INVESTMENT ANALYSISINVESTMENT ANALYSIS&&

PORTFOLIO MANAGEMENTPORTFOLIO MANAGEMENT

Lecture # 2

Dr. Shahid A. ZiaShahid A. Zia

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An exchange serves three principal functions:

The Role of the Capital Markets

• Continuous Pricing Function

• Fair Pricing Function

• Economic Function

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Capital markets facilitate the flow of capital from lenders to borrowers.

Capital

Lenders Borrowers

Capital Market

Economic Function

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Bank

Banks offer home mortgages so that home buyers who are short of cash can borrow money to buy houses.

$

$

Mortgage

Home Seller

Home Buyer

Home Ownership

Economic Function: An Example

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Capital markets remove the fear that people have of buying or selling at a rip-off price. This creates trust in the system.

The greater the number of participants ( a lot of potential sellers and buyers) and the more formal the marketplace, the “fairer” the price. (Exchanges – very formal).

Fair Pricing Function

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Capital markets enable market participants to get accurate, up-to-date price information.

Continuous Pricing Function

Compare against alternative of prices that are not up-to-date: Antique clocks, Chinese porcelain, Pine timberland, Houses.

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• Borrowings ¾ or 75% from debt market i.e. Bank.

• Borrowings ¼ or 25% from equity market i.e. Stock Exchange

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In stock market this is relatively free place in

which you borrow easily.

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Dividend

Dividend is the return whether in the form of cash or shares (assets) on the amount invested with you.

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Advantage of Equity Market

But the advantage of going to the equity market

to raise capital is that you have to pay a dividend only if you have made a profit.

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The primary market is the “new securities” market where securities are sold to the public for the first time.

The secondary market is the “used securities” market, where previously issued securities are traded among security holders.

Economic Function

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Initial Public Offering IPO

Initial public offering means those shares that are being offered first time.

Offer for sale means offer those shares that are already issued.

Offer For Sale OFS

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United States

National Exchanges New York Stock Exchange (NYSE) American Stock Exchange (till 1999)

Regional Exchanges e.g. Philadelphia Stock Exchange and others

International Exchangese.g. London SE, Euronext, Tokyo SE, Bolsa Mexicana de Valores

The Exchanges

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The Exchanges

• National Exchanges

1. New York Stock Exchange (NYSE)

2. American Stock Exchange (AMEX)

• Regional Exchanges

1. Philadelphia Stock Exchange (Oldest US exchange)

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The Exchanges

• International Stock Exchanges

1. London Stock Exchange

2. Hong Kong Stock Exchange

3. Kuala Lumpur Stock Exchange

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National and Regional Exchanges

• National Exchanges1. New York Stock Exchange (NYSE)

Also known as the Big Board In 2004, on an average day, 1.46 billion

shares, valued at $46.1 billion, traded on the NYSE

2. American Stock Exchange (AMEX)• Merged with NASDAQ in 1999

Regional Exchanges

Philadelphia Stock Exchange (oldest US exchange).Others (Boston, Cincinnati, Chicago, Pacific).Some securities are dual listed. Traded on both national and regional exchanges. Some traded on international exchanges.

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Trading Systems - NYSE

• Specialists are charged with making a fair and orderly market in one or more assigned securities at posts on the exchange floor.– Distinct feature of NYSE and AMEX.– A post is a location where a particular stock trades.– Human runners physically take wired orders from brokers to the

specialist.– Specialists post screen shows bid/ask/last price.

• Bid price – highest price at which anyone is willing to buy.• Offer (Ask) price – lowest price at which anyone is willing to sell. • Difference between the two prices is the spread.

– Specialists ensure buyers will find sellers and sellers will find buyers (important in crisis situations like October 27, 1997- the Asian flu – DJ Industrials dropped 554 points)

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• SuperDot is an electronic system enabling NYSE firms to send market orders (up to 30,000 shares before open and up to 2,100 shares after open) and limit orders directly - without human runner - to the specialists’ posts (up to 100,000 shares). Trades are confirmed by specialists, so there is the potential for price improvement (“Split the spread”).– Covers about 85% of orders that reach the specialist

• NYSE Direct is a system offering automatic execution of limit orders up to 1,099 shares (small orders). No possibility of price improvement. Execution price will be the bid or ask price. No exchange fees charged on such transactions.

Trading Systems - NYSE

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Pakistan Trading System

• LOTS:

Lahore Online Trading System.

• KATS:

Karachi Automated Trading System.

• ISECTS:

Islamabad Stock Exchange Computerized Trading System.

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Trading Systems - CBOE

• Market makers are groups of competing individuals – “the crowd” - (rather than a single person) who maintain a fair and orderly market through open outcry trading in pits on the exchange floor.– Used in Options trading like Chicago Board

Options Exchange (CBOE – world’s largest options exchange)

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Participants of Stock Market

Member: A very important participant is member. Member

would mean a member of stock exchange. If missed a member of stock exchange, you cannot do business for people. You are authorized to do business by the exchange if you are a member.

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Participants of Stock Market

Brokers:

Brokers are those which participate in the brokerage industry. They may be a member or a part of corporate entity.

Agents:

Agents are the authorized representatives of members licensed by regulatory body as well as exchanges.

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Participants of Stock Market

Traders:

Trader is somebody who is directly in touch with the investors. Traders helps execute your trade.

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Capital Market

Money market and capital market are types of Financial markets. Stock market is a type of capital market.

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Corporate Culture

Corporate Culture is not mature culture till yet because when we develop our organization from scrap, we have some emotional attachment with organization.

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If you have no dividend in your company, then you are not bound to pay dividend. This is basic difference between borrowing from debt market and equity market.

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Forms of Organization

• Proprietorship

• Partnership

• Private Limited Companies

• Public Limited companies

Public Unlisted Company

Public Listed Company

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Types of Stock Exchanges

• Physical Stock Exchange

• Electronic Stock Exchange

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Physical Stock Exchange

The trading in Physical Stock Exchange is on:

• Actual Physical Tradition.

• Auction Market.

Overview of Lecture