ims cfa reading 52
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Organization and Functioning
of Securities Market
Reading - 52
Quantitative Methods
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Learning Objective Statements (LOS)
a. What is Market
b. Facts about Market
c. Characteristics of Good market
d. Types of Market
e. Primary Capital Market
f. Secondary Financial Market
g. U.S. Secondary Equity Markets
h. Requirements for listing in Nasdaq National Market
i. Regional Stock Exchanges
j. Other Markets
k. Exchange Markets
l. Margin Transactions
m. New Trading Systems
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Market
Buyer Seller
Buy
goods & service
Sell goods &
service
Market
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Market
Facts about Market:
1. Not necessary to have physical location or entity, only thing
required is that the buyers and sellers can communicate for
relevant transaction.
2. Not necessary to own the goods or services but to provide a
platform for transaction of goods and service.
3. No hurdle for transaction of any type of goods or service.
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Characteristics of Good Market
Timely and accurate information on the volume and prices of past transactionsand current outstanding bids and offers are must for buyers and sellers.
Timely and accurateinformation
The ability to buy or sell an asset quickly and at a known price that not
substantially different from prices of recent prior transactions (assuming nonew information).
Liquidity
There should not be a substantial change in price from one transaction to next
until there is a vital information in the market.Price Continuity
There should be buyers and sellers willing to trade prices above and below the
current market price to maintain the balance of the market and hence
preventing drastic price changes.Depth
Lower the transaction cost as a % of the transaction amount, higher would be
the volume of transaction.Transaction Cost
Market price should adequately reflect all the information available regardingsupply and demand factors.Informational Efficiency
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Type of Markets
Primary Market: In this market, new issues of bonds,preferred stock, or common stock are sold by entities like
government units, municipalities or companies to raise capital
for growth.
Secondary Market: Outstanding securities that already sold to
the public are bought and sold here.
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Primary Capital Market
Treasury Bills
maturity of 1year or less.
Treasury
Notes
maturity of 2to 10 years.
Treasury
Bonds
maturity ofmore than 10
years.
Government
Bond Issues
Government Bond Issues Municipal Bond Issues
Methods of Selling
MunicipalBond Issue
CompetitiveBid
NegotiatedSales
PrivatePlacements
Corporate Stock Issues
CorporateStockIssues
Seasoned
EquityIssues
New
Issues
InitialPublic
Offerings
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Secondary Financial Market
Importance of Secondary Market:o It provides liquidity to the individuals who purchase securities
from the primary market.
o It also helps the issuer in determining the price for seasoned
securities.
o New issues of outstanding stocks or bonds are based on the
price and yields in the secondary market.
o It also effects price volatility and market volatility.
o Forthcoming IPO price are also based on comparable stocks
and bonds in the secondary market.
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Secondary Financial Market
o Secondary Bond Market Secondary Markets for U.S. Government and Municipal Bonds
Secondary Corporate Bond Market
o Financial Futures
o Secondary Equity Markets
Basic Trading Systems
Pure Auction Market
Dealer Market
Call and Continuous Markets
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U.S. Secondary Equity Markets
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Requirements for listing in Nasdaq National Market
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Regional Stock Exchanges
Reason for existence of Regional Stock Exchanges:A. Benefit to small local companies: It provides trading facilities
to local companies who cannot afford to get listed in national
exchanges.
B. Benefit to local brokers who are not members of national
exchange as they can purchase the stock listed in national
exchanges that are also listed in local exchanges.
C. Regional Exchanges can also trade some stock on the
NASDAQ market under unlisted trading privileges (UTP)
which granted by SEC.
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Other Markets
Third Market:
As per the name, dealers and brokers trade shares that are listedon an exchange, away from the exchange. Trading of well knownblue chip stocks are done in third market.
Success and Failure of Third Market depends on two factors:
1. Efficiency of the non-exchange market
2. Transaction cost as compare to national exchange.
Alternative Trading Systems (ATSs):
o Electronic Communication Networks (ECNs): It matches thebuy and sell orders via computer mainly for retail and smallinstitutional trading.
o Electronic Crossing Systems (ECSs): It acts as a broker to matchlarge buy and sell orders.
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Exchange Markets
Types of members:1. Specialists: They are the market makers who perform two
major functions namely:
o They serve as the brokers to match buy and sell orders.
o They act as dealer to maintain fair and orderly market byproviding liquidity to the market.
2. Commission Brokers: These are the employees of the firmwho buy and sell for the customers of the firm.
3. Floor Brokers: These are independent members of anexchange who act as brokers for other members.
4. Registered Traders: They have their own membership andthey buy and sell stocks for themselves.
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Exchange Markets
Types ofOrders
MarketOrders
Limit Orders Short SalesSpecialOrders
Stop LossOrders
Stop BuyOrder
MarginTransactions
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Margin Transactions
Example:Ram has acquired 100 share of ABC Ltd. for a price ofRs.25/share. A 50% margin requirement allowed Ram to borrowRs.1250 which makes the initial investment of Ram to Rs.1250against which he take an exposure of Rs.2500. Now, if the stock
price rises by 30%, what would be the return on investment forRam?
Solution:
Exposure = 100 share x Rs.25 = Rs.2500
Margin = 50%
Investment = Rs.2500 x 50% = Rs.1250
Loan from Broker = 2500 1250 = Rs.1250
Current Market Price of share = Rs.25 x (1 + 30%) = Rs.32.5
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Margin Transactions
Current Value of 100 shares = Rs.32.5 x 100 = 3250Income after paying off debt = Rs.3250 Rs.1250 = Rs.2000
Return on Investment = (Rs.2000 /Rs.1250) 1 = 0.6 or 60%.
Hence, the return on investment for Ram on an investment ofRs.1250 by of margin transaction is 60%. Had been the total
investment from Rams end, the ROI would have been:
= (Rs.3250/Rs.2500) 1 = 0.3 or 30%.
ROI with margin transaction = 60%
ROI without margin transaction = 30%
Effect of Using
Margin
Transaction
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New Trading Systems
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Thank You
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