1. Fundamentals of Investments2
C h a p t e r
Buying and Selling Securities
Fundamentals of Investments
Valuation & Management
second edition
Charles J. Corrado Bradford D. Jordan
McGraw Hill / Irwin
Slides by Yee-Tien (Ted) Fu

2. If it goes up, sell it. If it doesn’t go up, don’t buy it.
First you buy a stock.
First you buy a stock.
If it goes up, sell it. If it doesn’t go up, don’t buy it.
– Will Rogers

3. Buying and Selling Securities
Goal
This chapter covers the basics of the investing process.
We begin by describing how you go about buying and selling securities such as stocks and bonds.
Then we outline some important considerations and constraints to keep in mind as you get more involved in the investing process.

4. Getting Started Open a brokerage or trading account Deposit money
Buy securities
Sell securities
Withdraw money
from account
Deposit money
into account
Close account

5. Choosing a Broker
The first step in opening an account is choosing a broker . brokers are traditionally divided into three groups :
Full service brokers
Discount brokers
Deep discount brokers
What distinguish the three groups is the level of service they provide and the resulting commissions they charge .

6. Choosing a Broker
With deep discount broker : essentially the only services provided are account maintenance and order execution that is " buying and selling "
With full service broker will provide investment advice regarding the types of securities and investment strategies that might be appropriate for you to consider ( or avoid ) , the large brokerage firms do extensive research on individual companies and securities and maintain lists of recommended securities .a full service broker will even manage your account for you if you wish .
With discount broker , with fall somewhere between the two cases , offering more investment counseling than the deep discounters and lower commissions than the full service brokers .

7. Which type of broker should you choose ?
It depend on how much advice and service you want . if you are the do –it –yourself type then you may seek out the lower commissions , if you are not ,then a full service broker might be more suitable .
Often investors begin with a full service broker , and then as they gain experience and confidence , move on to a discount broker .

8. Online broker
The most important recent change in the brokerage industry is the rapid growth of online brokers , also known as e- brokers or cyber brokers . with an online broker , you place buy and sell orders over the internet using a web browser .
online brokers will almost surely become the dominant form because of their enormous convenience and the low commission rates.

9. Choosing a Broker Commissions Level of
# of shares ($50/share)
Full-Service Brokers
A.G. Edwards $150 $200 $300
Merrill Lynch
Discount Brokers
Charles Schwab $100 $125 $150
Fidelity Brokerage
Deep-Discount Brokers
Olde Discount $50 $75 $100
Quick & Reilly
Provides extensive investment advice
Maintains account and executes buy/sell orders only
Level of
Service

10. Choosing a Broker
However, as the brokerage industry becomes more competitive, the differences among the broker types seem to be blurring.
Another important change is the rapid growth of online brokers, also known as e-brokers or cyberbrokers.
Online investing has fundamentally changed the discount and deep-discount brokerage industry by slashing costs dramatically.

11. Choosing a Broker Broker Commission for Simple Trade
Charles Schwab $29.95, up to 1000 shares 
Fidelity Investments $25, up to 1000 shares 
CSFBdirect $20, up to 1000 shares 
E*Trade $14.95, up to 5000 shares 
TD Waterhouse $12, up to 5000 shares 
Ameritrade $8, no share limits 

12. Security Investors Protection Corporation
Security Investors Protection Corporation (SIPC)
Insurance fund covering investors’ brokerage accounts with member firms.
Most brokerage firms belong to the SIPC, which insures each account for up to $500,000 in cash and securities, with a $100,000 cash maximum.
Note that SIPC does not guarantee the value of any security.

13. Security Investors Protection Corporation
As you probably aware , when you deposit money in a bank , your account is normally protected (up to 100,000 $ ) by the federal deposit insurance corporation or FDIC , which is an agency of the U.S government . however , brokerage firms ,even though they are often called investment banks , can not offer FDIC coverage . most brokerage firms do belong to the SIPC which was created in the SPIC insures your account for up to (500,000$ in cash and securities ,with a 100,000 $ cash maximum )

14. Security Investors Protection Corporation
SIPC is not a government agency , it is a private fund supported by the securities industry . however in the USA all the brokerage firma operating in it , must be a member of the SPIC .
NOTE ;that under SPIC your money are not guaranteed , so you can lose every thing in an SPIC covered account if the value of your securities falls to zero .

15. Broker-Customer Relations
There are several important things to keep in mind when dealing with a broker.
Any advice you receive is not guaranteed.
Your broker works as your agent and has a legal duty to act in your best interest. On the other hand, brokerage firms are in the business of generating brokerage commissions.
Finally , in the unlikely event of a significant problem , your account agreement will probably specify very closely that you must waive your right to sue or seek a jury trial , instead you are going to agree that any disputes will be settled by arbitration and that arbitration is final and binding .

16. Brokerage Accounts Margin account
Cash account
A brokerage account in which all transactions are made on a strictly cash basis.
So securities can be purchased to the extent that sufficient cash is available in the account .
Margin account
A brokerage account in which, subject to limits, securities can be bought and sold on credit.

