How Securities are Traded• How firms issue securities• How securities are traded

Trading basicsTrading costOrder type

Buying on marginShort sales

Primary vs. Secondary Security Sales

PrimaryNew issueKey factor: issuer receives the proceeds

from the saleSecondary

Existing owner sells to another partyIssuing firm doesn’t receive proceeds and

is not directly involved

Public OfferingsPublic offerings: registered with the SEC and

sale is made to the investing publicInitial Public Offerings (IPOs)

Private PlacementsPrivate placement: sale to a limitednumber of sophisticated investors notrequiring the protection of registrationDominated by institutionsVery active market for debt securitiesNot active for stock offerings

Costs of TradingCommission: fee paid to broker for

making the transactionSpread: cost of trading with dealer (NOT

an explicit cost, it is not a fee, but will affect your return)Bid: price dealer will buy from youAsk: price dealer will sell to youSpread: ask - bid

Types of OrdersInstructions to the brokers on how tocomplete the orderMarket order: executed immediately at

current market pricesLimit order: An order specifying a price at

(or better than) which an investor is willing to buy or sellLimit buy: buy at price same or below the

stipulated limit priceLimit sell: Sell at price same or above the

stipulated limit price

Types of OrdersStop order: trade is not executed unless

stock hits a price limitStop-loss orders:

Def: A stock is to be sold if its price falls below a price limit

Idea: sell to stop further lossStop-buy orders:

Def: a stock should be bought when price rises above a limit

Idea: limit loss from short sales Idea 2:don’t want to lose opportunity to buy

before prices goes even higher

Margin TradingUsing only a portion of the proceeds for an

investmentBorrow remaining componentMargin:

The net worth (Equity) of the investor’s accountMargin =Asset-Liability ( borrowed funds or

stocks)% margin=Equity/Value of stockThe idea for margin requirement: The % of

decline of your stock value before equity value drops to zero. It serves as a cushion for the lender.

Stock Margin TradingMaintenance margin: minimum

percentage of margin in trading before additional funds must be put into the account

Initial margin: maintenance margin when first purchasing the stock

Margin call: notification from broker you must put up additional funds

Margin Trading - Initial ConditionsX Corp $7050% Initial Margin40% Maintenance Margin1000 Shares PurchasedInitial PositionStock $70,000 Borrowed $35,000 Equity 35,000

Margin Trading - Maintenance MarginStock price falls to $60 per shareNew PositionStock $60,000 Borrowed $35,000 Equity 25,000Margin% = $25,000/$60,000 = 41.67%If sock price falls 41.67%, equity will be wiped

out (equity value will be zero).

Margin Trading - Margin CallHow far can the stock price fall before amargin call?

(1000P - $35,000)* / 1000P = 40%

P = $58.33* 1000P - Amt Borrowed = Equity

Short SalesPurpose: to profit from a decline in the price of a stock or security

MechanicsBorrow stock through a dealerSell it and deposit proceeds and margin in

an accountClosing out the position: buy the stock

and return to the party from which is was borrowed

% Margin=Equity / Values of stocks owned

Short Sale - Initial ConditionsZ Corp 100 Shares50% Initial Margin30% Maintenance Margin$100 Initial Price

Sale Proceeds $10,000Margin & Equity 5,000Stock Owed 10,000

Short Sale - Maintenance MarginStock Price Rises to $110

Sale Proceeds $10,000Initial Margin 5,000Stock Owed 11,000Net Equity 4,000Margin % (4000/11000) 36%If stock price rises 36%, equity will be zero.

Short Sale - Margin CallHow much can the stock price rise before a margin call?

($15,000* - 100P) / (100P) = 30%P = $115.38

* Initial margin plus sale proceeds

WarningDon’t short!

Short has unlimited potential lossShort is against the long term trend (positive

return for investing)Stay away from:

Small cap, fast growing, high valuation (Netflix) Potential turning around company (Ford) Potential taken over target

Short candidatesStocks with a broken business model (BBI,

DTV, BKS)and struggling in competition (Dell,

MOT,NOK…)and with a high valuationand with a large Cap. (small cap stocks can

rise very fast and kill the shorts)