Chapter 3 investments securities markets

Securities Markets Chapter 3 3.1 How Firms Issue Securities 3-2 Primary vs. Secondary Market Security Sales • Primary – New issue is created and sold – Key factor: issuer receives the proceeds from the sale – Initial Public Offerings (IPOs) and Seasoned Equity Offerings(SEOs) – Public offerings: registered with the SEC and sale is made to the investing public – Private offerings: not registered, and sold to only a limited number of investors, with restrictions on resale • Secondary – Existing owner sells to another party – Issuing firm doesn’t receive proceeds and is not directly involved. – Trading in secondary markets does not affect the outstanding amount of securities. 3-3 • Privately Held Firms      ! !"   • 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 - Do not trade in secondary markets, reducing their liquidity and presumably reducing the prices that investors will pay for the issue. Private Placements → 3-5 Publicly Traded Companies - # $ - %"&%!'($  - )"&*'(+  - !  !, Figure 3.1 Relationship Among a Firm Issuing Securities, the Underwriters and the Public → 3-7 Shelf Registrations : The securities are “on the shelf”, ready to be issued • SEC Rule 415 - " - • %./0 • 1 1  Initial Public Offerings • IPO Process - Issuer and banker put on the “Road Show” - Purpose: Book building and pricing • Underpricing - Post initial sale returns average about 10% or more. (“Left on the table”) - Easier to market the issue, but costly to the issuing firm 3-9 Figure 3.2 Average First Day Returns for European and Non-European IPOs 3-10 [...]... Tick Size 3. 4 U.S Security Markets 3- 23 U.S Security Markets Overview • Nasdaq • Small stock OTC - Pink sheets • Organized Exchanges - New York Stock Exchange - American Stock Exchange - Regionals • Electronic Communication Networks (ECNs) 3- 24 U.S Security Markets • NASDAQ - Approximately 3, 000 firms • New York Stock Exchange (NYSE) - Stock exchanges: Secondary markets where already-issued securities. .. 1970-2006 3- 11 3. 2 How Securities are Traded 3- 12 Functions of Financial Markets Overall purpose: facilitate low cost investment 1 2 3 4 Bring together buyers and sellers at low cost Provide adequate liquidity by minimizing time and cost to trade and promoting price continuity Set & update prices of financial assets Reduce information costs associated with investing Types of Markets • Direct Search Markets. .. are paid 3. 8 Buying on Margin 3- 32 Buying on Margin • Defined: borrowing money to purchase stock • Initial Margin Requirement (IMR) (minimum set by Federal Reserve under Regulation T), currently 50% for stocks • The IMR is the minimum % initial investor equity (= the ratio of the equity value in the account to the market value of the securities) 1-IMR = Maximum % amount investor can borrow 3- 33 Buying... participants can buy/sell large blocks of securities anonymously - Blocks: Transactions of at least 10,000 shares Figure 3. 8 Market Capitalization of Major World Stock Exchanges, 2011 3. 6 Globalization of Stock Markets • Moving to automated electronic trading • Current trends will eventually result in 24-hour global markets • Moving toward market consolidation 3. 7 Trading Costs • Commission: Fee paid... a sell limit order at $50.25 3- 15 Figure 3. 4 Limit Order Book for Intel on the NYSE Arca Market, July 22, 2011 3- 16 Types of Orders 2) Stop loss order: Becomes a market sell order when the trigger price is encountered - E.G: You own stock trading at $40 You could place a stop loss at $38 The stop loss would become a market order to sell if the price of the stock hits $38 3) Stop buy order: Becomes a... the stock hits $42 3- 17 Types of Orders 3- 18 Trading Mechanisms - Dealer markets  Over-the-counter (OTC) market: Informal network of brokers/dealers who negotiate securities sales  NASDAQ stock market: Computer-linked price quotation system for OTC market - Electronic communication networks (ECNs)  Computer networks that allow direct trading without market makers - Specialist markets  Specialist:... exchanges 3. 3 The Rise of Electronic Trading  Timeline of Market Changes • 1997: SEC drops minimum tick size from 1/8 to 1/16 of $1 • 2000: National Association of Securities Dealers splits from NASDAQ • 2001: Minimum tick size $.01 • 2006: NYSE acquires Archipelago Exchanges and renames it NYSE Arca - SEC adopts Regulation NMS, requiring exchanges to honor quotes of other exchanges Figure 3. 6 Effective... before additional funds must be put into the account 3- 34 Margin Call • Margin call: notification from broker you must put up additional funds or have your position liquidated • At what price does the investor receive a margin call? The investor's equity = Market Value - Amount borrowed Thus, a declining stock price reduces the investor's equity 3- 35 Margin Call • If (the Equity / Market Value) ≤ MMR,... Brokered Markets - Third party assistance in location buyer or seller - Brokers offer search serviced to buyers and sellers Real estate market and primary market • Dealer Markets - Third party acts as intermediate buyer/seller - Dealers specialize in various assets, purchase these assets for their own accounts, and later sell them for a profit from their inventory The over-the counter (OTC) securities. ..  Specialist: Makes market in shares of one or more firms; maintains “fair and orderly market” by dealing personally 3. 3 The Rise of Electronic Trading  Timeline of Market Changes • 1969: Instinet (first ECN) established • 1975: Fixed commissions on NYSE eliminated - Congress amends Securities and Exchange Act to create National Market System (NMS) • 1994: NASDAQ scandal - SEC institutes new order-handling . Securities Markets Chapter 3 3.1 How Firms Issue Securities 3- 2 Primary vs. Secondary Market Security Sales • Primary – New issue. firm 3- 9 Figure 3. 2 Average First Day Returns for European and Non-European IPOs 3- 10 Long-term Relative Performance of Initial Public Offerings 1970-2006 3- 11 3. 2 How Securities are Traded 3- 12 Functions.  - )"&*'(+  - !  !, Figure 3. 1 Relationship Among a Firm Issuing Securities, the Underwriters and the Public → 3- 7 Shelf Registrations : The securities are “on the shelf”, ready to