Securities Markets The Role of Financial Markets
Description: Securities Markets The Role of Financial Markets 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
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slide1. Securities Markets<br>
slide2. The Role of Financial Markets 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
Foreign Exchange markets<br>
slide3. Primary vs Secondary Markets New 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 market
Registration not required<br>
slide4. Underwriting Investment banks: advise or underwrite new issues; distribute shares to institutional investors through road shows
For Large Issues, a Syndicate is Used
Hot Issue Market
During some periods, over 50 news firms go public every month.
Many investors want these shares
Initial returns are high
Who 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!<br>
slide5. Markets where investors trade previously issued securities
Auction markets involve bidding in a specific physical location (example NYSE)
Brokers represent investors for a fee
Others trade for their own account
Negotiated markets consist of decentralized dealer network (example NASDAQ, Bond markets, FX markets) Secondary Markets<br>
slide6. Equity Markets New York Stock Exchange
An 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.<br>
slide7. Electronic market
NASDAQ National Market
NASDAQ SmallCap Market
Negotiated market
Market makers are dealers
They quote bid-ask prices (ask is greater than bid)
Bid: price dealer/market maker buys
Ask: price dealer/market maker sells Nasdaq<br>
slide8. Network of dealers standing ready to either buy or sell securities at specified prices
Dealers profit from spread between buy and sell prices
Handle unlisted securities
Nasdaq SmallCap Market
800 small firms seeking Nasdaq market maker sponsorship
No penny stocks (price < $1)
Over-the-Counter Bulletin Board
3,000+ securities offered by 300+ market makers
Penny stocks traded here
Electronic Communication Networks (ECNs)
Electronic market for institutional investors to trade with each other
ECNs handle the after hours trading too Over-the-Counter Markets<br>
slide9. Provide a composite report of market behavior on a given day
Price Weighted: Dow Jones Industrial Average
Value Weighted: S&P500 Equity Market Indicators/Indices<br>
slide10. Brokerage firms earn commissions on executed trades, sales loads on mutual funds, profits from securities sold from inventory, underwriting fees and administrative account fees
Full-service brokers offer order execution, information on markets and firms, and investment advice
Discount brokers offer order execution Brokerage Operations<br>
slide11. Cash account: Investor pays 100% of purchase price for securities
Margin account: Investor borrows part of the purchase price from the broker
Cash management account
Checks can be written against account’s assets
Wrap account: Brokers match investors with outside money managers
All costs, fees wrapped into one Account Types<br>
slide12. Dealers ready to either buy or sell
Bid price is highest offer price to buy
Ask price is lowest price willing to sell
Ask price - Bid price >0 (dealer spread)
“Makes a market” in the security
More than one dealer for each security in over-the-counter markets Orders in OTC Markets<br>
slide13. 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 authorized
How long to wait?
Fill or kill
Day order
Good ‘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<br>
slide14. Types of Orders Stop 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<br>
slide15. Impact on Return Before going online:
average turnover was 70%
beat the market by 2.4% per year
After going online:
turnover jumped to 120%
under performed the market by 3.5% per year Brad 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.<br>
slide16. To open margin account, exchanges set minimum required deposit of cash or securities
Investor then pays part of investment cost, borrows remainder from broker
Margin is percent of total value that cannot be borrowed from broker
Federal Reserve sets the minimum initial margin on securities
Unchanged since 1974 at 50%
Actual margin at any time cannot go below the maintenance margin level set by exchanges, brokers
Investor’s equity changes with price
Margin call when equity below maintenance level Margin Accounts<br>
slide17. Margin Accounts Margin is percent of total value that cannot be borrowed from broker
Initial Margin: Amount investor put up/ Value of the account
Ex: 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 $4,000
Maintenance margin: percentage of investor’s equity on hand at all times<br>
slide18. Margin account Consider 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?<br>
slide19. Leverage, the reason to use margin Using 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 = $800
Return is $800 / $4,000 = 20%
A 20% return from a stock that increased 10%!<br>
slide20. Leverage, the reason NOT to use margin Using 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 = -$1,200
Return is -$1,200 / $4,000 = -30%
A -30% return from a stock that declined -15%!<br>
slide21. Short selling: Profiting from falling stock prices Selling 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?”<br>
slide2. The Role of Financial Markets 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
Foreign Exchange markets<br>
slide3. Primary vs Secondary Markets New 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 market
Registration not required<br>
slide4. Underwriting Investment banks: advise or underwrite new issues; distribute shares to institutional investors through road shows
For Large Issues, a Syndicate is Used
Hot Issue Market
During some periods, over 50 news firms go public every month.
