7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
1/36
How Securities are Traded?Week 2
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
2/36
Moving to automated electronic trading
Current trends will eventually result in 24-hour global markets
Moving toward market consolidation
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
3/36
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
4/36
Primary New issue, usually involves an initial public
offering or IPO
Key factor: issuer receives the proceeds fromthe sale
Secondary
Existing owner sells to another party
Issuing firm doesnt receive proceeds and isnot directly involved
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
5/36
Process
Road shows
Bookbuilding Underpricing
Post sale returns
Cost to the issuing firm
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
6/36
3-6
Process
Road shows to publicize new offering
Bookbuilding to determine demand forthe new issue
Degree of investor interest in the newoffering provides valuable pricinginformation
Underpricing
Post sale returns
Cost to the issuing firm
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
7/36
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
8/363-8
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
9/363-9
Bid Price
Bids are offers to buy. Investors sell to the
bid. Bid-Asked spread is the
profit for making amarket in a security.
Ask Price
Asked prices representoffers to sell.
Investors must pay theasked price to buy thesecurity.
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
10/363-10
Market Order: Executed immediately
Trader receives current market price
Price-contingent Order:
Traders specify buying or selling price
A large order may be filled
at multiple prices
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
11/36
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
12/36
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
13/36
Different types oforders allow you to bemore specific about how you'd like your
broker to fulfill your trades. When you place astop or limit order, you are telling your brokerthat you don't want the market price (thecurrent price at which a stock is trading), butthat you want the stock price to move in acertain direction before your order isexecuted.
http://www.investopedia.com/terms/o/order.asphttp://www.investopedia.com/terms/b/broker.asphttp://www.investopedia.com/terms/s/stoporder.asphttp://www.investopedia.com/terms/l/limitorder.asphttp://www.investopedia.com/terms/l/limitorder.asphttp://www.investopedia.com/terms/s/stoporder.asphttp://www.investopedia.com/terms/b/broker.asphttp://www.investopedia.com/terms/o/order.asp7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
14/36
There are two types of price-contingent orders: Limit orders to buy or sell
Stop orders to buy or sell
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
15/36
A stop order will be executed only when the security
you want to buy or sell reaches a particular levelthe stop price. Once it reaches the stop price it
becomes a market order. Because a stop order isfilled at the market price after the stop price hasbeen hit, it's possible that you could get a really bad
fill in fast-moving markets.
A limit order is one that is at a certain price orbetter. Limit orders are beneficial because when thetrade goes through, investors get the specified
purchase or sell price.
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
16/36
A stop-buyorder is an order to buy whenthe price rises to the stop price and isintended toprotect a short-selleragainstprice increases
A stop-sellorder is an order to sell whenthe price falls to the stop price and isintended to limit the investors losses, (akastop loss order). This type of order can
also be used to guarantee profits.
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
17/36
A Buy to Cover Stop Order is very similar to aStop Buy Order, the only difference being thistype of order is used to exit a Short positionrather than enter a Long position.
http://www.solerinvestments.com/Online-Trading/Buy-Stop-Order.htmhttp://www.solerinvestments.com/Online-Trading/Buy-Stop-Order.htm7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
18/36
Limit orders are used when the trader wishes to
control price rather than certainty of execution. Limit-buycan only be executed at the limit price or
lower. For example, if an investor wants to buy astock, but doesn't want to pay more than $20 for it,the investor can place a limit order to buy the stock
at $20 "or better". By entering a limit order rather
than a market order, the investor will not buy thestock at a higher price, but, may get fewer sharesthan he wants or not get the stock at all.
Limit-sellis analogous; it can only be executed at
the limit price or higher.
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
19/36
Scenario One:
United Plantations currently sells for RM17.00whichyou think is too high. However you think the stock
would be a good buy if it could be purchased for NOMORE than RM15.ACTION
Execute a Limit Buy Order at RM15
(Order to BUYif price falls to limit price. Since it is alimited order, RM15 is the maximum price at which
the order will be executed)
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
20/36
The main benefit of a Limit Buy Order is thatyou may be able to buy the shares that you
want at a price that is below the currentmarket price and you are able to set amaximum on how much you're willing tospend per share.Buy Limit Orders are great for buyingshort-term market pullbacks.
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
21/36
Scenario Two:
You are long Top Glove which currently sells for
RM5.00. You think the current price is close to the
fundamental value but since the stock has risensharply over the recent weeks you think it should riseby another 10%--which is the minimum price you are
willing to sell your shares.
