Chapter 3 How Securities Are Traded911

7/31/2019 Chapter 3 How Securities Are Traded911

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Investments, 8th editionBodie, Kane and Marcus

Slides by Susan Hine

McGraw-Hill/Irwin Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

CHAPTER 3 How Securitiesare Traded


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How Firms Issue Securities

Primary New issue

Key factor: issuer receives the proceeds

from the sale Secondary

Existing owner sells to another party

Issuing firm doesnt receive proceedsand is not directly involved


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How Firms Issue Securities Continued

Investment Banking

Shelf Registration

Private Placements Initial Public Offerings (IPOs)


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Investment Banking

Underwritten: firm commitment on proceedsto the issuing firm

Red herring

Prospectus


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Figure 3.1 Relationship Among a Firm Issuing

Securities, the Underwriters and the Public


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Shelf Registrations

SEC Rule 415

Introduced in 1982

Ready to be issued on the shelf


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Sale to a limited number of sophisticatedinvestors not requiring the protection ofregistration

Allowed under Rule 144A Dominated by institutions

Very active market for debt securities

Not active for stock offerings

Private Placements


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Initial Public Offerings

Process

Road shows

Bookbuilding Underpricing

Post sale returns

Cost to the issuing firm


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Figure 3.3 Long-term RelativePerformance of Initial Public Offerings


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How Securities are Traded

Types of Markets Direct search

Least organized

Brokered

Trading in a good is active Dealer

Trading in a particular type of asset

increases Auction

Most integrated


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Types of Orders

Marketexecuted immediately

Bid Price

Ask Price

Price-contingent

Investors specify prices

Stop orders

Fi Th Li i O d B k f I l


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Figure 3.4 The Limit Order Book for Intelon the Archipelago Market,

January 19, 2007


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Figure 3.5 Price-Contingent Orders


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Trading Mechanisms

Dealer markets

Electronic communication networks (ECNs)

Specialists markets


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U.S. Security Markets

Nasdaq and NYSE have evolved in responseto new information technology

Both have increased their commitment to

automated electronic trading


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Nasdaq

National Market System Nasdaq Small Cap Market

Levels of subscribers

Level 1 inside quotes

Level 2receives all quotes but they cantenter quotes

Level 3 dealers making markets


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Table 3.1 Partial Requirements for Listingon NASDAQ Markets


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New York Stock Exchange

Member functions

Commission brokers

Floor brokers

Specialists

Block houses

SuperDot


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Table 3.2 Some Initial ListingRequirements for the NYSE


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Table 3.3 Block Transactions on theNew York Stock Exchange


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Other Systems

Electronic Communication Networks

Private computer networks that directly linkbuyers with sellers

National Market System

Securities Act of Amendments of 1975

Bond Trading Automated Bond System (ABS)


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Market Structure in Other Countries

London - predominately electronic trading Euronext market formed by combination of

the Paris, Amsterdam and Brussels

exchanges Tokyo Stock Exchange

Globalization and consolidation of stock

markets

Fi 3 6 M k t C it li ti f M j


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Figure 3.6 Market Capitalization of MajorWorld Stock Exchanges, 2007


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Trading Costs

Commission: fee paid to broker for makingthe 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


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Buying on Margin

Using only a portion of the proceeds for aninvestment

Borrow remaining component

Margin arrangements differ for stocks andfutures


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Stock Margin Trading

Marginis currently 50%; you can borrow up to50% of the stock value

Set by the Fed

Maintenance margin: minimum amount equityin trading can be before additional funds mustbe put into the account

Margin call: notification from broker that youmust put up additional funds

M i T di I iti l C diti


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Margin Trading - Initial ConditionsExample 3.1

X Corp $100

60% Initial Margin

40% Maintenance Margin

100 Shares Purchased

Initial Position

Stock $10,000 Borrowed $4,000Equity $6,000

M i T di M i t M i


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Margin Trading - Maintenance MarginExample 3.1

Stock price falls to $70 per share

New Position

Stock $7,000 Borrowed $4,000Equity $3,000

Margin% = $3,000/$7,000 = 43%


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Margin Trading - Margin Call Example 3.2

How far can the stock price fall before amargin call?

(100P - $4,000)* / 100P = 30%

P = $57.14* 100P - Amt Borrowed = Equity

T bl 3 4 Ill t ti f B i St k


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Table 3.4 Illustration of Buying Stockon Margin


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Short Sales

Purpose: to profit from a decline in the priceof 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 stockand return to the party from which is wasborrowed


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Short Sale - Maintenance Margin

Stock Price Rises to $110

Sale Proceeds $10,000

Initial Margin 5,000Stock Owed 11,000

Net Equity 4,000

Margin % (4000/11,000) 36%


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Short Sale - Margin Call

How much can the stock price rise before amargin call?

($150,000* - 1000P) / (100P) = 30%P = $115.38

* Initial margin plus sale proceeds


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R l i S i i M k C i d


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Regulation Securities Markets Continued

Regulatory Responses to Recent Scandals Public Company Accounting Oversight

Board

Financial experts to serve on auditcommittees of boards of directors

CEOs and CFOs personally certify firms

financial reports

Boards must have independent directors

Sarbanes-Oxley Act

Ci i B k


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Circuit Breakers

Trading halts Collars


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Insider Trading

Officers, directors, major stockholders mustreport all transactions in firms stock

Insiders do exploit their knowledge

Leakage of useful information to sometraders

Documents

Chapter 3 How Securities Are Traded911