Many investors want these shares
Initial returns are high
Who 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!<br>
slide5. Markets where investors trade previously issued securities
Auction markets involve bidding in a specific physical location (example NYSE)
Brokers represent investors for a fee
Others trade for their own account
Negotiated markets consist of decentralized dealer network (example NASDAQ, Bond markets, FX markets) Secondary Markets<br>
slide6. Equity Markets New York Stock Exchange
An 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.<br>
slide7. Electronic market
NASDAQ National Market
NASDAQ SmallCap Market
Negotiated market
Market makers are dealers
They quote bid-ask prices (ask is greater than bid)
Bid: price dealer/market maker buys
Ask: price dealer/market maker sells Nasdaq<br>
slide8. Network of dealers standing ready to either buy or sell securities at specified prices
Dealers profit from spread between buy and sell prices
Handle unlisted securities
Nasdaq SmallCap Market
800 small firms seeking Nasdaq market maker sponsorship
No penny stocks (price < $1)
Over-the-Counter Bulletin Board
3,000+ securities offered by 300+ market makers
Penny stocks traded here
Electronic Communication Networks (ECNs)
Electronic market for institutional investors to trade with each other
ECNs handle the after hours trading too Over-the-Counter Markets<br>
slide9. Provide a composite report of market behavior on a given day
Price Weighted: Dow Jones Industrial Average
Value Weighted: S&P500 Equity Market Indicators/Indices<br>
slide10. Brokerage firms earn commissions on executed trades, sales loads on mutual funds, profits from securities sold from inventory, underwriting fees and administrative account fees
Full-service brokers offer order execution, information on markets and firms, and investment advice
Discount brokers offer order execution Brokerage Operations<br>
slide11. Cash account: Investor pays 100% of purchase price for securities
Margin account: Investor borrows part of the purchase price from the broker
Cash management account
Checks can be written against account’s assets
Wrap account: Brokers match investors with outside money managers
All costs, fees wrapped into one Account Types<br>
slide12. Dealers ready to either buy or sell
Bid price is highest offer price to buy
Ask price is lowest price willing to sell
Ask price - Bid price >0 (dealer spread)
“Makes a market” in the security
More than one dealer for each security in over-the-counter markets Orders in OTC Markets<br>
slide13. 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 authorized
How long to wait?
Fill or kill
Day order
Good ‘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<br>
slide14. Types of Orders Stop 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<br>
slide15. Impact on Return Before going online:
average turnover was 70%
beat the market by 2.4% per year
After going online:
turnover jumped to 120%
under performed the market by 3.5% per year Brad 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.<br>
slide16. To open margin account, exchanges set minimum required deposit of cash or securities
Investor then pays part of investment cost, borrows remainder from broker
Margin is percent of total value that cannot be borrowed from broker
Federal Reserve sets the minimum initial margin on securities
Unchanged since 1974 at 50%
Actual margin at any time cannot go below the maintenance margin level set by exchanges, brokers
Investor’s equity changes with price
Margin call when equity below maintenance level Margin Accounts<br>
slide17. Margin Accounts Margin is percent of total value that cannot be borrowed from broker
Initial Margin: Amount investor put up/ Value of the account
Ex: 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 $4,000
Maintenance margin: percentage of investor’s equity on hand at all times<br>
slide18. Margin account Consider 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?<br>
slide19. Leverage, the reason to use margin Using 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 = $800
Return is $800 / $4,000 = 20%
A 20% return from a stock that increased 10%!<br>
slide20. Leverage, the reason NOT to use margin Using 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 = -$1,200
Return is -$1,200 / $4,000 = -30%
A -30% return from a stock that declined -15%!<br>
slide21. Short selling: Profiting from falling stock prices Selling 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?”<br>