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Electronic Communications Networks

Electronic Communications Networks. Marcus Woo Kevin Appel. Activity. Person 1 represents a brokerage and has control over 1,000 shares and have access to market information

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Electronic Communications Networks

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  1. Electronic Communications Networks Marcus Woo Kevin Appel

  2. Activity Person 1 represents a brokerage and has control over 1,000 shares and have access to market information Person 2, 3, and 4 are private investors who have 100 shares to invest and only know that all 3 stocks have been performing stably. Assume that all stocks have the same share prices. • Stock X • Stock Y • Stock Z

  3. What is an Electronic Communications Network (ECN)? • Alternative Trading System • Privately Owned • Subscription Service • Establishes anonymous and direct connection between buyers and sellers • Accounts for 65% of trading volume of NASDAQ-listed shares as of 2005

  4. History of ECNs • Technological changes • Securities industry quick to adapt (SuperDOT) • Instinet recognized as first electronic exchange market – 1998 • Skeptical about lack of human interaction

  5. Trading on ECNs • Essentially a limit order book • Eliminates middleman • ECN listed as contra-side party • Smaller profit spreads (Buyer/Seller) • ECN acts as 3rd party guarantor

  6. Benefits of Trading on an ECN • Anonymity • Lower transaction costs/errors • Competitive pricing (transparency) • Extended hours of operation • Efficient transaction times • Ability to pursue market makers

  7. Advantages of NYSE • Preference ability and internalization • More suitable for large stock orders • Price improvement via the auction process • No subscription fee for retail investors

  8. Regulations • ECN serves a limited regulatory function • Assume default risk • NYSE Rule 390 • Heavily criticized and repealed on May 8, 2000

  9. Going public • $1 billion class action lawsuit against market makers • Maintaining high stock prices on open market • Trading with each other at lower prices on Instinet • Result: ECNs open to the public

  10. Electronic Communications Networks Today Goldman Sachs Merrill Lynch Morgan Stanley J.P. Morgan Bear Stearns Salomon Smith Barney PaineWebber Credit Suisse First Boston Lehman Brothers

  11. Electronic Communications Networks Today • Expand markets in which they hold investments • Reduce volume of transactions flowing through specialist • Cuts costs • Involvement allows small-time investors access to ECNs

  12. Questions?

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