Market Structure

Understanding market structure is foundational for anyone entering the securities industry. By familiarizing yourself with the different types of markets, participants, and regulatory entities, you’ll understand how the financial markets operate and their roles in the economy.

Market structure is an essential chapter for the SIE preparation, and 2-3 questions are asked every year in the examination. This page of the SIE guide covers different types of capital markets and their functionalities.

Types of Markets

There are four types of capital markets in the securities industry. Below is detailed information about each market.

The Primary Market: The primary market is where securities are issued and sold for the first time. It is the critical channel for issuers such as companies and governments to raise capital by selling stocks, bonds, or other securities directly to investors.

Initial Public Offerings (IPOs) are a well-known example of transactions that occur in the primary market. This market is essential for economic growth as it allows businesses to acquire the necessary funds for expansion and operational development.

The Secondary Market: Unlike the primary market, where securities are first issued and sold by the issuing companies, the secondary market allows investors to trade these securities without involving the issuing companies directly.

This market includes stock exchanges like the New York Stock Exchange (NYSE) and Nasdaq, facilitating liquidity and enabling price discovery through the ongoing buying and selling of stocks, bonds, and other financial instruments.

The secondary market is the stock market, where investors trade the companies’ shares through brokerage accounts like Charles Schwab, Fidelity, ETrade, Merrill Edge, etc.

The Third Market: The Third Market, commonly called the Over-the-counter (OTC) market, is where exchange-listed securities are traded directly between parties, bypassing traditional stock exchange mechanisms.

This market operates through a network of dealers who negotiate and trade among themselves, often facilitated by electronic systems.

Key characteristics of the OTC market include its flexibility and accessibility, allowing for trading a diverse range of securities, including those not typically eligible for formal exchange listings.

The Fourth Market: The Fourth Market refers to the direct trading of securities between investors without the involvement of broker-dealers or other intermediaries.

This market primarily involves transactions between large institutional investors through electronic systems that match buy and sell orders.

The Fourth Market is notable for its efficiency and cost-effectiveness, as it eliminates the need for middlemen and reduces transaction fees.

It is predominantly used for trading large blocks of stocks, making it an attractive option for institutions looking to execute substantial trades with minimal impact on the market price.

Foreign Markets: Foreign markets are global trading platforms where investors can buy and sell securities outside the United States. It includes stocks, bonds, and derivatives.

These markets offer opportunities for portfolio diversification and access to international growth. Generally, this type of investment is considered risky due to currency fluctuation and geopolitical dynamics.

  • American Depositary Receipts (ADRs): American Depositary Receipts (ADRs) allow U.S. investors to own foreign stocks without buying them directly on overseas markets. Each ADR represents one or more shares of a foreign stock and trades on U.S. exchanges. They simplify investing in foreign companies by managing currency conversions and trades.
  • Regulation S Offerings: Regulation S Offerings allow companies to sell securities outside the U.S. without the usual registration required by the U.S. Securities Act of 1933. This provides a streamlined way for both U.S. and foreign issuers to access global capital markets, bypassing the complexities of U.S. registration as long as these transactions are entirely conducted abroad.