IFM10 Ch01 Web Extension 1C Show

8/10/2019 IFM10 Ch01 Web Extension 1C Show

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Chapter 1Web Extension 1C

A Closer Look at the Stock

Markets


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Topics in Web ExtensionStock indexesRegulationOverview of investment bankingStock trading


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Index CompositionReplicate a particular exchangeMeasure a countrys most importantstocksMeasure a particular business sectorMeasure a particular investment style Measure an international region

(More . .)


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Composition by ExchangeNYSE CompositeNasdaq Composite

(More . .)


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Composition by Business

SectorMany different index providers, such as:

Dow Jones AmexMorgan Stanley

Many different sectors, such as: AirlinesBiotechnologyChemicalsConsumer retailersTechnology


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Composition by StyleTwo important investment styles are by thesize of the firm and by its growth prospects.

Growth is measure by high-expected salesgrowth and high price-book ratios (valuestocks have lower growth and lower price-book ratios)Examples:

Russell 1000 GrowthRussell Midcap Value


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Composition by International

RegionMorgan Stanley Capital International(MSCI)

EAFE (Europe, Asia, Far East) IndexEmerging Markets IndexPacific Index


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Stock Weighting in IndexesPrice weighted

DJIAMarket-value weighted

S&P500Nasdaq Composite

Equally weighted Value Line Index


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Regulation of Securities

MarketsGovernment Regulation such as SEC.Insider trading oversight (SEC)Margin oversight (Federal Reserve)Self-regulation such as NASD.

Circuit Breakers automatic halt in tradingif stock prices have exceptional changes.


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Public vs. Private OfferingsPublic offerings: registered with the SEC andsale is made to the investing public.

Shelf registration (Rule 415, since 1982) allows firms toregister an offering and sell parts of the offering over time.

Private offering: Sale to a limited number ofsophisticated investors not requiring the protection ofregistration.

- Dominated by institutions.- Very active market for debt securities.- Not as active for stock offerings .


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Investment Banking and

Security OfferingsUnderwritten vs. Best Efforts

Underwritten: firm commitment on proceeds tothe issuing firm.Best Efforts: no firm commitment.

Negotiated vs. Competitive BidNegotiated: issuing firm negotiates terms withinvestment banker. Usually a 7% spread.Competitive bid: issuer structures the offeringand secures bids (more common in bonds thanstocks).


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Initial Public OfferingsInitial Public Offerings (IPOs)

Underpricing Average increase is 14% onfirst day.Performance Underperforms similar stockduring three years after IPO.


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Costs of TradingCommission: fee paid to broker for makingthe transactionSpread: cost of trading with dealer

Bid: price dealer will buy from you Ask: price dealer will sell to youSpread: ask - bid

Price Impact Large sales or purchasemight cause prices to change.

Payment for Order Flow Exchange will paybrokers to direct orders to them.


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The Specialist at the NYSEHandles around 10-20 stocks (one perspecialist)Stocks trade at the specialists post

Makes a market by matching buyers/sellerand by buying/selling from own inventoryGoal is to maintain a fair and orderlymarket so that price changes are smooth Specialist loses money when smoothing themarket, but makes it back during normalconditions


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Trading Away from Exchanges

Third Market trading listed stocks butnot through exchange

Institutional market: to facilitate trades oflarger blocks of securities.Involves services of dealers and brokers

Fourth Market institutions trading withinstitutions

No middleman involved in the transaction


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Margin Trading

Investor uses only a portion of owncapital for an investment.Borrows remaining component.Margin arrangements differ for stocksand futures.


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Stock Margin Trading

Maximum initial marginCurrently 50%

Set by the FedMaintenance margin

Minimum level of equity margin if priceschange

Margin callCall for more equity funds


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Short Sales Mechanics

Opening a short position:Borrow stock through a dealer.

Sell itDeposit proceeds and margin in account.

Closing out the position:

Buy the stockReturn to the party from which it wasborrowed.


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Short Sales Purposes andFeatures

Purpose: to profit from a decline in theprice of a stock or security.

Must pay the broker the equivalent ofany dividends paid by the stock

Uptick restrictions can only sell short

when the ask price of a stock is higherthan the last transactionUnlimited loss potential

IFM10 Ch01 Web Extension 1C Show

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