1. Fall-02 http://pluto.mscc.huji.ac.il/~mswiener/zvi.html Investments Zvi Wiener tel: 02-588-3049 mswiener@mscc.huji.ac.il How securities are traded BKM Ch 3

2. Zvi WienerBKM Ch 3 slide 2 How Securities Are Traded How Firms Issue Securities Where Securities are Traded Trading on the Exchanges Buying on Margin Short Sales Regulation of Securities Markets Mutual Funds

3. Zvi WienerBKM Ch 3 slide 3 Primary market - when issued Secondary market - any time later Primary market public offering private placement IPO (initial public offering) Seasoned new issue

4. Zvi WienerBKM Ch 3 slide 4 Public offerings of stocks and bonds are usually underwritten by investment bankers. A lead investment banker forms an underwriting syndicate to share the commitment. The syndicate provides market advice and handle the SEC registration process. (red herring=preliminary prospectus) 1. Firm Commitment 2. Best-Efforts Basis

5. Zvi WienerBKM Ch 3 slide 5 Shelf Registration Since 1982 the SEC allows (rule 415) shelf registration. One can register now but actually trade during two years. Rule 144A of SEC Trading of private placements among some institutions.

6. Zvi WienerBKM Ch 3 slide 6 IPO Road show Book – indication of interest IPO underpricing effect in the first days and bad performance later. Internet IPO

7. Zvi WienerBKM Ch 3 slide 7 Private Placements Private placement: sale to a limited number of sophisticated investors not requiring the protection of registration. Dominated by institutions. Very active market for debt securities. Not active for stock offerings.

8. Zvi WienerBKM Ch 3 slide 8 Secondary Market national (NYSE, AMEX) regional - firms located in its area exchanges for derivatives Trading conducted by members (seat owners) Commission brokers seats - full-service brokers

9. Zvi WienerBKM Ch 3 slide 9 Seat price on the NYSE in $K

10. Zvi WienerBKM Ch 3 slide 10 NYSE Listing Requirements Pretax Income last year$2,5M Average annual pretax in 2 years$2M Market value of publicly held stock$60M Shares publicly held1.1M Holders of 100 shares or more2,000

11. Zvi WienerBKM Ch 3 slide 11 The Over-the-Counter Market More than 35,000 issues are traded Since 1972 the NASDAQ gives quotes (National Association of Security Dealers) network of dealers linked by a computer system.

12. Zvi WienerBKM Ch 3 slide 12 OTC levels Level 3: Market makers Maintain inventories of securities May enter bid-ask prices and update them Level 2: Receive all bid-ask quotes Can not enter quotes Are brokers who act for clients Do not actively deal on their own account Level 1: Receive median bid-ask quotes Investors looking for information.

13. Zvi WienerBKM Ch 3 slide 13 Third and Fourth Markets The third market - exchange-listed securities traded on the OTC Fourth marked - investors trading directly

14. Zvi WienerBKM Ch 3 slide 14 The National Market System Securities Act Amendments of 1975 directed SEC (Securities and Exchange Commission) to implement a national competitive system. Requirements to companies Insider trading is prohibited Public Information control

15. Zvi WienerBKM Ch 3 slide 15 Other Countries LSE - London Stock Exchange TSE - Tokyo Stock Exchange German Zurich Paris Toronto Israel

16. Zvi WienerBKM Ch 3 slide 16 Participants Commission Brokers - serve clients Floor Broker - independent broker Registered Traders - act on their own account Specialists

17. Zvi WienerBKM Ch 3 slide 17 Types of Orders Market Order Limit Order (price, time) Stop-Loss Order (sell if the price falls below some level) Stop-Buy Order (buy if the price rises above some level) Block sales (10,000 shares), block houses, standard price taking assumption isn’t valid.

18. Zvi WienerBKM Ch 3 slide 18 Limit Orders

19. Zvi WienerBKM Ch 3 slide 19 Roles of a Specialist Specialist “makes a market” in a share. He can act either as a broker or as a dealer. Specialist maintains a “book”- list of outstanding orders. Provides liquidity. Is obligated to provide price continuity.

20. Zvi WienerBKM Ch 3 slide 20 Trading on the OTC Market Dealer Market Investor contacts broker The broker tries to find a dealer Computerized system

21. Zvi WienerBKM Ch 3 slide 21 Trading Costs Full-Service - advice, research, execution Discount Brokerage - only execute Brokerage fees + the bid-ask spread Paying for order flow Odd versus even quotes Internet innovation

22. Zvi WienerBKM Ch 3 slide 22 Buying on Margin Initial Margin is defined by the FRS (Federal Reserve System) about 50% by investor’s funds, the rest is borrowed from the broker. Margined stock is left with the broker. Maintenance Margin are set by the NYSE and the brokerage firm. If the balance falls below, the investor is subject to a margin call. Margin is equity in the account as a percent of the value of the account, a leveraged position.

23. Zvi WienerBKM Ch 3 slide 23 Below Maintenance Margin Value of securities no longer support loan Investor must do something! 1. Sell some shares 2. Send cash Above Initial Margin Investor may 1. Do nothing 2. Buy more shares with no additional cash 3. Increase loan amount

24. Zvi WienerBKM Ch 3 slide 24 Short Sales An investor borrows a stock from the broker The short seller expect the price to decline Covering the position - purchasing the stock One can short a stock only after an uptick Required deposit (50%) All dividends must be paid Margin call possible What is the difference between buying on margin and selling short?

