Chapter Three How Securities are Traded How firms

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Chapter Three How Securities are Traded How firms

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Chapter Three How Securities are Traded How firms issue securities Primary vs. secondary market Privately held vs. publicly traded companies Initial public offerings Market transactions Short selling and buying on margin Rise of electronic

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Chapter Three How Securities
are Traded

How firms issue securities
Primary vs. secondary market
Privately held vs. publicly traded companies
Initial public offerings
Market transactions
Short selling and buying on margin
Rise of electronic trading and globalization of stock markets
https://www.ilsole24ore.com/art/il-bond-italia-dollari-fa-pieno-7-miliardi-e-non-e-autolesionismo-ACegJQq
Market regulation Chapter Overview ©2018 McGraw-Hill Education 3-2

Primary Market
Market for newly-issued securities
Firms issue new securities through underwriter to public

Secondary Market
Investors trade previously issued securities among themselves How Firms Issue Securities(1 of 6) ©2018 McGraw-Hill Education 3-3

Privately Held Firms
Up to 499 shareholders
Raise funds through private placement
Lower liquidity of shares
Fewer obligations to release financial statements How Firms Issue Securities(2 of 6) ©2018 McGraw-Hill Education 3-4

Publicly Traded Companies
Public offerings are marketed by underwriters
Initial Public Offering:

Seasoned equity offering:
(= sale of additional shares in firms that already are publicly traded.)

Registration must be filed with the SEC How Firms Issue Securities(3 of 6) ©2018 McGraw-Hill Education 3-5

Relationship Among a Firm Issuing Securities, the Underwriters, and the Public ©2018 McGraw-Hill Education 3-6 In a typical underwriting arrangement, the investment bankers purchase the securities from the issuing company and then resell them to the public

Shelf Registration
SEC Rule 415:
Shelf registration is a method for publicly traded companies to register new stock offerings without having to issue them immediately. Instead, the securities can be issued at any time within a two-year period, allowing a company to adjust the timing of the sales to take advantage of more favorable market conditions should they arise. How Firms Issue Securities(4 of 6) ©2018 McGraw-Hill Education 3-7

Initial Public Offerings
Road shows to publicize new offering
Bookbuilding to determine demand
Degree of investor interest provides valuable pricing information How Firms Issue Securities(5 of 6) ©2018 McGraw-Hill Education 3-8 https://www.borsainside.com/mercati_italiani/71154-ipo-yacht-ferretti-su-borsa-italiana-range-prezzo-fissato-quotazione-su-star/amp/

Initial Public Offerings
Underwriter bears price risk:
IPOs are commonly underpriced compared to the price they could be marketed
Example: : Groupon
Some IPOs are well overpriced
Example: Facebook
Others cannot even fully be sold How Firms Issue Securities(6 of 6) ©2018 McGraw-Hill Education 3-9

Types of Markets:
Direct search
Buyers and sellers seek each other
Brokered markets
Brokers search out buyers and sellers (typically primary market)
Dealer markets
Dealers have inventories of assets from which they buy and sell
(The main difference between a broker and a dealer is in respect of their role in the market, as well as the capital required. A broker is a person who executes the trade on behalf of others, whereas a dealer is a person who trades business on their own behalf)
Auction markets
The most integrated market is an auction market, in which all traders converge at one place (either physically or “electronically”) to buy or sell an asset. The New York Stock Exchange (NYSE) is an example of an auction market. How Securities are Traded ©2018 McGraw-Hill Education 3-10

Bid Price Bids are offers to buy

In dealer markets, the bid price is the price at which the dealer is willing to buy

Investors “sell to the bid” Ask Price Asked prices are sell offers

In dealer markets, the asked price is the price at which the dealer is willing to sell

Investors must pay the asked price to buy the security Bid and Asked Prices ©2018 McGraw-Hill Education 3-11 Bid-asked spread is the profit for making a market in a security

