Changes in Market Structure: Approaches to Securities Trading 15 April 2003

©Copyright 2003, The Nasdaq Stock Market, Inc. All rights reserved.

Changes in Market Structure:Approaches to Securities Trading

15 April 2003

Alfred R. Berkeley, IIIVice Chairman

The NASDAQ Stock Market


Slide 2

Creating An Efficient Consolidated Market

• Competitive Challenges – Fragmentation• Improve Access and Lower Costs

Secondary Markets

National Markets

Broker-Dealers

Electronic Brokerage

Firms (ECNs)


Three Liquidity Models

Bull

Bear

PanicThre

e Ty

pes

of M

arke

ts

Accelerated Steady DecliningThree Types of Growth

MultipleLiquidity Providers(NASDAQ)

SingleLiquidity Provider(NYSE, AMEX)

No Professional Liquidity Providers(ECNs)


Three Liquidity Models

Bull

Bear

PanicThre

e Ty

pes

of M

arke

ts

High Volume Medium Volume Low VolumeThree Types of Activity

MultipleLiquidity Providers(NASDAQ)

SingleLiquidity Provider(NYSE, AMEX)

No Professional Liquidity Providers(ECNs)


Slide 5

Average Daily Trades by Dollar Value of Float Category

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

$100 to$250

$250 to$500

$500 to$1,000

$1,000 to$5,000

$5,000 to$50,000

Greater than$50,000

Dollar Value of Float (mil.)

Aver

age

Daily

Tra

des

NASDAQNYSE

Average daily trades for all stocks within each dollar value of float category. All common stock on NASDAQ National Market and NYSE; NYSE data represent specialist trades only. Source: NASDAQ ER DataMart, FactSet Research Systems. December 2002.


Slide 6

OldNASDAQ NYSE ECN

Dealer InterventionContinuous Support

xLimit Order BookTransparency, Critical Mass

x Electronic ExecutionSpeed

x AuctionPrice Improvement x xCompetitionBenefits Investors x

Severe Competition in the 1990s


Slide 7

OldNASDAQ NYSE ECN New

NASDAQ

Dealer InterventionContinuous Support

x Limit Order BookTransparency, Critical Mass

x Electronic ExecutionSpeed

x AuctionPrice Improvement x x CompetitionBenefits Investors x

Integrating Market Models Improves Liquidity


Slide 8

NASDAQ Initiatives Reduce Liquidity Costs• NASDAQ continues to enact a variety of initiatives to reduce

liquidity costs, ultimately reducing the cost of capital and increasing shareholder value.

Value = NPV(Cash Flows)(1-Cost of Capital)

Direct Cost

TaxesFeesMarket Charges

Commissions

Opportunity Cost

Adverse Selection

Bid/Ask SpreadLong-termDecline in Spreads

Post-Trade Market Impact Cost

Depth at Quote, Reserve Size

Execution Delay

Pre-Trade Market Impact Cost

SuperMontageSM, Primex

Market MovementBefore ExecutionFast Execution

Cost of Capital = Risk Premium + Liquidity Premium

Risk Free Rate of Return

Company RiskIR tools,

Brand Development

Source: Amihud, Yakov and Haim Mendelson, “The Liquidity Route to a Lower Cost of Capital’” Journal of Applied Corporate Finance, Volume 12, Number 4, Winter 2000, 8-25.


Slide 9

SuperMontageSM Addresses Competitive Challenges

TotalViewSM Detail


Slide 10

Greater Depth, Stronger Center of Liquidity

Average Cumulative Depth of Book Before SuperMontageSM

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

$400,000

-5 -4 -3 -2 -1(Inside

Bid)

0 1(Inside

Ask)

2 3 4 5

Dolla

r Val

ue o

f Sha

res

Avai

labl

e

ReserveDisplay

Source: NASDAQ.


Slide 11

Greater Depth, Stronger Center of Liquidity

Average Cumulative Depth of Book After SuperMontageSM

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

$350,000

$400,000

-5 -4 -3 -2 -1(Inside

Bid)

0 1(Inside

Ask)

2 3 4 5

Dolla

r Val

ue o

f Sha

res

Avai

labl

e

ReserveDisplay

• With more and more market makers submitting orders at multiple price levels, depth should continue to increase.

Source: NASDAQ.


Slide 12

Impact of Changes on Market Quality

Average Execution Speed (secs)

4.8

21.7

NASDAQ NYSE

Data represent execution quality for S&P 500 issues listed on NASDAQ vs. those listed on the NYSEIncludes time for Market Center’s proprietary systems as mandated by SEC Rule 11Ac1-5. Based on all marketable orders up to 9,999 shares. Marketable orders are represented by both true market orders and limit orders that are at or within the prevailing bid-ask quote.Source: Market Systems Inc. December 2002.

• NASDAQ-listed S&P 500 stocks execute faster, with lower transaction costs and better pricing than NYSE comparables.

Average Effective Spread (¢)

1.9

2.8

NASDAQ NYSE

Average Quoted Spread (¢)

1.1

2.5

NASDAQ NYSE

Average Ex. Price Rel. to the Quote

15% 23%

71% 56%

14% 20%

NASDAQ NYSE

Price Improvement

At theQuote

Price Dis-Improvement


Slide 13

Improved Liquidity as a Result of Changes

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

500,000

550,000

$100 to $250 $250 to $500 $500 to $1,000 $1,000 to $5,000 $5,000 to$50,000

Greater than$50,000

Dollar Value of Float (mil)

Avg

Amiv

est L

iqui

dity

Rat

io (0

00)

NASDAQNYSE

The Amivest Liquidity Ratio measures the amount of dollar volume of trading associated with a one percent change in price over a twenty-day period. Includes all domestic common stock on NASDAQ National Market and NYSE.Source: FactSet Research Systems. December 2002.

• More stock can be bought or sold on NASDAQ without impacting the price.


Slide 14

Offer PriceGoldman Sachs. . . . . 25.05NASDAQ SIZE. . . . . . 25.05Hong Kong. . . . . . . 25.10Schwab Capital Mkts. . 25.10CS First Boston. . . . 25.10Tokyo. . . . . . . . . 25.10Merrill Lynch. . . . . 25.10Salomon Smith Barney . 25.15...

Bid PriceHong Kong. . . . . . . 25.00Morgan Stanley . . . . 25.00NASDAQ SIZE. . . . . . 25.00Merrill Lynch. . . . . 24.95Deutsche Börse . . . . 24.95Instinet . . . . . . . 24.95Spear Leeds. . . . . . 24.95Singapore. . . . . . . 24.95...

Tomorrow’s Market• International Exchanges, Electronic Networks and Traditional

Market Makers Compete for Every Trade.


Slide 15

Fair Allocation of Regulatory Costs

• Increasing Fragmentation of the Market for Trading NASDAQ Securities

•Need to Rebalance the Costs of Regulating that Trading


Documents

Changes in Market Structure: Approaches to Securities Trading 15 April 2003