From the June 2006 issue of Research Magazine • Subscribe!

Stock Exchange, Version 2.0

The Nasdaq Stock Exchange has always been an innovator. From its start in the 1970s, when competing stock exchanges were still entrenched in the auction-based system of market specialists, the Nasdaq was electronic. Instead of being connected by floor representatives, buyers and sellers were connected by a sophisticated network of computer terminals. What seemed like a novel idea at the time has become a marketplace norm. Today, the trading of stocks and other financial products has undergone a monumental shift in favor of technology. On any given day, the average share volume of Nasdaq-listed securities outpaces competing markets.

In 1999, when ETFs were still little known, the Nasdaq-100 (Nasdaq: QQQQ) sometimes referred to as "cubes," became among the earliest funds to begin trading. Today, it's the most actively traded security in the U.S.

John Jacobs, CEO of Nasdaq Global Funds and chief marketing officer for the Nasdaq Stock Market, has played a key role in the growth and management of Nasdaq and its related business. The "cubes" were launched under his direction and plans for similar products are in the works.

Research sits down with Jacobs to discuss the challenges and opportunities

at hand.

When investors hear the Nasdaq name, they often think of it as a stock exchange and nothing more, because other parts of your business are less familiar. Besides listing stocks and ETFs, what else does Nasdaq do?

Our business can be separated into a few key segments. First, we list stocks, structured products, closed-end funds and ETFs. Second, we trade those financial products no matter where they're listed. Third, we sell data. You can't get real-time price data on Nasdaq-listed securities without coming to us. And, lastly, we're an indexer, which no other stock market has been able to successfully duplicate. Nasdaq indexes are the benchmark being used with over 400 products in 32 countries.

Where does Nasdaq Global Funds rank in terms of ETF assets under management compared to its competitors?

Our Global Funds division is a subsidiary of The Nasdaq Stock Market and sponsor of five ETFs in the U.S. and one in Europe. The Nasdaq ETF family consists of the Nasdaq-100 Index (QQQQ), the EQQQ [the European version of cubes] and the four BLDRs.

The three largest ETF sponsors in terms of assets under management are Barclays Global Investors, State Street Global Advisors and Nasdaq Global Funds. Our six ETF products collectively are in the neighborhood of $21 billion with the bulk of assets in the Nasdaq-100.

Each of the leading U.S. stock exchanges has an ETF angle. The NYSE and ArcaEx captured the primary listing of 80-plus iShares. The Amex sold the licensing rights to its top ETFs to focus on new product development. How does Nasdaq's strategy compare to these?

Compared to the competing exchanges, I think we have the most comprehensive strategy.

Unlike other exchanges, we view ourselves as an index developer because we've created benchmark indexes that are actually used. Contrast the success of Nasdaq indexes versus the others. ETFs tracking NYSE indexes have low trading volume and a limited following.

Listing ETFs and sponsoring fund products will continue to be a key element of our plan. Trading is another important aspect of our business and there too, we've embraced the future. The majority of ETF trading volume is done electronically. For the period of 2005 year to date ended November 30, 2005, QQQQ traded an average of about 92.5 million of shares per day.

In terms of the sheer number of ETFs listed, Nasdaq still lags the NYSE and Amex. What's more important -- the quantity or quality of ETFs listed?

The quality of an ETF is determined by the investor, not by us. Our job is to provide access to the financial products that investors and traders want to use. Whether it's listed on the Nasdaq or not, our mission is to provide access.

It's been a little more than one year since the Nasdaq-100 exchange-traded fund shifted its primary listing from the Amex to Nasdaq. How has this change gone and what has it meant for your organization?

When the Nasdaq-100 Index Tracking Stock moved from the Amex, 96 percent of the trading volume had already left the Amex because of the migration to electronic trading. Where an ETF is listed isn't the same place it's necessarily traded. On its last day at the Amex, the Nasdaq-100 traded 102 million shares. On its first day on Nasdaq it traded 103 million shares because the trading in this security was already with us.

Around mid-2005, the Nasdaq revealed its plan to develop indexes that would likely result in new ETFs. What are some of the indexes we can look forward to seeing and who has the Nasdaq been partnering with to create these?

To date, most of the ETFs offered have been based upon traditional indexes. However, we think indexing is maturing beyond this and enhanced or intelligent indexing is the next evolution. We have several indexes we've developed including an equal-weighted version of both the Nasdaq-100 and Nasdaq Biotechnology index, as well as a Nasdaq-100 buy-write index, which uses a covered call options strategy. These are not plain vanilla indexes.

We use the FTSE indexing classification system to categorize individual companies according to their respective industry groups. Late last year, FTSE merged its classification systems with Dow Jones to create one system.

Some brokerage firms and their advisors still view ETFs as a threat. What do you have to say to them?

As a whole, I think this group is diminishing. When ETFs first emerged there was fear that it meant the end of mutual funds and that it was going to cut advisors out of the picture, but none of that has turned out to be true.

ETFs are another tool for financial professionals to use. They're a very inexpensive and effective way to help their clients build a portfolio. I'm in touch with people in the advisor community and the resistance level to ETFs is less and less.

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