What a Merger Would Do


A potential merger of the Nasdaq stock market and the American Stock Exchange could have a dramatic effect on stock exchanges across the country--as well as on the prices that millions of individual investors pay to buy and sell stocks and other securities.

Here's what's happening:

Q: What is Nasdaq and why would it want to buy Amex?

A: Nasdaq is home to many major technology companies--such as Microsoft Corp.--as well as thousands of smaller companies in a range of industries.

Nasdaq was founded just 27 years ago but has grown rapidly, in part because it operates differently than Amex and other traditional exchanges. Nasdaq stocks are traded by brokers at computer terminals worldwide. Conventional exchanges have huge rooms in which brokers interact in person.

A merger could help Nasdaq compete against the more established New York Stock Exchange. It would give Nasdaq access to Amex's profitable options business. And Nasdaq could cut costs by blending the administrative functions of the two markets.


Q: Why would Amex sell out?

A: Though Amex is 87 years old, it has been overtaken by Nasdaq in recent years. More than seven times as many companies list on Nasdaq, for example. Like all exchanges, Amex is owned by its member brokerages. So combining with the larger Nasdaq could lead to more business for those brokerages.


Q: Would a merger prompt deals among regional exchanges?

A: Experts have long predicted that stock exchanges would begin to merge in much the same way that companies in other industries have combined at a record-setting pace. Years ago, the handful of regional exchanges--including the Pacific, Chicago and Boston markets--specialized in trading stocks of local companies. But technological advances have eliminated much of the need for that.

"It's hard to imagine these smaller exchanges having much of a future" on their own, said Samuel Hayes, an investment banking professor at Harvard University.

As a result, smaller players have branched into other products. Amex, for example, does a big business trading options on stocks and key indexes.


Q: Would a merger help individual investors?

A: Experts are split on the effect for small investors. In theory, the deal could help if it spurs other mergers because investors would stand a better chance of executing what are known as limit orders.

A limit order is a request by an investor to trade a stock at a specific price. Basically, an investor uses a limit order to try to get a better price than the current market price.

Now a limit order placed on one exchange may not have a chance to be executed on another. That could change as mergers occur.

"It's great news for individual investors," said Junius Peake, a finance professor at the University of Northern Colorado. "It's a sea change because finally the industry is moving away from breaking up into little pieces and more toward consolidation of order flow, which is good for investors because it'll mean much better prices and lower trading costs."


Q: Why do others disagree?

A: They say the supposed benefits may never come about and they dismiss the idea that cost savings from a merged Nasdaq-Amex would filter down to investors.

"It doesn't mean anything to investors," Hayes said.


Q: Nasdaq has come under criticism for inflating trading costs for small investors. Have recent changes made Nasdaq a fairer market?

A: Yes. Regulators began scrutinizing Nasdaq in 1994 after a study by two college professors showed major brokerages may have colluded to keep trading costs excessively high. Wall Street denied that but agreed in December to pay more than $900 million to settle lawsuits arising from the charges.

Nasdaq has also implemented reforms in the last year to help investors secure better prices. Last year it enacted a policy to ensure that small investors' limit orders are executed. Previously there was criticism that brokers simply disregarded them.

Under pressure from regulators, Nasdaq, the NYSE and the Amex last year began quoting stocks in increments of 1/16ths, a cut from the 1/8th increments that had prevailed for decades. By narrowing that spread between prices at which brokers buy stocks from investors and the prices at which they sell, the three markets lowered trading costs for investors.

Nasdaq "is just a really different market than it was five years ago and investors have benefited the most," said Bill Christie, a finance professor at Vanderbilt University who co-authored the 1994 study.

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