7.1.  Types of Markets

Recall from Chapter Six that before a security can be traded (bought or sold to others) it must be issued to the public through the primary market. The entities issuing the securities may be corporations, such as Microsoft or Google; municipalities, such as New York City; or even the U.S. government, in the form of Treasury securities. Companies that issue securities must register their securities with the SEC before they can be issued to the public. They usually do this with the help of an underwriter. The underwriter purchases securities from the issuer at a discount and then sells them to investors in a primary offering.

After the primary offering, securities may be traded among investors. “Traded” means that the securities were bought and sold with money. This trading between investors takes place in the secondary market. If there is an appreciation in the value of the security, this appreciation goes to the investor of the security, not the issuer of the security.

The secondary market in the United States can be divided into four types of markets. While you should know the distinctions among these markets for your exam, keep in mind that the differences have blurred due to technological advances in trading.

Auction market. In an auction market, also called the first market, securities are traded on an exchange floor. It is called an auction market because brokers gather around a trading post where a Designated Market Maker (DMM) acts as auctioneer and allows supply and demand to determine the price of the security. The DMM is also referred to as the Specialist. The stock exchange will assign one DMM to be the auctioneer for each stock on the exchange. The DMM is also responsible for posting quotes in a security and keeping a fair and orderly market. The DMM’s quotes will consist of the highest bid at which it is willing to buy the security and the lowest offer price at which it is willing to sell the security. As au