Chapter 12

1. Chapter 12 Securities Markets

2. Learning Objectives • Identify and describe the primary and secondary securities markets. • Trade securities using a broker. • Locate and use several different sources of investment information to trade securities.

3. Introduction • One way to improve your chances of success is to understand how the securities markets work. • Success in investing cannot be guaranteed—but the first step to becoming rich through a great investment is learning how to make that investment.

4. Securities Markets • Securities —stocks and bonds—are issued by corporations to raise money • Securities Markets — places where you buy and sell securities—primary and secondary markets • After the initial issue of a security, the company doesn’t make money on trading; securities are bought and sold among investors

5. Primary Markets • Place where new securities are traded • Initial public offering (IPO)—the first time a stock is traded publicly • Seasoned new issues – stock offerings from companies that already have traded stock. A sale of new shares from Nike would be considered a seasoned new issue • All stock offerings must be approved by the SEC

6. Figure 12.1 Five Best and Worst IPOs of 2010

7. Primary Markets • Investment Banker • The middleman between the firm issuing the securities and the buying public • Underwriter • An investment banker who purchases a block of securities and then sells them to investors • Prospectus • A legal document that is made available to investors that describes a securities issue

8. Secondary Markets—Stocks • Markets in which previously issued securities are traded • Any time that a stock is traded after its IPO it is traded on a secondary market • Organized exchange —a physical location where stocks trade, such as the New York Stock Exchange and the American Stock Exchange

9. Secondary Markets - Stocks • Over-the-counter market —transactions conducted over phone or computer rather than at an organized exchange • It is highly automated • Brokers can see up-to-the-second price quotes on about 35,000 securities • The largest of these exchanges is NASDAQ

10. Secondary Markets - Stocks • Bid price is the highest price someone is willing to pay for a security • Ask price is the lowest price someone is willing to sell a security

11. Secondary Markets - Stocks • New York Stock Exchange (NYSE) • The oldest exchange, since 1792 • 1,366 seats available • To be listed, a company must meet strict requirements • In 2011, there were 2,800 companies traded on the NYSE • American Stock Exchange (AMEX) • 660 seats and lists 500 companies • 3% of the volume of the NYSE

12. Table 12.1 Initial Listing Requirements for the NYSE, 2011

13. Secondary Markets - Bonds • Some bonds trade at the NYSE, but most trading is done by bond dealers who deal directly with large financial institutions. • Small investors access bond dealers through their broker • Volume of trading for government bonds is enormous, dominated by Federal Reserve, commercial banks, and financial institutions

14. International Markets • Been around for centuries • Since 2000 BC • Some foreign shares traded on exchanges in the U.S. • American Depository Receipt (ADR) • A document that certifies that a bank holds shares of a foreign firm’s stock • International stocks can be traded through ADRs • Foreign investments account for about 10% of U.S. investors’ holdings

15. Figure 12.2 The World Stock Market More than half of all stocks are from foreign companies.

16. Regulation of theSecurities Markets • Regulations are aimed at protecting investors so that all have a fair chance of making money. • Securities and Exchange Commission (SEC), the federal institution that regulates buying and selling of stocks • Self-regulation – much of day-to-day regulation is left up to the markets themselves

17. Regulation of Securities Markets • Insider trading - trading with insider knowledge, allowing an unfair advantage • Martha Stewart, some members of Congress • Market abuses: • Stock price run-ups and abnormal volume • Churning – excessive trading on a client’s account, generating extra commissions for the broker

18. The Role of the Specialist in Securities Trading • Continuous markets —markets in which trading can occur at any time, with prices free to fluctuate as trading occurs • Stock prices can fluctuate sharply • Specialist —an exchange member who oversees the trading in one or more stocks—to “maintain a fair and orderly market.” Specialists may buy and sell stocks to keep prices stable

19. Order Characteristics • Order Size • Odd lots – orders between 1 and 99 shares • Round lots – orders in multiples of 100 • Time Period for Which the Order Will Remain Outstanding • Day orders expire at the end of the trading day • Open orders or Good-till-cancelled (GTC) orders remain open until filled or cancelled • In a discretionary account, the trader gives his/her broker power to make trades

20. Types of Orders • Market Orders —buy or sell immediately at the best price available • Limit Orders —trade is to be made only at a certain price or better • Stop Orders or Stop-Loss Orders —order to sell if the price drops below a specified level or to buy if the price climbs above a specified level

