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Chapter 3

Chapter 3. Securities Markets. Investment Banking Arrangements. Primary vs. Secondary Market Security Sales Underwritten vs. “Best Efforts” Negotiated vs. Competitive Bid SEC Rule 415 (Shelf Reg. 2yr & 4 hr notice ) SEC Rule 144A – private placement. 3- 2.

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Chapter 3

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  1. Chapter 3 Securities Markets

  2. Investment Banking Arrangements Primary vs. Secondary Market Security Sales Underwritten vs. “Best Efforts” Negotiated vs. Competitive Bid SEC Rule 415 (Shelf Reg. 2yr & 4 hr notice) SEC Rule 144A – private placement 3-2

  3. Initial Public Offeringshttp://bear.warrington.ufl.edu/ritter/ipodata.htm IPO Process Underpricing Issuer and banker put on the “Road Show” Purpose: Book building and pricing Post initial sale returns average about 10% or more, “Winner’s curse” problem? Easier to market the issue, but costly to the issuing firm 3-3

  4. Types of Markets • Direct Search Markets • Buyers and sellers locate one another on their own • Brokered Markets • 3rd party assistance in location buyer or seller • Dealer Markets • 3rd party acts as intermediate buyer/seller • Auction Markets • Brokers & dealers trade in one location, trading is more or less continuous 3-4

  5. Types of Orders Instructions to the brokers on how to complete the order Market order:execute immediately at the best price Limit order: Order to buy or sell at a specified price or better Stop loss/buy order:Becomes a market sell/buy order when the trigger price is encountered. Jargon AON: all or none, important for penny stocks IOC (FOK): immediate or cancel Day: by default GTC: good until canceled (usually 60 days) 3-5

  6. U.S. Security Markets Overview Nasdaq – dealer market; level I, II, III quotes Small stock OTC Pink sheets Organized Exchanges – auction market New York Stock Exchange (specialist) American Stock Exchange Regionals Electronic Communication Networks (ECNs) National Market System 3-6

  7. Block Transactions and Block Houses Block Houses Specialize in large block trades Trade for ≥ 10,000 shares 3-7

  8. Market Consolidation Trends • NYSE: • Merging w/ Deutsche Boerse in 02/2011 • Merged with Archipelago ECN in 2006 • Merged with Euronext in 2007 • Acquired the ASE in 2008 • Entering Indian and Japanese stock markets • NASDAQ • Acquired Instinet/Island in 2005 • Acquired Philly/Boston Stock Exchange in 2007 • Jointly acquired Swedish exchange OMX • CME acquired CBOT in 2007 3-8

  9. Market Structures in Other Countries • Moving to automated electronic trading • Specialist system is largely unique to U.S. • Most exchanges • No trading floor, all electronic trading • Sections for different size firms 3-9

  10. 3.5 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 3-10

  11. Buying on Margin Defined: borrowing money to purchase stock. Initial Margin Requirement IMR (minimum set by Federal Reserve under Regulation T), currently 50% for stocks Maintenance margin requirement (MMR): minimum amount equity can be before additional funds must be put into the accountExchanges mandate minimum 25%. Margin call: notification from broker you must put up additional funds or have your position liquidated. 3-11

  12. Short Sales How is it done? Mechanics • Borrow stock from a broker/dealer, must post margin • Broker sells stock and deposits proceeds and margin in a margin account (you are not allowed to withdraw the sale proceeds until you ‘cover’) • Covering or closing out the position: Buy the stock and broker returns the stock title to the party from which it was borrowed • Naked short sales 3-12

  13. Insider Trading Illegal, but what is it? – nonpulic & material Definition of insiders can be ambiguous SEC’s Official Summary of Securities Transactions and Holdings 3-13

  14. Response toScandals Increased regulation Sarbanes-Oxley (SOX) Additional regulation will occur as a result of the financial crisis 3-14

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