Equity Markets & Market Structure

Definition

• Primary Market: Where companies issue new securities to raise capital — typically through IPOs, follow-on offerings, or private placements.
• Secondary Market: Where existing securities are bought and sold among investors. The issuing company does not receive any money here.

Mechanism

• Primary: Company issues new shares → Investors subscribe → Company receives proceeds.
• Secondary: Investor A sells shares to Investor B → Proceeds go to Investor A, not the company.

Example

Primary: Tesla raises $2B by issuing new shares in a follow-on offering.
Secondary: You buy Tesla shares from another investor on Nasdaq — Tesla receives no new capital.

Interview Tip: Primary Market = Capital Formation. Secondary Market = Liquidity Provision.

Definition

• Stock Exchange: A regulated marketplace where securities are listed and traded (e.g., NYSE, Nasdaq, LSE, BSE).
• Alternative Trading System (ATS): Non-exchange trading venues like electronic communication networks (ECNs) or dark pools.
• Dark Pools: Private venues for large trades with minimal pre-trade transparency to reduce market impact.

Mechanism

Exchanges match buy and sell orders based on price and time priority. ATS and dark pools are often used by institutions for block trades to avoid market impact.

Example

A hedge fund wants to sell 5 million shares of Apple. If placed on the NYSE all at once, the large supply might push the price down. Instead, it executes the trade in a dark pool to minimize this price impact (slippage).

Order-Driven Markets

Prices are determined by the supply and demand of buy and sell orders from the public. Orders are matched directly in a central limit order book. Examples include NYSE, LSE, and NSE.

Quote-Driven Markets

Market makers provide liquidity by quoting continuous bid (buy) and ask (sell) prices. Investors trade against these quotes. Examples include Nasdaq (historically) and OTC markets.

Example

Order-Driven: The order book shows a bid for 100 shares @ $50.00 and an ask for 200 shares @ $50.05. A market buy order would execute at $50.05.
Quote-Driven: A dealer quotes a price of $49.95 / $50.05. An investor can sell to the dealer at $49.95 or buy from the dealer at $50.05.

Interview Tip: Most major exchanges today are hybrid systems, using a central order book but also having designated market makers to ensure liquidity.

Definitions

• Market Makers: Financial firms that provide liquidity by continuously quoting bid and ask prices, profiting from the bid-ask spread.
• Liquidity Providers: A broader term that includes market makers, institutional investors, and algorithmic traders who add depth to the market.
• Designated Market Makers (DMMs): Specific firms appointed by an exchange (like the NYSE) to maintain a fair and orderly market in certain stocks. They are obligated to provide liquidity during volatile periods.

Example

A Nasdaq market maker quotes a stock at Bid: $49.90 (their buy price) and Ask: $50.10 (their sell price). The $0.20 difference is their spread. On the NYSE, a DMM for Apple ensures there are always bids and asks available, even during sharp market moves.

Definitions

• Best Execution: A regulatory requirement for brokers to execute client orders on the most favorable terms possible (considering price, speed, cost, etc.).
• Order Routing: The process by which brokers use smart order routers (SORs) to send client orders to different venues (exchanges, dark pools) to achieve best execution.
• Payment for Order Flow (PFOF): A practice where brokers receive compensation from market makers for routing client orders to them.

Example

You place a market order on a retail brokerage app. The app routes your order to a large market maker like Citadel Securities. Citadel executes your trade and pays the brokerage a small fee for sending them the order flow.

Definitions

• Off-Exchange Trading: Trading executed outside traditional exchanges, often through dark pools, OTC, or internalization by brokers.
• Block Trades: Large transactions (typically over 10,000 shares) that are executed privately to avoid impacting the public market price.

Mechanism

Block trades are often negotiated directly between institutions or through specialized brokers. The trade is reported to the public tape after execution for transparency.

Example

A pension fund wants to sell 5 million shares. Selling on the open market would cause the price to collapse. Instead, they execute a block trade with another fund over-the-counter at a privately negotiated price.

Definitions

• Tick Size: The minimum price increment at which a security can trade (e.g., $0.01 for most U.S. stocks).
• Price Improvement: Executing a trade at a better price than the current national best bid and offer (NBBO).

Example

The NBBO for a stock is $50.00 / $50.05. Your market buy order is filled at $50.03. You have received $0.02 of price improvement per share.

Summary Table (Cheat Sheet)

Final Interview Tips

Be prepared to answer common questions like: "What’s the difference between primary and secondary markets?", "How do dark pools reduce market impact?", "Explain a market order vs. a limit order and when you’d use each.", and "How does payment for order flow work and why is it controversial?"