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Jimmy Gentry presents "Markets: An Overview" during Reynolds Business Journalism Week 2013. Reynolds Business Journalism Week is an all-expenses-paid seminar for journalists hoping to enhance their business coverage, and for professors hoping to enhance or create business journalism courses at their schools. For more information about business journalism training, please visit businessjournalism.org.
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Markets: An Overview
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Jan. 2, 2013
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Donald W. Reynolds National Center for Business Journalism
at Arizona State University
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n James K. Gentry, Ph.D. n Clyde M. Reed Teaching Professor n School of Journalism and Mass Communications n University of Kansas n [email protected]
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Risk-Return Relationship
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Basic Types of Risk
n Systematic or market n Unsystematic or nonmarket. Also called
“business risk.” Can be diversified away.
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Specific Types of Risk n Financial risk, credit risk, default risk n Market risk n Interest-rate risk n Purchasing power or inflation risk n Event risk n Exchange-rate or foreign-exchange risk n Liquidity risk n Political or sovereign risk n Tax risk
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Types of Businesses n Sole proprietorship n Partnership n Corporation
n Limited liability n Greater access to capital n Permanency n Flexibility n Double taxation
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Types of Structures
n Private corporations n Public corporations n Nonprofits
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Types of Investments
n Stocks n Bonds n Other
n Options, futures, commodities, real estate, collectibles, currencies
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Types of Markets
n Equity: Stocks n Credit: Bonds, debt or fixed income n Others
n Derivatives (such as options and futures), commodities, real estate, collectibles, currencies
n Historically, the amount of long-term debt financing issued in the U.S. greatly exceeds the volume of equity financing.
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Stock
n Stockholders want: n Stock price to increase n Dependable dividend stream n Increase in size of dividend
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Types of Stock
n Common stock n Preferred stock
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Common Stock
n Risk: Lose your money if company falters
n Reward: Owners share in success when company does well. n Appreciation n Dividends
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Dividends
n Represent a return on capital invested by shareholders.
n Board must declare dividend for it to be paid. n Dividend payment is not a business expense.
It is an after-tax expense. n Usually relationship between company’s age
and size, and the dividends it pays.
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Preferred Stock n Reduced risk, but reward may be limited n Dividend amount is stated and is paid before
dividends on common. n If company is liquidated, holders are
preferred over common holders. n Dividends don’t necessarily increase if
company prospers.
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Bond n Bond is debt a company owes n Individual or company “loans” money to the
company by buying a bond n Bond pays interest over a fixed period of time n Principal is repaid to the lender or holder of the
bond at end of the term n Interest rate is typically fixed when the bond is
sold (i.e., fixed-income security) n Interest rate is comparable to what other
bonds, with that rating, are paying Strictly Financials
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Bond Terminology n Interest rate: Fixed percentage of the bond’s
purchase price that is paid annually to the bond holder
n Yield: Return on investment if bond is held to maturity. Equals interest rate. If bond is traded before maturity date, yield could change, although interest rate stays the same.
n Par value: Dollar amount paid for bond at time of issue
n Maturity date: When bond comes due Strictly Financials
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Issuers Prefer Bonds n When companies need to raise funds, they
can issue stock or sell bonds. n They often prefer bonds, in part because
issuing more stock can dilute the value of shares investors already own.
n Bonds also may have income-tax advantages.
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A Quasi-Bond?
n Is preferred-stock debt (i.e., a bond) in disguise?
n Preferred holders have a “guaranteed” dividend. Is that like the fixed interest rate of a bond?
n Why do investors pick common, preferred or bonds?
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Risk and Reward
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Yield Curve Y
ield
Maturity
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Equity or Securities Markets
n Primary market n Go public n Private placement
n Secondary market
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Going Public
n Entrepreneurs have an idea. Company grows with an investment from the private-equity market (venture capital).
n Owners decide to “go public.” n Register with SEC to make an initial
public offering or IPO. n Investment bankers typically underwrite
the offering through a syndicate.
