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Unformatted text preview: Module 9. Stock Market Learning Goals To know the instruments and the issuing process. To interpret a Variable Income market according to their phases and characteristics. To understand and interpret the fundamental role that each of these characteristics plays in proper pricing, and therefore in the efficient allocation of resources. To define the criteria that allow us to critically evaluate the different structures of Variable Income markets. Context The savings bank where you work carries out a range of activities including stockbroking. However, the Board of Directors thinks that the broking business has peaked, and has decided to carry out a major strategic expansion. Given that there are no legal barriers (MiFID), the savings bank has decided to offer Stock Exchange services. Your boss wants you as head of the project. They are aware that there are different ways of carrying out the project successfully, and that one of the keys to success is the appropriate design of the market structure, and they are interested particularly in understanding what types of market structure they can implement. They know that there are two basic market models: Price‐driven and orders‐driven, but that nowadays no market is purely one type or another. Your work must focus on providing them detailed information on different market systems and advise them on the market structure best suited to expanding their business. Overview 1. Introduction 2. Pricing 3. Primary Market 4. Secondary market a. Key characteristics b. Types of orders c. Open Market d. Suspended Market 5. Stockmarket Indices Evaluation Perform the exercises 1 1. Introduction The Stock Exchange is a financial market where savers and lenders meet, thus contributing to the growth of an economy, since this is a means of channelling savings toward productive investment. The Stock Exchange is therefore a financing instrument for companies and an investment instrument for savers. Two important characteristics: • The Stock Exchange provides buyers of securities the option to convert them into cash whenever they want (liquidity). • In addition, the stock market is increasingly efficient at resolving the problem of valuing financial instruments through free establishment of prices under transparent conditions. The instruments used for the financing companies are shares. Shares are ownership certificates that represent one of the equally divided shares in the capital of a company. The concept of value in references to shares is subjective, and can have different meanings in different contexts. • Nominal value: historical value at which the securities were formerly issued (in Spain it was usually 500 or 1,000 Pesetas, is currently 1 €, and in the U.S. it has traditionally been $1). Its purpose is to establish and fill the capital account. • Accounting value, or book value: the value on the company balance sheet (difference between net assets and liabilities outstanding) and represents a static value rather than the real one. • Liquidation value, or the value of the instrument considered individually: the value the instrument would have without considering its contribution to the business activity. • Intrinsic or fundamental value: the value the instrument would have according to the current value of future cash flows expected from this instrument. • Market value: the value of the instrument resulting from the balance between supply and demand on the market for this instrument at a given time. Among all these values, there are two that interest us from a financial viewpoint (From an accounting or legal viewpoint it would be different): the intrinsic value and the market value The Market value reflects investors’ expectations on the prospects for the company. When a company is quoted on the Stock Exchange, the shares are traded on the market and prices are determined by the balance of supply and demand. The price the market establishes on the basis of expectations for the companies quoted are reflected in these prices. Purchasing shares means you acquire certain rights. 2 • Dividend rights: the dividend is the part of the profits that the company shares among its shareholders. The dividend depends on the company profits and company policy. • Transfer rights: every shareholder has the right to receive the proportional share from of the winding‐up of the society, and to sell (transferred) • Preferential rights to subscriptions: the current shareholders have preferential rights to subscribe (commit to the purchase of) new shares when a limited company expands its capital. • Voting rights: All shareholders have the right to vote at the General Shareholders' Meeting (except some preferential ) 2. Pricing Stockmarkets: One of the key characteristics of shares is that future cashflows are unknown, meaning greater risk. In fact, in the case of shares the risk is the key to pricing. However there are different approaches to pricing, which we will not discuss: • Net assets (capital + reserves) between the number of shares. • Current value of dividends • Fundamental Analysis. This is based on the fact that the quoted price of a share depends on the evolution of company profits compared with those of competitors. Some ratios used: o Solvency: Shareholder equity / Total liabilities. o Borrowing level: Bank borrowing / Total liabilities. o Liquidity: Current assets / Current liabilities. o ROA: Profits / Average assets. o ROE (Return On Equity): Profits / Average shareholder equity • Equilibrium models: CAPM (general) and APT (partial). 