Your SlideShare is downloading. ×
0
Chapter 18. The Common Stock Market <ul><li>Types of markets </li></ul><ul><li>Trading mechanics </li></ul><ul><li>Stock m...
Common stock <ul><li>equity security </li></ul><ul><ul><li>ownership </li></ul></ul><ul><ul><li>entitled to distributed ea...
I.  Type of Markets <ul><li>exchanges </li></ul><ul><li>OTC trading of  </li></ul><ul><ul><li>unlisted stocks & listed sto...
Exchanges <ul><li>physical location for trading </li></ul><ul><li>trading by members </li></ul><ul><ul><li>own a  seat  on...
NYSE <ul><li>the “Big Board” </li></ul><ul><li>about 2800 listed U.S. companies </li></ul><ul><ul><li>& 450 non-U.S. compa...
<ul><li>stocks trade at  post  on the trading floor </li></ul><ul><ul><li>20 posts, trading about 100 stocks </li></ul></u...
role of the specialist <ul><li>MUST maintain a fair and orderly market for stock </li></ul><ul><li>act as buyer or seller ...
the future of the specialist <ul><li>may be phased on with next 5-10 years </li></ul><ul><li>recent SEC fines for improper...
AMEX <ul><li>merged w/ Nasdaq 1998 </li></ul><ul><li>specializes in equity derivative securities and closed-end funds </li...
Regional exchanges <ul><li>stocks may be listed on both NYSE and regional exchange </li></ul><ul><li>5 regional exchanges ...
OTC markets <ul><li>electronic network of dealers all over the world </li></ul><ul><li>ECNs </li></ul><ul><ul><li>electron...
Nasdaq <ul><li>not the only OTC system, but the largest </li></ul><ul><li>over 4000 companies listed </li></ul><ul><ul><li...
 
