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Securities Markets Economics 71a Spring 2007 Mayo, Chapter 3 Lecture notes 2.3 Outline Markets Orders Positions Information Markets Primary markets New issues (IPO’s, corporate and public debt) Secondary markets Trading old stuff In many cases most activity in secondary

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Securities markets l.jpg

Securities Markets

Economics 71a

Spring 2007

Mayo, Chapter 3

Lecture notes 2.3


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Outline

  • Markets

  • Orders

  • Positions

  • Information


Markets l.jpg
Markets

  • Primary markets

    • New issues (IPO’s, corporate and public debt)

  • Secondary markets

    • Trading old stuff

    • In many cases most activity in secondary


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Money and Capital Markets

  • Money markets

    • Short term securities (1 year or less)

  • Capital markets

    • Longer term


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Money Market Securities

  • Treasury bills

    • U.S. government debt

    • Short term (less than 1 year)

  • Commercial paper

    • Short term corporate borrowing

  • Discount pricing

    • Buy for $10, get paid $11 in future

    • No interest payments


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Capital Market Securities

  • Bonds (longer term borrowing)

    • U.S. Treasury

    • Municipal (tax free)

    • Corporate

    • More later


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Capital Market Securities

  • Stocks

    • Common stock

    • Preferred stock

    • International

    • More later


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Trading and Secondary Markets

  • Stock markets

  • Bond markets

  • Derivatives

  • Foreign Exchange


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U.S. Stock Markets

  • New York Stock Exchange (NYSE)

  • National Association of Securities Dealers Automated Quotation (Nasdaq)

    • American Stock Exchange (AMEX)


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Continuous Trading

  • Market types

    • Specialist

    • Electronic dealer

    • Open outcry

    • Over the counter

      • NASDAQ

      • Upstairs (negotiated)

      • ECN (electronic crossing network)


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ECN’s: Electronic Crossing Networks

  • Internet based trade networks

  • Customers can meet directly (no broker)

  • Used mostly by professional money managers

  • Advantage: fewer intermediaries

  • Disadvantage: less liquidity

    • (Fewer people to trade with)

  • Fastest growing markets


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Other Markets

  • Futures/Options

  • Foreign Exchange

    • Spot versus forward

  • Bond


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International Markets

  • Many major international stock markets

    • London

    • Tokyo

    • China

    • many more

  • US accounts for only 36% of the companies listed on stock markets around the world


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International Investments

  • Purchase stocks or bonds in foreign countries

  • Purchase shares in foreign firms in U.S. (American Depository Receipts) ($/English)

  • Bonds can be issued in different currencies

    • Eurobond: Intel issues $ denominated bond in Japan


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Trading Hours

  • Most U.S. stock markets

    • 9:30-4:00

  • Extended hours on electronic trading networks

  • “After hours trading”

  • International markets (local times)

  • Foreign exchange markets (24 hours)

  • Hours increasing : toward a 24 hour market


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Outline

  • Markets

  • Orders

  • Positions

  • Information


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Types of Orders

  • Market order

  • Limit order


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Market Order

  • Buy or sell at the current market price

  • No restrictions

  • “Buy 50 shares at market”


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Limit Orders

  • Buy when price drops below a limit

  • Sell when price moves above a limit

  • Example

    • Limit buy at 50 (price at 60)

    • Stock moves to 55 (nothing happens)

    • Stock moves to 49 (order executed)

  • Advantage

    • Might end up with a better price

  • Disadvantage

    • Order might end up unfilled


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Brokers

  • Enable trading of financial services

  • Dealer function

  • Access

    • Mail

    • Phone

    • Internet


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Types of Brokers

  • Full service

    • Extensive research

    • Merrill Lynch

  • Premium discount

    • Limited research

    • Charles Schwab

  • Basic discount

    • No research

    • E*trade

  • Classification is difficult


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Transaction Costs

  • Commissions

  • Bid/ask spreads


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Costs of Trading

  • Commissions

    • Fixed

    • Negotiated

    • Varying structures (fixed + varying)

      • $20 + shares * C

  • Bid/ask spread

    • Buy at the ask

    • Sell at the bid


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Bid/ask Spread

  • Example:

    • Ask = 88.5 (buy)

    • Bid = 88 (sell)

  • Spreads may change

    • Over time

    • Over stocks

  • Reveal the ease of trading a stock

    • “Liquidity” again


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Order Books

  • Order book

    • List of current limit buy and sell orders

  • If you want to buy

    • Can “hit” limit sell orders

    • Walk up the book

    • Higher price for more stock

  • If you want to sell

    • Can “hit” limit buy orders

    • Walk down the book

  • ECN’s and visible order books


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Settlement and Delivery

  • Settlement dates

    • Usually trade date + 3 days

  • Take delivery or leave shares with broker (street name)


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Outline

  • Markets

  • Orders

  • Positions

  • Information


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Long Purchase

  • Straight purchase of a security

  • Speculate that price will increase

    • Buy at 100

    • Sell at 110

    • 10% return


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Margin Purchase

  • “Buying on margin”

  • Borrow money to buy stock

  • Buy at 75% margin

    • 75% of money in investment is yours

    • 25% is borrowed from broker or bank

  • Purchase $100 of stock at 75% margin

    • You put in $75, and you borrow $25



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Margins and Magnification

  • Example stock: Price = $100

    • Up: Price = $150

    • Down: Price = $75

  • If you purchased with your own money

    • $100 total investment

    • Up: + $50

    • Down: - $25


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Margins and Magnification

  • Buy on 50% margin (zero interest charges)