3. Primary Market (IPO) An Initial Public Offering (IPO) is the first public offering of the company's shares. Companies have to meet some minimum requirements concerning size and activity so that they are attractive enough to a reasonable number of investors. If the company meets those requirements the decision depends on the comparison of advantages and disadvantages of trading on the Stock Exchange. The IPO is divided into the following phases: • decision by the Board, General Shareholders' Meeting • documentation sent to CNMV • approval by CNMV • company fixes a price range • demand survey • price fixing and sale. Advantages: • Allows companies access a new type of financing. • Trading on formal markets increases company prestige. 3 Drawbacks • Direct costs. Here we include the costs of consultancy, market research, lawyers, and auditors. In addition we must include the commission or costs paid to the financial authorities and the underwriter. This cost of the underwriter will depend on its role. If it guarantees the issue, the cost will be greater. • Requirements for provision of Information. Quoted companies are obliged to inform the market of all decisions that might change the value of the company. This includes Balance sheets and Profit and Loss accounts, presentations to investors, etc. • Underpricing. This refers to setting the price too low. The idea is that if the price of a share is 10€ nobody will buy it if we do not offer a discount, so the issuer tends to ask a lower price at the company's IPO. The evidence shows that this effect exists and is especially evident on the first day. How can we measure it? We calculate the return from the first day as: P − PIPO R= 1 PIPO where P1 is the closing price on the first day and PIPO is the price of the share offer. If this return is positive we have evidence of underpricing. The following table shows this return and the cost this discount implies for the companies. They are North American companies The following table contains international evidence of underpricing in different countries. 4 EVIDENCE OF UNDERPRICING IN IPOs Under pricing Germany 172 1978‐92 11.1 Belgium 28 1984‐90 10.2 Brazil 62 1979‐90 78.5 Chile 19 1982‐90 16.3 USA 10626 1960‐92 15.3 Spain 71 1985‐90 35 France 187 1983‐92 4.2 Italy 75 1985‐91 27.1 Japan 472 1970‐91 32.5 Mexico 37 1987‐90 33 Netherlands 72 1982‐91 7.2 Portugal 62 1986‐87 54.4 United Kingdom 2133 1959‐90 12 Sweden 213 1970‐91 39 Loughran, Ritter & Rydqvist (1994) and Ibbotson & Ritter (1995). Country Number of IPOs Period Not all the IPOs are underpriced and some are very successful Others are not. For example The first Stock Exchange placement offering of a company after a year and a half gets off to a bad start. The shareholders of Zinkia, the Spanish production company that created Pocoyo, have decided to abandon the Initial Public Offering (IPO). This decision arose after the stockmarket launch price had been set at 1.92 euros per share, below the trading range of between 2.65 and 4.09 euros initially set for the operation 5 4. Secondary Market Shares are traded on Stock Exchanges (organised markets). Electronic trading of shares began in Spain in 1989. The electronic system is run by Sociedad de Bolsas, S.A.; a company owned by the four Spanish Stock Exchanges. In November 1995 the platform for electronic trading was replaced by the current system: the SIBE (Spanish Stockmarket Interconnection System), entirely developed by the Madrid Stock Exchange. The SIBE is an order‐driven market, with real‐time information on screen and automatic reporting of trading information. Key Characteristics of SIBE The main characteristics of the market are: • Existence of a single price in each security for the four Spanish Stock Exchanges. • Continuous trading: 8 and a half hours of open trading (From 09:00 to 5:30), during which orders are placed and trades are carried out. • Opening and closing auctions: a period in which orders can be placed but trading is not carried out and the system calculates a price in equilibrium between supply and demand, in real time. Possibility of Volatility Auctions. These Volatility Auctions last for 5 minutes. • The unit of