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Capital Market Overview

Capital Market Overview Capital Markets Debt Common stock Preferred stock Derivative securities Security Trading Trading Trading Costs Buy on margin versus short sell Major Types of Securities Debt Money market instruments Bonds Common stock Preferred stock Derivative securities

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Capital Market Overview

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  1. Capital Market Overview • Capital Markets • Debt • Common stock • Preferred stock • Derivative securities • Security Trading • Trading • Trading Costs • Buy on margin versus short sell

  2. Major Types of Securities • Debt • Money market instruments • Bonds • Common stock • Preferred stock • Derivative securities

  3. Markets and Instruments • Money Market • Debt Instruments • Derivatives • Capital Market • Bonds • Equity • Derivatives

  4. Money Market Instruments • Treasury bills • Certificates of deposit • Commercial Paper • Bankers Acceptances • Eurodollars • Repurchase Agreements • Federal Funds • LIBOR Market

  5. Bond Markets • US Treasury Bonds and Notes • Agency Issues (Fed Gov) • International Bonds • Municipal Bonds • Corporate Bonds • Mortgage-Backed Securities

  6. Municipal Bond Yields • Interest income on most municipals is not subject to tax • To compare the yields on municipals to other bonds use equivalent taxable yield (municipal return) / (1 – tax rate) • Or solve for the tax rate that equates the two yields Tax rate = 1 – (municipal rate/taxable rate)

  7. Capital Market - Equity • Common stock • Residual claim • Limited liability • Analyzing stocks – finance.yahoo.com • Preferred stock • Fixed dividends - limited • Priority over common • Tax treatment

  8. Stock Market Indexes • Uses • Track average returns • Comparing performance of managers • Base of derivatives • Factors in constructing or using an Index • Representative? • Broad or narrow? • How is it constructed?

  9. Examples of Indexes - Domestic • Dow Jones Industrial Average (30 Stocks) • Standard & Poor’s 500 Composite • NASDAQ Composite • NYSE Composite

  10. Examples of Indexes - International • Nikkei 225 & Nikkei 300 • FTSE (Financial Times of London) • Dax • Region and Country Indexes • EAFE • Far East • United Kingdom

  11. Bond Indexes • Lehman Brothers • Merrill Lynch • Salomon Brothers • Specialized Indexes • Merrill Lynch Mortgage

  12. Construction of Indexes • How are stocks weighted? • Price weighted (DJIA) • Market-value weighted (S&P500, NASDAQ) • Equally weighted (Value Line Index) • How returns are averaged? • Arithmetic (DJIA and S&P500) • Geometric (Value Line Index)

  13. Derivatives Securities Options Basic Positions Call (Buy) Put (Sell) Terms Exercise Price Expiration Date Assets Futures Basic Positions Long (Buy) Short (Sell) Terms Delivery Date Assets

  14. Tips on Investment • Buy under-valued stocks • Buy recent-past winners • Don’t over trade – investing in stocks is costly • You can buy bonds • Invest in real estates

  15. Security Trading • Primary Market versus Secondary Market • Types of Orders • Trading Mechanisms • Buy on margin and short selling

  16. 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

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

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

  19. Initial Public Offerings • Process • Road shows • Bookbuilding • Underpricing • Post sale returns • Cost to the issuing firm • See page 60-61

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

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

  22. Types of Orders Instructions to the brokers on how to complete the order • Market • Limit • Stop orders • Page 64-65

  23. Figure 3.6 Price-Contingent Orders

  24. Trading Mechanisms • Dealer markets • Electronic communication networks (ECNs) • Specialists markets • Page 66

  25. 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

  26. Nasdaq • National Market System • Nasdaq SmallCap Market • Levels of subscribers • Level 1 – inside quotes (investors) • Level 2 – receives all quotes but they can’t enter quotes • Level 3 – dealers making markets • SuperMontage

  27. Table 3.1 Requirements for Listing on Nasdaq Markets

  28. New York Stock Exchange • Member functions • Commission brokers • Floor brokers • Specialists • Block houses • SuperDot (70% of NYSE trading volume)

  29. Table 3.3 NYSE Listing Requirements

  30. 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

  31. Margin Trading • Using only a portion of the proceeds for an investment • Borrow remaining component • 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

  32. Margin Trading - Initial Conditions Example 3.1 X Corp $100 60% Initial Margin 30% Maintenance Margin 100 Shares Purchased Initial Position Stock $10,000 Borrowed $4,000 Equity $6,000

  33. Margin Trading - Maintenance Margin Ex. 3.1 Stock price falls to $70 per share New Position Stock $7,000 Borrowed $4,000 Equity $3,000 Margin% = $3,000/$7,000 = 43%

  34. Margin Trading - Margin Call Example 3.2 How far can the stock price fall before amargin call? The maintenance margin is 30%.

  35. 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

  36. Short Sale - Initial Conditions Dot Bomb 1,000 Shares 50% Initial Margin 30% Maintenance Margin $100 Initial Price Sale Proceeds $100,000 Margin & Equity 50,000 Stock Owed 100,000 What if price increases to 110? How much can the stock price rise before a margin call?

  37. Short Sale - Margin Call How much can the stock price rise before a margin call?

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