21. Short Selling • Short selling — the more the price drops, the more money you make • You borrow stock from your broker and then sell it. If the price goes down, you buy it at the lower price and pay back your broker, making money • If the price goes up, you buy it back at a higher price and lose money • Margin requirement – the percentage that an investor must have on deposit with a broker when selling short

22. Example of Short Selling • You think McDonalds (MCD) is going to drop from its current price of $70 • You borrow 1,000 shares from your broker and sell 1,000 shares short. The $70,000 you make goes into your account, but you can’t access the money • You also have to have an additional $35,000 margin requirement in your account • If MCD drops to $50, you purchase 1,000 shares for $50,000 and pay back your broker, making $20,000 • If MCD goes up to $90, you purchase 1,000 shares for $90,000 and lose $20,000

23. Figure 12.3 Profits from Purchasing Versus Selling Short

24. Dealing with Brokers • Most common way to purchase stock is through stockbroker, who is licensed to buy or sell stocks for others • Asset Management Accounts – financial services packages offered by a brokerage: • Checking account • Debit and credit cards • Money market mutual funds • Loans

25. Types of Brokers • Full-Service Brokers or Account Executive – they are paid commissions based on sales volume (Merrill Lynch, Edward Jones, Morgan Stanley, etc.) • Discount and Online Brokers – execute trades but do not provide advice • Charge lower commission, usually a flat amount per trade • Fidelity, ScotTrade, E-Trade, etc.

26. Checklist 12.1

27. Cash Versus Margin Accounts • Cash Accounts – the investors pay in full for security purchases; payment due within 3 business days • Margin Accounts – investors borrow a portion of the purchase price of the stock from broker • Margin or Initial Margin – the amount the investor must pay for the stock; it has been 50% for the last 30 years

28. When shares are bought on margin, they remain in the broker’s name. They are collateral on the loan to buy the shares • Buying on margin can be a dangerous practice • Maintenance margin – a minimum percentage of collateral that you must maintain • Margin call – requires that you replenish the margin account by adding cash to bring the amount back up to its required minimum level. This happens when the stock goes down.

29. Registration: Street Nameor Your Name • Securities can be registered in your name or “street name.” • Street Name – registered securities remain in the broker’s custody and are a computer entry in your name. • More convenient to sell • May have maintenance fee for inactivity • Avoid fee by registering stock in your name

30. Joint Accounts • Joint Tenancy with Right of Survivorship – when one owner dies, the other receives full ownership of assets in the account • Tenancy-in-Common Account – the deceased’s portion of the account goes to the heirs of the deceased, not the surviving account holder

31. Choosing a Broker • Using a full-service broker – personal service and advice but for higher price • Using a discount broker – keeps transaction costs down because they cost 10 to 20 times less; personal service is much lower, but some offer free research reports

32. Checklist 12.2

33. The Cost of Trading • Sales commission to buy stock – for a full-service broker, it can be very expensive, and they also charge a commission to sell the stock • Transaction fee, generally small • Annual fee for inactive accounts – could range from $25 - $200 a year • Use discount broker especially for large purchases

34. Online Trading • Day traders – investors who trade, generally on Internet, with a very short-term time horizon • The idea is to trade on the up or down momentum of a stock and get out before it changes direction • Be prepared to suffer severe financial losses • Don’t confuse day trading (speculation) with investing. • Don’t believe claims of easy profits • Watch out for “hot tips” or “expert advice”

35. Checklist 12.3

36. Sources of Investment Information • Corporate Sources – annual reports • Brokerage Firm Reports – available from stock analysts • The Press – the Wall Street Journal, Forbes, Fortune, Barron’s, Money, etc. • Investment Advisory Services – Value Line Investment Survey follows 1700 companies; also evaluates industries

37. Sources of Investment Information • Internet Sources • Investment Clubs – people join the club and pool their money; knowledge and experience is shared

38. Table 12.3 Great Sources of Investment Information on the Web

39. Summary • Primary securities markets are where new securities are sold. • Previously issued securities are traded in the secondary markets which can be organized exchanges. • Investors must specify time period for orders in day orders, open orders, or fill-or-kill orders.

40. Summary • Short selling involves borrowing stocks from a broker, selling high and buying back low, making a profit, and returning the stocks to the broker • Be careful on where you get information to make investment decisions