increment from one price to the next (Tick) is set according to the price of the security in question: o Prices lower than 50 Euros: 0.01 Euros. o Prices higher than 50 Euros: 0.05 Euros. • In the case of subscription rights, the unit of increment (Tick) is always 0.01 Euros regardless of the price. • The orders are ordered according to the criteria of price and when they were placed. If there is a counterparty to the price set in the order, it is carried out automatically; otherwise, it remains in an order book waiting for a Counterparty. • The market has two main phases : Open Market and suspended market. Types of order • Market orders: orders with no specific price limit, traded at best price from the opposite side of the order book on entry. If the order is not 6 completely filled against the first order from the opposite side, it will continue to be executed against as many prices from the opposite side as is necessary to complete it. If there is no counterparty for a market order, they are placed in the order book waiting for a counterparty. • “Market‐to‐limit” orders or Best price orders: these are orders without a price which are limited to the best bid from the opposite side of the order book. If there are no orders on the opposite side, the order is rejected. Both market orders and Best price orders have priority over limit orders. • Limit orders: these are orders to be executed at their limit price or better. If it is a buy order, it is executed at this price or at a lower price found on the opposite side of the book. If is a sale, it will be executed at the price limit or at a higher price found on the opposite side of the book. These orders allow the expression of a desire to trade up to/starting at a certain price, and to fill an order against existing orders on the market at a price no worse than the price limit, leaving the rest on the market at the price limit. • Hidden volume orders. These orders allow the participants to place orders without disclosing the full amount to the market. This possibility is especially interesting for large scale orders. In this way, the operator can avoid adverse price movements. On placing the order, the operators must show a part of the volume of the order (visible portion) which will be at least 250 shares. This visible portion is included in the book alongside the time of entry. Example of LO, MO and BPO. You are an investor that wants to buy 2,000 shares in the company Telefónica. The current status of the Order Book is as follows: Sale Purchase Vol. Price Price Vol. 1000 13.07 13.08 1250 1000 13.06 13.09 501 1000 13.05 13.10 457 The order is: MO Telefónica 20.00. Given that you have sent a MO, the transaction is carried out immediately. Buy 1,250 at 13.08, 501 at 13.09 and 249 at 13.10. The full amount of the transaction is 26,169.99 € plus commission. The status of the Order Book following the transaction is: Purchase Sale Vol. Price Price Vol. 1000 13.07 13.10 208 1000 13.06 1000 13.05 7 If instead of placing a MO we had placed a LO, you would have asked for a better price. For example, LO to buy 2,000 shares with a price limit of 13.07 €. The situation in the Order Book would be: Purchase Sale Vol. Price Price Vol. 13.08 1250 3,000 = 1,000 + 2,000 13.07 13.09 501 1000 13.06 13.10 457 1000 13.05 Another possibility would be to place a BPO for 2000 shares So you would have carried out a transaction for 1250 shares and the rest would be logged on the purchase side Sale Purchase Vol. Price Price Vol. 13.09 501 750 13.08 1000 13.07 13.10 457 1000 13.06 1000 13.05 Example of a Hidden volume order Imagine a market situation where we have the following OrderBook: Purchase Sale Vol. Price* Price* Vol. Hidden vol. 1000 10.49 10.51 250 1000 5000 10.40 10.51 100 There is a sale order for 1,250 securities with Hidden volume, in which the visible portion to be entered is set at 250. In the order book it is placed first owing to the order of priority (in other words, it was entered before the sale order for 100 securities at 10.51). When prices are equal, the order entered earliest is placed first. A purchase order for 200 securities is entered at 10.51 (positioned as the first purchase). In the book, this order entry is highlighted in red: Purchase Sale Vol. Price Price Vol. Hidden vol. 200 10.51 10.51 250 1000 1000 10.49 10.51 100 5000 10.4 And 200 shares come up at 10.51, leaving the order book as follows: Purchase Sale Vol. Price Price Vol. Hidden vol. 1000 10.49 10.51 50 1000 5000 10.4 10.51 100 Only 50 shares are shown, because until all of the visible portion is traded, more shares are not shown (does not increment to another visible portion). 