II.  Trading Mechanics <ul><li>types of orders </li></ul><ul><li>short selling </li></ul><ul><li>buying on the margin </li...
Types of orders <ul><li>instructions from investors to brokers </li></ul><ul><li>market order </li></ul><ul><ul><li>buy/se...
<ul><li>market order (cont.) </li></ul><ul><ul><li>market orders given priority in trading </li></ul></ul><ul><ul><li>no g...
<ul><li>limit order </li></ul><ul><ul><li>buy/sell order where investor specifies price range </li></ul></ul><ul><ul><li>“...
<ul><ul><li>investor sets reservation price </li></ul></ul><ul><ul><li>BUT </li></ul></ul><ul><ul><li>no guarantee that li...
<ul><li>stop order </li></ul><ul><ul><li>order lies dormant  </li></ul></ul><ul><ul><li>turns into market order when certa...
<ul><li>investor does not have to watch market </li></ul><ul><ul><li>but in a volatile market stop could be triggered prem...
<ul><li>stop limit order </li></ul><ul><ul><li>turns into limit order when stop is reached </li></ul></ul><ul><ul><li>“ bu...
<ul><li>market if touched order </li></ul><ul><ul><li>turns into market order if certain price is reached </li></ul></ul><...
how long is an order good? <ul><li>fill or kill order </li></ul><ul><ul><li>executed when reaches trading floor, or cancel...
order size <ul><li>round lots </li></ul><ul><ul><li>lots of 100 shares </li></ul></ul><ul><li>odd lots </li></ul><ul><ul><...
short selling <ul><li>sale of borrowed stock </li></ul><ul><li>profit from belief that stock price is too high will fall s...
<ul><li>short selling could further destabilize falling prices </li></ul><ul><ul><li>tick test rules on exchange </li></ul...
<ul><li>so short sellers </li></ul><ul><ul><li>believe price will fall and SOON </li></ul></ul><ul><ul><li>but price not c...
Buying on the margin <ul><li>buyer borrows part of purchase price of stock, using stock as collateral </li></ul><ul><ul><l...
<ul><li>if stock price falls </li></ul><ul><ul><li>collateral worth less </li></ul></ul><ul><ul><li>if collateral worth on...
example <ul><li>1000 shares, $20 per share </li></ul><ul><ul><li>$20,000 cost </li></ul></ul><ul><ul><li>$10,000 cash, bor...
<ul><li>if prices falls to $12, </li></ul><ul><ul><li>value of stock $12,000 </li></ul></ul><ul><ul><li>below 125% of $10,...
Institutional trading <ul><li>vs. retail trades </li></ul><ul><ul><li>institutional trades are larger </li></ul></ul><ul><...
block trades <ul><li>large # shares in one stock </li></ul><ul><li>executed in “upstairs” market </li></ul><ul><ul><li>oth...
program trades <ul><li>large # shares, different stocks </li></ul><ul><li>used by mutual funds for asset allocation </li><...
what is frontrunning? <ul><li>brokers trade ahead of program trade </li></ul><ul><ul><li>to benefit from anticipated price...
example <ul><li>broker buys ahead of large buy order </li></ul><ul><ul><li>broker buys first </li></ul></ul><ul><ul><li>la...
agency basis <ul><li>brokers bid for trade by commission </li></ul><ul><li>low commission, but </li></ul><ul><li>frontrunn...
agency incentive agreement <ul><li>set benchmark value for trade </li></ul><ul><ul><li>based on last day’s prices </li></u...
III.  Stock market indicators <ul><li>measure average performance of a group of stocks </li></ul><ul><li>different indexes...
indexes differ due to <ul><li>stocks included in the index </li></ul><ul><li>weighting of stocks </li></ul><ul><ul><li>equ...
stock exchange index <ul><li>includes all stocks listed on exchange </li></ul><ul><li>NYSE Composite </li></ul><ul><li>Nas...
subjectively selected index <ul><li>organization picks group of stocks to measure </li></ul><ul><li>Dow Jones Industrial a...
DJIA <ul><li>price weighted </li></ul><ul><li>30 large blue chip companies </li></ul><ul><ul><li>cross section of industri...
S&P 500 <ul><li>500 large blue chip companies </li></ul><ul><li>value weighted </li></ul><ul><li>most popular benchmark fo...
objectively selected index <ul><li>inclusion of stock based on objective criteria </li></ul><ul><ul><li>market value </li>...
IV.  Pricing Efficiency of the  Stock Market <ul><li>what information is reflected in current stock prices? </li></ul><ul>...
3 levels of price efficiency <ul><li>what are they? </li></ul><ul><li>implication? </li></ul><ul><li>evidence for U.S. sto...
Weak form efficiency <ul><li>current stock prices reflect  </li></ul><ul><ul><li>information about past prices  </li></ul>...
implication <ul><li>if markets are weak-form efficient </li></ul><ul><ul><li>using past price/trading pattern to predict f...
evidence <ul><li>U.S. stock market is weak-form efficient </li></ul><ul><li>technical analysts do not beat the market </li...
Semi strong form efficiency <ul><li>current stock prices reflect </li></ul><ul><ul><li>all publicly available information ...
implication <ul><li>using public info to predict future stock prices will not work </li></ul><ul><ul><li>fundamental analy...
evidence <ul><li>mixed </li></ul><ul><li>Yes </li></ul><ul><ul><li>most actively managed portfolios do not outperform rand...
<ul><li>No. </li></ul><ul><ul><li>certain pricing anomalies persist for long periods of time </li></ul></ul><ul><ul><li>Ja...
Strong form efficiency <ul><li>current stock prices reflect all information </li></ul><ul><ul><li>public and private </li>...
implication <ul><li>impossible to predict future stock prices </li></ul><ul><ul><li>stock prices are a random walk </li></...
evidence <ul><li>U.S. stock market is not strong form efficient </li></ul><ul><li>why? </li></ul><ul><ul><li>corporate ins...
active strategy <ul><li>using fundamental or technical analysis to select stocks to buy/sell </li></ul><ul><li>growth, sec...
passive strategy <ul><li>believe market is efficient, just capture long-run returns of market </li></ul><ul><li>buy-and-ho...
Upcoming SlideShare
Loading in...5
×

342chapter18

330

Published on

hi

0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total Views
330
On Slideshare
0
From Embeds
0
Number of Embeds
0
Actions
Shares
0
Downloads
3
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

Transcript of "342chapter18"

