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CHAPTER 3

CHAPTER 3. How Securities are Traded. Securities Markets. Primary market : New issue Secondary market : Existing owner sells to another party Initial Public Offerings Evidence of “underpricing” Subsequent underperformance. Types of Orders.

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CHAPTER 3

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  1. CHAPTER 3 How Securities are Traded

  2. Securities Markets Primary market: New issue Secondary market: Existing owner sells to another party Initial Public Offerings Evidence of “underpricing” Subsequent underperformance

  3. Types of Orders • Market order (MO): buy or sell at the best price now available • Limit order (LO): buy or sell at the stated price or better. Normally, a LO: • To buy is below the market price • To sell is above the market price

  4. Example of Limit Order • You own a stock that is trading at $50. You are willing to buy more at a price of $40 and you are willing to sell at a price of $60. • Enter a LO to buy @ $40. • Enter a LO to sell @ $60. • If the mkt price drops to $40, you will buy, if it increases to $60, you will sell.

  5. Types of Orders: Stop Order • Stop (or stop loss) order: • To sell is normally to close a long position and price is below market. • To buy is normally to cover a short position, and price is above market.

  6. Example of Stop Order • You buy a stock when the price is $50. You are not willing to lose more than $10 per share. • Enter a stop loss order to sell @ $40. If the mkt price drops to $40, it becomes a market order and will be sold.

  7. Order Size • Block trade: 10,000 share minimum • Round lot: 100 shares • Odd lot: less than 100 shares • Block trades account for about 20% of shares traded; odd lot trades are less than 5%.

  8. Trading Mechanisms Dealer markets (NASDAQ) Electronic communication networks (ECNs) Specialists markets (NYSE)

  9. Trading Costs 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

  10. Buying on Margin • Investing on margin is purchasing securities with borrowed funds. • In margin transactions, margin refers to the investor’s equity in the position.

  11. Stock Margin Trading Margin is currently 50%; you can borrow up to 50% of the stock value Set by the FRS Maintenance margin: minimum amount equity in trading can be before additional funds must be put into the account Margin call: notification from broker that you must put up additional funds

  12. 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

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