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Going Public (cont.)
n Company prepares a prospectus, which is a detailed analysis of the company’s financial history, its products and services, as well as management’s background and experience.
n Prospectus should identify and assess risk factors the company faces.
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IPO Terms
n Prospectus n Road show n Quiet period n Lockup period
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Shelf Registration
n Firm can file one registration statement for a relatively large block of stock and sell parts over a two-year period.
n This can reduce red tape and costs, and because stock can be sold directly to institutional investors, can eliminate the underwriting fee.
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Private Placement
n New issues can be sold in large lots to a small group of buyers. Lets start-up firms show appeal by raising capital on their own.
n Additional shares later can be offered through an underwriter.
n Many debt issues are placed privately, usually to large buyers such as insurance companies.
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Secondary Offering
n If company already is public, it can sell more stock through a secondary offering. n Causes dilution
n Major owners sell their shares. They get the funds, so no dilution.
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New York Stock Exchange
n In March 1792, Wall Street leaders met to establish an improved auction market.
n In May 1792, 24 men signed an agreement to trade securities only among themselves, maintain fixed commission rates and avoid other auctions.
n Considered the origination of NYSE Strictly Financials
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NYSE (cont.)
n Until March 2006, was owned by 1,366 seat-holding members
n Highest price ever paid for a seat was $4 million.
n Price was determined by auction.
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NYSE Members n Floor brokers
n House brokers n Independent brokers
n Specialists n Manage auction process n Execute orders for brokers n Serve as catalysts n Provide capital n Stabilize prices
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Making an Order
n Tell your broker or “registered representative” to buy or sell a stock at the current price, or market price. Called a market order.
n If you name the price to buy or sell, you’re making a limit order.
n Tell your broker to buy or sell once the price hits a specific price, you’re placing a stop order at a stop price.
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Trading on the NYSE Floor
n Trading occurs in the “Big Room.” n Numerous stations, each with a roughly
figure-eight shape, with counters and screens above. Called “trading posts.”
n Each counter is a “specialist’s” post.
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NYSE Floor (cont.)
n Order comes to the booth that is rented by a brokerage house.
n Floor broker takes order to appropriate specialist’s post.
n Specialist keeps a list of unfilled orders. Processes orders as prices move.
n Specialist’s job is to maintain an orderly market in the stock (match buyers/sellers).
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NYSE Floor (cont.)
n Stocks or groups of stocks are traded at trading posts near the specialists’ positions.
n Floor brokers can use a specialist or trade between themselves, called trading in the “crowd.”
n Terminals display the stock’s activity. n After every trade, a reporter records the stock
symbol, price and initiating broker. n Successful trades are confirmed.
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NYSE Floor (Then & Now)
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Round or Odd Lots
n Round lots: Buying or selling stock in multiples of 100 shares
n Odd lots: Buying or selling stock in other quantities
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Who Holds Your Stock?
n Virtually all investors leave shares in their brokerage account in what’s called the street name. Investor retains beneficial ownership, though.
n This offers safe storage. n You can get tangible certificates if you
want them. Typically, you must pay for them.
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SuperDOT System
n Super Designated Order Turnaround System n Allows orders to be sent electronically to
specialist rather than phoned to floor trader. n Can handle trades of 100,000 shares or less.
Priority to orders of 2,100 shares or less. n More than three-fourths of NYSE executed
orders involve SuperDOT system. n Originally for small trades. Increasingly big
role in portfolio or basket trading. Strictly Financials
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American Stock Exchange
n Non-members of NYSE couldn’t afford office space, so traded in the street
n 1842: New York Curb Exchange n By late 1870s ,known as “curbstone
brokers,” and their market was known as the Curb.
n Merged with NASDAQ in 1998 n Acquired by NYSE Euronext in 2009
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NASDAQ
n National Association of Securities Dealers Automated Quotations system
n NASDAQ is a computer network with no physical location for trading.
n Uses a multiple market-maker system, not the specialist system
n About 4,000-plus companies
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Trading on the NASDAQ
n Trading is through an open-market, multiple-dealer system, with many market makers and broker-dealers competing for transactions.
n Computer network checks for matches, which can be handled instantly.
n Market makers buy and sell, and maintain an inventory of shares.
n Broker-dealers are “independent” firms and business units of banks and investment firms.
