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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 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


How securities are traded l.jpg
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


Slide3 l.jpg

  • 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


Slide4 l.jpg

  • 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


Shelf registration l.jpg
Shelf Registration underwritten by investment bankers. A lead investment banker forms an

  • 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


Slide6 l.jpg
IPO underwritten by investment bankers. A lead investment banker forms an

  • Road show

  • Book – indication of interest

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

  • Internet IPO

BKM Ch 3


Private placements l.jpg
Private Placements underwritten by investment bankers. A lead investment banker forms an

  • 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


Secondary market l.jpg
Secondary Market underwritten by investment bankers. A lead investment banker forms an

  • 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


Seat price on the nyse in k l.jpg
Seat price on the NYSE in $K underwritten by investment bankers. A lead investment banker forms an

BKM Ch 3


Nyse listing requirements l.jpg
NYSE Listing Requirements underwritten by investment bankers. A lead investment banker forms an

  • Pretax Income last year $2,5M

  • Average annual pretax in 2 years $2M

  • Market value of publicly held stock $60M

  • Shares publicly held 1.1M

  • Holders of 100 shares or more 2,000

BKM Ch 3


The over the counter market l.jpg
The Over-the-Counter Market underwritten by investment bankers. A lead investment banker forms an

  • 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


Otc levels l.jpg
OTC levels underwritten by investment bankers. A lead investment banker forms an

  • 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


Third and fourth markets l.jpg
Third and Fourth Markets underwritten by investment bankers. A lead investment banker forms an

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

  • Fourth marked - investors trading directly

BKM Ch 3


The national market system l.jpg
The National Market System underwritten by investment bankers. A lead investment banker forms an

  • 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


Other countries l.jpg
Other Countries underwritten by investment bankers. A lead investment banker forms an

  • LSE - London Stock Exchange

  • TSE - Tokyo Stock Exchange

  • German

  • Zurich

  • Paris

  • Toronto

  • Israel

BKM Ch 3


Participants l.jpg
Participants underwritten by investment bankers. A lead investment banker forms an

  • Commission Brokers - serve clients

  • Floor Broker - independent broker

  • Registered Traders - act on their own account

  • Specialists

BKM Ch 3


Types of orders l.jpg
Types of Orders underwritten by investment bankers. A lead investment banker forms an

  • 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


Limit orders l.jpg
Limit Orders underwritten by investment bankers. A lead investment banker forms an

BKM Ch 3


Roles of a specialist l.jpg
Roles of a Specialist underwritten by investment bankers. A lead investment banker forms an

  • 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


Trading on the otc market l.jpg
Trading on the OTC Market underwritten by investment bankers. A lead investment banker forms an

  • Dealer Market

  • Investor contacts broker

  • The broker tries to find a dealer

  • Computerized system

BKM Ch 3


Trading costs l.jpg
Trading Costs underwritten by investment bankers. A lead investment banker forms an

  • 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


Buying on margin l.jpg
Buying on Margin underwritten by investment bankers. A lead investment banker forms an

  • 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


Slide23 l.jpg

  • Below Maintenance Margin underwritten by investment bankers. A lead investment banker forms an 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


Short sales l.jpg
Short Sales underwritten by investment bankers. A lead investment banker forms an

  • 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


Slide25 l.jpg

BKM Ch 3


Short sale l.jpg
Short Sale underwritten by investment bankers. A lead investment banker forms an

  • 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


Margin calls on short transactions you go short 100 shares at 50 mm 30 l.jpg

Assets underwritten by investment bankers. A lead investment banker forms an

$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


Regulation on securities markets l.jpg
Regulation on Securities Markets underwritten by investment bankers. A lead investment banker forms an

  • 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


Other restrictions l.jpg
Other Restrictions underwritten by investment bankers. A lead investment banker forms an

  • 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


Home assignment l.jpg
Home Assignment underwritten by investment bankers. A lead investment banker forms an

  • 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


Mutual funds bkm ch 4 l.jpg

Mutual Funds underwritten by investment bankers. A lead investment banker forms an BKM Ch 4

Zvi Wiener

tel: 02-588-3049 [email protected]

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


Mutual funds l.jpg
Mutual Funds underwritten by investment bankers. A lead investment banker forms an

  • 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


Slide33 l.jpg

  • Advantages: underwritten by investment bankers. A lead investment banker forms an

  • Diversification and divisibility

  • Professional management

  • Small investment

  • Reinvestment of dividends, capital gains

  • Disadvantages:

  • Commissions (loads)

  • Time delay or illiquidity

BKM Ch 3


Home assignment34 l.jpg
Home Assignment underwritten by investment bankers. A lead investment banker forms an

  • • 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


Additional slides l.jpg
Additional Slides underwritten by investment bankers. A lead investment banker forms an

BKM Ch 3


Costs of trading l.jpg
Costs of Trading underwritten by investment bankers. A lead investment banker forms an

  • 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


Margin trading l.jpg
Margin Trading underwritten by investment bankers. A lead investment banker forms an

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

  • Borrow remaining component.

  • Margin arrangements differ for stocks and futures.

BKM Ch 3


Stock margin trading l.jpg
Stock Margin Trading underwritten by investment bankers. A lead investment banker forms an

  • 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


Margin trading initial conditions l.jpg
Margin Trading - Initial Conditions underwritten by investment bankers. A lead investment banker forms an

  • X Corp $70

  • 50% Initial Margin

  • 40% Maintenance Margin

  • 1000 Shares Purchased

  • Initial Position

  • Stock $70,000 Borrowed $35,000

  • Equity $35,000

BKM Ch 3


Margin trading maintenance margin l.jpg
Margin Trading - Maintenance Margin underwritten by investment bankers. A lead investment banker forms an

  • 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


Margin trading margin call l.jpg
Margin Trading - Margin Call underwritten by investment bankers. A lead investment banker forms an

  • 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


Short sales42 l.jpg
Short Sales underwritten by investment bankers. A lead investment banker forms an

  • 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


Short sale initial conditions l.jpg
Short Sale - Initial Conditions underwritten by investment bankers. A lead investment banker forms an

  • Z Corp 100 Shares

  • 50% Initial Margin

  • 30% Maintenance Margin

  • $100 Initial Price

  • Sale Proceeds $10,000

  • Margin & Equity 5,000

  • Stock Owed 10,000

BKM Ch 3


Short sale maintenance margin l.jpg
Short Sale - Maintenance Margin underwritten by investment bankers. A lead investment banker forms an

  • 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


Short sale margin call l.jpg
Short Sale - Margin Call underwritten by investment bankers. A lead investment banker forms an

  • 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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