1. Securities Markets and Transactions

2. Securities Markets and Transactions
Learning Goals
Identify the basic types of securities markets and describe their characteristics.
Explain the initial public offering (IPO) process.
Describe broker and dealer markets, and discuss how they differ from alternative trading systems.

3. Securities Markets and Transactions
Learning Goals (cont’d)
Review the key aspects of the globalization of securities markets, and discuss the importance of international securities markets.
Discuss trading hours and regulation of securities markets.
Explain long purchases, margin transactions and short sales.

4. Types of Markets
Money Markets: the market where short-term securities are bought and sold
Capital Market: the market where long-term securities such as stocks and bonds are bought and sold
Primary Market: the market in which new issues of securities are sold to the public
Secondary Market: the market in which securities are traded after they have been issued

5. Primary Markets Initial Public Offering (IPO)
First public sale of a company’s stock
Requires SEC approval
Three Choices to Market Securities in Primary Market
Public offering: an offering to sell to the investing public a set number of shares of a firm’s stock at a specified price
Rights offering: an offering of a new issue of stock to existing stockholders, who may purchase new shares in proportion to their current ownership
Private Placement: an offering of a company's securities that is not registered with the Securities and Exchange Commission (SEC) and is not offered to the public at large.

6. Table 2.1 Annual IPO Data, 1999–2011

7. Going Public: The IPO Process
Underwriting the offering: promoting the stock and facilitating the sale of the company’s shares
Prospectus: registration statement describing the issue and the issuer
Red Herring: preliminary prospectus available during the waiting period
Quiet Period: time period after prospectus is filed when company must restrict what is said about the company
Road Show: series of presentations to potential investors

8. Figure 2.1 Cover of a Preliminary Prospectus for a Stock Issue

9. The Investment Banker’s Role
Underwriting the Issue: purchases the security at agreed-on price and bears the risk of reselling it to the public
Underwriting Syndicate: group formed by investment banker to share the financial risk of underwriting
Selling Group: other brokerage firms that help the underwriting syndicate sell issue to the public
Tombstone: public announcement of issue and role of participants in underwriting process
Investment Banker Compensation: typically in the form of a discount on the sale price of the securities

10. Figure 2.2 The Selling Process for a Large Security Issue

11. Secondary Markets
Secondary Market: the market in which securities are traded after they have been issued
Role of Secondary Markets
Provides liquidity to security purchasers
Provides continuous pricing mechanism
Securities Exchanges: forums where buyers and sellers of securities are brought together to execute trades
Nasdaq Market: employs an all-electronic trading platform to execute trades
Over-the-counter (OTC) Market: involves trading in smaller, unlisted securities

12. Broker Markets and Dealer Markets
Broker Markets: consists of national and regional securities exchanges
60% of the total dollar volume of all shares in U.S. stock market trade here
New York Stock Exchange (NYSE) is largest and most well-known (but after book went to press, NYSE acquired by IntercontinentalExchange of Atlanta)
Trades are executed when a buyer and a seller are brought together by a broker and the trade takes place directly between the buyer and seller
Dealer Markets: consists of both the Nasdaq OMX market and the OTC market
Trades are executed with a dealer (market maker) in the middle. Sellers sell to a market maker at a stated price. The market maker then offers the securities to a buyer.
A broker executes the trade on behalf of others, a dealer trades on their own behalf.

13. Figure 2.3 Broker and Dealer Markets

14. Broker Markets New York Stock Exchange (NYSE)
Largest stock exchange—over 2,700 companies
Over 350 billion shares of stock traded in 2005
Accounts for 90% of stocks traded on exchanges
Specialists make transactions in key stocks
Strictest listing policies
NYSE Amex (formally American Stock Exchange)
More than 500 companies listed
Major market for Exchange Traded Funds
Typically smaller and younger companies who cannot meet stricter listing requirements for NYSE

15. Broker Markets (cont’d)
Regional Stock Exchanges
Typically lists between 100–500 companies, usually with local and regional appeal
Listing requirements are more lenient than NYSE
Often include stocks that are also listed on NYSE or NYSE Amex
Best-known: Midwest, Pacific, Philadelphia, Boston, and Cincinnati
Options Exchanges
Allows trading of options
Best-known: Chicago Board Options Exchange (CBOE)
Futures Exchanges
Allows trading of financial futures
Best-known: Chicago Board of Trade (CBT)

16. Dealer Markets
No centralized trading floor; comprised of market makers linked by telecommunications network Both IPOs and secondary distributions are sold on OTC
40% of the total dollar volume of all shares in U.S. stock market trade here
Both IPOs and secondary distributions are sold on OTC
Bid Price: the highest price offered by market maker to purchase a given security
Ask Price: the lowest price at which a market maker is willing to sell a given security

17. Dealer Markets Nasdaq Largest dealer market
Lists large companies (Microsoft, Intel, Dell, eBay) and smaller companies
Over-the-counter (OTC) Bulletin Board
Lists smaller companies that cannot or don’t wish to be listed on Nasdaq
Companies are regulated by SEC
Over-the-counter (OTC) Pink Sheets
Lists smaller companies that are not regulated by SEC
Liquidity is minimal or almost non-existent
Very risky; many nearly worthless stocks