  1. 1. Chapter 18. The Common Stock Market <ul><li>Types of markets </li></ul><ul><li>Trading mechanics </li></ul><ul><li>Stock market indexes </li></ul><ul><li>Pricing efficiency </li></ul>
  2. 2. Common stock <ul><li>equity security </li></ul><ul><ul><li>ownership </li></ul></ul><ul><ul><li>entitled to distributed earnings </li></ul></ul><ul><ul><li>entitled to share of assets </li></ul></ul>
  3. 3. I. Type of Markets <ul><li>exchanges </li></ul><ul><li>OTC trading of </li></ul><ul><ul><li>unlisted stocks & listed stocks </li></ul></ul><ul><li>direct trading </li></ul>
  4. 4. Exchanges <ul><li>physical location for trading </li></ul><ul><li>trading by members </li></ul><ul><ul><li>own a seat on the exchange </li></ul></ul><ul><li>stock traded on exchange are listed stocks </li></ul>
  5. 5. NYSE <ul><li>the “Big Board” </li></ul><ul><li>about 2800 listed U.S. companies </li></ul><ul><ul><li>& 450 non-U.S. companies </li></ul></ul><ul><li>$18 trillion market value (2/04) </li></ul><ul><li>1366 seats (fixed) </li></ul><ul><ul><li>seat price $2 million 2002 </li></ul></ul><ul><ul><li>10/2003 $1.35 million </li></ul></ul>
  6. 6. <ul><li>stocks trade at post on the trading floor </li></ul><ul><ul><li>20 posts, trading about 100 stocks </li></ul></ul><ul><li>each stock has one specialist </li></ul><ul><ul><li>10 specialist firms, 470 specialists </li></ul></ul><ul><ul><li>each specialist has 5-10 stocks </li></ul></ul><ul><ul><li>process trades from floor brokers (5%) and electronically (95%) </li></ul></ul>
  7. 7. role of the specialist <ul><li>MUST maintain a fair and orderly market for stock </li></ul><ul><li>act as buyer or seller as needed (10% of trades) </li></ul><ul><li>match buyers and sellers </li></ul><ul><li>maintain order priority </li></ul>
  8. 8. the future of the specialist <ul><li>may be phased on with next 5-10 years </li></ul><ul><li>recent SEC fines for improper trading for several major firms </li></ul>
  9. 9. AMEX <ul><li>merged w/ Nasdaq 1998 </li></ul><ul><li>specializes in equity derivative securities and closed-end funds </li></ul>
  10. 10. Regional exchanges <ul><li>stocks may be listed on both NYSE and regional exchange </li></ul><ul><li>5 regional exchanges </li></ul><ul><li>cheaper seat prices </li></ul>
  11. 11. OTC markets <ul><li>electronic network of dealers all over the world </li></ul><ul><li>ECNs </li></ul><ul><ul><li>electronic communication networks </li></ul></ul><ul><li>more than one dealer per stock </li></ul><ul><ul><li>not obligated to make a market </li></ul></ul>
  12. 12. Nasdaq <ul><li>not the only OTC system, but the largest </li></ul><ul><li>over 4000 companies listed </li></ul><ul><ul><li>mkt. value $2 trillion (2/28/03) </li></ul></ul><ul><li>leader in daily share volume </li></ul><ul><li>over 500 dealers </li></ul><ul><li>listing requirements </li></ul>
  13. 14. II. Trading Mechanics <ul><li>types of orders </li></ul><ul><li>short selling </li></ul><ul><li>buying on the margin </li></ul><ul><li>institutional trading </li></ul>
  14. 15. Types of orders <ul><li>instructions from investors to brokers </li></ul><ul><li>market order </li></ul><ul><ul><li>buy/sell order to be executed at best price </li></ul></ul><ul><ul><li>-- get lowest price for buy order </li></ul></ul><ul><ul><li>-- get highest price for sell order </li></ul></ul>
  15. 16. <ul><li>market order (cont.) </li></ul><ul><ul><li>market orders given priority in trading </li></ul></ul><ul><ul><li>no guarantee of execution price </li></ul></ul><ul><ul><li>-- price could rise/fall from time order is placed to time it is executed </li></ul></ul>
  16. 17. <ul><li>limit order </li></ul><ul><ul><li>buy/sell order where investor specifies price range </li></ul></ul><ul><ul><li>“ buy at $50 or less” </li></ul></ul><ul><ul><li>“ sell at $52 or more” </li></ul></ul><ul><ul><li>specialist records orders in </li></ul></ul><ul><ul><li>limit order book </li></ul></ul>