  • $100 own, and $100 borrowed (needs to be paid back)

  • Purchase $200/$100 shares = 2 shares

    • $100 total investment

    • Up: 2*150 - 100 - 100 = $100 (50)

    • Down: 2*75 - 100 - 100 = $-50 (-25)


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Margin Buying

  • Borrowing money to buy stocks

  • Magnifies gains and losses

  • Can lose more than you put in

    • Buy $200 of stock

      • $100 your own

      • $100 borrowed

    • Stock goes to zero

      • Lose $100 of own investment, and

      • Owe $100 of borrowed money too


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Maintenance Margins

  • Margin required for investor to maintain

  • If margin falls below this level investors must add more of their own money

  • “Margin call”

  • Common margin call

    • Prices fall

    • Margin rises

    • Investor needs to come up with more funds


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Margin Requirements

  • Common stock: 50%

  • Bonds: 50%

  • Options: 20% stock value

  • Futures: 2-10% of the contract value


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Short Sales

  • Holding negative stock

    • Sell stock you don’t have (borrow)

    • Buy it back later

    • Pay dividends yourself in between

  • Key issue

    • Make money on a price fall

    • Lose money on a rise

  • Betting against a stock


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The Mechanics of a Short

  • Tell broker you want to sell 100 shares of IBM short (price = $50)

  • Broker “borrows” shares of 100 shares of IBM owned by another client

  • Sells it to someone for 50*100=5000, and pays this to you

  • You must keep this amount on account with broker

  • When dividends are to be paid, you pay broker, and broker pays the other client


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The Mechanics of a Short

  • IBM goes down to $40 per share

  • You “buy” your 100 shares to take you back to zero, pay broker 40*100=4000.

  • Broker buys at market, and puts the shares back in the other person’s account

  • You make 5000-4000 = 1000 (less dividends)

  • Make money when price falls

  • Lose money when price rises


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The Mechanics of a Short

  • IBM goes up to $60 per share

  • You “buy” your 100 shares to take you back to zero, pay broker 60*100=6000.

  • Broker buys at market, and puts the shares back in the other person’s account

  • You lose 5000-6000 = -1000 (less dividends)


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Margins and Shorts

  • Broker requires additional funds to cover possible losses

  • Fraction of additional sale amount

  • Example

    • Sell $5000 worth of stock at 50% margin

    • Need to keep 1.5*5000 = 7500 on account with the broker

    • When the price goes up, need to increase this

    • “Margin call”


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Oddities About Shorts

  • Can lose unbounded amounts of money

    • Normally only lose what you put in

    • With short price can go up forever, and your losses keep increasing

  • Also, broker can get in trouble if you default

    • Other customer could lose original shares

    • Often insured for this


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Short Interest

  • Fraction of shares sold short

  • Measure of market pessimism in a stock

  • Common market indicator

  • Measures market pessimism


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Squeeze Play

  • Assume Microsoft has a large number of short sellers

  • Price starts to rise

    • Short sellers losing money

    • Get nervous

    • Buy stock to close out their short positions

    • Prices rise more, more buying .. (etc. etc)


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Outline

  • Markets

  • Orders

  • Positions

  • Information


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Information Sources

  • Private

    • Quicken and Yahoo finance

    • Wall St. Journal (fee)

    • Value line and Standard and Poors (fee)

    • Brokerage firms

    • Corporations

  • Government

    • Federal Reserve

    • SEC


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Information Sources

  • Key publications

    • Economic information

      • Federal reserve bulletins (economic info)

    • Firm/investment data

      • Value Line Survey

      • Standard and Poor’s Handbook

      • Security firm reports

      • Firm annual reports


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The Internet and Investing

  • Cheap and accessible information

  • Investor tools

    • Charts

    • Screening

    • Calculators

  • Online trading


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Investment Information on the Web

  • News articles

    • NY times

    • CBS Market watch

    • CNN financial


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More Investment Information

  • Stock information

    • Yahoo

    • Google

    • Quicken

  • Historical information

    • Yahoo

    • Datastream (fee)

    • Bloomberg (fee)


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Warnings on Internet Information

  • Don’t use information to trade to frequently

  • Don’t believe everything you see on the web


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More (biased) Information

  • Firm annual reports and accounting info

  • Analyst information

    • Analysts recommend (buy, sell, hold)

    • Problems:

      • Firms often are biased in what they tell analysts

      • Analysts are biased since stocks they analyze can be their own clients


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Internet Tools

  • Education

    • www.investorguide.com

    • www.fool.com

    • www.smartmoney.com

  • Calculators

    • www.financenter.com


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Internet Tools

  • Stock screening

    • Quicken

    • Yahoo

    • Google

  • Plotting/graphics

    • bigcharts.com

    • smartmoney.com


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Market Indices

  • Summarize market movements

  • Examples

    • Dow Jones Industrial (30 stocks)

    • NYSE Composite

    • S&P 500 Composite (500 stocks)

    • NASDAQ Composite

    • Nikkei (Japan)

    • Wilshire 5000

    • Sector indices


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Index Construction

  • Weighted sum

  • Weighting options

    • Equal w = (1/N)

    • Relative value of the firm (S&P, NASDAQ)

      • Value weighting

    • Odd (Dow Jones)


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Index Uses

  • Summary of the market

  • Investor benchmark (performance check)

    • Compare own result to index

  • Investment target

    • Index mutual fund


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Index Problems

  • Index is not constant

    • Additions and removals

    • Changing weights

  • As stock increases in value, share in index increases

  • Index can drift towards growing sectors in the market


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