Investments

1
How securities are tradedBKM Ch 3

• Zvi Wiener
• tel [phone] mswiener_at_mscc.huji.ac.il

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

3

• Primary market - when issued
• Secondary market - any time later

Primary market public offering private
placement IPO (initial public
offering) Seasoned new issue
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 herringpreliminary prospectus)
• 1. Firm Commitment
• 2. Best-Efforts Basis

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.
6
IPO

• Road show
• Book indication of interest
• IPO underpricing effect in the first days and bad
  performance later.
• Internet IPO

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.

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

9
Seat price on the NYSE in K
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

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.

12
OTC levels

• Level 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.

13
Third and Fourth Markets

• The third market - exchange-listed securities
  traded on the OTC
• Fourth marked - investors trading directly

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

15
Other Countries

• LSE - London Stock Exchange
• TSE - Tokyo Stock Exchange
• German
• Zurich
• Paris
• Toronto
• Israel

16
Participants

• Commission Brokers - serve clients
• Floor Broker - independent broker
• Registered Traders - act on their own account
• Specialists

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 isnt valid.

18
Limit Orders
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.

20
Trading on the OTC Market

• Dealer Market
• Investor contacts broker
• The broker tries to find a dealer
• Computerized system

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

22
Buying on Margin

• Initial Margin is defined by the FRS (Federal
  Reserve System) about 50 by investors 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.

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

24
Short Sales

• An 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?

25

• Short position - pessimist
• Long position - optimist

26
Short Sale

• You 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)

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
• 7,500

Margin (Assets-Liabilities)/Liabilities 0.3
(7,500-100 P)/(100 P) P 57.69
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

29
Other Restrictions

• Circuit Breakers. Trading is stopped for 1 hour
  when DJIA falls 250 points from the previous
  days 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).

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!

31
Mutual FundsBKM Ch 4

• Zvi Wiener
• tel [phone] mswiener_at_mscc.huji.ac.il

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

33

• Advantages
• Diversification and divisibility
• Professional management
• Small investment
• Reinvestment of dividends, capital gains
• Disadvantages
• Commissions (loads)
• Time delay or illiquidity

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?

35
Additional Slides
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

37
Margin Trading

• Using only a portion of the proceeds for an
  investment.
• Borrow remaining component.
• Margin arrangements differ for stocks and futures.

38
Stock Margin Trading

• Maximum margin
• Currently 50
• Set by the Fed
• Maintenance margin
• Minimum level the equity margin can be
• Margin call
• Call for more equity funds

39
Margin Trading - Initial Conditions

• X Corp 70
• 50 Initial Margin
• 40 Maintenance Margin
• 1000 Shares Purchased
• Initial Position
• Stock 70,000 Borrowed 35,000
• Equity
  35,000

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

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

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.

43
Short Sale - Initial Conditions

• Z Corp 100 Shares
• 50 Initial Margin
• 30 Maintenance Margin
• 100 Initial Price
• Sale Proceeds 10,000
• Margin Equity 5,000
• Stock Owed 10,000

44
Short Sale - Maintenance Margin

• Stock Price Rises to 110
• Sale Proceeds 10,000
• Initial Margin 5,000
• Stock Owed 11,000
• Net Equity 4,000
• Margin (4000/11000) 36

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