ACTIONExecute a Limit Sell Order at RM5.50
(Order to SELL if price rises to limit price. As a limit order,RM5.50 is the minimum price which the order will be
executed)
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
22/36
The main benefit of a Limit Sell Order is thatyou may be able to sell the shares that you
own at a minimum price that you specify IFthe stock's price raises to that price. LimitSell Orders are great for maximizing profit-taking.
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
23/36
Day order (the most common) is a market or limit order thatis in force from the time the order is submitted to the end ofthe day's trading session.
Good-till-cancelled order requires a specific cancellingorder. It can persist indefinitely (although brokers may setsome limits, for example, 90 days).
Immediate-or-cancel order (IOC) will be immediatelyexecuted or cancelled by the exchange.
Fill-or-kill orders (FOK) are usually limit orders that must beexecuted or cancelled immediately. Unlike IOC orders, FOKorders require the full quantity to be executed.
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
24/36
Using only a portion of the proceeds for an investment
Borrow remaining component
Can MAGNIFY both gains and losses
i.e. Stock is purchased for $10 using 40% margin and borrowingcost of 8% annually, or, in other words, $6 is borrowed at 8%while the remaining $4 is equity. Suppose that one year laterthe stock sells for $12 or an increase of 20%. The 1-year HPR
using margin is [12 (10 + .08x6)] / 4 = 1.52 / 4 = 0.38 or 38% Margin arrangements differ for stocks and futures
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
25/36
Margin for the US is currently 50%; equity mustbe at least 50% of the stock value
Set by the US Federal Reserve
Maintenance margin: minimum amount equity intrading can be before additional funds must beput into the account
Margin call: notification from broker that youmust put up additional funds
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
26/36
X Corp $100
60% Initial Margin
40% Maintenance Margin
100 Shares Purchased
Initial Position
Stock $10,000 Borrowed $4,000Equity $6,000
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
27/36
Stock price falls by 30% to $70 per share
New Position
Stock $7,000 Borrowed $4,000
Equity $3,000
NOTE: Both assets and equity declined by $3,000, a 30% decline inassets but a 50% decline in equity!
Margin% = Equity / Value of Stock Owned
= $3,000/$7,000 = 43%
which is still above the maintenance requirement of 40%
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
28/36
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
29/36
Note: A useful formula to calculate the Investors Rate of Return is:
[%Stock Price x (1 / Initial Margin) - % Interest on Loan](Margin Loan / Beginning Equity)
i.e. Using the above example, if % Stock Price = .30, initialmargin = .50, and interest rate is 0.09 per year, the marginloan is $10,000 and the beginning equity is $10,000,the 1-year HPR = 0.30(1/0.50) 0.09(10,000/10,000) = 0.51 or
51%
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
30/36
How far can the stock price fall before amargin call?
Let P = price at which a margin call is triggered:
(100P - $4,000) / 100P = 30%
Solving for P = $57.14
where 100P - Amt Borrowed = Equity and
100P = Market Value of the Stocks Held
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
31/36
Purpose: to profit from a decline in the price ofa 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 andreturn to the party from which is wasborrowed
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
32/36
Required initial margin: Usually 50%
More for low-priced stocks
Liable for any cash flows
Dividend on stock
Zero tick, uptick rule
Eliminated by SEC in July 2007
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
33/36
Short-sale maintenance marginrequirements (equity)
Price MMR
< $2.50 $2.50
$2.50-$5.00 100% market value
$5.00-$16.75 $5.00
> $16.75 30% market value
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
34/36
Dot Bomb 1,000 Shares Shorted50% Initial Margin30% Maintenance Margin$100 Initial Price
Sale Proceeds 1,000 share @ $100 = $100,000Margin & Equity 50% of $100,000 or $50,000
Stock Owed $100,000(Assets = Cash Receivable from sale of $100,000 plus margin
deposit receivable $50,000 for a total of $150,000Liabilities = Stock Owed $100,000
Thus Equity is $50,000)
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
35/36
Stock Price Rises from $100 to $110 per shareAssets:Sale Proceeds (1,000 shares @$100) $100,000Initial Margin 50,000Liability:
Stock Owed (1,000 shares @$110) 110,00Net Equity 40,000Note: the liability increases causing equity to decreaseMargin % = Net Equity / Value Shares Owed
(40,000/110,000) = 36%
which is still above the maintenance margin of 30%
7/29/2019 AFW3121 Lecture Week 2 (Semester 1, 2013)
36/36
How much can the stock price rise before a margincall?
($150,000*
- 1,000P**
) / (1,000P**
) = 30%SOLVING FOR PP = $115.38
Thus a margin call would occur if the stock price
rose from the initial $100 to $115.38 per share
*Initial margin plus sale proceeds of sale of stock
**V l f St k O d