Agenda

1
Agenda

• Group 2 presents
• Presentation by Robert Hersey Specialist on the
  NYSE with LaBranch and Company
• Review questions from Chapter 2
• Discuss Chapter 3
• Review materiel previously covered
• BRING YOUR QUESTIONS!!
• Begin Chapter 14 if time

2
Test will Cover

• Chapter 1
• Real vs. Financial assets
• Financial intermediaries Who are they and why
  do they exist
• Investment considerations
• Time horizon
• Risk preference
• Taxes
• Liquidity (be sure you understand this concept!)
• Financial markets
• Primary markets
• Secondary markets
• How technology has effected markets and trading
• Understanding of recent financial trends
• Globalization
• Securitization
• Financial Engineering Bundling and unbundling
  cash flows and risk

3
Test will Cover

• Chapter 2
• Markets and instruments
• Money market (know what these securities are)
• Capital market (know what these securities are)
• T-Bills, Bonds and Notes
• Bank Discount Yield lt Bond Equivalent Yield lt
  Effective Annual Yield
• Compound versus simple interest
• Compound Annual Growth Rate
• Corporate Bonds (Investment grade versus high
  yield, rating agency ratings)
• Municipal Bonds
• Tax implications
• Formulas for comparing tax free interest to
  taxable interest
• Common Stock
• Calculating a return (Div. Price appreciation)
• P/E ratio

4
Test will Cover

• Chapter 2 (continued)
• Preferred Stock
• Derivatives
• Option (exercise price, strike price,
  in-the-money, out-of-the-money)
• Put
• Call
• Forwards and Futures
• Selling short and short interest
• Part 1 of A Random Walk Down Wall Street
• Castles in the air
• Irrational vs. rational markets
• Differed periods of irrational pricing in the
  markets and what followed those periods
• Tulip bulbs, Shipping Cos. in England, Florida,
  1920s in US, Real Estate in Florida, Biotech boom
  in the US, Conglomerate boom in the US, Japanese
  real estate and stock market, recent .com craze

5
Chapter Concepts

• Primary and Secondary Markets
• Organization of Secondary Markets
• Trading on exchanges
• Buying on margin
• Short selling and short selling margin

6
Primary vs. Secondary Securities Sales

• Primary
• Issuer gets proceeds
• Secondary
• Second parties sell among themselves
• Primary issuer gets no proceeds
• Investment Banking Arrangements
• Underwritten vs. best efforts
• Negotiated vs. competitive (neg. terms with
  investment bank versus structuring
  independently)
• New issues or IPOs are often under priced to
  ensure they are sold and that they will provide
  increase in price and provide a return for the
  investor

7
Public Offerings

• Registered with the SEC and sale is made to the
  public
• On the equity side this is an IPO Initial
  Public Offering
• Shelf registration Rule 415 (1982)
• Can have shares registered for 2 years and do the
  issuance at any time

8
Private Placement

• Sale to a limited number of sophisticated
  investors
• No registration protection
• Dominated by institutions
• 144A Registered after the trasaction is
  completed
• Very comment with high yield corporate bonds
• Private placements of equity became very popular
  during the .com craze
• Private Equity firms

9
Organization of Secondary Markets

• Organized exchanges
• OTC Market
• Third market
• Fourth market

10
Organized Exchanges

• NYSE New York Stock Exchange
• AMEX -American Stock Exchange
• CBOE
• Regionals
• Auction Market with centralized order flow
• Dealership function can be assigned by the
  exchange (Specialists) or competitive

11
OTC Market

• Dealer market without centralized order flow like
  the NYSE or AMEX
• NASDAQ largest organized stock market for OTC
  trading
• Lost a lot of credability with the recent market
  declines following the gains of the 90s

12
Third Market

• Trading exchange listed companies away from the
  exchanges
• Institutional market for larger block
  trades(over 10,000 shares)
• Involves services of dealers and brokers

13
Fourth Market

• Institutions trading directly with institutions
• No middle man at all
• Organized information and trading systems
• ENC Development Electronic Communications
  Network

14
International Markets

• London Stock Exchange
• Dealer markets similar to NASDAQ
• Greater anonymity
• Tokyo Stock Exchange
• No market making service
• Satori provides bookkeeping services
• Feature a floor and electronic trading
• Global Market Alliances

15
Logistics of Trading on Exchanges

• Specialist Organized Exchanges
• Makes a market
• Maintains a fair and orderly market
• Maintains a book of orders
• The brokers broker
• Dot and SuperDot system go directly to the
  specialist
• Settlement of all trades is three working days
• OTC AMEX
• No negotiated market
• No specialists
• Can be many market makers
• Computer system for NASDAQ

16
Trading Vocabulary

• 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

17
Exchange Orders

• Market Order
• Time is the priority
• Limit Order
• Price is the priority
• Good til Cancelled Order
• Price is the priority longer term
• Stop Loss Order
• Price is the signal to change from price to time
• Once price hits x sell

18
Example

• Example You bought a stock for 50 and later
  sold it for 80 You received 10 in dividends,
  paid an initial brokers fee of 1.00, and paid
  another 1.00 when you sold the stock. What is
  your return on this investment (ignoring taxes)?

19
Buying on Margin

• Using a portion of the proceeds as an investment
  and borrowing the rest
• Margin arrangement and regulation vary depending
  on security
• Federal Reserve requirement is the minimum margin
  is currently 50
• All exchanges have a maintenance margin of 30

20
Buying on Margin

• Example
• What is the initial margin if the investor
  purchases 100 shares of stock at 100 per share
  using 6,000 of her own money and borrows the
  rest?

21
Buying on Margin

• Example (continued)
• If the value of the above stock fell to 70 per
  share, what is now the actual margin?

22
Margin Call What Price will the Phone Ring?
Pmin the lowest price a share can fall to
without a call L the loan value M the
margin requirement N the number of shares
23
Buying in Margin
Margin Call Example An investor purchases 100
shares of stock at 100 per share using 6,000 of
her own money and borrows the rest. If the
maintenance margin is 30, what is the lowest
price a share can fall without a call?
Pmin the lowest price a share can fall to
without a call L the loan value M the
margin requirement N the number of shares
24
Leverage

• Borrowing magnifies ROE

25
Another Example
Example An investor purchases 100 shares of
stock at 100 per share using 10,000 of her own
money and borrows nothing. The stock price rises
to 130 per share (ignoring any dividends). What
is the return on the total investment? ... the
return on equity? ROA ROE
26
Another Example
Example An investor purchases 100 shares of
stock at 100 per share using 5,000 of her own
money and borrows 5,000. The stock price rises
to 130 per share (ignoring any dividends). What
is the return on the total investment? ... the
return on equity? ROA ROE
27
Short Selling
28
Example
Example An investor sells short 100 shares of
stock at 100 per share. The margin requirement
is 50 of the short sale. a. If the investor
covers her short sale when the stock price
declines to 70 per share, what is the return on
the short sale? b. What is the return if
there is no margin requirement?
29
Example
Example An investor sells short 100 shares of
stock at 100 per share. The margin requirement
is 50 of the short sale. c. If the investor
covers her short sale when the stock price
increases to 130 per share, what is the return
on the short sale?
30
Short Sales
Margin call price
31
Short Sale Example
Example An investor sells short 100 shares of
stock at 100 per share. The initial margin
requirement is 50 of the short sale. If the
maintenance margin is 30, what is the maximum
stock price without a margin call on the short
sale?