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 Types of Orders ©2018 McGraw-Hill Education 3-12

Dealer markets

Electronic communication networks (ECNs)

Specialists markets Trading Mechanisms ©2018 McGraw-Hill Education 3-15 https://www.investopedia.com/ask/answers/128.asp

1975: Elimination of fixed commissions on the NYSE
1994: New order-handling rules on NASDAQ, leading to narrower bid-ask spreads
1997: Reduction of minimum tick size from one-eighth to one-sixteenth
2000s: In the US, the share of electronic trading rose from 16% to 80% in 2000s The Rise of Electronic Trading(1 of 2) ©2018 McGraw-Hill Education 3-16

2000: Emergence of NASDAQ Stock Market
2001: Reduction of minimum tick size from one-sixteenth to 1 cent
2006: NYSE is renamed to NYSE Arca after acquiring the electronic Archipelago Exchange
2007: Creation of National Market System (NMS) to link exchanges electronically The Rise of Electronic Trading(2 of 2) ©2018 McGraw-Hill Education 3-17

The New York Stock Exchange
The largest U.S. stock exchange *
Automatic electronic trading runs side-by-side with broker/specialist system
SuperDot: https://www.investopedia.com/terms/d/dot.asp
Direct+:
Specialists: Specialists are also mandated to maintain a “fair and orderly” market when the book of limit buy and sell orders is so thin that the spread between the highest bid price and lowest ask price becomes too wide. In this case, the specialist firm would be expected to offer to buy and sell shares from its own inventory at a narrower bid-ask spread. In this role, the specialist serves as a dealer in the stock. U.S. Markets: NYSE ©2018 McGraw-Hill Education 3-19 * as measured by the value of the stocks listed on the exchange

NASDAQ
Lists about 3,000 firms
Originally a dealer market with a price quotation system
Today, NASDAQ’s Market Center offers a sophisticated electronic trading platform with automatic trade execution U.S. Markets: NASDAQ ©2018 McGraw-Hill Education 3-20

ECNs
Private computer networks that link buyers with sellers for automated order execution over multiple exchanges
Compete in terms of the speed they can offer
Latency:
Major ECNs include Direct Edge, BATS, and NYSE Arca
https://en.wikipedia.org/wiki/BATS_Global_Markets U.S. Markets: ECNs ©2018 McGraw-Hill Education 3-21

Algorithmic Trading
https://www.quantinsti.com/blog/algorithmic-trading-strategies/

High-Frequency Trading https://it.wikipedia.org/wiki/High- frequency_trading

Dark Pools
https://it.wikipedia.org/wiki/Dark_pool New Trading Strategies(1 of 2) ©2018 McGraw-Hill Education 3-22

Bond Trading
Most bond trading takes place in the OTC market among bond dealers
NYSE Bonds is the largest centralized bond market of any U.S. exchange
Market for many bond issues is “thin” and is subject to liquidity risk New Trading Strategies(2 of 2) ©2018 McGraw-Hill Education 3-23

Widespread alliances and mergers
NYSE acquired Archipelago (ECN), American Stock Exchange, and merged with Euronext
International Exchange (ICE) acquired NYSE Euronext
NASDAQ acquired Instinet/INET (ECN), Boston Stock Exchange, and merged with OMX to form NASDAQ OMX Group
Chicago Mercantile Exchange acquired Chicago Board of Trade and New York Mercantile Exchange Globalization of Stock Markets ©2018 McGraw-Hill Education 3-24

Brokerage Commission:

Explicit cost of trading
Full service vs. discount brokerage

Spread:

Implicit cost of trading Trading Costs ©2018 McGraw-Hill Education 3-26

When purchasing securities, investors have easy access to a source of debt financing called broker’s call loans. The act of taking advantage of broker’s call loans is called buying on margin.