17. Margin Accounts
Those securities purchased on credit using money loaned to you by your broker ,such a purchase is called a margin purchase . the interest rate you pay on the money you borrow is based on the broker's call money rate , which is the rate the broker pays to borrow the money , so you pay some a mount over the call money rate , called the spread , which depend on your broker and the size of the loan .

18. Margin Accounts
Margin : the portion of the value of an investment that is not borrowed .
In general , when you purchase securities on credit , some of the money is yours and the rest is borrowed . the amount that is yours called the margin .
Margin is usually expressed as a percentage , for example :
If you take 7000 $ of your own money and borrow an additional 3000 $ from your broker , your total investment will be 10,000 $ , 7000 $ from you ,and the margin is 10,000 /7000 =70%

19. Liabilities & Account Equity
Margin Accounts
Example: The Account Balance Sheet
You want to buy 1000 Wal-Mart shares at $24 per share. You put up $18,000 and borrow the rest.
Amount borrowed = $24,000 – $18,000 = $6,000
Margin = $18,000 / $24,000 = 75%
Liabilities & Account Equity
Assets
1000 WM shares $24,000 Margin loan $ 6,000
Account equity 18,000
Total $24, Total $24,000

20. Margin Accounts
In a margin purchase, the minimum margin that must be supplied is called the initial margin.
The maintenance margin is the minimum margin that must be present at all times in a margin account.
When the margin drops below the maintenance margin, the broker may demand for more funds. This is known as a margin call.
Note : there is little initial margin requirement for government bonds . on the other hand , margin is not allowed at all on certain other types of securities .

21. Liabilities & Account Equity
Margin Accounts
Example: Margin Requirements
Your account requires an initial margin of 50% and a maintenance margin of 30%. Stock A is selling at $50 per share. You have $20,000, and you want to buy as much of stock A as you possibly can.
You may buy up to $20,000 / 0.5 = $40,000 worth of shares.
Liabilities & Account Equity
Assets
800 A shares $40,000 Margin loan $20,000
Account equity 20,000
Total $40, Total $40,000

22. Liabilities & Account Equity
Margin Accounts
Example: Margin Requirements
After your purchase, the share price of stock A falls to $35 per share.
Liabilities & Account Equity
Assets
800 A shares $28,000 Margin loan $20,000
Account equity 8,000
Total $28, Total $28,000
New margin = $8,000 / $28,000 = 28.6% < 30% Therefore, you are subject to a margin call.

23. Calculating initial margin
Suppose you have 6000$ in cash , in a trading account with a 50% as initial requirement , what is the largest order you can place ? if the initial margin were 60% how would your answer change ?
When the initial margin 50% the total order is $
When the initial margin 60% the total order = 6000/60% = $

24. Maintenance margin
Maintenance margin : the minimum margin that must be present at all times in a margin account .this level is established by the broker , and depend on what you are buying as example for low –priced and very volatile stocks , the house margin ( maintenance margin ) can be as high as 100% meaning no margin at all .
Atypical maintenance margin will be 30% , if your margin falls below 30% ,then you may be subject to a margin call : demand for more funds that occurs when the margin in an account drops below the maintenance margin .
If you do not comply ,your securities may be sold , the loan will be repaid out of the proceeds , and any remaining amount will be credited to your account .

25. Margin Accounts Margin is a form of financial leverage.
When you borrow money to make an investment, the impact is to magnify both your gains and your losses.

26. Calculating the critical price
You can calculate the critical price ( the lowest price before you get a margin call) as follows :
P* = amounts borrowed /number of shares
_______________________________
1 – maintenance margin
For example : suppose you had a margin loan of 40,000$ ,which you used to purchase in part , 1000 shares . the maintenance margin is 37.5 % , what is the critical stock price , and how do you interpret it ?
P* = (40,000$ / 1000 ) / ( 1 – 37.5% )
P* = 40$ / = 64 $

27. A Note on Annualizing Returns
To compare investments, we will usually need to express returns on a per-year, or annualized, basis.
Such a return is often called an effective annual return (EAR).
1 + EAR = (1 + holding period % return)m
where m is the number of holding periods in a year.
Percentage return = ( P1+ T – PT ) / PT =(85 – 80 ) / 80 $ = 6.25 %
The percentage 6.25% is your return for the three month holding period , but what does this return amount to on a per-year basis ? we need to convert this return to an annualizes return , meaning a return expressed on per –year basis .
This called an effective annual return : the return on an investment expressed on a per–year or annualized basis .
= ( ) 4 =
So the annual return is %

28. Hypothecation and Street Name Registration
Pledging securities as a collateral against a loan, so that the securities can be sold by the broker if the customer is unwilling or unable to meet a margin call.
Street name registration
An arrangement under which a broker is the registered owner of a security.
The account holder is the “beneficial owner.”

29. Street name registration
Some of the benefit of street name ownership :
1- since the broker holds the security , there is no danger of theft or other loss of the security .
2- any dividends or interest payments are automatically credited , and they are often credited more quickly .
3- the broker provides regular account statements showing the value of securities held in the account and any payments received , also for tax purposes the broker will provide all the needed information on a single form at the end of the year , greatly reducing the owner's record –keeping requirements .

