fall-02 mswiener/zvi.html investments zvi wiener tel: 02-588-3049 [email protected] how...

Fall-02http://pluto.mscc.huji.ac.il/

~mswiener/zvi.htmlInvestments

Zvi Wienertel: 02-588-3049 [email protected]

How securities are tradedBKM Ch 3

Zvi Wiener BKM Ch 3 slide 2

How Securities Are Traded

How Firms Issue Securities

Where Securities are Traded

Trading on the Exchanges

Buying on Margin

Short Sales

Regulation of Securities Markets

Mutual Funds


Primary market - when issued

Secondary market - any time later

Primary market

public offering

private placement

IPO (initial public offering)

Seasoned new issue


Public offerings of stocks and bonds are usually underwritten by investment bankers. A lead investment banker forms an underwriting syndicate to share the commitment.

The syndicate provides market advice and handle the SEC registration process.

(red herring=preliminary prospectus)

1. Firm Commitment

2. Best-Efforts Basis


Shelf Registration

Since 1982 the SEC allows (rule 415) shelf registration. One can register now but actually trade during two years.

Rule 144A of SEC

Trading of private placements among some institutions.


IPO

Road show

Book – indication of interest

IPO underpricing effect in the first days and bad performance later.

Internet IPO


Private Placements

Private placement: sale to a limited number of sophisticated investors not requiring the protection of registration.

Dominated by institutions.

Very active market for debt securities.

Not active for stock offerings.


Secondary Market

national (NYSE, AMEX)

regional - firms located in its area

exchanges for derivatives

Trading conducted by members (seat owners)

Commission brokers seats - full-service brokers


Seat price on the NYSE in $K

year high low year high low 1875 6.8 4.3 1985 600 310 1905 140 72 1990 430 250 1935 250 65 1995 1,050 785 1965 138 190 1999 2,650 2,000 1975 275 55 1980 480 175


NYSE Listing Requirements

Pretax Income last year $2,5M

Average annual pretax in 2 years $2M

Market value of publicly held stock $60M

Shares publicly held 1.1M

Holders of 100 shares or more 2,000


The Over-the-Counter Market

More than 35,000 issues are traded

Since 1972 the NASDAQ gives quotes

(National Association of Security Dealers)

network of dealers linked by a computer system.


OTC levelsLevel 3: Market makers

Maintain inventories of securities

May enter bid-ask prices and update them

Level 2: Receive all bid-ask quotes

Can not enter quotes

Are brokers who act for clients

Do not actively deal on their own account

Level 1: Receive median bid-ask quotes

Investors looking for information.


Third and Fourth Markets

The third market - exchange-listed securities traded on the OTC

Fourth marked - investors trading directly


The National Market System

Securities Act Amendments of 1975 directed SEC (Securities and Exchange Commission) to implement a national competitive system.

Requirements to companies

Insider trading is prohibited

Public Information control


Other Countries

LSE - London Stock Exchange

TSE - Tokyo Stock Exchange

German

Zurich

Paris

Toronto

Israel


Participants

Commission Brokers - serve clients

Floor Broker - independent broker

Registered Traders - act on their own account

Specialists


Types of Orders

Market Order

Limit Order (price, time)

Stop-Loss Order

(sell if the price falls below some level)

Stop-Buy Order

(buy if the price rises above some level)

Block sales (10,000 shares), block houses, standard price taking assumption isn’t valid.


Limit Orders

ConditionAction

Price belowthe limit

Price abovethe limit

Buy Limit buyorder

Stop buyorder

Sell Stop lossorder

Limit sellorder


Roles of a Specialist

Specialist “makes a market” in a share.

He can act either as a broker or as a dealer.

Specialist maintains a “book”- list of outstanding orders.

Provides liquidity.

Is obligated to provide price continuity.


Trading on the OTC Market

Dealer Market

Investor contacts broker

The broker tries to find a dealer

Computerized system


Trading Costs

Full-Service - advice, research, execution

Discount Brokerage - only execute

Brokerage fees + the bid-ask spread

Paying for order flow

Odd versus even quotes

Internet innovation


Buying on Margin

Initial Margin is defined by the FRS (Federal Reserve System) about 50% by investor’s funds, the rest is borrowed from the broker. Margined stock is left with the broker.

Maintenance Margin are set by the NYSE and the brokerage firm. If the balance falls below, the investor is subject to a margin call.

Margin is equity in the account as a percent of the value of the account, a leveraged position.


