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Securities Markets

Securities Markets Economics 71a Spring 2007 Mayo, Chapter 3 Lecture notes 2.3 Outline Markets Orders Positions Information Markets Primary markets New issues (IPO’s, corporate and public debt) Secondary markets Trading old stuff In many cases most activity in secondary

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Securities Markets

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  1. Securities Markets Economics 71a Spring 2007 Mayo, Chapter 3 Lecture notes 2.3

  2. Outline • Markets • Orders • Positions • Information

  3. Markets • Primary markets • New issues (IPO’s, corporate and public debt) • Secondary markets • Trading old stuff • In many cases most activity in secondary

  4. Money and Capital Markets • Money markets • Short term securities (1 year or less) • Capital markets • Longer term

  5. Money Market Securities • Treasury bills • U.S. government debt • Short term (less than 1 year) • Commercial paper • Short term corporate borrowing • Discount pricing • Buy for $10, get paid $11 in future • No interest payments

  6. Capital Market Securities • Bonds (longer term borrowing) • U.S. Treasury • Municipal (tax free) • Corporate • More later

  7. Capital Market Securities • Stocks • Common stock • Preferred stock • International • More later

  8. Trading and Secondary Markets • Stock markets • Bond markets • Derivatives • Foreign Exchange

  9. U.S. Stock Markets • New York Stock Exchange (NYSE) • National Association of Securities Dealers Automated Quotation (Nasdaq) • American Stock Exchange (AMEX)

  10. Continuous Trading • Market types • Specialist • Electronic dealer • Open outcry • Over the counter • NASDAQ • Upstairs (negotiated) • ECN (electronic crossing network)

  11. ECN’s: Electronic Crossing Networks • Internet based trade networks • Customers can meet directly (no broker) • Used mostly by professional money managers • Advantage: fewer intermediaries • Disadvantage: less liquidity • (Fewer people to trade with) • Fastest growing markets

  12. Other Markets • Futures/Options • Foreign Exchange • Spot versus forward • Bond

  13. International Markets • Many major international stock markets • London • Tokyo • China • many more • US accounts for only 36% of the companies listed on stock markets around the world

  14. International Investments • Purchase stocks or bonds in foreign countries • Purchase shares in foreign firms in U.S. (American Depository Receipts) ($/English) • Bonds can be issued in different currencies • Eurobond: Intel issues $ denominated bond in Japan

  15. Trading Hours • Most U.S. stock markets • 9:30-4:00 • Extended hours on electronic trading networks • “After hours trading” • International markets (local times) • Foreign exchange markets (24 hours) • Hours increasing : toward a 24 hour market

  16. Outline • Markets • Orders • Positions • Information

  17. Types of Orders • Market order • Limit order

  18. Market Order • Buy or sell at the current market price • No restrictions • “Buy 50 shares at market”

  19. Limit Orders • Buy when price drops below a limit • Sell when price moves above a limit • Example • Limit buy at 50 (price at 60) • Stock moves to 55 (nothing happens) • Stock moves to 49 (order executed) • Advantage • Might end up with a better price • Disadvantage • Order might end up unfilled

  20. Brokers • Enable trading of financial services • Dealer function • Access • Mail • Phone • Internet

  21. Types of Brokers • Full service • Extensive research • Merrill Lynch • Premium discount • Limited research • Charles Schwab • Basic discount • No research • E*trade • Classification is difficult

  22. Transaction Costs • Commissions • Bid/ask spreads

  23. Costs of Trading • Commissions • Fixed • Negotiated • Varying structures (fixed + varying) • $20 + shares * C • Bid/ask spread • Buy at the ask • Sell at the bid

  24. Bid/ask Spread • Example: • Ask = 88.5 (buy) • Bid = 88 (sell) • Spreads may change • Over time • Over stocks • Reveal the ease of trading a stock • “Liquidity” again

  25. Order Books • Order book • List of current limit buy and sell orders • If you want to buy • Can “hit” limit sell orders • Walk up the book • Higher price for more stock • If you want to sell • Can “hit” limit buy orders • Walk down the book • ECN’s and visible order books

  26. Settlement and Delivery • Settlement dates • Usually trade date + 3 days • Take delivery or leave shares with broker (street name)

  27. Outline • Markets • Orders • Positions • Information

  28. Long Purchase • Straight purchase of a security • Speculate that price will increase • Buy at 100 • Sell at 110 • 10% return