25. Zvi WienerBKM Ch 3 slide 25 Short position - pessimist Long position - optimist

26. Zvi WienerBKM Ch 3 slide 26 Short Sale You short 100 shares at $50 Dividends of $1/share are paid You cover position at $40 Profit = $900 You short 100 shares at $50 Dividends of $1/share are paid You cover position at $60 Loss = ($1,100)

27. Zvi WienerBKM Ch 3 slide 27 Margin Calls on Short Transactions you go short 100 shares at $50; MM 30% Assets $5,000 Proceeds $2,500 Cash $7,500 Liability & Equity $5,000 C.S. $2,500 Equity $7,500 Margin = (Assets-Liabilities)/Liabilities 0.3 = ($7,500-100 P)/(100 P) P = $57.69

28. Zvi WienerBKM Ch 3 slide 28 Regulation on Securities Markets Securities Act of 1933 - disclosure of new issues Securities Act of 1934 - established SEC The Commodities Futures Trading Commission The Securities Investor Protection Corporation protects investors from losses against brokerage firm bankruptcy

29. Zvi WienerBKM Ch 3 slide 29 Other Restrictions Circuit Breakers. Trading is stopped for 1 hour when DJIA falls 250 points from the previous day’s close and stops trading for 2 hours if the drop is 400 points. Insider Trading. Insiders are: major shareholders, officers and directors. They must disclose their trades to SEC (and SEC discloses it to public).

30. Zvi WienerBKM Ch 3 slide 30 Home Assignment Required: read chapter 3 in BKM. read very carefully summary at the end. problems 2, 7, 12, 14, 16, 17 (3 rd ed). problems 2, 9, 18, 20, 22, 23 (5 th ed). find names of all 30 companies in DJIA find names of all 25 companies in TA-25 closely follow financial news!

31. Fall-02 http://pluto.mscc.huji.ac.il/~mswiener/zvi.html Investments Zvi Wiener tel: 02-588-3049 mswiener@mscc.huji.ac.il Mutual Funds BKM Ch 4

32. Zvi WienerBKM Ch 3 slide 32 Mutual Funds Open-End Funds, sell at net asset value + load. NAV = (Assets - Liabilities)/Shares Closed-End Funds. No new shares issued. Front-end load Back-end load Operating expenses 12B-1 Charges - annual fees

33. Zvi WienerBKM Ch 3 slide 33 Advantages: Diversification and divisibility Professional management Small investment Reinvestment of dividends, capital gains Disadvantages: Commissions (loads) Time delay or illiquidity

34. Zvi WienerBKM Ch 3 slide 34 Home Assignment read chapter 4 in BKM (5 th ed). find major types of mutual funds in Israel find 5 largest mutual funds in Israel what was their performance and fees last year?

35. Zvi WienerBKM Ch 3 slide 35 Additional Slides

36. Zvi WienerBKM Ch 3 slide 36 Costs of Trading Commission: fee paid to broker for making the transaction Spread: cost of trading with dealer Bid: price dealer will buy from you Ask: price dealer will sell to you Spread: ask - bid Combination: on some trades both are paid

37. Zvi WienerBKM Ch 3 slide 37 Using only a portion of the proceeds for an investment. Borrow remaining component. Margin arrangements differ for stocks and futures. Margin Trading

38. Zvi WienerBKM Ch 3 slide 38 Maximum margin Currently 50% Set by the Fed Maintenance margin Minimum level the equity margin can be Margin call Call for more equity funds Stock Margin Trading

39. Zvi WienerBKM Ch 3 slide 39 X Corp$70 50%Initial Margin 40%Maintenance Margin 1000Shares Purchased Initial Position Stock $70,000 Borrowed $35,000 Equity $35,000 Margin Trading - Initial Conditions

40. Zvi WienerBKM Ch 3 slide 40 Margin Trading - Maintenance Margin Stock price falls to $60 per share New Position Stock $60,000 Borrowed $35,000 Equity 25,000 Margin% = $25,000/$60,000 = 41.67%

41. Zvi WienerBKM Ch 3 slide 41 Margin Trading - Margin Call How far can the stock price fall before a margin call? (1000P - $35,000)* / 1000P = 40% P = $58.33 * 1000P - Amount Borrowed = Equity

42. Zvi WienerBKM Ch 3 slide 42 Short Sales Purpose: to profit from a decline in the price of a stock or security. Mechanics Borrow stock through a dealer. Sell it and deposit proceeds and margin in an account. Closing out the position: buy the stock and return to the party from which it was borrowed.

43. Zvi WienerBKM Ch 3 slide 43 Short Sale - Initial Conditions Z Corp100 Shares 50%Initial Margin 30%Maintenance Margin $100Initial Price Sale Proceeds$10,000 Margin & Equity 5,000 Stock Owed 10,000

44. Zvi WienerBKM Ch 3 slide 44 Short Sale - Maintenance Margin Stock Price Rises to $110 Sale Proceeds$10,000 Initial Margin 5,000 Stock Owed 11,000 Net Equity 4,000 Margin % (4000/11000) 36%

45. Zvi WienerBKM Ch 3 slide 45 Short Sale - Margin Call How much can the stock price rise before a margin call? ($15,000* - 100P) / (100P) = 30% P = $115.38 * Initial margin plus sale proceeds