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CHAPTER 3

CHAPTER 3. Securities Markets. Primary vs. Secondary Security Sales. Primary New issue Key factor: issuer receives the proceeds from the sale Secondary Existing owner sells to another party Issuing firm doesn’t receive proceeds and is not directly involved. How Firms Issue Securities.

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CHAPTER 3

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  1. CHAPTER 3 Securities Markets

  2. Primary vs. Secondary Security Sales • Primary • New issue • Key factor: issuer receives the proceeds from the sale • Secondary • Existing owner sells to another party • Issuing firm doesn’t receive proceeds and is not directly involved

  3. How Firms Issue Securities • Investment Banking • Shelf Registration • Private Placements • Initial Public Offerings (IPOs)

  4. Investment Banking Arrangements • Underwritten vs. “Best Efforts” • Underwritten: firm commitment on proceeds to the issuing firm • Best Efforts: no firm commitment • Negotiated vs. Competitive Bid • Negotiated: issuing firm negotiates terms with investment banker • Competitive bid: issuer structures the offering and secures bids

  5. Figure 3.1 Relationship Among a Firm Issuing Securities, the Underwriters and the Public

  6. Figure 3.2 A Tombstone Advertisement

  7. Shelf Registrations • SEC Rule 415 • Introduced in 1982 • Ready to be issued – on the shelf

  8. Private Placements Private placement: sale to a limited number of sophisticated investors not requiring the protection of registration • Allowed under Rule 144A • Dominated by institutions • Very active market for debt securities • Not active for stock offerings

  9. Initial Public Offerings • Process • Road shows • Bookbuilding • Underpricing • Post sale returns • Cost to the issuing firm

  10. Figure 3.3 Average Initial Returns for IPOs in Various Countries

  11. Figure 3.4 Long-term Relative Performance of Initial Public Offerings

  12. Types of Secondary Markets • Direct search • Brokered • Dealer • Auction

  13. Types of Orders Instructions to the brokers on how to complete the order • Market • Limit • Stop loss

  14. Figure 3.5 Limit Order Book for Intel on Archipelago

  15. Figure 3.6 Price-Contingent Orders

  16. Trading Mechanisms • Dealer markets • Electronic communication networks (ECNs) • Specialists markets

  17. U.S. Security Markets • Nasdaq • Small stock OTC • Pink sheets • Organized Exchanges • New York Stock Exchange • American Stock Exchange • Regionals • Electronic Communication Networks (ECNs) • National Market System

  18. Nasdaq • National Market System • Nasdaq SmallCap Market • Levels of subscribers • Level 1 – inside quotes • Level 2 – receives all quotes but they can’t enter quotes • Level 3 – dealers making markets • SuperMontage • OTC Bulletin Board

  19. New York Stock Exchange • Member functions • Commission brokers • Floor brokers • Specialists • Block houses • SuperDot

  20. Table 3.6 Electronic Computer Networks (ECNs)

  21. Market Structures in Other Countries • London - predominately electronic trading • Euronext – market formed by combination of the Paris, Amsterdam and Brussels exchanges • Tokyo Stock Exchange

  22. 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

  23. Margin Trading • Using only a portion of the proceeds for an investment • Borrow remaining component • Margin arrangements differ for stocks and futures

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

  25. Margin Trading - Initial Conditions X Corp $70 50% Initial Margin 40% Maintenance Margin 1000 Shares Purchased Initial Position Stock $70,000 Borrowed $35,000 Equity 35,000

  26. 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%

  27. Margin Trading - Margin Call How far can the stock price fall before amargin call? (1000P - $35,000)* / 1000P = 40% P = $58.33 * 1000P - Amt Borrowed = Equity

  28. 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 is was borrowed

  29. Short Sale - Initial Conditions 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

  30. 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%

  31. 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

  32. Regulation and Trends in Markets • Major regulations • Securities Acts of 1933 • Securities Acts of 1934 • Securities Investor Protection Act of 1970 • Trading scandals and reactions • Sarbanes-Oxley Act

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