8 A purchase order is then entered for 100 securities, at 10.51 (positioning it at the top of the purchase list). In the book, the entry of this order is shown in red: Purchase Sale Vol. Price Price Vol. Hidden vol. 100 10.51 10.51 50 1000 1000 10.49 10.51 100 5000 10.4 Given this situation in the Order Book, two transactions are matched. The first matches 50 shares with the Hidden volume order. The second transaction is for 50 shares against the order for 100 at 10.51. This is the case as the visible portion of 250 shares has been used up, the new order for 250 shares (additional visible portion) has lost priority and slips down the list. Trades are instantaneous, later it is not possible to visualise the previous window in the system, and the order book is left as follows: Purchase Sale Vol. Price Price Vol. Hidden vol. 1000 10.49 10.51 50 5000 10.4 10.51 250 750 Types of orders, by conditions for execution Limit orders, Best price orders and Market orders can have the following conditions for execution: • Excecute or cancel: this condition means that the part that matches with a counterparty will be executed immediately, and the system will reject the rest of the volume of the order. • Minimum volume: when this order enters the market, a minimum specified amount must be executed. If that minimum quantity is not executed, it is rejected by the system. • Fill or kill: this order must be executed in full on entry or rejected before trading. It is a special type of order with a minimum volume equal to the total value of the order. These conditions for execution are instantaneous and cannot be entered into auctions Example of fill or kill You want to buy 1,000 shares in the company Telefónica to complete your share portfolio. You decide to send a MO for 1,000 with an fill or kill condition. The current status of the Order Book is as follows: Purchase Sale Vol. Price Price Vol. 100 10.50 10.51 350 1000 10.49 10.52 100 5000 10.4 9 Given the status of the Order Book you carry out a purchase of 450 shares, but your order does not stay in the system awaiting the arrival of a new seller ‐ rather the system deletes the rest of the order. Example of Minimum volume You want to buy 2,000 shares in the company Telefónica to complete your share portfolio, and you need at least 1,000. You decide to place a MO for 2,000 with a minimum volume condition (1,000 shares). The current status of the Order Book is as follows: Purchase Sale Vol. Price Price Vol. 100 10.50 10.51 350 1000 10.49 10.52 100 5000 10.40 Given the status of the Order Book, you do not make a purchase. The entire order is rejected by the system. If there are enough shares to complete the minimum volume, the transaction will be carried out and the rest will be left. The same would happen for this order with an fill or kill condition. In general, once entered orders can • Be modified: all data for an order entered and not executed can be modified, except the direction (purchase or sale) and the security to be traded. Price modifications and increases in volume lead to a loss of priority for the order. • Be cancelled: It is possible to cancel the outstanding part of an order or group of orders. • Expiry of orders: When entering an order it is possible to set a duration: (i) Valid for the current session, (ii) Valid until a set date, (iii) Valid for 90 days. Open Market. The Open Market phase in any continuous market is defined as the phase during which purchase orders are placed, and in addition trading is carried out. The fact that trading occurs is what distinguishes it from a suspended market. The Spanish Open Market is characterised by the existence of different trading options and different market sections. Trading options In the Spanish market we have two trading options: • Continuous trading. This type of trading is based on a continuous order‐driven market ‐ in other words, with an order book for each instrument, with an opening auction to launch the session and with a closing auction at the end of the session. • Instruments in ongoing auction or trading of securities with single set prices: fixing. 10 The securities included in this system are quoted for the whole session in an auction, with two share allocation periods, thus facilitating efficient pricing and decreasing volatility. The inclusion in one or other system does not depend on the company but rather on the Stock Exchange, and the reason the market uses for transferring an asset from one system to another is the effective trading volume in this instrument. The two trading options are mutually exclusive, so the trading of a company's shares in one option makes it impossible to do so in the other. Sections of the market1 The sections of the market attempt to cover the peculiarities of certain customers or of certain securities. This allows for diversity in a market that, on the other hand, relies on a single electronic system. In the Spanish market there are four large market sections: • Latibex: this comprises Latin American securities quoted in euros on the SIBE system. • Block trades market: in this section large volume operations are communicated during the open