Presentation is loading. Please wait.

Presentation is loading. Please wait.

3 Securities Markets Bodie, Kane, and Marcus

Similar presentations

Presentation on theme: "3 Securities Markets Bodie, Kane, and Marcus"— Presentation transcript:

1 3 Securities Markets Bodie, Kane, and Marcus
Essentials of Investments, 9th Edition

2 3.1 How Firms Issue Securities
Primary vs. Secondary Market Security Sales Primary New issue created/sold Key factor: Issuer receives proceeds from sale Public offerings: Registered with SEC; sale made to investing public Private offerings: Not registered; sold only to limited number of investors with restrictions on resale Secondary Existing owner sells to another party Issuing firm doesn’t receive proceeds, is not directly involved

3 3.1 How Firms Issue Securities
Privately Held Firms Up to 499 shareholders Fewer obligations to release financial statements to public Private placement: Primary offerings sold directly to a small group of investors

4 3.1 How Firms Issue Securities
Publicly Traded Companies Sell securities to the general public; allow investors to trade shares in securities markets Initial public offering: First sale of stock by a formerly private company Underwriters: Purchase securities from issuing company and resell them Prospectus: Description of firm and security being issued

5 Figure 3.1 Relationship among a Firm Issuing Securities, the Underwriters, and the Public

6 3.1 How Firms Issue Securities
Shelf Registration SEC Rule 415 Security is preregistered and then may be offered at any time within the next two years 24-hour notice: Any or all of preregistered amount may be offered Introduced in 1982 Allows timing of issues

7 3.1 How Firms Issue Securities
7 3.1 How Firms Issue Securities Initial Public Offerings Issuer and banker put on “road show” Purpose: Bookbuilding and pricing Underpricing Post-initial sale returns average 10% or more—“winner’s curse” problem? Easier to market issue; costly to issuing firm

8 Figure 3.2 Average First-Day Returns for European IPOs

9 Figure 3.2 Average First-Day Returns for Non-European IPOs

10 3.2 How Securities Are Traded
1010 3.2 How Securities Are Traded Functions of Financial Markets Overall purpose: Facilitate low-cost investment Bring together buyers and sellers at low cost Provide adequate liquidity by minimizing time and cost to trade and promoting price continuity Set and update prices of financial assets Reduce information costs associated with investing

11 3.2 How Securities Are Traded
Types of Markets Direct Search Markets Buyers and sellers locate one another on their own Brokered Markets Third-party assistance in locating buyer or seller Dealer Markets Third party acts as intermediate buyer/seller Auction Markets Brokers and dealers trade in one location Trading is more or less continuous

12 3.2 How Securities Are Traded
Types of Orders Market order: Execute immediately at best price Bid price: price at which dealer will buy security Ask price: price at which dealer will sell security Price-contingent order: Buy/sell at specified price or better Limit buy/sell order: specifies price at which investor will buy/sell Stop order: not to be executed until price point hit

13 Figure 3.3 Average Market Depth for Large (S&P 500) and Small (Russel 2000) Firms

14 Figure 3.4 Limit Order Book for Intel on the NYSE Arca Market, July 22, 2011

15 3.2 How Securities Are Traded
Trading Mechanisms Dealer markets Over-the-counter (OTC) market: Informal network of brokers/dealers who negotiate securities sales NASDAQ stock market: Computer-linked price quotation system for OTC market Electronic communication networks (ECNs) Computer networks that allow direct trading without market makers Specialist markets Specialist: Makes market in shares of one or more firms; maintains “fair and orderly market” by dealing personally

16 Figure 3.5 Price-Contingent Orders

17 3.3 The Rise of Electronic Trading
Timeline of Market Changes 1969: Instinet (first ECN) established 1975: Fixed commissions on NYSE eliminated Congress amends Securities and Exchange Act to create National Market System (NMS) 1994: NASDAQ scandal SEC institutes new order-handling rules NASDAQ integrates ECN quotes into display SEC adopts Regulation Alternative Trading Systems, giving ECNs ability to register as stock exchanges

18 3.3 The Rise of Electronic Trading
Timeline of Market Changes 1997: SEC drops minimum tick size from 1/8 to 1/16 of $1 2000: National Association of Securities Dealers splits from NASDAQ 2001: Minimum tick size $.01 2006: NYSE acquires Archipelago Exchanges and renames it NYSE Arca SEC adopts Regulation NMS, requiring exchanges to honor quotes of other exchanges

19 Figure 3.6 Effective Spread vs. Minimum Tick Size

20 3.4 U.S. Markets NASDAQ New York Stock Exchange (NYSE) ECNs
Approximately 3,000 firms New York Stock Exchange (NYSE) Stock exchanges: Secondary markets where already-issued securities are bought and sold NYSE is largest U.S. Stock exchange ECNs Latency: Time it takes to accept, process, and deliver a trading order