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In Which Market?
n In general, but with exceptions: n NYSE: Oldest, largest, best known n AMEX: Smaller, younger n NASDAQ: Youngest, least experienced n Some of NYSE’s most actively traded
stocks are also quoted on the NASDAQ.
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ECNs
n Electronic Communications Networks n Are basically websites that allow
investors to trade directly with one another
n Eliminates trading through an exchange n Archipelago and Instinet best known n BATS Trading
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NYSE - Archipelago Marriage
n Merged in March 2006 to create NYSE Group Inc., a publicly held company.
n Largest merger ever between securities exchanges.
n Combined leading equities market with most successful electronic exchange.
n Archipelago: low fees, user-friendly technology
NYSE Euronext
n Merged April 2007 n Operates world’s largest, most liquid
exchange with diverse products and services
n Six equities exchanges in five countries and six derivatives exchanges
Deutsche Borse Purchase Of NYSE Euronext Blocked
n Worked on a deal since early 2011. n Would have created world’s largest
trading entity. n EU blocked the merger on Feb. 1, 2012,
fearing the new company would be a near monopoly.
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NYSE ‘Hybrid Market’
n Floor trading and automated trading n Specialists or Archipelago strengths n Why? Customers’ desire for faster
access to liquidity and greater anonymity
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NASDAQ Response
n NASDAQ acquired Instinet Group Inc., another ECN
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Exchanges v. OTC Market
n Stocks in almost 10,000 companies aren’t listed on any exchanges.
n They are traded “over the counter” (OTC)
n Typically handled by phone or computer n Generally, comparatively inexpensive
and infrequently, or “thinly,” traded
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BATS Global Markets
n Newer exchange, founded in 2005 n Located in Kansas City n Competes on technology and cost n Developed its own software platform n Also offers an options-trading platform n An ECN
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U.S Equities Market Share 2012 2011
n NYSE 23% 27.5% n Arca 12% 14% n Floor 11% 13.5%
n NASDAQ 19% 21.5% n BATS 13% 12%
n Direct Edge 9% 8%
October 2012
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Direct Edge n Another ECN n Has exchange status
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Dark Pools n Also “Dark Liquidity” or “Dark Pool Liquidity” n Lightly regulated trading not open to the public. n Mostly involves block trades by institutions away from
public exchanges so trades are anonymous. n Main advantage to institutional investors: Can buy or
sell in large blocks without other investors knowing since neither size of trade or trader’s identity are revealed. Prices are reported after trades completed.
n Also means some market participants are disadvantaged since they can’t see trades executed and prices paid, so this market is not transparent.
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High-Frequency Trading
n Also known as “high-speed trading.” n Electronic-trading strategies driven by
statistics and algorithms. n WSJ reported in 2011 that by some
measures, such firms make up 5 of every 10 stock trades in the U.S. each day.
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High-Frequency Trading
n Research has shown that algorithmic trading broadly makes prices less volatile and reduces the overall cost of trading.
n These firms’ ability to buy and sell large blocks of securities in fractions of a second has raised fears that ordinary investors are being left behind. Much criticism.
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Second Markets
n Markets where illiquid assets are traded. n Employees or investors can sell private
company stock or options, bankruptcy claims, restricted stock, structured products, loans.
n Examples: Facebook, Zynga, Groupon. n Buyers: Hedge funds, private equity funds,
individuals. n Largest are Second Market, SharesPost
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Stock Ownership
n In 2011, 54% of Americans said they had money in the stock market, either in an individual stock, a mutual fund or self-directed 401(k) or IRA
n This was down from 56% in ‘10 and 57% in ‘09. High in the 21st Century was 67% in ‘02 and 65% in ‘07.
n Gallup, April 2011
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Stock Ownership
n 87% of upper-income Americans ($75,000 or more annually) own stocks.
n 83% of postgraduates and 73% of college graduates own stocks.
n 64% of Republicans hold stocks, compared with half of Democrats and independents.
n Ages 50 to 64 are most likely to say they have money in the stock market.
n Gallup, April 2011
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Institutional Investors
n Organizations that invest their own assets or pool those they hold in trust for others.
n Examples: Investment companies (including mutual funds), pension systems, insurance companies, universities and banks.
n Trade regularly and in tremendous volume. n Must buy or sell at least 10,000 shares for a
transaction to be an “institutional trade.”