30. Other Account Issues
If you do not to manage your account yourself , you can set up an advisory accounts , you pay someone else to make buy and sell decisions on your behalf .
Trading accounts can also be differentiated by the ways they are managed.
Advisory account - You pay someone else to make buy and sell decisions on your behalf.
Wrap account - All the expenses associated with your account are “wrapped” into a single fee.
Discretionary account - You simply authorize your broker to trade for you.
Asset management account - Provide for complete money management, including check-writing privileges, credit cards, and margin loans.

31. Other Account Issues
To invest in financial securities, a brokerage account is not a necessity.
One alternative is to buy securities directly from the issuer.
Another alternative is to invest in mutual funds.

32. Short Sales
Short sale
A sale in which the seller does not actually own the security that is sold.
Borrow
shares
from
broker
Sell the
Buy
market
Return
the
Note that an investor who buys and owns shares of stock is said to be long in the stock or to have a long position.

33. Short Sales
An investor with a long position benefits from price increases.
Buy low,
sell high!
On the other hand, an investor with a short position benefits from price decreases.
Sell high,
buy low!

34. Liabilities & Account Equity
Short Sales
Example: Short Sales
You want to short 100 Sears shares at $30 per share. Your broker has a 50% initial margin and a 40% maintenance margin on short sales.
Worth of stock borrowed = $30 × $100 = $3,000
Liabilities & Account Equity
Assets
Proceeds from sale $3,000 Short position $ 3,000
Initial margin deposit 1,500 Account equity 1,500
Total $4, Total $4,500

35. Liabilities & Account Equity
Short Sales
Example: Short Sales …continued
Scenario 1: The stock price falls to $20 per share.
Liabilities & Account Equity
Assets
Proceeds from sale $3,000 Short position $ 2,000
Initial margin deposit 1,500 Account equity 2,500
Total $4, Total $4,500
New margin = $2,500 / $2,000 = 125%

36. Liabilities & Account Equity
Short Sales
Example: Short Sales …continued
Scenario 2: The stock price rises to $40 per share.
Liabilities & Account Equity
Assets
Proceeds from sale $3,000 Short position $ 4,000
Initial margin deposit 1,500 Account equity 500
Total $4, Total $4,500
New margin = $500 / $4,000 = 12.5% < 40% Therefore, you are subject to a margin call.

37. Short Sales
You can calculate the critical price on a short sale ( the highest price before you get a margin call) as follows :
P* = (initial margin deposit + short proceeds ) / number of shares
_______________________________
1 + maintenance margin
For example : suppose you shorted 1000 shares at 50 $ , the initial margin is 50 % and the maintenance margin is 40 % . what is the critical stock price , and how do you interpret it ?
P* ={ ( ) / ( 1000 shares ) } / ( % )
P* = $

38. Short Sales Short interest
The amount of common stock held in short positions.
In practice, short selling is quite common and a substantial volume of stock sales are initiated by short sellers.
Note that with a short position, you may lose more than your total investment, as there is no limit to how high the stock price may rise.

39. Investor objectives , constraints , and strategies
Different investors will have very different investment objectives and strategies , for example some will be very active , buying and selling frequently , others
Will be relatively inactive , buying and holding for long periods of time .
Investment mean that we simply deferred consumption , instead of spending today , we choose to wait because we wish to have more to spend later so there are no difference between investing and saving .
The particular investment strategy will be chosen depend on among other things : willingness to bear risk , the time horizon , and taxes .

40. Risk and Return
In formulating investment objectives, the individual must balance return objectives with risk tolerance.

41. Investor Constraints
Resources. What is the minimum sum needed? What are the associated costs?
Horizon. When do you need the money?
Liquidity. How high is the possibility that you need to sell the asset quickly?
Taxes. Which tax bracket are you in?
Special circumstances. Does your company provide any incentive? What are your regulatory and legal restrictions?

42. Strategies and PoliciesBe
Passive!
Active!
Investment management. Should you manage your investments yourself?
Market timing. Should you try to buy and sell in anticipation of the future direction of the market?

43. Strategies and PoliciesBe
Passive!
Active!
Asset allocation. How should you distribute your investment funds across the different classes of assets?
Security selection. Within each class, which specific securities should you buy?

44. Strategies and Policies
A useful way to distinguish asset allocation from security selection is to note that assets allocation is essentially a macro-level activity because the focus is on whole markets or classes of assets .security selection is a much more micro –level activity because the focus is on individual securities .

45. Chapter Review Getting Started Choosing a Broker Online Brokers
Security Investors Protection Corporation
Broker-Customer Relations

46. Chapter Review Brokerage Accounts Cash Accounts Margin Accounts
A Note on Annualizing Returns
Hypothecation and Street Name Registration
Other Account Issues

47. Chapter Review Short Sales
Basics of a Short Sale
Some Details
Investor Objectives, Constraints, and Strategies
Risk and Return
Investor Constraints
Strategies and Policies