Money markets debt type securities with maturity up to one year Capital Markets everything else Stock Markets Bonds Fixed Income Markets bonds loans notes securitizations Financial Derivatives Futures Options Swaps ID: 1028020
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1. Securities Markets
2. The Role of Financial MarketsMoney markets: debt type securities with maturity up to one yearCapital Markets: everything elseStock MarketsBonds (Fixed Income Markets): bonds, loans, notes, securitizations Financial Derivatives: Futures, Options, SwapsForeign Exchange markets
3. Primary vs Secondary MarketsNew securities are issued with the help of investment banks (or underwriter)New issues are sold on the primary market first, and subsequently sell on the secondary market.The secondary markets are the security exchanges.The selling of shares for the first time in a new company is called a initial public offering (IPO) A private placement means new securities are sold directly to investors, bypassing the open marketRegistration not required
4. UnderwritingInvestment banks: advise or underwrite new issues; distribute shares to institutional investors through road showsFor Large Issues, a Syndicate is UsedHot Issue MarketDuring some periods, over 50 news firms go public every month.Many investors want these sharesInitial returns are highWho gets shares?Those who want shares ask their broker.When more shares are sought, than are being issued, priority tends to go to the large shareholders and the broker’s best clients. If you are a small-money investor and receive shares of an IPO, look out, it may be a lemon!
5. Markets where investors trade previously issued securitiesAuction markets involve bidding in a specific physical location (example NYSE)Brokers represent investors for a feeOthers trade for their own accountNegotiated markets consist of decentralized dealer network (example NASDAQ, Bond markets, FX markets)Secondary Markets
6. Equity MarketsNew York Stock ExchangeAn Agency Auction Market Market in which brokers represent buyers and sellers and prices are determined by supply and demand. Trading All trading in a specific stock is done at the post where that stock is assigned on the NYSE floor.Trading is managed by the specialist.
7. Electronic market NASDAQ National MarketNASDAQ SmallCap MarketNegotiated marketMarket makers are dealersThey quote bid-ask prices (ask is greater than bid)Bid: price dealer/market maker buysAsk: price dealer/market maker sellsNasdaq
8. Network of dealers standing ready to either buy or sell securities at specified pricesDealers profit from spread between buy and sell pricesHandle unlisted securitiesNasdaq SmallCap Market800 small firms seeking Nasdaq market maker sponsorshipNo penny stocks (price < $1)Over-the-Counter Bulletin Board3,000+ securities offered by 300+ market makersPenny stocks traded hereElectronic Communication Networks (ECNs)Electronic market for institutional investors to trade with each otherECNs handle the after hours trading tooOver-the-Counter Markets
9. Provide a composite report of market behavior on a given dayPrice Weighted: Dow Jones Industrial AverageValue Weighted: S&P500Equity Market Indicators/Indices
10. Brokerage firms earn commissions on executed trades, sales loads on mutual funds, profits from securities sold from inventory, underwriting fees and administrative account feesFull-service brokers offer order execution, information on markets and firms, and investment adviceDiscount brokers offer order executionBrokerage Operations
11. Cash account: Investor pays 100% of purchase price for securitiesMargin account: Investor borrows part of the purchase price from the brokerCash management accountChecks can be written against account’s assetsWrap account: Brokers match investors with outside money managersAll costs, fees wrapped into one Account Types
12. Dealers ready to either buy or sellBid price is highest offer price to buyAsk price is lowest price willing to sellAsk price - Bid price >0 (dealer spread)“Makes a market” in the securityMore than one dealer for each security in over-the-counter marketsOrders in OTC Markets
13. Market orders: Authorizes immediate transaction at best available price “Buy 50 shares of Home Depot at market”Limit orders: Specifies a particular market price before a transaction is authorizedHow long to wait?Fill or killDay orderGood ‘til canceled“Sell 100 shares of IBM at $82.70 or better, today”“Buy 200 shares of Dell at $30.72 or better, fill or kill”Types of Orders
14. Types of OrdersStop orders: Specifies a particular market price at which a market order is authorized - Stop Loss order: Placing an order to sell when a stock falls to a specific price.Most settlement dates are three business days after the trade date
15. Impact on ReturnBefore going online:average turnover was 70%beat the market by 2.4% per yearAfter going online:turnover jumped to 120%under performed the market by 3.5% per yearBrad Barber and Terrance Odean, 2002, “Online Investors: Do the Slow Die First?” Review of Financial Studies, 15, 455-487. A study of 1,607 investors which moved from discount broker to online broker.
16. To open margin account, exchanges set minimum required deposit of cash or securitiesInvestor then pays part of investment cost, borrows remainder from brokerMargin is percent of total value that cannot be borrowed from brokerFederal Reserve sets the minimum initial margin on securitiesUnchanged since 1974 at 50%Actual margin at any time cannot go below the maintenance margin level set by exchanges, brokersInvestor’s equity changes with priceMargin call when equity below maintenance level Margin Accounts
17. Margin AccountsMargin is percent of total value that cannot be borrowed from brokerInitial Margin: Amount investor put up/ Value of the accountEx: if the initial margin is 60%, and an investor wants to buy (transact) $10,000 of stock he needs to post $6,000 his money and borrow from broker $4,000Maintenance margin: percentage of investor’s equity on hand at all times
18. Margin accountConsider that you borrowed $10,000 to buy $20,000 of stock.If the value of the stock increases to $25,000, what is your margin?If the value of the stock declines to $15,000, what is your margin?
19. Leverage, the reason to use marginUsing margin magnifies the realized return.Example: buy 200 shares at $40 per share ($8,000 total)Use $4,000 or your own money and borrow $4,000. What is your return if the stock rises to $44? (a 10% increase)Solution:Profit is ($44 - $40) × 200 = $800Return is $800 / $4,000 = 20%A 20% return from a stock that increased 10%!
20. Leverage, the reason NOT to use marginUsing margin magnifies the realized return.Example: buy 200 shares at $40 per share ($8,000 total)Use $4,000 or your own money and borrow $4,000. What is your return if the stock falls to $34? (a 15% decline)Solution:Loss is ($34 - $40) × 200 = -$1,200Return is -$1,200 / $4,000 = -30%A -30% return from a stock that declined -15%!
21. Short selling: Profiting from falling stock pricesSelling short (or short selling)By executing a short sale, the investor sell stock that they do not own (by borrowing it from the brokerage). Later, after the price falls (hopefully!) the stock is repurchased (called covering the short) and given back to the broker. The simple rule of “buy low, sell high” works well when prices are increasing.When prices are falling, can you “sell high, buy low?”