Markets
CHAPTER Securities 3
McGrawHill/Irwin 2007 The McGrawHill Companies, Inc., All Rights Reserved.
Primary vs. Secondary Security Sales
Primary
New issue Key factor: issuer receives the proceeds from the sale
Secondary
Existing owner sells to another party Issuing firm doesn't receive proceeds and is not directly involved
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How Firms Issue Securities
Investment Banking Shelf Registration Private Placements Initial Public Offerings (IPOs)
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Investment Banking Arrangements
Underwritten vs. "Best Efforts"
Underwritten: firm commitment on proceeds to the issuing firm Best Efforts: no firm commitment
Negotiated vs. Competitive Bid
Negotiated: issuing firm negotiates terms with investment banker Competitive bid: issuer structures the offering and secures bids
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Figure 3.1 Relationship Among a Firm Issuing Securities, the Underwriters and the Public
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Figure 3.2 A Tombstone Advertisement
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Shelf Registrations
SEC Rule 415 Introduced in 1982 Ready to be issued on the shelf
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Private Placements
Private placement: sale to a limited number of sophisticated investors not requiring the protection of registration Allowed under Rule 144A Dominated by institutions Very active market for debt securities Not active for stock offerings
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Initial Public Offerings
Process
Road shows Bookbuilding
Underpricing
Post sale returns Cost to the issuing firm
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Figure 3.3 Average Initial Returns for IPOs in Various Countries
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Figure 3.4 Long-term Relative Performance of Initial Public Offerings
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Types of Secondary Markets
Direct search Brokered Dealer Auction
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Types of Orders
Instructions to the brokers on how to complete the order Market Limit Stop loss
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Figure 3.5 Limit Order Book for Intel on Archipelago
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Figure 3.6 Price-Contingent Orders
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Trading Mechanisms
Dealer markets Electronic communication networks (ECNs) Specialists markets
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U.S. Security Markets
Nasdaq Small stock OTC
Pink sheets
Organized Exchanges
New York Stock Exchange American Stock Exchange Regionals
Electronic Communication Networks (ECNs) National Market System
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Nasdaq
National Market System Nasdaq SmallCap Market Levels of subscribers
Level 1 inside quotes Level 2 receives all quotes but they can't enter quotes Level 3 dealers making markets SuperMontage
OTC Bulletin Board
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New York Stock Exchange
Member functions
Commission brokers Floor brokers Specialists
Block SuperDot
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Table houses 3.6 Electronic Computer Networks (ECNs)
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Market Structures in Other Countries
London - predominately electronic trading Euronext market formed by combination of the Paris, Amsterdam and Brussels exchanges Tokyo Stock Exchange
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Costs of Trading
Commission: fee paid to broker for making the transaction Spread: cost of trading with dealer
Bid: price dealer will buy from you Ask: price dealer will sell to you Spread: ask - bid
Combination: on some trades both are paid
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Margin Trading
Using only a portion of the proceeds for an investment Borrow remaining component Margin arrangements differ for stocks and futures
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Stock Margin Trading
Maximum margin is currently 50%; you can borrow up to 50% of the stock value Set by the Fed Maintenance margin: minimum amount equity in trading can be before additional funds must be put into the account Margin call: notification from broker you must put up additional funds
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Margin Trading - Initial Conditions
X Corp $70 50% Initial Margin 40% Maintenance Margin 1000 Shares Purchased Initial Position Stock $70,000 Borrowed $35,000 Equity 35,000
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Margin Trading - Maintenance Margin
Stock price falls to $60 per share New Position Stock $60,000 Borrowed $35,000 Equity 25,000 Margin% = $25,000/$60,000 = 41.67%
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Margin Trading - Margin Call
How far can the stock price fall before a margin call? (1000P - $35,000)* / 1000P = 40% P = $58.33 * 1000P - Amt Borrowed = Equity
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Short Sales
Purpose: to profit from a decline in the price of a stock or security Mechanics Borrow stock through a dealer Sell it and deposit proceeds and margin in an account Closing out the position: buy the stock and return to the party from which is was borrowed
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Short Sale - Initial Conditions
Z Corp 50% 30% $100 100 Shares Initial Margin Maintenance Margin Initial Price
Sale Proceeds $10,000 Margin & Equity 5,000 Stock Owed 10,000
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Short Sale - Maintenance Margin
Stock Price Rises to $110 Sale Proceeds $10,000 Initial Margin 5,000 Stock Owed 11,000 Net Equity 4,000 Margin % (4000/11000) 36%
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Short Sale - Margin Call
How much can the stock price rise before a margin call? ($15,000* - 100P) / (100P) = 30% P = $115.38 * Initial margin plus sale proceeds
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Regulation and Trends in Markets
Major regulations
Securities Acts of 1933 Securities Acts of 1934 Securities Investor Protection Act of 1970
Trading scandals and reactions
Sarbanes-Oxley Act
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