Below Maintenance Margin Value of securities no longer support loan Investor must do something! 1. Sell some shares 2. Send cash

Above Initial Margin Investor may 1. Do nothing 2. Buy more shares with no additional cash 3. Increase loan amount


Short SalesAn investor borrows a stock from the broker

The short seller expect the price to decline

Covering the position - purchasing the stock

One can short a stock only after an uptick

Required deposit (50%)

All dividends must be paid

Margin call possible

What is the difference between buying on margin and selling short?


Short position - pessimist

Long position - optimist


Short SaleYou short 100 shares at $50

Dividends of $1/share are paid

You cover position at $40

Profit = $900

You short 100 shares at $50

Dividends of $1/share are paid

You cover position at $60

Loss = ($1,100)


Margin Calls on Short Transactionsyou go short 100 shares at $50; MM 30%

Assets

$5,000 Proceeds

$2,500 Cash

$7,500

Liability & Equity

$5,000 C.S.

$2,500 Equity

$7,500Margin = (Assets-Liabilities)/Liabilities

0.3 = ($7,500-100 P)/(100 P)

P = $57.69


Regulation on Securities Markets

Securities Act of 1933 - disclosure of new issues

Securities Act of 1934 - established SEC

The Commodities Futures Trading Commission

The Securities Investor Protection Corporation protects investors from losses against brokerage firm bankruptcy


Other Restrictions

Circuit Breakers. Trading is stopped for 1 hour when DJIA falls 250 points from the previous day’s close and stops trading for 2 hours if the drop is 400 points.

Insider Trading. Insiders are: major shareholders, officers and directors. They must disclose their trades to SEC (and SEC discloses it to public).


Home Assignment

Required: •

read chapter 3 in BKM. •

read very carefully summary at the end.

• problems 2, 7, 12, 14, 16, 17 (3rd ed).

• problems 2, 9, 18, 20, 22, 23 (5th ed).

• find names of all 30 companies in DJIA

• find names of all 25 companies in TA-25

• closely follow financial news!

Fall-02http://pluto.mscc.huji.ac.il/

~mswiener/zvi.htmlInvestments

Zvi Wienertel: 02-588-3049 [email protected]

Mutual FundsBKM Ch 4


Mutual Funds

Open-End Funds, sell at net asset value + load.

NAV = (Assets - Liabilities)/Shares

Closed-End Funds. No new shares issued.

Front-end load

Back-end load

Operating expenses

12B-1 Charges - annual fees


Advantages: Diversification and divisibility

Professional management

Small investment

Reinvestment of dividends, capital gains

Disadvantages: Commissions (loads)

Time delay or illiquidity


Home Assignment

• read chapter 4 in BKM (5th ed).

• find major types of mutual funds in Israel

• find 5 largest mutual funds in Israel

• what was their performance and fees last

year?


Additional Slides


Costs of Trading

Commission: fee paid to broker for making the transaction

Spread: cost of trading with dealer

Bid: price dealer will buy from you

Ask: price dealer will sell to you

Spread: ask - bid

Combination: on some trades both are paid


Using only a portion of the proceeds for an investment.

Borrow remaining component.

Margin arrangements differ for stocks and futures.

Margin Trading


Maximum marginCurrently 50%Set by the Fed

Maintenance marginMinimum level the equity margin can be

Margin callCall for more equity funds

Stock Margin Trading


X Corp $7050% Initial Margin40% Maintenance Margin1000 Shares PurchasedInitial PositionStock $70,000 Borrowed $35,000 Equity $35,000

Margin Trading - Initial Conditions


Margin Trading - Maintenance Margin

Stock price falls to $60 per share

New Position

Stock $60,000 Borrowed $35,000

Equity 25,000

Margin% = $25,000/$60,000 = 41.67%


Margin Trading - Margin Call

How far can the stock price fall before a margin call?

(1000P - $35,000)* / 1000P = 40%

P = $58.33* 1000P - Amount Borrowed = Equity


Short Sales

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 Sale - Initial Conditions

Z Corp 100 Shares50% Initial Margin30% Maintenance Margin$100 Initial Price

Sale Proceeds $10,000Margin & Equity 5,000Stock Owed 10,000


Short Sale - Maintenance Margin

Stock Price Rises to $110

Sale Proceeds $10,000Initial Margin 5,000Stock Owed 11,000Net Equity 4,000Margin % (4000/11000) 36%


Short Sale - Margin Call

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

($15,000* - 100P) / (100P) = 30%P = $115.38

* Initial margin plus sale proceeds

fall-02 mswiener/zvi.html investments zvi wiener tel: 02-588-3049 [email protected] how...

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