Fall-02http://pluto.mscc.huji.ac.il/
~mswiener/zvi.htmlInvestments
Zvi Wienertel: 02-588-3049 [email protected]
How securities are tradedBKM Ch 3
Zvi Wiener BKM Ch 3 slide 2
How Securities Are Traded
How Firms Issue Securities
Where Securities are Traded
Trading on the Exchanges
Buying on Margin
Short Sales
Regulation of Securities Markets
Mutual Funds
Zvi Wiener BKM Ch 3 slide 3
Primary market - when issued
Secondary market - any time later
Primary market
public offering
private placement
IPO (initial public offering)
Seasoned new issue
Zvi Wiener BKM Ch 3 slide 4
Public offerings of stocks and bonds are usually underwritten by investment bankers. A lead investment banker forms an underwriting syndicate to share the commitment.
The syndicate provides market advice and handle the SEC registration process.
(red herring=preliminary prospectus)
1. Firm Commitment
2. Best-Efforts Basis
Zvi Wiener BKM Ch 3 slide 5
Shelf Registration
Since 1982 the SEC allows (rule 415) shelf registration. One can register now but actually trade during two years.
Rule 144A of SEC
Trading of private placements among some institutions.
Zvi Wiener BKM Ch 3 slide 6
IPO
Road show
Book – indication of interest
IPO underpricing effect in the first days and bad performance later.
Internet IPO
Zvi Wiener BKM Ch 3 slide 7
Private Placements
Private placement: sale to a limited number of sophisticated investors not requiring the protection of registration.
Dominated by institutions.
Very active market for debt securities.
Not active for stock offerings.
Zvi Wiener BKM Ch 3 slide 8
Secondary Market
national (NYSE, AMEX)
regional - firms located in its area
exchanges for derivatives
Trading conducted by members (seat owners)
Commission brokers seats - full-service brokers
Zvi Wiener BKM Ch 3 slide 9
Seat price on the NYSE in $K
year high low year high low 1875 6.8 4.3 1985 600 310 1905 140 72 1990 430 250 1935 250 65 1995 1,050 785 1965 138 190 1999 2,650 2,000 1975 275 55 1980 480 175
Zvi Wiener BKM Ch 3 slide 10
NYSE Listing Requirements
Pretax Income last year $2,5M
Average annual pretax in 2 years $2M
Market value of publicly held stock $60M
Shares publicly held 1.1M
Holders of 100 shares or more 2,000
Zvi Wiener BKM Ch 3 slide 11
The Over-the-Counter Market
More than 35,000 issues are traded
Since 1972 the NASDAQ gives quotes
(National Association of Security Dealers)
network of dealers linked by a computer system.
Zvi Wiener BKM Ch 3 slide 12
OTC levelsLevel 3: Market makers
Maintain inventories of securities
May enter bid-ask prices and update them
Level 2: Receive all bid-ask quotes
Can not enter quotes
Are brokers who act for clients
Do not actively deal on their own account
Level 1: Receive median bid-ask quotes
Investors looking for information.
Zvi Wiener BKM Ch 3 slide 13
Third and Fourth Markets
The third market - exchange-listed securities traded on the OTC
Fourth marked - investors trading directly
Zvi Wiener BKM Ch 3 slide 14
The National Market System
Securities Act Amendments of 1975 directed SEC (Securities and Exchange Commission) to implement a national competitive system.
Requirements to companies
Insider trading is prohibited
Public Information control
Zvi Wiener BKM Ch 3 slide 15
Other Countries
LSE - London Stock Exchange
TSE - Tokyo Stock Exchange
German
Zurich
Paris
Toronto
Israel
Zvi Wiener BKM Ch 3 slide 16
Participants
Commission Brokers - serve clients
Floor Broker - independent broker
Registered Traders - act on their own account
Specialists
Zvi Wiener BKM Ch 3 slide 17
Types of Orders
Market Order
Limit Order (price, time)
Stop-Loss Order
(sell if the price falls below some level)
Stop-Buy Order
(buy if the price rises above some level)
Block sales (10,000 shares), block houses, standard price taking assumption isn’t valid.
Zvi Wiener BKM Ch 3 slide 18
Limit Orders
ConditionAction
Price belowthe limit
Price abovethe limit
Buy Limit buyorder
Stop buyorder
Sell Stop lossorder
Limit sellorder
Zvi Wiener BKM Ch 3 slide 19
Roles of a Specialist
Specialist “makes a market” in a share.
He can act either as a broker or as a dealer.
Specialist maintains a “book”- list of outstanding orders.
Provides liquidity.
Is obligated to provide price continuity.
Zvi Wiener BKM Ch 3 slide 20
Trading on the OTC Market
Dealer Market
Investor contacts broker
The broker tries to find a dealer
Computerized system
Zvi Wiener BKM Ch 3 slide 21
Trading Costs
Full-Service - advice, research, execution
Discount Brokerage - only execute
Brokerage fees + the bid-ask spread
Paying for order flow
Odd versus even quotes
Internet innovation
Zvi Wiener BKM Ch 3 slide 22
Buying on Margin
Initial Margin is defined by the FRS (Federal Reserve System) about 50% by investor’s funds, the rest is borrowed from the broker. Margined stock is left with the broker.
Maintenance Margin are set by the NYSE and the brokerage firm. If the balance falls below, the investor is subject to a margin call.
Margin is equity in the account as a percent of the value of the account, a leveraged position.
