Salaar - Finance

Investments Investments Investments Investments Investments Investments Investments Investments

BSCBSCSummer Semester 2009Summer Semester 2009

Lahore School of EconomicsLahore School of Economics

Salaar Farooq – Assistant Professor

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Chapter 5

Lecture

SecuritiesSecuritiesSecuritiesSecuritiesSecuritiesSecuritiesSecuritiesSecurities

MarketsMarketsMarketsMarketsMarketsMarketsMarketsMarkets

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Chapter 4

Securities Markets

Summary

� Why are Financial Markets Important?

� What are Primary Markets?

� What are Secondary Markets?

� What are Types Markets?

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How Securities are Traded

Learning Objectives

� What is a Secondary Market?

� Where are Securities Traded?

� Types of Orders?

� What are Brokers?

� What is a Margin?

� Price Efficiency?

� Transaction Costs?

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Financial Markets?

Secondary Markets

Markets where existing securities are traded

For investments to be attractive…

they must have…

“LIQUIDITY” & SECONDARY markets provide that

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Financial Markets?

Secondary Markets

Function of Secondary Markets?

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Financial Markets?

Secondary Markets

Function of Secondary Markets

� Provides info on Value of Security

� Indicates Consensus price

� Shows how well the Firm is using funds

� Gives an idea of how NEW issues would be received

� Provides Liquidity to the markets

� Allows for investments to change ownership easily

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Financial Markets?

US Securities Markets for Equities

Where are these exchanges?

Equity

NYSE

AMEX

NASDAQ

ECN’S

KSE

BONDS

NYSE & AMEX Bond markets

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Financial Markets?

US Securities Markets for Equities

Equity

NYSE (New York Stock Exchange)

AMEX (American Stock Exchange)

NASDAQ (National Association of Securities Dealers)

ECN’S (Electronic Communications Network)

KSE (Karachi!)

BONDS

NYSE & AMEX Bond markets

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Financial Markets?

US Securities Markets for Equities

Equity

NYSE – 1366 seats (1.5mil$)-2800 co’s valued 13 trillion-Dvol 1.5Bil

AMEX – 807 seats – 760 companies – 2% of ttl value – 200mil vol

NASDAQ- 3843 co’s – 1bil vol – computerized mkt network

ECN’S (Electronic Communications Network)-linked to all

OTC – Not listed but registered, 3000 co’s – dealer network linked

KSE: 200 seats, 163 active, 658 co’s, 35B MCap, 350m! vol, 100 co’s =90% Mcap

BONDS

NYSE & AMEX Bond markets

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Perfect Markets?

Conditions Required?

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Perfect Markets?

Conditions Required

1. Large no. of buyers & sellers & no one is significant. (LIQUIDITY)

2. Everyone is a price taker

3. Price is determined by pure Supply-Demand

4. No frictions exist (COSTS)

Frictions

Costs & barriers to affecting Buyers/sellers payoffs

Eg.

Commisions

Bid-ask spreads

Taxes etc

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Financial Markets?

Securities Markets for Equities

Bid price

Offer Price

Block trades

Program trading

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Financial Markets?

Securities Markets for Equities

Bid price

Px some one will buy for

Offer Price

Px someone will sell for

Block trades

Trades of 10,000 or more

Program trading

Computer generated buy & sell signals for $1 mil or more

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Financial Markets?

Securities Markets for Equities

OTC (Over the counter mkts)

ECN’s

After Hours Trading

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Financial Markets?

Securities Markets for Equities

OTC (Over the counter mkts)

Stocks not listed on an exchange but traded on closed computer networks

ECN’s

Computerized trading network for large traders & brokers – computer matched orders

After Hours Trading

Normal hrs: 9.30 – 1600

AHT hrs: 1600-2000

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Financial Markets?

Securities Markets for Equities

Dow Jones Industrial Average

Standard & Poor’s (S&P 500)

Nasdaq

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Financial Markets?

Securities Markets for Equities

Dow Jones Industrial Average

30 Blue chip stocks – stock price weighted average

Standard & Poor’s (S&P 500)

500 stock composite

Nasdaq

100 Large cap companies

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KSE 30

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• The Dow Jones Industrial Average consists of the following 30 companies:

• 3M Co. (NYSE: MMM) (conglomerates, "manufacturing")

• ALCOA Inc. (NYSE: AA) (aluminium) • Altria Group, Inc. (NYSE: MO) (tobacco, foods) • American International Group, Inc. (NYSE: AIG)

(property & casualty insurance) • American Express Co. (NYSE: AXP) (credit

services) • AT&T Inc. (NYSE: T) (telecoms) • Boeing Co., The (NYSE: BA) (aerospace/defense) • Caterpillar, Inc. (NYSE: CAT) (farm & construction

equipment) • Citigroup, Inc. (NYSE: C) (money center banks) • Coca-Cola Co. (NYSE: KO) (beverages) • E.I. du Pont de Nemours & Co. (NYSE: DD)