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Changing Attitudes
n Institutional investors who own large blocks of stock are increasingly demanding a say in corporate management.
n Socially or environmentally conscious individual shareholders also are becoming more involved.
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Stock Market Averages n Dow Jones Industrial Average: Best known
and most widely reported market indicator n Made up of 30 industrial companies n Dow Jones Transportation Average: 20
airlines, railroads and trucking companies n Dow Jones Utility Average: 15 gas, electric
and power companies n Dow Jones 65 Composite Average: all 65
companies in the other three averages
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Stock Market Indexes n NYSE Composite Index: All stocks traded on
the NYSE. n Standard & Poor’s 500 Index: Broad base of
500 stocks. Considered benchmark for large-stock investors.
n NASDAQ Stock Market Composite Index: Stocks traded through its electronic system. Often more volatile because of types of companies it covers.
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Market Indexes (cont.) n AMEX Composite: Companies on the AMEX. n Russell 2000: Follows smallest two-thirds of
the 3,000 largest U.S. companies. Includes many IPOs of past few years. Benchmark for small-company stocks.
n Value-Line: 1,700 common stocks. n Wilshire 5000: Broadest index, including
nearly all stocks traded in U.S. markets.
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Reg FD, Disclosure and Guidance
n Regulation Fair Disclosure, October 2000
n Bars public issuers from selectively revealing material nonpublic information to securities analysts, broker-dealers, investment advisers, and institutional investors, before disclosing it to the public.
n Tension: Guidance vs. disclosure Strictly Financials
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Stock Split
n If stock price increases significantly, a company might do a split to lower the price, which it expects to stimulate trading.
n In a split, more shares are available, but total market value is still the same.
n Price may move up after split, therefore increasing the value of your stock.
n Reverse split: Exchange more shares for fewer, say 10 for five. To boost share price.
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Credit or Debt Markets
n Historically, the amount of long-term debt financing issued in the U.S. greatly exceeds the volume of equity financing.
n Short-term or “money market” n Bond market
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Money Market
n Commercial paper n Bankers’ acceptance n Repurchase agreements n Certificates of deposit n Municipal notes n Treasury bills n Money-market mutual funds
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Who Issues Bonds
n Issued by U.S. companies n Issued by the U.S. Treasury n Issued by federal, state and local
government agencies n Issued by overseas companies and
governments. When sold in dollars, are sometimes called Yankee Bonds.
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Issuers Prefer Bonds
n When companies need to raise money, they can issue stock or sell bonds
n They often prefer bonds, in part because issuing more stock tends to dilute the value of shares investors already own.
n Bonds also may have income-tax advantages
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Treasury Issues
n Life, or term, is fixed at time of issue n Treasury bill: One year or less n Treasury note: One to 10 years n Treasury bond: 10 years or more n Generally, the longer the term, the
higher the interest rate
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How Bonds Are Traded
n Most already issued bonds are traded over the counter.
n Bonds also can be purchased from the inventory of a brokerage firm that might make a market in the bonds.
n Commissions and markups
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Rating Bonds
n Standard & Poor’s, Moody’s Investors Services and Fitch are best known.
n Corporate, international and municipal bonds are rated.
n Credit ratings influence interest rates. n If a company’s rating is downgraded,
investors demand a higher yield.
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Bond Rating Code
n Aaa/AAA: Best quality n Aa/AA: High quality
n A/A: High-medium quality
n Baa/BBB: Medium quality n Ba/BB: Some speculative element n B/B: Future default risk
n Caa/CCC: Poor quality, default danger n Ca/CC: Highly speculative n C/C: Lowest rated, poor prospects
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