FIN401- Chapter 3

FIN401- Chapter 3 - Chapter 3 Chapter Securities Markets...

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Unformatted text preview: Chapter 3: Chapter Securities Markets The Role of Financial Markets The Help firms and governments Help raise cash by selling claims against themselves selling Provide a place where investors can act Provide on their beliefs on Help allocate cash to where it is most Help productive productive Help lower the cost of exchange Help lower Types of Markets Types Primary markets: where new securities are where sold for the first time sold Secondary markets: where existing where securities trade securities Issuing New Securities Issuing Initial public offering (IPO): Initial private company goes public company Seasoned issues: existing companies sell Seasoned new securities to raise more capital new Issue facilitated by investment banker Issue investment » Specialists in advice, design, and sales Specialists advice, » Intermediaries between issuer and investor Intermediaries Investment Banking Investment Underwritten vs. best efforts → Underwritten: firm commitment; bank assumes Underwritten: risk of selling to investors risk → Best efforts: no firm commitment Best Negotiated vs. competitive bid → Negotiated: issuing firm negotiates terms with Negotiated: issuing investment bank investment → Competitive bid: issuer structures the offering Competitive and secures the bid and Relationship Among a Firm Issuing Securities, the Underwriters and the Public the Investment Banking Investment SEC Rule 415 (shelf rule): sell new SEC securities over time after filing a single securities registration registration Reduces Reduces issuance cost issuance Private placement: new securities are sold directly to investors, bypassing the open market market Registration not required Initial Public Offerings Initial Process → Road shows Road → Book building Book Underpricing → Post sale returns Post → Cost to the issuing firm Cost A Tombstone Advertisement Tombstone Secondary Markets Secondary Markets where investors trade previously issued securities issued In the U.S., listed stocks trade in 2 major In markets: NYSE, Nasdaq NYSE, Stocks not listed in any market are Stocks considered to be over-the-counter securities securities Auction Markets Auction Auction markets involve Auction bidding in a specific physical location specific Brokers represent investors for a fee Others trade their own account Auction Markets Auction Organized exchanges » Examples: NYSE, Regionals, CME » Members purchase a seat on the Members purchase exchange; gives them the right to trade and right have a say in the governance of the have exchange exchange NYSE NYSE Specialists: make a market in a stock make Electronic order placement is growing; large orders still require human intervention orders Nasdaq Nasdaq Largest organized stock market for OTC Largest trading trading » Dealers make a market; profit from spread between buy and sell prices between Computerized market with an Computerized electronic trading system trading Securities: stocks, most bonds, some Securities: derivatives derivatives Other Markets Other OTC stocks are OTC not listed or traded on an organized exchange organized OTC Bulletin Board » Pink sheets Pink Electronic Communication Networks Electronic (ECNs): Additional trading mechanism Additional Market Consolidation Trends Market NYSE: » merged with Archipelago ECN in 2006 » merged with Euronext in 2007 » acquired ASE in 2008 Nasdaq: » acquired Instinet/Island in 2005 acquired » acquired Boston Stock Exchange in 2007 acquired CME acquired CBOT in 2007 Market Capitalization of Major Exchanges Major Trading Costs Trading Brokerage commissions differ by security, broker, Brokerage and investor and → Institutional investors have negotiating power Institutional → Brokers earn a commission for executing a Brokers trade trade Spread: Cost of trading with a dealer Spread: Cost → Bid: price dealer will buy from you price Ask: price dealer will sell to you price » Ask price – Bid price > 0 (dealer spread) Types of Orders Types Market orders: Authorizes immediate transaction at best available price best Limit orders: Specifies a particular market price Stop orders: Specifies a particular market price at which a market order is authorized which Order timing → IOC: immediate or cancelled (“fill or kill”) immediate → Day: by default by → GTC: good until cancelled (usually 60 days max) good Buying on Margin Buying Borrowing money to purchase stock Margin is percent of total value that a Margin customer has as equity in the transaction customer » The part that cannot be borrowed from The broker broker Initial margin requirement (IMR): Initial » Set by the Fed the » Currently 50% for stocks 50% » The minimum % initial investor equity initial Stock Margin Accounts Stock Maintenance margin: minimum amount minimum equity in trading account can be before additional funds must be added additional Margin call: notification from broker that notification you must put up additional funds you Margin Trading - Initial Conditions Margin Z Corp $70 50% Initial Margin 40% Maintenance Margin 1000 Shares Purchased Initial Position Stock $70,000 Borrowed $35,000 Borrowed Equity $35,000 Equity Margin Trading - Maintenance Margin Margin Stock price falls to $60 per share Stock $60 New Position Stock $60,000 Borrowed $35,000 $35,000 Equity $25,000 Equity Margin% = $25,000 Margin% $25,000 = $60,000 = 41.67% 41.67% Margin Trading - Margin Call Margin How far can the stock price fall before a margin call? Equity / Market value = margin % 1000P – Amt Borrowed = Equity (1000P- $35,000) / 1000P = 40% P = $58.33 Short Sales Short Purpose: Purpose: to profit from a decline in the price to of a stock or security of Mechanics → Borrow stock through a dealer Borrow → Sell it → Deposit proceeds and margin in an account Deposit → Closing out the position: buy the stock and return to the party from which it was borrowed return Investor liable for Investor declared dividends declared Short Sale - Initial Conditions Short Q Corp 50% 30% $100 100 Shares Initial Margin Maintenance Margin Initial Price Sale Proceeds Margin (Equity) Stock Owed $10,000 $5,000 $10,000 Short Sale - Maintenance Margin Short Stock Price Rises to $110 Stock $110 Sale Proceeds $10,000 $10,000 Initial Margin $5,000 Stock Owed $11,000 Net Equity $4,000 Margin % = (4000/11000) = 36% Short Sale - Margin Call Short How much can the stock price rise before a How margin call? margin Equity / Market value = margin % ($15,000* - 100P) / (100P) = 30% *Initial margin plus sale proceeds P = $115.38 $115.38 Federal Regulation Federal Securities Act of 1933: regulates new issues Securities Exchange Act of 1934: regulates regulates secondary markets, established SEC secondary Investment Company Act of 1940: regulates regulates mutual funds, closed-end funds mutual Securities Investor Protection Act of 1970: protects investors from losses if brokerage firms fail fail Regulation Regulation SEC administers all securities law » Also monitors public securities transactions monitors » Requires issuer registration Requires » Investigates indications of violations such as Investigates insider trading insider ...
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