System (CQ) Plans are administered by participating exchanges, which decide the policy matters and oversee the system operations. The CTA/CQ Plans are filed with and approved by the SEC in accordance with Section 11A of the federal securities laws.
The CTA is the policy making and administrative body that oversees the collection, processing and distribution of exchange-listed market data. It consists of voting members from each of the following markets: American Stock Exchange (AMEX), Boston Stock Exchange, Chicago Stock Exchange, National Stock Exchange, New York Stock Exchange, NYSE Arca, Philadelphia Stock Exchange, Chicago Board Options Exchange and the National Association of Securities Dealers.
Automated Consolidated Quotation System
The Consolidated Quotation System (CQS) is an electronic system for disseminating the bid, ask and size for a security in each market in which the security is traded. CQS was started in 1978 by the National Association of Securities Dealers and the organized exchanges. The plans were filed with the SEC and approved in accordance with Section 11A of the Securities Exchange Act of 1934.
The CQS has a similar historical path as the CTA. Each exchange had its own quotation system, like they each once had their own tapes. The exchanges decided to consolidate their quotation systems as well, and preparations began in 1979. They wanted one central processing system to consolidate all of their quotation systems and create a unified collection of the data.
Nick Niehoff, of the CSE, offers this historical insight. “The Security Information Processor (SIP) was, and is, a designated entity recognized by the SEC as being a securities information processor. That entity processed and took in all of the various quote feeds and tape feeds from the various exchanges and consolidated them into a single stream of data. And that’s what occurred. The name of the corporation that was formed as a result of the SIP was SIAC, Securities Industry Automation Corporation.”
The CQS is regulated by the SEC and contains quotation information for securities listed on the NYSE, the AMEX and other regional exchanges, in addition to firms who are members of the National Association of Securities Dealers. NASDAQ also processes the data and gives it to its members under the name of Composite Quotation Service.
All SEC-registered exchanges and markets that trade on the NYSE or AMEX-listed securities have sent their trades and quotes to a central consolidator where the Consolidated Tape System (CTS) and Consolidated Quote System (CQS) produce data streams that are distributed worldwide.
These are the current participants of the CQS: American Stock Exchange, Chicago Board Options Exchange, Chicago Stock Exchange, Financial Industry Regulatory Authority, International Securities Exchange, NASDAQ Stock Market, National Stock Exchange, NYSE, NYSE Archa, and the Philadelphia Stock Exchange.