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KembaraXtra-Islamic Finance-Islamic Capital Market-Categories of Secondary Market
Auction Market (Secondary Market Category)
What it is
• An auction market is a type of secondary market where prices are determined through continuous bidding and asking by participants.
• Buyers and sellers announce prices they are comfortable with.
Who trades
• Transactions mainly occur between investors.
• Issuing companies are not involved.
• Business expansion is not the objective of these trades.
How prices are formed
• All participants openly declare their bid and ask prices.
• This makes prices more concrete, transparent, and efficient.
• Market efficiency improves because everyone sees price information.
Price discovery process
• Buyers and sellers come together in the market.
• Buyers submit the highest price they are willing to pay.
• Sellers submit the lowest price they are willing to accept.
• A transaction is completed when bid and ask prices match.
Benefits to investors
• Investors do not need to search for the best price elsewhere.
• A fair and justified price range is automatically discovered.
Example
• The New York Stock Exchange (NYSE) is a well-known auction market.
Dealer Market
Core idea
• Dealer markets do not require buyers and sellers to converge directly.
• Transactions take place electronically through dealers.
How it differs from auction markets
• In auction markets, investors meet each other.
• In dealer markets, investors trade with dealers.
Role of dealers
• Dealers maintain an inventory of securities.
• They are ready to buy or sell at any time.
• Dealers quote:
– a buying price (bid)
– a selling price (ask)
Liquidity and risk
• Dealers use their own capital to hold securities.
• By doing so, they provide liquidity to the market.
• Their capital is exposed to price risk.
How dealers earn profit
• Profit is earned from the spread between buying and selling prices.
Transparency and competition
• Dealer prices are displayed publicly.
• This transparency encourages competition among dealers.
• Competition helps investors get better prices.
Markets where dealer systems dominate
• Currency markets
• Bond markets
• Futures and options
• Other standardised contracts and derivatives
Foreign exchange example
• The foreign exchange market operates mainly as a dealer market.
• Banks and currency exchanges act as dealer intermediaries.
Example
• NASDAQ (New York) is a popular dealer market.
Broker Market
Basic principle
• A broker market works only when a buyer and seller are matched as counterparties.
• Brokers act as agents, not principals.
Counterparty issue and liquidity
• The longer it takes to find a suitable counterparty, the lower the liquidity.
• This makes broker markets generally less liquid than dealer or exchange markets.
Historical background
• Traditional stock markets were brokered.
• Brokers physically searched for counterparties on trading floors.
• This created the classic Wall Street image of traders shouting orders and writing on paper.
Role of brokers
• Brokers search for appropriate buyers or sellers for their clients.
• They do not usually trade using their own capital.
Use in securities markets
• Broker markets are used for many types of securities.
• Particularly important for initial issues.
IPO context
• During an IPO, investment banks broker the issue.
• Their role is to find subscribers for the shares.
Bond and custom products
• Broker markets are suitable for:
– new bond issues
– less liquid securities
– tailored or customised financial products
Exchanges
Market structure
• Exchange markets are mostly automated.
• Trades are executed using order books that match buyers and sellers.
• Stocks are no longer brokered manually.
Price agreement rule
• A trade only occurs if buyer and seller prices match.
• If no agreement is reached, the trade is cancelled.
Role of intermediaries
• There is no involvement of brokers or dealer intermediaries in trade matching.
• Buyers and sellers find counterparties directly through the exchange.
Advantages of automated exchanges
• Centralised trading location
• Faster execution
• Higher transparency
• Lower transaction costs
Types of securities traded
• Standardised securities such as:
– stocks
– bonds
– futures
– options
– other standardised contracts
Key characteristics of exchange-traded securities
• Contract or lot size
• Time required to execute the contract
• Tick size
• Terms of delivery
• Quality specifications
Contract or lot size
• Securities must be traded in minimum quantities.
• Example: stocks traded in lots of 100 shares.
Tick size
• Tick size is the smallest price movement allowed.
• Example: US stock exchanges allow a minimum price change of $0.01.
Contract tick size
• Contract tick size = tick size × lot size.
• Example: $0.01 × 100 shares = $1.
Delivery and quality standards
• Mainly relevant for commodities and derivatives.
• Assets like gold and diamonds are traded based on quality and ratings.
• Physical assets must be in deliverable form.
Liquidity
• Standardisation, automation, and immediate execution make exchange markets highly liquid.
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