orders market session. • Special operations market: after the orders market closes authorized or communicated operations are reported that must comply with some cash and price requirements. • Alternative Stockmarket (MAB): a section of the market specially designed for companies with low capitalisation and collective investment schemes (SICAV). MAB and Latibex are systems characterised by the instruments they cover, while the Block trades market and Special operations market are characterised by the size of the transactions carried out in them. Suspended market. The suspended market or auction phase can be understood in broad terms as that market phase when orders can be placed but not executed ‐ i.e. transactions are not carried out. It is important to be clear about the concept of auctions. We can distinguish between three types of auctions, not in terms of their organisation but rather for the moment when they occur and the circumstances that cause them: • Opening auction. The session begins with the Opening auction, a phase in which the order book is partially visible. Only the equilibrium price of the auction is shown, as well as the purchase and sale volumes that could be traded at this price, and the number of orders associated with these volumes. If 1 A complete description can be found in the document marketmodel.pdf 11 there is no auction price, the best purchase and sale price is shown with associated volumes (and number of orders). During this phase, participants can enter, modify or cancel orders, but never carry out trading. All orders from previous days that remain in the book, and those entered during the Opening auction take part. The Opening auction has a duration of 30 minutes with a (random end) of 30 seconds, which helps to avoid price manipulation. Following this random end comes the allocation of shares, where securities that could be executed at the equilibrium price set in the auction are traded. While this allocation process happens, orders cannot be placed, modified or cancelled. In exceptional circumstances, the Opening auction can be extended. Once the allocation of shares has finalised, the members receive information on the full or partial execution of their orders. All orders not executed in the allocation of shares remain in the order book. The market is informed of the opening price, volume traded, time of each trade and identity of the parties. At this moment, the open market situation begins. • Closing auction. The session ends with a 5 minute auction, with the same characteristics as the Opening auction, between 5:30 and 5:35pm with a 30 second random end. The price that results from this auction is the closing price of the session. In exceptional circumstances the Closing auction may be extended. The Closing auction was introduced into the SIBE on 1st June 2000 in order to set up a more efficient system for setting closing prices. The closing prices for instruments are very important, not only for the information they transmit to the market but because some of the instruments act as underlying instruments in the trading and settlement of derivatives: futures, options, etc. • Volatility auction. The duration of the Volatility Auctions on the SIBE is 5 minutes plus a 30 second random end. Volatility Auctions can occur when a static or a dynamic trading range is broken. The aim is to correct a rise or fall that moves outside of the normal trading limits set by the Stock Exchange. They normally avoid large swings in prices on rumours, unexpected news, errors on the part of market operators, etc. However, the auctions do not avoid sharp rises or falls in daily share prices, as once finalised the volatility auction ends a new range is set at a higher Level (if the share is rising), or lower (if it is falling), which may be broken again, provoking a new auction, and so on. The static and dynamic ranges are calculated with the recent historical volatility of securities. They are unique to a security, they are public and are updated periodically, so that they gradually adapt to the new characteristics that each security acquires as time goes by. 12 Static ranges define the maximum variation allowed (symmetrical) in the static price, and are expressed as a percentage. The static price is the price set at the latest auction (allocation price at the auction). Dynamic ranges, on the other hand, define the maximum variation allowed (symmetrical) in the dynamic price, and are expressed as a percentage. The dynamic price is the price set in the latest trade. Volatility auction for static range (real example). 15,5 15,25 15 14,75 14,5 14,25 Gráfico 1: UNIPAPEL (14 de MAYO de 2001) SUBASTA POR VOLATILIDAD POR RANGO ESTÁTICO
14,43 EUR, PRECIO DETONANTE DE LA SUBASTA (NO HAY NEGOCIACIÓN A DICHO PRECIO)
14,25 EUR, NUEVO PRECIO ESTÁTICO RESULTANTE DE LA SUBASTA POR VOLATILIDAD PRECIO 14 13,75 13,5 13,25 13 12,75 SUB. AP.
