1. Chapter 5 Charles P. Jones, Investments: Analysis and Management, Twelfth Edition, John Wiley & Sons 5- 1

2.  Brokerage firms execute trades and may offer advice to clients ◦ Full-service brokers offer order execution, information on markets and firms, and investment advice ◦ Discount brokers offer order execution  Some may offer research and recommendations ◦ Brokers may also sell mutual funds, facilitate IPOs, underwrite new issues 5- 2

3.  Cash account ◦ Investor pays 100% of purchase price for securities ◦ Investors may add margin borrowing  Cash management account ◦ Checks can be written against account’s assets ◦ Instant loans at a markup to broker’s call money rate  Wrap account ◦ Brokers match investors with outside money managers ◦ All costs wrapped into one fee 5- 3

4. 5- 4  Dividend Reinvestment Plans (DRIPs) ◦ Offered by companies ◦ Investors can buy stock through brokers or, sometimes, directly from the company  Broker-less accounts ◦ Direct Stock Purchase Programs (DSPs) ◦ Treasury Direct Program

5.  NYSE ◦ Uses both physical auction (coordinated by market makers) and automated trading system ◦ Auction for those seeking the best price, automated system for those seeking quickest execution  NASDAQ ◦ Electronic, but also uses market makers  Market makers stand ready to buy or sell certain securities, thereby matching supply with demand 5- 5 Order Execution

6.  Algorithmic Trading ◦ Computer algorithms determine order details ◦ Used by large institutional investors to break orders into smaller pieces  High Frequency Traders ◦ Have little effect on individual buy-and-hold investors 5- 6 Order Execution

7.  Market orders: Authorizes immediate transaction at best available price ◦ Ensures execution, not price  Limit orders: Specifies a particular market price before a transaction is authorized ◦ Ensures price, not execution  Stop orders: Specifies a particular market price at which a market order is authorized 5- 7

8.  Most settlement dates are three business days after the trade date ◦ Legal ownership transferred and financial arrangements settled with brokerage firm ◦ Most customers have brokerages hold shares on their behalf 5- 8

9.  Most federal regulation of securities enacted during the Great Depression  SEC Act of 1934 created the Securities and Exchange Commission ◦ Administers all securities law ◦ Monitors public securities transactions  Requires issuer registration for public offers  Investigates indications of violations such as “insider trading” 5- 9

10.  Stock exchanges are also self-regulated ◦ In own self-interest to regulate and monitor member behavior ◦ NYSE “circuit-breakers” attempt to reduce volatility  Financial Industry Regulatory Authority (FINRA) ◦ Largest regulator of U.S. securities firms ◦ Objectives: protect investors, ensure market integrity 5- 10

11.  Securities Investor Protection Corporation (SIPC) ◦ Non-profit overseen by SEC ◦ Insures accounts against brokerage firm failure  Mediation and Arbitration ◦ Processes through which investors may resolve disputes with brokers ◦ Mediation decisions are nonbinding, arbitration decisions are binding 5- 11 Other Protections

12.  To open margin account, exchanges set minimum required deposit of cash or securities  Investor then pays part of investment cost, borrows remainder from broker ◦ Margin is the investor’s equity: it is the percent of total value that is not borrowed from the broker  Margin trading used to magnify potential gains, but also magnifies potential losses 5- 12

13.  Federal Reserve sets the minimum initial margin on securities ◦ Unchanged since 1974 at 50% ◦ Amount investor provides divided by value of transaction  Actual margin at any time cannot go below the maintenance margin level ◦ Investor’s equity changes with security’s price ◦ Margin call when equity below maintenance level 5- 13

14.  Investor that buys a stock is “long”  Investor that expects price of stock he does not own to decline can borrow stock then sell it “short”  Borrowed security sold in open market, to be repurchased later at an expected price lower than sale price  Short Interest Ratio indicates how bearish investors are about a stock 5- 14

15. 5- 15 You think a particular stock’s price will decline You instruct your broker to establish a short position in this stock The broker borrows the shares, sells them, and credits your account The price declines so you buy the stock back and replace the borrowed shares This closes out your short position on which you made a profit

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