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How securities are traded BKM Ch 3. Zvi Wiener tel: 02-588-3049 [email protected] How Securities Are Traded. How Firms Issue Securities Where Securities are Traded Trading on the Exchanges Buying on Margin Short Sales Regulation of Securities Markets Mutual Funds.

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How securities are traded BKM Ch 3

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How securities are traded bkm ch 3 l.jpg

How securities are tradedBKM Ch 3

Zvi Wiener

tel: 02-588-3049 [email protected]

http://pluto.mscc.huji.ac.il/~mswiener/zvi.html


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How Securities Are Traded

  • How Firms Issue Securities

  • Where Securities are Traded

  • Trading on the Exchanges

  • Buying on Margin

  • Short Sales

  • Regulation of Securities Markets

  • Mutual Funds

BKM Ch 3


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  • Primary market - when issued

  • Secondary market - any time later

Primary market

public offering

private placement

IPO (initial public offering)

Seasoned new issue

BKM Ch 3


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  • Public offerings of stocks and bonds are usually underwritten by investment bankers. A lead investment banker forms an underwriting syndicate to share the commitment.

  • The syndicate provides market advice and handle the SEC registration process.

  • (red herring=preliminary prospectus)

  • 1. Firm Commitment

  • 2. Best-Efforts Basis

BKM Ch 3


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Shelf Registration

  • Since 1982 the SEC allows (rule 415) shelf registration. One can register now but actually trade during two years.

Rule 144A of SEC

Trading of private placements among some institutions.

BKM Ch 3


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IPO

  • Road show

  • Book – indication of interest

  • IPO underpricing effect in the first days and bad performance later.

  • Internet IPO

BKM Ch 3


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Private Placements

  • Private placement: sale to a limited number of sophisticated investors not requiring the protection of registration.

  • Dominated by institutions.

  • Very active market for debt securities.

  • Not active for stock offerings.

BKM Ch 3


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Secondary Market

  • national (NYSE, AMEX)

  • regional - firms located in its area

  • exchanges for derivatives

  • Trading conducted by members (seat owners)

  • Commission brokers seats - full-service brokers

BKM Ch 3


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Seat price on the NYSE in $K

BKM Ch 3


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NYSE Listing Requirements

  • Pretax Income last year$2,5M

  • Average annual pretax in 2 years$2M

  • Market value of publicly held stock$60M

  • Shares publicly held1.1M

  • Holders of 100 shares or more2,000

BKM Ch 3


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The Over-the-Counter Market

  • More than 35,000 issues are traded

  • Since 1972 the NASDAQ gives quotes

  • (National Association of Security Dealers)

  • network of dealers linked by a computer system.

BKM Ch 3


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OTC levels

  • Level 3: Market makers

  • Maintain inventories of securities

  • May enter bid-ask prices and update them

  • Level 2: Receive all bid-ask quotes

  • Can not enter quotes

  • Are brokers who act for clients

  • Do not actively deal on their own account

  • Level 1: Receive median bid-ask quotes

  • Investors looking for information.

BKM Ch 3


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Third and Fourth Markets

  • The third market - exchange-listed securities traded on the OTC

  • Fourth marked - investors trading directly

BKM Ch 3


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The National Market System

  • Securities Act Amendments of 1975 directed SEC (Securities and Exchange Commission) to implement a national competitive system.

  • Requirements to companies

  • Insider trading is prohibited

  • Public Information control

BKM Ch 3


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Other Countries

  • LSE - London Stock Exchange

  • TSE - Tokyo Stock Exchange

  • German

  • Zurich

  • Paris

  • Toronto

  • Israel

BKM Ch 3


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Participants

  • Commission Brokers - serve clients

  • Floor Broker - independent broker

  • Registered Traders - act on their own account

  • Specialists

BKM Ch 3


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Types of Orders

  • Market Order

  • Limit Order (price, time)

  • Stop-Loss Order

  • (sell if the price falls below some level)

  • Stop-Buy Order

  • (buy if the price rises above some level)

  • Block sales (10,000 shares), block houses, standard price taking assumption isn’t valid.

BKM Ch 3


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Limit Orders

BKM Ch 3


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Roles of a Specialist

  • Specialist “makes a market” in a share.

  • He can act either as a broker or as a dealer.

  • Specialist maintains a “book”- list of outstanding orders.

  • Provides liquidity.

  • Is obligated to provide price continuity.

BKM Ch 3


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Trading on the OTC Market

  • Dealer Market

  • Investor contacts broker

  • The broker tries to find a dealer

  • Computerized system

BKM Ch 3


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Trading Costs

  • Full-Service - advice, research, execution

  • Discount Brokerage - only execute

  • Brokerage fees + the bid-ask spread

  • Paying for order flow

  • Odd versus even quotes

  • Internet innovation

BKM Ch 3


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Buying on Margin

  • Initial Margin is defined by the FRS (Federal Reserve System) about 50% by investor’s funds, the rest is borrowed from the broker. Margined stock is left with the broker.

  • Maintenance Margin are set by the NYSE and the brokerage firm. If the balance falls below, the investor is subject to a margin call.

  • Margin is equity in the account as a percent of the value of the account, a leveraged position.