  29. Margin Purchase • “Buying on margin” • Borrow money to buy stock • Buy at 75% margin • 75% of money in investment is yours • 25% is borrowed from broker or bank • Purchase $100 of stock at 75% margin • You put in $75, and you borrow $25

  30. Basic Margin Formula

  31. Margins and Magnification • Example stock: Price = $100 • Up: Price = $150 • Down: Price = $75 • If you purchased with your own money • $100 total investment • Up: + $50 • Down: - $25

  32. Margins and Magnification • Buy on 50% margin (zero interest charges) • $100 own, and $100 borrowed (needs to be paid back) • Purchase $200/$100 shares = 2 shares • $100 total investment • Up: 2*150 - 100 - 100 = $100 (50) • Down: 2*75 - 100 - 100 = $-50 (-25)

  33. Margin Buying • Borrowing money to buy stocks • Magnifies gains and losses • Can lose more than you put in • Buy $200 of stock • $100 your own • $100 borrowed • Stock goes to zero • Lose $100 of own investment, and • Owe $100 of borrowed money too

  34. Maintenance Margins • Margin required for investor to maintain • If margin falls below this level investors must add more of their own money • “Margin call” • Common margin call • Prices fall • Margin rises • Investor needs to come up with more funds

  35. Margin Requirements • Common stock: 50% • Bonds: 50% • Options: 20% stock value • Futures: 2-10% of the contract value

  36. Short Sales • Holding negative stock • Sell stock you don’t have (borrow) • Buy it back later • Pay dividends yourself in between • Key issue • Make money on a price fall • Lose money on a rise • Betting against a stock

  37. The Mechanics of a Short • Tell broker you want to sell 100 shares of IBM short (price = $50) • Broker “borrows” shares of 100 shares of IBM owned by another client • Sells it to someone for 50*100=5000, and pays this to you • You must keep this amount on account with broker • When dividends are to be paid, you pay broker, and broker pays the other client

  38. The Mechanics of a Short • IBM goes down to $40 per share • You “buy” your 100 shares to take you back to zero, pay broker 40*100=4000. • Broker buys at market, and puts the shares back in the other person’s account • You make 5000-4000 = 1000 (less dividends) • Make money when price falls • Lose money when price rises

  39. The Mechanics of a Short • IBM goes up to $60 per share • You “buy” your 100 shares to take you back to zero, pay broker 60*100=6000. • Broker buys at market, and puts the shares back in the other person’s account • You lose 5000-6000 = -1000 (less dividends)

  40. Margins and Shorts • Broker requires additional funds to cover possible losses • Fraction of additional sale amount • Example • Sell $5000 worth of stock at 50% margin • Need to keep 1.5*5000 = 7500 on account with the broker • When the price goes up, need to increase this • “Margin call”

  41. Oddities About Shorts • Can lose unbounded amounts of money • Normally only lose what you put in • With short price can go up forever, and your losses keep increasing • Also, broker can get in trouble if you default • Other customer could lose original shares • Often insured for this

  42. Short Interest • Fraction of shares sold short • Measure of market pessimism in a stock • Common market indicator • Measures market pessimism

  43. Squeeze Play • Assume Microsoft has a large number of short sellers • Price starts to rise • Short sellers losing money • Get nervous • Buy stock to close out their short positions • Prices rise more, more buying .. (etc. etc)

  44. Outline • Markets • Orders • Positions • Information

  45. Information Sources • Private • Quicken and Yahoo finance • Wall St. Journal (fee) • Value line and Standard and Poors (fee) • Brokerage firms • Corporations • Government • Federal Reserve • SEC

  46. Information Sources • Key publications • Economic information • Federal reserve bulletins (economic info) • Firm/investment data • Value Line Survey • Standard and Poor’s Handbook • Security firm reports • Firm annual reports

  47. The Internet and Investing • Cheap and accessible information • Investor tools • Charts • Screening • Calculators • Online trading

  48. Investment Information on the Web • News articles • NY times • CBS Market watch • CNN financial

  49. More Investment Information • Stock information • Yahoo • Google • Quicken • Historical information • Yahoo • Datastream (fee) • Bloomberg (fee)

  50. Warnings on Internet Information • Don’t use information to trade to frequently • Don’t believe everything you see on the web

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