1. Objectives Primary market Secondary Market
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Security Markets
Objectives
Primary market
Secondary Market

2. Objectives U.S. Treasury Bonds Stock Issue in the Primary Market
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Objectives
U.S. Treasury Bonds
Stock Issue in the Primary Market
Why do companies issue stock?
How are stocks placed?
Where are the opportunities?
Stock Trading in the Secondary Market
Where are stocks traded?
How are stocks traded?
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3. U.S. Treasury Bonds Initially sold in an auction by the NY Fed
Auction participants:
Primary dealers
Competitive vs. Non-competitive bids
On-the-run vs. off-the-run treasuries
On-the-run - most recently issued bonds or notes of a particular maturity
Off-the-run – treasuries issued before on-the-run treasuries
On-the-run treasuries are more liquid and expensive compared to off-the-run treasuries
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4. Primary Market Why do Companies Issue Stock?
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Primary Market
Why do Companies Issue Stock?
To finance business expansion
A new factory costs $100MM
To retire existing debt
Payoff $10MM high interest loan from the bank
To buy-out venture capital
Venture capitalist exits in 1-3 years after IPO
*usually 7% of the issue
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5. Underwriting Syndicate
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Primary Market
How are Stocks Placed?
IPO (initial public offering) market for new issues
SEO (seasoned equity offering) for secondary
Private placement (not traded in secondary markets)
Underwriting Process
Issuing Firms
Underwriting Syndicate
Lead Underwriter
Investment
Banker A
Investment
Banker B
Investment
Banker C
Investors
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6. Primary Market IPO Process Underwriters Potential Investors
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Primary Market
IPO Process
Underwriters
Potential Investors
Road Shows
Book Building
Issue
Choosing investment bankers
Filing a preliminary registration
with the SEC (red herring)
Approval of the final statement
by the SEC (prospectus)
The issuing firm
Investors
Underwriters
Best-Efforts Agreement
The issuing firm
Underwriters
Investors
Firm Commitment
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7. IPO Performance – Short-Term
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IPO Performance – Short-Term
Opportunities
First day underpricing
>10% appreciation from IPO price to first day closing
E.g. $10 IPO closes at more than $11 on the first day of trading
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8. IPO Performance – Long-Term
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IPO Performance – Long-Term
Subsequent underperformance
* Data for IPOs
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9. Primary Market Money on the Table
Q: FBN, Inc sold 100,000 shares at offer price of $50/share in an IPO, underwriter charges a fee of $70,000 and the share price jumps immediately to $53 after trading
What is the cost of equity issue to FBN?
What is the profit for the underwriter?
A: The stock is under priced at $50. The company could have got $53, so …
Total cost to the company
Money on the table = 100,000×3 = 300,000,
Fee = 70,000,
Total cost = 370,000
Underwriter’s profit
Fee = 70,000
Where did the $300,000 go?
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10. Primary Market Exploiting the Opportunities
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Primary Market
Exploiting the Opportunities
Buy at IPO price and flip after IPO date
Benefit:
>10% return on average for one day
Concern:
Smaller chance of getting into good IPOs
Greater chance of getting into bad IPOs
Sell short IPO stocks on the first day of trading
Profit from the long-run underperformance
Problem:
Cost of shorting IPO shares
Cost of shorting, see Jones and Lamont (2002, JFE), Geczy, Musto, and Reed (2002, JFE)
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11. Secondary Market Definition How are stocks traded?
Markets for investors to buy and sell stocks
How are stocks traded?
Q: How do I buy 100 shares of Microsoft?
A: Depending on the type of order
Market order: buy immediately at current market price
Quick execution with unknown price
E.g., last transaction for MSFT is $26.12, so you will be able to buy at a price around $26.12 immediately.
Limit order: buy with a price specified
Slow execution with known price
E.g., you submit an order to buy MSFT at $26 (limit price), and wait until the price drops to $26.
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12. Secondary Market How are stocks traded? Where is the price going?
Sell order
Market (23.723?)
Limit (above 23.74?)
Stop-loss (below ?)
Buy order
Market (23.74?)
Limit (below ?)
Stop-buy (above 23.74?)
Limit Order
Limit the gain
Stop Order
Stop the loss
Where is the price going?
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13. Secondary Market Market Buy of 4,100 shares
100 at 23.74
3,000 at 23.74
1,000 at
Market Sell of 2,000 shares
1,720 at
280 at
Limit Buy 100 share at
100 share appears on the book between and 23.72
1,720
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14. Secondary Market Where are stocks traded? Exchanges NYSE
Specialist (Designated Market Maker) system
Commission Broker
Floor Broker
Specialist
Brokerage Firm
Buyers
Sellers
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15. Secondary Market Where are stocks traded? Over-the-Counter Market
NASDAQ
Multiple dealer system
Dealer
Brokerage Firm
Buyers
Sellers
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16. Secondary Market Where are stocks traded?
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Secondary Market
Where are stocks traded?
Electronic Communication Network (ECN)
The fourth market
Island, ArcaEx, Instinet, …
Direct trading among investors on a electronic limit order book
Electronic
Limit Order
Book
Brokerage Firm
Buyers
Sellers
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17. To Think About… NYSE, NASDAQ, ECNs – are they all linked together?
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To Think About…
NYSE, NASDAQ, ECNs – are they all linked together?
Current trends in security trading:
Computers that run the stock market
Flash Boys
Dark Pools
Price Discovery
What is it?
Where does it take place?
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