21 Figure 3.7 Market Share of Trading in NYSE-Listed Shares

22 3.5 New Trading Strategies
Algorithmic Trading Use of computer programs to make rapid trading decisions High-frequency trading: Uses computer programs to make very rapid trading decisions in order to compete for very small profits Dark Pools ECNs where participants can buy/sell large blocks of securities anonymously Blocks: Transactions of at least 10,000 shares

23 Figure 3.8 Market Capitalization of Major World Stock Exchanges, 2011

24 3.6 Globalization of Stock Markets
Moving to automated electronic trading Current trends will eventually result in 24- hour global markets Moving toward market consolidation

25 3.7 Trading Costs Commission: Fee paid to broker for making transaction Spread: Cost of trading with dealer Bid: Price at which dealer will buy from you Ask: Price at which dealer will sell to you Spread: Ask — bid Combination: On some trades both are paid

26 3.8 Buying on Margin Margin: Describes securities purchased with money borrowed in part from broker Net worth of investor's account Initial Margin Requirement (IMR) Minimum set by Federal Reserve under Regulation T, currently 50% for stocks Minimum % initial investor equity 1 − IMR = Maximum % amount investor can borrow

27 3.8 Buying on Margin Equity Maintenance Margin Requirement (MMR)
Position value – Borrowing + Additional cash Maintenance Margin Requirement (MMR) Minimum amount equity can be before additional funds must be put into account Exchanges mandate minimum 25% Margin Call Notification from broker that you must put up additional funds or have position liquidated

28 3.8 Buying on Margin If Equity / Market value  MMR, then margin call occurs (Market value – Borrowed) / Market Value  MMR; solve for market value A margin call will occur when: Market value = Borrowed/(1 − MMR)

29 3.8 Buying on Margin Margin Trading: Initial Conditions
X Corp: Stock price = $70 50%: Initial margin 40%: Maintenance margin 1000 shares purchased Initial Position Stock $70,000 Borrowed $35,000 Equity

30 3.8 Buying on Margin Stock price falls to $60 per share
Position value – Borrowing + Additional cash Margin %: $25,000/$60,000 = 41.67% How far can price fall before margin call? Market value = $35,000/(1 – .40) = $58,333 New Position Stock $60,000 Borrowed $35,000 Equity $25,000

31 3.8 Buying on Margin With 1,000 shares, stock price for margin call is $58,333/1,000 = $58.33 Margin % = $23,333/$58,333 = 40% To restore IMR, equity = ½ x $58,333 = $29,167 New Position Stock $60,000 Borrowed $35,000 Equity $23,333

32 3.8 Buying on Margin Buy at $70 per share
Borrow at 7% APR interest cost if using margin; use full amount margin APRs (365-day year) Buy at $70 Sell at $72 in 90 days Sell at $68 in 90 days No margin 11.59% −11.59% Margin 16.17% −30.17% Leverage factor 1.4x 2.6x

33 Table 3.1 Illustration of Buying Stock on Margin

34 3.9 Short Sales Sale of shares not owned by investor but borrowed through broker and later purchased to replace loan Mechanics Borrow stock from broker; must post margin Broker sells stock, and deposits proceeds/margin in margin account (you cannot withdraw proceeds until you “cover”) Covering or closing out position: Buy stock; broker returns title to party from which it was borrowed

35 3.9 Short Sales Round Trips Long position Buy first, sell later
Bullish Short position Sell first, buy later Bearish “Round trip” is a purchase and a sale

36 3.9 Short Sales Required initial margin: Usually 50%
More for low-priced stocks Liable for any cash flows Dividend on stock Zero tick, uptick rule Eliminated by SEC in July 2007

37 3.9 Short Sales Short-sale maintenance margin requirements (equity)
Price MMR < $2.50 $2.50 $2.50-$5.00 100% market value $5.00-$16.75 $5.00 > $16.75 30% market value

38 3.9 Short Sales Example You sell 100 short shares of stock at $60 per share $6,000 must be pledged to broker You must also pledge 50% margin You put up $3,000; now you have $9,000 in margin account Short sale equity = Total margin account – Market value

39 3.9 Short Sales Example Maintenance margin for short sale of stock with price > $16.75 is 30% market value 30% x $6,000 = $1,800 You have $1,200 excess margin What price for margin call?

