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Essentials of Investments: Chapter 3 - Securities market incldudes Primary vs. Secondary Security Sales, Investment Banking Arrangements, Public Offerings, Private Placements, Organization of Secondary Markets, Organized Exchanges.
1 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Chapter Securities market Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 2 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Primary vs Secondary Security Sales • Primary – New issue – Key factor: issuer receives the proceeds from the sale • Secondary – Existing owner sells to another party – Issuing firm doesn’t receive proceeds and is not directly involved Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 3 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Investment Banking Arrangements • Underwritten vs “Best Efforts” – Underwritten: firm commitment on proceeds to the issuing firm – Best Efforts: no firm commitment • Negotiated vs Competitive Bid – Negotiated: issuing firm negotiates terms with investment banker – Competitive bid: issuer structures the offering and secures bids Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 4 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Public Offerings • Public offerings: registered with the SEC and sale is made to the investing public – Shelf registration (Rule 415, since 1982) • Initial Public Offerings (IPOs) – Evidence of underpricing – Performance Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 5 Bodie • Kane • Marcus Essentials of Investments Fourth Edition 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 Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 6 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Organization of Secondary Markets • • • • Organized exchanges OTC market Third market Fourth market Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 7 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Organized Exchanges • Auction markets with centralized order flow • Dealership function: can be competitive or assigned by the exchange (Specialists) • Securities: stock, futures contracts, options, and to a lesser extent, bonds • Examples: NYSE, AMEX, Regionals, CBOE Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 8 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Types of Orders Instructions to the brokers on how to complete the order • Market • Limit • Stop loss Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 9 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Margin Trading • Using only a portion of the proceeds for an investment • Borrow remaining component • Margin arrangements differ for stocks and futures Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 10 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Stock Margin Trading • Maximum margin is currently 50%; you can borrow up to 50% of the stock value • Set by the Fed • Maintenance margin: minimum amount equity in trading can be before additional funds must be put into the account • Margin call: notification from broker you must put up additional funds Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 11 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Margin Trading - Initial Conditions X Corp $70 50% Initial Margin 40% Maintenance Margin 1000 Shares Purchased Initial Position Stock $70,000 Borrowed $35,000 Equity 35,000 Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 12 Bodie • Kane • Marcus Essentials of Investments Fourth Edition 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% Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 13 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Margin Trading - Margin Call How far can the stock price fall before a margin call? (1000P - $35,000)* / 1000P = 40% P = $58.33 * 1000P - Amt Borrowed = Equity Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 14 Bodie • Kane • Marcus Essentials of Investments Fourth Edition 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 is was borrowed Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 15 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Short Sale - Initial Conditions Z Corp 50% 30% $100 100 Shares Initial Margin Maintenance Margin Initial Price Sale Proceeds $10,000 Margin & Equity 5,000 Stock Owed 10,000 Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 16 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Short Sale - Maintenance Margin Stock Price Rises to $110 Sale Proceeds $10,000 Initial Margin 5,000 Stock Owed 11,000 Net Equity 4,000 Margin % (4000/11000) 36% Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 17 Bodie • Kane • Marcus Essentials of Investments Fourth Edition 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 Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved ... Trading - Margin Call How far can the stock price fall before a margin call? (1000P - $35 ,000)* / 1000P = 40% P = $58 .33 * 1000P - Amt Borrowed = Equity Irwin / McGraw-Hill © 2001 The McGraw-Hill... Borrowed $35 ,000 Equity 35 ,000 Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc All rights reserved 12 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Margin Trading - Maintenance... McGraw-Hill Companies, Inc All rights reserved 6 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Organization of Secondary Markets • • • • Organized exchanges OTC market Third market