Zvi Wiener BKM Ch 3 slide 23
Below Maintenance Margin Value of securities no longer support loan Investor must do something! 1. Sell some shares 2. Send cash
Above Initial Margin Investor may 1. Do nothing 2. Buy more shares with no additional cash 3. Increase loan amount
Zvi Wiener BKM Ch 3 slide 24
Short SalesAn investor borrows a stock from the broker
The short seller expect the price to decline
Covering the position - purchasing the stock
One can short a stock only after an uptick
Required deposit (50%)
All dividends must be paid
Margin call possible
What is the difference between buying on margin and selling short?
Zvi Wiener BKM Ch 3 slide 25
Short position - pessimist
Long position - optimist
Zvi Wiener BKM Ch 3 slide 26
Short SaleYou short 100 shares at $50
Dividends of $1/share are paid
You cover position at $40
Profit = $900
You short 100 shares at $50
Dividends of $1/share are paid
You cover position at $60
Loss = ($1,100)
Zvi Wiener BKM Ch 3 slide 27
Margin Calls on Short Transactionsyou go short 100 shares at $50; MM 30%
Assets
$5,000 Proceeds
$2,500 Cash
$7,500
Liability & Equity
$5,000 C.S.
$2,500 Equity
$7,500Margin = (Assets-Liabilities)/Liabilities
0.3 = ($7,500-100 P)/(100 P)
P = $57.69
Zvi Wiener BKM Ch 3 slide 28
Regulation on Securities Markets
Securities Act of 1933 - disclosure of new issues
Securities Act of 1934 - established SEC
The Commodities Futures Trading Commission
The Securities Investor Protection Corporation protects investors from losses against brokerage firm bankruptcy
Zvi Wiener BKM Ch 3 slide 29
Other Restrictions
Circuit Breakers. Trading is stopped for 1 hour when DJIA falls 250 points from the previous day’s close and stops trading for 2 hours if the drop is 400 points.
Insider Trading. Insiders are: major shareholders, officers and directors. They must disclose their trades to SEC (and SEC discloses it to public).
Zvi Wiener BKM Ch 3 slide 30
Home Assignment
Required: •
read chapter 3 in BKM. •
read very carefully summary at the end.
• problems 2, 7, 12, 14, 16, 17 (3rd ed).
• problems 2, 9, 18, 20, 22, 23 (5th ed).
• find names of all 30 companies in DJIA
• find names of all 25 companies in TA-25
• closely follow financial news!
Fall-02http://pluto.mscc.huji.ac.il/
~mswiener/zvi.htmlInvestments
Zvi Wienertel: 02-588-3049 [email protected]
Mutual FundsBKM Ch 4
Zvi Wiener BKM Ch 3 slide 32
Mutual Funds
Open-End Funds, sell at net asset value + load.
NAV = (Assets - Liabilities)/Shares
Closed-End Funds. No new shares issued.
Front-end load
Back-end load
Operating expenses
12B-1 Charges - annual fees
Zvi Wiener BKM Ch 3 slide 33
Advantages: Diversification and divisibility
Professional management
Small investment
Reinvestment of dividends, capital gains
Disadvantages: Commissions (loads)
Time delay or illiquidity
Zvi Wiener BKM Ch 3 slide 34
Home Assignment
• read chapter 4 in BKM (5th ed).
• find major types of mutual funds in Israel
• find 5 largest mutual funds in Israel
• what was their performance and fees last
year?
Zvi Wiener BKM Ch 3 slide 35
Additional Slides
Zvi Wiener BKM Ch 3 slide 36
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
Zvi Wiener BKM Ch 3 slide 37
Using only a portion of the proceeds for an investment.
Borrow remaining component.
Margin arrangements differ for stocks and futures.
Margin Trading
Zvi Wiener BKM Ch 3 slide 38
Maximum marginCurrently 50%Set by the Fed
Maintenance marginMinimum level the equity margin can be
Margin callCall for more equity funds
Stock Margin Trading
Zvi Wiener BKM Ch 3 slide 39
X Corp $7050% Initial Margin40% Maintenance Margin1000 Shares PurchasedInitial PositionStock $70,000 Borrowed $35,000 Equity $35,000
Margin Trading - Initial Conditions
Zvi Wiener BKM Ch 3 slide 40
Margin Trading - Maintenance Margin
Stock price falls to $60 per share
New Position
Stock $60,000 Borrowed $35,000
Equity 25,000
Margin% = $25,000/$60,000 = 41.67%
Zvi Wiener BKM Ch 3 slide 41
Margin Trading - Margin Call
How far can the stock price fall before a margin call?
(1000P - $35,000)* / 1000P = 40%
P = $58.33* 1000P - Amount Borrowed = Equity
Zvi Wiener BKM Ch 3 slide 42
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 it was borrowed.
Zvi Wiener BKM Ch 3 slide 43
Short Sale - Initial Conditions
Z Corp 100 Shares50% Initial Margin30% Maintenance Margin$100 Initial Price
Sale Proceeds $10,000Margin & Equity 5,000Stock Owed 10,000
Zvi Wiener BKM Ch 3 slide 44
Short Sale - Maintenance Margin
Stock Price Rises to $110
Sale Proceeds $10,000Initial Margin 5,000Stock Owed 11,000Net Equity 4,000Margin % (4000/11000) 36%
Zvi Wiener BKM Ch 3 slide 45
Short Sale - Margin Call
How much can the stock price rise before a margin call?
($15,000* - 100P) / (100P) = 30%P = $115.38
* Initial margin plus sale proceeds