40 3.9 Short Sales Example When equity  (.30 x Market value)
Equity = Total margin account – Market value When Market value = Total margin account / (1 + MMR) Market value = $9,000/( ) = $6,923 Price for margin call: $6,293/100 shares = $69.23

41 3.9 Short Sales Example If this occurs:
Equity = $9,000 − $6,923 = $2,077 Equity as % market value = $2,077/$6,923 = 30% To restore 50% initial margin: ($6,923/2) − $2,077 = $1,384.50

42 Table 3.2 Cash Flows from Purchasing vs. Short-Selling
Purchase of Stock Time Action Cash Flow* Buy share − Initial price 1 Receive dividend, sell share Ending price + Dividend Profit = (Ending price + Dividend) – Initial price Short Sale of Stock Borrow share; sell it + Initial price Repay dividend and buy share to replace share originally borrowed − (Ending price + Dividend) Profit = Initial price – (Ending price + Dividend) *Note: A negative cash flow implies a cash outflow.

43 3.10 Regulation of Securities Markets
Self-Regulation The Sarbanes-Oxley Act Insider Trading Inside information: Nonpublic knowledge about a corporation possessed by officers, major owners, etc., with privileged access to information

44 Selected Problems 3-44

45 Chapter 3: Problem 1 Explicit and Implicit costs.
Explicit: Underwriter’s Fee $70,000 Implicit: Underpricing ($53 -$50) x 100,000 = $300,000 Total Costs = $370,000 No. The underwriters did not directly profit from the underpricing of the securities. 3-45 45

46 Chapter 3: Problem 2 If the price keeps going up your losses are unlimited. The stop-buy order at $128 limits your max loss to about $8 per share. 3-46

47 Chapter 3: Problem 3 a. The stock is purchased for: 300  $40 = $12,000 The amount borrowed is $4, Therefore, the investor put up equity, or margin, of $8,000. 3-47 47

48 Chapter 3: Problem 3 b. If the share price falls to $30, then the value of the stock falls to $30 x $300 = $9,000. By the end of the year, the amount of the loan owed to the broker grows to: $4,000  1.08 = $4,320 Therefore, the remaining equity in the investor’s account is: $9,000  $4,320 = $4,680 The percentage margin is now: __________________________ Therefore the investor will not receive a margin call. $4,680 / $9,000 = 0.52 = 52% 3-48 48

49 Chapter 3: Problem 3 c. The rate of return on the investment over the year is: (Ending equity in the account  Initial equity) / Initial equity HPR = ($4,680  $8,000) / $8,000 = 0.415 = 41.5% Beginning Equity = $8,000 End Equity = $4,680 3-49 49

50 Chapter 3: Problem 4 Many exchanges and the ECNs have pretty much
eliminated market-making specialists. Here the computer finds the best prices to make the trades. 3-50

51 Chapter 3: Problem 5 $50.25 $51.50 a. The buy order will be filled at the best limit-sell order, $50.25 b. The next market buy order would be filled at the next best price, $51.50 c. You should probably increase your position. There is plenty of buying demand at prices just below $50, so downside risk is limited. The limit sell orders are less concentrated. 3-51

52 Chapter 3: Problem 6 You buy $10,000/$50= 200 shares
Shares go up 10% $50$55 $55 X 200=$6000 You pay interest .08 X $5000 = $400 Rate of return = 6000 – 400 – = 12% 5000 b. The margin call will occur when Market Value = Amount Borrowed / (1 - MMR) Market Value = Stock price = $5,000 / (1 – 0.30) = $7,142.86 $7, / 200 shares = $35.71 3-52

53 Chapter 3: Problem 7 a 55.25 The trade will not be executed because the bid price is lower than the price specified in the limit sell order. The trade will not be executed because the ask price is greater than the price specified in the limit buy order. 3-53

54 Chapter 3: Problem 8 a. In an exchange market, there can be price improvement in the two market orders. Brokers for each of the market orders (i.e., the buy and the sell orders) can agree to execute a trade inside the quoted spread. For example, they can trade at $55.37, thus improving the price for both customers by either $0.12 or $0.13 relative to the quoted bid and asked prices. For example, they can trade at $55.37, thus improving the price for both customers by $0.12 or $0.13 relative to the quoted bid and asked prices. The buyer gets the stock for $0.13 less than the quoted asked price, The seller receives $0.12 more for the stock than the quoted bid price. 3-54 54

55 Chapter 3: Problem 8 b. Whereas the limit order to buy at $55.37 would not be executed in a dealer market (since the asked price is $55.50), it could be executed in an exchange market. A broker for another customer with a market sell order would view the limit buy order as the best bid price; the two brokers could agree to the trade and bring it to the specialist, who would then execute the trade. 3-55 55

56 Chapter 3: Problem 9 (Round Trip) 3-56 56

57 Chapter 3: Problem 10 Cannot tell from the information given. The
broker will attempt to sell after the first transaction at $55 or less. 3-57

Download ppt "3 Securities Markets Bodie, Kane, and Marcus"

Similar presentations

Ads by Google