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FINA 4310 Survey of Investments Dr. Mayhew Spring 2002

FINA 4310 Survey of Investments Dr. Mayhew Spring 2002 Chapter 3: How Securities Are Traded Primary Market Initial Public Offerings (IPOs) Example Seasoned Offerings Example Secondary Markets Over-The-Counter (OTC) Markets Bond Market Foreign Exchange Market Derivatives Market

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FINA 4310 Survey of Investments Dr. Mayhew Spring 2002

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  1. FINA 4310Survey of InvestmentsDr. MayhewSpring 2002 Chapter 3: How Securities Are Traded

  2. Primary Market • Initial Public Offerings (IPOs) Example • Seasoned Offerings Example

  3. Secondary Markets • Over-The-Counter (OTC) Markets • Bond Market • Foreign Exchange Market • Derivatives Market • OTC Stock Market • Exchanges • Stock Exchanges • Futures Exchanges • Option Exchanges

  4. Exchanges • Centralized public trading venue • Does not have to be a physical location • Provides regulated trading environment • Trades and Prices become public info. • Various different structures possible • Dealer Market • Specialist Market • Order-Driven Market

  5. Dealer Markets • Simultaneous quotes from multiple dealers • OTC Markets have dealership structure • Futures Exchanges • NASDAQ Stock Market • NASDAQ National Market • NASDAQ SmallCap Market • OTC Bulletin Board

  6. Dealer Market Order Order Broker Market Maker Market Maker Order Market Maker

  7. Specialist Markets • A Specialist... • Disseminates one set of quotes (bid and ask) • Oversees matching of buyers and sellers • Represents public limit orders • Helps maintain orderly market • Trades on own account • New York Stock Exchange (NYSE) • American Stock Exchange (AMEX) • Regional Exchanges

  8. Specialist Market Specialist Broker Broker- Dealer Order Order

  9. Order-Driven Markets • Electronic Communication Networks(ECN) • Island • Instinet • Archipelago • London SETS • Euronext Paris

  10. Order-Driven Market Order Book Broker Broker- Dealer Order Order

  11. Bid Ask Spread • Bid price: • Somebody else has offered to buy at this price • Therefore, you can sell at the bid • Ask price: • Somebody else has offered to sell at this price • Therefore, you can buy at the ask • Bid price is less than the Ask price • Difference is the bid ask spread

  12. Bid Ask Spread • Measures the round-trip transaction cost • Tends to be narrower for actively traded stocks • For the most active stocks, often one penny • Ten or fifteen cents for less active stocks • Sometimes wider

  13. Order Types: Market Order • Order to buy or sell immediately • Execution price is uncertain • Should execute at or near the quote • Buy order: at the ask price • Sell order: at the bid price • Quotes can move • Price improvement is possible

  14. Order Types: Limit Order • Price-contingent order • May not execute immediately • May never execute • If it does, it will be at the specified price or better. • Limit buy: at or below specified limit price • Limit sell: at or above specified limit price • “Marketable” limit order: can be executed immediately

  15. Order Types: Limit Order • Limit orders can be: • Day orders (cancelled if unfilled at close) • Good until cancelled • In a specialist market or order-driven market, limit orders go into an “order book” • Price priority • Time priority • Market makers in a dealer market can accept limit orders, but there may not be a consolidated book.

  16. Order Types: Stop orders • Becomes market order when price hits target “stop” price • Example: Stop loss order • Price is currently at 55 • Put in stop loss order at 50 • If stock hits 50, sell immediately

  17. Order Types: Stop Limit Order • Becomes limit order when stock hits target stop price • Example: • Stock is currently at 35 • Submit limit order to buy at 39, with stop at 40 • If stock hits 40, then it converts into a limit order to buy at 39

  18. Order Types: All or Nothing • When submitting a limit order, it is possible that only part of your order may be filled. • For example, you may want to buy 1,000 shares, but only get 800 shares. • To avoid this, specify “All or nothing”

  19. Order Types: Fill or Kill • A limit order that will be cancelled if it does not execute immediately • Example: • The current ask is $20 • If you use a market buy, price could move up while you are submitting the order, and you could pay more • Submit a fill or kill at 20 if you don’t want to pay more. • If the price does increase, order will not execute

  20. StocksBuying on Margin • Borrowing money to buy a stock • Margin: the percentage of the stock position that belongs to you MV = Market Value of Assets Margin = ( MV – Loan ) / MV

  21. StocksBuying on Margin • Initial Margin Requirement: Minimum margin required at entry. Broker cannot set it below 50%

  22. StocksBuying on Margin Example Amazing.com is at 20 You have $150,000 in cash Borrow $50,000 You buy 10,000 shares for $200,000 Initial Margin = 150K / 200K = 75%

  23. StocksBuying on Margin Your margin level changes whenever the stock price changes. Example: Amazing.com goes to 25 Margin = (250K-50K)/250K = 80% Amazing.com goes to 10 Margin = (100K-50K)/100K = 50%

  24. StocksBuying on Margin Maintenance Margin: • The minimum margin required to keep a position open • Broker cannot set below 25% • If your margin falls below this level, you receive a margin call

  25. StocksBuying on Margin Example: Maintenance Requirement = 35% When would you get a margin call? (10,000 X – 50,000) / 10,000 X = .35 50,000 / 10,000 X = .65 X = 50,000 / 10,000 (.65) = 7.69

  26. StocksBuying on Margin • When you buy on margin, you pay interest on the margin loan. Margin Rates for Deep Discount Brokers

  27. Links NASD Regulation Motley Fool justquotes.com Equity Analytics TradeStar American Express Wachovia Fidelity Firstrade Datek StocksBuying on Margin

  28. StocksShort Selling • Borrowing a stock and selling it • Eventually, you must buy it back • Make money when stock goes down • Lose when the stock goes up

  29. StocksShort Selling Example: Short 1,000 shares of Dog at 60. Receive $60,000. Dog goes down to 50. Buy back for $50,000 You made $10,000.

  30. StocksShort Selling Example, continued Dog goes up to 75 Buy back for $75,000 You lost $15,000.

  31. StocksShort Selling • A lender must be found • The lender can demand the security back at any time • If no new lender can be found, you can be squeezed out of the short • The short party is responsible for dividends

  32. StocksShort Selling Margin Requirement for Shorting As a collateral against default, you must keep 100% of the proceeds of the short plus an additional margin. Initial requirement: at least 50% Maintenance requirement: at least 30%

  33. StocksShort Selling Margin for a Short Position: CM = Cash in Margin Account MV = Market Value of Stock Margin = ( CM – MV ) / MV = (CM/MV) - 1

  34. StocksShort Selling Example, continued Short 1,000 shares of Dog at 60. Initial margin requirement = 50% Must keep the $60,000 proceeds plus an additional $30,000 (90,000 – 60,000) / 60,000 = .5

  35. StocksShort Selling Example, continued Maintenance requirement = 30% When will you get a margin call? (90,000 / 1,000 X) - 1 = .30 90,000 = 1.30 (1000 X) X = 69.23

  36. Links Laughing Stock Motley Fool Equity Analytics TradeStar Viswanath York Securities Vanguard StocksShort Selling

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