18. Alternative Trading Systems
Third Market
Large institutional investors go through market makers that are not members of a securities exchange
Institutional investors (mutual funds, life insurance companies, pension funds) receive reduced trading costs due to large size of transactions
Fourth Market
Large institutional investors deal directly with each other to bypass market makers
Electronic Communications Networks (ECNs) allow direct trading
ECNs most effective for high-volume, actively traded securities

19. General Market Conditions
Bull Market
Favorable markets
Rising prices
Investor/consumer optimism
Economic growth and recovery
Government stimulus
Bear Market
Unfavorable markets
Falling prices
Investor/consumer pessimism
Economic slowdown
Government restraint

20. Globalization of Securities Markets
Diversification: the inclusion of a number of different investment vehicles in a portfolio to increase returns or reduce risks
Use of International Securities Improves Diversification
More industries and securities available
Securities denominated in different currencies
Opportunities in rapidly expanding economies
International Investment Performance
Opportunities for high returns
Foreign securities markets do not necessarily move with the U.S. securities market
Foreign securities markets tend to be more risky than U.S. markets

21. Globalization of Securities Markets (cont’d)
Indirect Ways to Invest in Foreign Securities
Purchase shares of U.S.-based multinational with substantial foreign operations
Direct Ways to Invest in Foreign Securities
Purchase securities on foreign stock exchanges
Buy securities of foreign companies that trade on U.S. stock exchanges
Buy American Depositary Receipts (ADRs): dollar denominated receipts for stocks of foreign companies held in vaults of banks

22. Risks of International Investing
Usual Investment Risks Still Apply
Government Policies Risks
Unstable foreign governments
Different laws in trade, labor or taxation
Different economic and political conditions
Less stringent regulation of foreign securities markets
Currency Exchange Rate Risks
Value of foreign currency fluctuates compared to U.S. dollar
Value of foreign investments can go up and down with exchange rate fluctuations

23. Trading Hours of Securities Markets
Regular Trading Session for U.S. Exchanges and Nasdaq
9:30 A.M. to 4:00 P.M. Eastern time
Extended-Hours Electronic-Trading Sessions
NYSE: 4:15 to 5:00 P.M. Eastern time
Nasdaq: 4:00 P.M. to 6:30 P.M. Eastern time
Regional exchanges also have after-hours trading sessions
Orders only filled if matched with identical opposing orders

24. Regulation of Securities Markets
Insider Trading
Use of nonpublic information about a company to make profitable securities transactions
Blue Sky Laws
Laws imposed by individual states to regulate sellers of securities
Intended to prevent investors from being sold nothing but “blue sky”

25. Regulation of Securities Markets
Securities Act of 1933
Required full disclosure of information by companies
Securities Act of 1934
Established SEC as government regulatory body
Maloney Act of 1938
Allowed self-regulation of securities industry through trade associations such as the National Association of Securities Dealers (NASD)
Investment Company Act of 1940
Created & regulated mutual funds

26. Regulation of Securities Markets
Investment Advisors Act of 1940
Required investment advisers to make full disclosure about their backgrounds and their investments, as well as register with the SEC
Securities Acts Amendments of 1975
Abolished fixed-commissions and established an electronic communications network to make stock pricing more competitive
Insider Trading and Fraud Act of 1988
Prohibited insider trading on nonpublic information
Sarbanes-Oxley Act of 2002
Tightened accounting and audit guidelines to reduce corporate fraud

27. Basic Types of Securities Transactions
Long Purchase
Investor buys and holds securities
“Buy low and sell high”
Make money when prices go up

28. Basic Types of Securities Transactions (cont’d)
Margin Trading
Uses borrowed funds to purchase securities
Currently owned securities used as collateral for margin loan from broker
Margin requirements set by Federal Reserve Board
Determines the minimum amount of equity required
On $4,445 purchase with 50% margin requirement, investor puts up $2, and broker will lend remaining $2,222.50
Can be used for common stocks, preferred stocks, bonds, mutual funds, options, warrants and futures

29. Table 2.4 Initial Margin Requirements for Various Types of Securities

30. Margin Trading Advantages Disadvantages
Allows use of financial leverage
Magnifies profits
Disadvantages
Magnifies losses
Interest expense on margin loan
Margin calls

31. Margin Formulas
Basic Margin Formula
Example of Using Margin

32. Table 2.3 The Effect of Margin Trading on Security Returns

33. Margin Formulas (cont’d)
Return on Invested Capital
Example of Return on Invested Capital

34. Basic Types of Securities Transactions
Short Selling
Investor sells securities they don’t own
Investor borrows securities from broker
Broker lends securities owned by other investors that are held in “street name”
“Sell high and buy low”
Investors make money when stock prices go down

35. Short Selling Advantages Disadvantages
Chance to profit when stock price declines
Disadvantages
Limited return opportunities: stock price cannot go below $0.00
Unlimited risks: stock price can go up an unlimited amount
If stock price goes up, short seller still needs to buy shares to pay back the “borrowed” shares to the broker
Short sellers may not earn dividends

36. Table 2.5 The Mechanics of a Short Sale

37. Table 2.6 Margin Positions on Short Sales