BKM Ch 3


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  • Below Maintenance Margin Value of securities no longer support loan Investor must do something! 1. Sell some shares 2. Send cash

  • Above Initial Margin Investor may 1. Do nothing 2. Buy more shares with no additional cash 3. Increase loan amount

BKM Ch 3


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Short Sales

  • An investor borrows a stock from the broker

  • The short seller expect the price to decline

  • Covering the position - purchasing the stock

  • One can short a stock only after an uptick

  • Required deposit (50%)

  • All dividends must be paid

  • Margin call possible

  • What is the difference between buying on margin and selling short?

BKM Ch 3


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  • Short position - pessimist

  • Long position - optimist

BKM Ch 3


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Short Sale

  • You short 100 shares at $50

  • Dividends of $1/share are paid

  • You cover position at $40

  • Profit = $900

  • You short 100 shares at $50

  • Dividends of $1/share are paid

  • You cover position at $60

  • Loss = ($1,100)

BKM Ch 3


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Assets

$5,000 Proceeds

$2,500 Cash

$7,500

Liability & Equity

$5,000 C.S.

$2,500 Equity

$7,500

Margin Calls on Short Transactionsyou go short 100 shares at $50; MM 30%

Margin = (Assets-Liabilities)/Liabilities

0.3 = ($7,500-100 P)/(100 P)

P = $57.69

BKM Ch 3


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Regulation on Securities Markets

  • Securities Act of 1933 - disclosure of new issues

  • Securities Act of 1934 - established SEC

  • The Commodities Futures Trading Commission

  • The Securities Investor Protection Corporation protects investors from losses against brokerage firm bankruptcy

BKM Ch 3


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Other Restrictions

  • Circuit Breakers. Trading is stopped for 1 hour when DJIA falls 250 points from the previous day’s close and stops trading for 2 hours if the drop is 400 points.

  • Insider Trading. Insiders are: major shareholders, officers and directors. They must disclose their trades to SEC (and SEC discloses it to public).

BKM Ch 3


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Home Assignment

  • Required: • read chapter 3 in BKM. • read very carefully summary at the end. • problems 2, 7, 12, 14, 16, 17 (3rd ed).

  • • problems 2, 9, 18, 20, 22, 23 (5th ed).

  • • find names of all 30 companies in DJIA

  • • find names of all 25 companies in TA-25

  • • closely follow financial news!

BKM Ch 3


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Mutual FundsBKM Ch 4

Zvi Wiener

tel: 02-588-3049 [email protected]

http://pluto.mscc.huji.ac.il/~mswiener/zvi.html


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Mutual Funds

  • Open-End Funds, sell at net asset value + load.

  • NAV = (Assets - Liabilities)/Shares

  • Closed-End Funds. No new shares issued.

  • Front-end load

  • Back-end load

  • Operating expenses

  • 12B-1 Charges - annual fees

BKM Ch 3


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  • Advantages:

  • Diversification and divisibility

  • Professional management

  • Small investment

  • Reinvestment of dividends, capital gains

  • Disadvantages:

  • Commissions (loads)

  • Time delay or illiquidity

BKM Ch 3


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Home Assignment

  • • read chapter 4 in BKM (5th ed).

  • • find major types of mutual funds in Israel

  • • find 5 largest mutual funds in Israel

  • • what was their performance and fees last year?

BKM Ch 3


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Additional Slides

BKM Ch 3


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Costs of Trading

  • Commission: fee paid to broker for making the 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

BKM Ch 3


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Margin Trading

  • Using only a portion of the proceeds for an investment.

  • Borrow remaining component.

  • Margin arrangements differ for stocks and futures.

BKM Ch 3


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Stock Margin Trading

  • Maximum margin

    • Currently 50%

    • Set by the Fed

  • Maintenance margin

    • Minimum level the equity margin can be

  • Margin call

    • Call for more equity funds

BKM Ch 3


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Margin Trading - Initial Conditions

  • X Corp$70

  • 50%Initial Margin

  • 40%Maintenance Margin

  • 1000Shares Purchased

  • Initial Position

  • Stock $70,000 Borrowed $35,000

  • Equity $35,000

BKM Ch 3


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Margin Trading - Maintenance Margin

  • Stock price falls to $60 per share

  • New Position

  • Stock $60,000 Borrowed $35,000

  • Equity 25,000

  • Margin% = $25,000/$60,000 = 41.67%

BKM Ch 3


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Margin Trading - Margin Call

  • How far can the stock price fall before a margin call?

  • (1000P - $35,000)* / 1000P = 40%

  • P = $58.33

  • * 1000P - Amount Borrowed = Equity

BKM Ch 3


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Short Sales

  • Purpose: to profit from a decline in the price of 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 stock and return to the party from which it was borrowed.

BKM Ch 3


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Short Sale - Initial Conditions

  • Z Corp100 Shares

  • 50%Initial Margin

  • 30%Maintenance Margin

  • $100Initial Price

  • Sale Proceeds$10,000

  • Margin & Equity 5,000

  • Stock Owed 10,000

BKM Ch 3


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Short Sale - Maintenance Margin

  • Stock Price Rises to $110

  • Sale Proceeds$10,000

  • Initial Margin 5,000

  • Stock Owed 11,000

  • Net Equity 4,000

  • Margin % (4000/11000) 36%

BKM Ch 3


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Short Sale - Margin Call

  • How much can the stock price rise before a margin call?

  • ($15,000* - 100P) / (100P) = 30%

  • P = $115.38

  • * Initial margin plus sale proceeds

BKM Ch 3


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