(chemicals) • Exxon Mobil Corp. (NYSE: XOM) (major

integrated oil & gas) • General Electric Co. (NYSE: GE) (conglomerates,

media) • General Motors Corporation (NYSE: GM) (auto

manufacturers) • Hewlett-Packard Co. (NYSE: HPQ) (diversified

computer systems) • Home Depot, Inc. (NYSE: HD) (home

improvement stores)

• Honeywell International, Inc. (NYSE: HON) (conglomerates)

• Intel Corp. (NYSE: INTC) (semiconductors) • International Business Machines Corp. (NYSE: IBM)

(diversified computer systems) • JPMorgan Chase and Co. (NYSE: JPM) (money

center banks) • Johnson & Johnson Inc. (NYSE: JNJ) (consumer and

health care products conglomerate) • McDonald's Corp. (NYSE: MCD) (restaurant

franchise) • Merck & Co., Inc. (NYSE: MRK) (drug

manufacturers) • Microsoft Corp. (NYSE: MSFT) (software) • Pfizer, Inc. (NYSE: PFE) (drug manufacturers) • Procter & Gamble Co. (NYSE: PG) (consumer

goods) • United Technologies Corp. (NYSE: UTX)

(conglomerates) • Verizon Communications (NYSE: VZ) (telecoms) • Wal-Mart Stores, Inc. (NYSE: WMT) (discount,

variety stores) • Walt Disney Co., The (NYSE: DIS) (entertainment)

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Brokerags vs Dealers?

� Brokers = middle-men

� Dealers = shopkeepers (MARKET MAKERS)

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Brokerage Firms

� Full Service Brokers

� Discount Brokers

� Online Discount Brokers

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Brokerage Firms

� Full Service Brokers

Offer Full Range of services including info and advice.

� Discount Brokers

offers execution services

� Online Discount Brokers

offers platforms on the net

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Types of Brokerage Accounts

� Cash Account

� Margin Account

� Asset Management Account

� Wrap Account

� Commissions

� Drip (Dividend Reinvestment Plan)

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Types of Brokerage Accounts

� Cash AccountOnly cash transactions

� Margin AccountAllows cash and debt transactions

� Asset Management AccountOffers investment of cash balances and Cheque writing

� Wrap Accountall fees are wrapped into one

� Commissions

� Drip (Dividend Reinvestment Plan)free reinvestment by companies

� DOLLAR COST AVERAGING - illustrate

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How Orders Work

� Organize Exchanges (NYSE, NASDAQ)

� Super Dot (NYSE)

� NASDAQ System of dealers

� Decimalization of stock prices

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How Orders Work

� Organize Exchanges (NYSE, NASDAQ)

� Super Dot (NYSE)Electronic system for NYSE

� NASDAQ System of dealersThrough computer market making firms

� Decimalization of stock pricesJan 2001 stocks were decimalized, average spread five cents (NOW 1c)

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Types of Orders

� Market Order

� Limit Order

� Stop Order

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Types of Orders

� Market OrderBest price on the floor – ENSURES EXECUTION NOT PX

� Limit Order (new position)specified or better price – ENSURES PX – NOT EXECUTION

� Stop Order (existing position)Automatic execution at specified price

� BUY STOP – PROTECTS PROFITS

� SELL STOPS – PROTECT LOSSES

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Investor Protection

� Government Regulation

� SEC

� Self Regulation

� NASD

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Investor Protection

� Government Regulation

� SEC1934

� Self Regulationstock exchanges monitor and regulate

� NASDAlso monitor

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Margin

� Margin

� Initial Margin

� Maintenance Margin

� Margin Call

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Margin (Leveraged Positions)

� Marginpart of transaction value which is customers equity

� Initial Marginthe part the customer must pay to initiate a transaction – 50%

� Maintenance Margin%age of securities value which must be on hand as equity – 25%

� Margin Calldemand from broker for cash if actual M < maintenance M

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Margin

� Marginpart of transaction value which is customers equity

� Initial Marginamount investor puts up / value of transaction

� Maintenance Margin%age of securities value which must be on hand as equity

� Margin Call

MARKED TO MARKET EVERYDAY

� Actual margin =

(current value of stock – amount borrowed) / current value

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Short Sales

� Being Long

� Being Short

� Short Sale

� Short Interest Ratio

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Short Sales

� Being Longnormal position of buying stock

� Being Shorthaving sold stock not owned

� Short Saleselling stock not owned but borrowed

� Short Interest Ratioshares short to average daily volume

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Market Efficiency

Markets absorb & reflect all new information

into security prices

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Chapter 5

How Securities are Traded

Learning Summary

� What are brokerage transactions?

� How Orders Work?

� What is Investor Protection?

� What is Margin?

� What are Short Sales?

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