12,5 12,25 MERCADO ABIERTO SUBASTA VOLATILIDAD MERCADO ABIERTO 8: 44 :5 7 9: 12 :4 6 10 :0 4: 00 10 :3 0: 03 10 :4 2: 41 10 :4 4: 28 10 :5 2: 28 11 :2 6: 25 11 :3 0: 15 11 :4 6: 55 11 :5 2: 30 11 :5 7: 28 12 :1 3: 52 12 :4 9: 01 12 :4 9: 24 12 :4 9: 25 12 :5 0: 34 12 :5 2: 19 12 :5 3: 45 12 :5 4: 44 14 :1 9: 54 14 :4 1: 47 14 :4 8: 04 15 :1 8: 16 16 :5 8: 06 8: 30 :0 0 HORA
PRECIO LIMITE ESTÁTICO MAX LIMITE ESTÁTICO MIN Fuente: Sociedad de Bolsas, S.A. Volatility auction for dynamic range (real example). Gráfico 2: AZKOYEN (14 de MAYO de 2001) SUBASTA POR VOLATILIDAD POR RANGO DINÁMICO
SE PRODUCE UNA BARRIDA PROVOCADA POR UNA ORDEN DE VENTA 8,75 SEÑALA EL RANGO DINÁMICO 8,5 PRECIO 8,25 8 7,75 7,9 EUR, PRECIO DETONANTE DE LA SUBASTA (NO HAY NEGOCIACIÓN A DICHO PRECIO) SUB. APERTURA MERCADO ABIERTO SUB. VOLATILIDAD MERCADO ABIERTO 7,5 7,25
8: 30 :0 8: 0 32 :1 8: 6 39 :4 8: 1 44 :1 8: 9 53 :4 8: 6 59 :4 9: 8 01 :5 9: 9 04 :5 9: 5 06 :1 9: 9 08 :0 9: 0 09 :4 9: 6 10 :1 9: 5 11 :0 9: 2 12 :5 9: 9 18 :3 9: 3 21 :5 9: 0 24 :0 9: 8 30 :0 9: 0 39 :5 9: 0 41 :0 9: 5 41 :3 9: 4 42 :1 9: 8 42 :5 9: 9 44 :1 9: 0 44 :5 9: 2 45 :0 9: 6 45 :2 9: 5 46 :0 9: 4 46 :2 9: 7 47 :3 9: 9 47 :5 9: 4 48 :5 9: 9 49 :4 9: 1 50 :2 9: 4 50 :5 9: 5 51 :1 9: 0 53 :3 9: 3 54 :4 9: 6 55 :2 9: 3 56 :0 9: 3 56 :4 9: 8 59 :0 9: 6 59 10 :54 :0 0: 25 HORA
PRECIO LIMITE ESTÁTICO MAX LIMITE ESTÁTICO MIN Fuente: Sociedad de Bolsas, S.A. Stockmarket Indices On the leading stockmarkets, a large number of securities are quoted, whose prices continually fluctuate. Since these fluctuations are not parallel in all securities, it becomes necessary to have indicators or instruments that summarise the aggregate movement of prices in these markets. This is the fundamental role of stockmarket indices. 13 The role of stockmarket indices is not merely informative, however. They are often used as benchmarks in portfolio management (benchmark). They serve as an underlying instrument for a large number of derivative products To build an index we must achieve representativeness and generality. To achieve this we must • Choose a number of securities whose relative weighting, in terms of both trading volume and capitalisation, is large enough to be considered representative of the market (often considered more than 50%). We have between 30 and 500. • Weighting and averaging method: Arithmetical measures are normally used (ordinary or weighted). In general the members of the indices will be weighted by stockmarket capitalisation (e.g. S&P500) or by the price of their own shares (e.g. Dow Jones). In some cases the weighting is corrected for “free float” (real percentage of the shares that are available for trading on the Stock Exchange) of the company (e.g. IBEX) • The Base Level is often similar for different indices, normally taking a value of 100 or 1000. However, as for the Base Period, there is a complete disparity of methods, with some indices over more than 50 years and other less than 5. Some good examples of indices are the IGBM and the IBEX®‐35. 14 ...
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This note was uploaded on 02/03/2011 for the course ECON 101 taught by Professor Flora during the Spring '11 term at Universidad Carlos III de Madrid.
- Spring '11