Borrowing part of the total purchase price of a position using a loan from a broker (call loans)
Investor contributes the remaining portion
Margin refers to the percentage or amount contributed by the investor
You profit when the stock rises Buying on Margin(1 of 2) ©2018 McGraw-Hill Education 3-27

Initial margin is set by the Fed
Currently 50%
Maintenance margin
Minimum equity that must be kept in the margin account
Margin call if value of securities falls too much Buying on Margin(2 of 2) ©2018 McGraw-Hill Education 3-28

Share price $100
Initial Margin: 60%
Maintenance Margin: 40%
Shares Purchased: 100

Initial Position
Stock $10,000 Borrowed $4,000
Equity $6,000 Margin Trading: Initial Conditions ©2018 McGraw-Hill Education 3-29

Stock price falls to $70 per share
New Position
Stock $7,000 Borrowed $4,000
Equity $3,000

Margin% = $3,000/$7,000 = 43% Margin Trading: Margin Call ©2018 McGraw-Hill Education 3-30

How far can the stock price fall before amargin call? Let maintenance margin = 30%
Equity = 100P - $4000
Percentage margin = (100P - $4,000)/100P
(100P - $4,000)/100P = 0.30
Solve to find:
P = $57.14 Margin Trading: Maintenance Margin ©2018 McGraw-Hill Education 3-31

Lo Short Selling è un operazione finanziaria che consiste nella vendita di strumenti finanziari non posseduti con successivo riacquisto
https://it.wikipedia.org/wiki/Vendita_allo_scoperto
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 Short Sales ©2018 McGraw-Hill Education 3-32

Naked Short Selling

Naked short selling, or naked shorting, is the practice of short-selling a tradable asset of any kind without first borrowing the securityor ensuring that the security can be borrowed, as is conventionally done in a short sale. When the seller does not obtain the shares within the required time frame, the result is known as a "failure to deliver". The transaction generally remains open until the shares are acquired by the seller, or the seller's broker settles the trade.

Short selling is used to anticipate a price fall, but exposes the seller to the risk of a price rise. Naked Short Sales ©2018 McGraw-Hill Education 3-33

Dot Bomb 1000 Shares
Initial Margin 50%
Maintenance Margin 30%
Initial Price $100

Sale Proceeds $100,000
Margin & Equity $50,000
Stock Owed 1000 shares Short Sale: Initial Conditions ©2018 McGraw-Hill Education 3-35

Short Sale: Dot Bomb falls to $70 per share Assets $100,000 (sale proceeds)
$50,000 (initial margin) Liabilities $70,000 (buy shares) Equity
$80,000 Profit = Ending equity - Beginning equity
= $80,000 - $50,000 = $30,000
= Decline in share price × Number of shares sold short ©2018 McGraw-Hill Education 3-36

How much can the stock price rise before a margin call?

($150,000* - 1000P)/(1000P) = 30%
P = $115.38

* Initial margin plus sale proceeds (ricavato della vendita) Short Sale: Margin Call ©2018 McGraw-Hill Education 3-37

Major regulations:
Securities Act of 1933
Securities Exchange Act of 1934
Securities Investor Protection Act of 1970
Self-Regulation
Financial Industry Regulatory Authority
CFA Institute standards of professional conduct Regulation of Securities Markets(1 of 2) ©2018 McGraw-Hill Education 3-38

Sarbanes-Oxley Act
Public Company Accounting Oversight Board
Independent financial experts to serve on audit committees of boards of directors
CEOs and CFOs personally certify firms’ financial reports
Boards must have independent directors Regulation of Securities Markets(2 of 2) ©2018 McGraw-Hill Education 3-39

Officers, directors, major stockholders must report all transactions in firm’s stock
Insiders do exploit their knowledge
Jaffe study:
Inside buyers > Inside sellers = Stock does well
Inside sellers > Inside buyers = Stock does poorly Insider Trading ©2018 McGraw-Hill Education 3-40

Chapter Three How Securities are Traded How firms

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