  17. 18. <ul><ul><li>investor sets reservation price </li></ul></ul><ul><ul><li>BUT </li></ul></ul><ul><ul><li>no guarantee that limit order will be executed </li></ul></ul>
  18. 19. <ul><li>stop order </li></ul><ul><ul><li>order lies dormant </li></ul></ul><ul><ul><li>turns into market order when certain price (“the stop”) is reached </li></ul></ul><ul><ul><li>“ buy if price rises to $60” </li></ul></ul><ul><ul><li>“ sell if price falls to $58” </li></ul></ul><ul><ul><li>-- stop loss order </li></ul></ul>
  19. 20. <ul><li>investor does not have to watch market </li></ul><ul><ul><li>but in a volatile market stop could be triggered prematurely </li></ul></ul><ul><ul><li>-- end up trading unnecessarily </li></ul></ul>
  20. 21. <ul><li>stop limit order </li></ul><ul><ul><li>turns into limit order when stop is reached </li></ul></ul><ul><ul><li>“ buy if price rises to $60, but only is executed at $65 or less” </li></ul></ul>
  21. 22. <ul><li>market if touched order </li></ul><ul><ul><li>turns into market order if certain price is reached </li></ul></ul><ul><ul><li>“ buy if price falls to $55” </li></ul></ul><ul><ul><li>“ sell if price rises to $62” </li></ul></ul>
  22. 23. how long is an order good? <ul><li>fill or kill order </li></ul><ul><ul><li>executed when reaches trading floor, or canceled </li></ul></ul><ul><li>good until canceled/open order </li></ul><ul><ul><li>is good indefinitely </li></ul></ul>
  23. 24. order size <ul><li>round lots </li></ul><ul><ul><li>lots of 100 shares </li></ul></ul><ul><li>odd lots </li></ul><ul><ul><li>less than 100 shares </li></ul></ul><ul><ul><li>more difficult to trade </li></ul></ul><ul><li>block trades </li></ul><ul><ul><li>10,000 shares or $200,000 value </li></ul></ul>
  24. 25. short selling <ul><li>sale of borrowed stock </li></ul><ul><li>profit from belief that stock price is too high will fall soon </li></ul><ul><li>how? </li></ul><ul><ul><li>borrow stock through broker </li></ul></ul><ul><ul><li>sell stock </li></ul></ul><ul><ul><li>buy and return later </li></ul></ul>
  25. 26. <ul><li>short selling could further destabilize falling prices </li></ul><ul><ul><li>tick test rules on exchange </li></ul></ul><ul><li>short sales allowed if </li></ul><ul><ul><li>uptick or zero uptick in price for previous trades: </li></ul></ul><ul><ul><li>$20.75, $21 (uptick) </li></ul></ul><ul><ul><li>$20.75, $20.75 (zero upick) </li></ul></ul><ul><ul><li>$20.75, $20 (downtick) </li></ul></ul>
  26. 27. <ul><li>so short sellers </li></ul><ul><ul><li>believe price will fall and SOON </li></ul></ul><ul><ul><li>but price not currently falling </li></ul></ul><ul><ul><li>face unlimited losses if price rises </li></ul></ul>
  27. 28. Buying on the margin <ul><li>buyer borrows part of purchase price of stock, using stock as collateral </li></ul><ul><ul><li>borrow at call money rate </li></ul></ul><ul><li>Fed sets initial margin requirement </li></ul><ul><ul><li>minimum cash payment </li></ul></ul><ul><ul><li>50% since 1975 </li></ul></ul>
  28. 29. <ul><li>if stock price falls </li></ul><ul><ul><li>collateral worth less </li></ul></ul><ul><ul><li>if collateral worth only 125% of loan (maintenance margin) </li></ul></ul><ul><ul><li>-- margin call </li></ul></ul><ul><ul><li>-- owner must put up more cash or sell stock </li></ul></ul><ul><ul><li>margin calls can worsen stock crash </li></ul></ul>
  29. 30. example <ul><li>1000 shares, $20 per share </li></ul><ul><ul><li>$20,000 cost </li></ul></ul><ul><ul><li>$10,000 cash, borrow $10,000 </li></ul></ul><ul><li>leverage </li></ul><ul><ul><li>gains/losses on $20,000 capital </li></ul></ul><ul><ul><li>but tied up only $10,000 capital </li></ul></ul>
  30. 31. <ul><li>if prices falls to $12, </li></ul><ul><ul><li>value of stock $12,000 </li></ul></ul><ul><ul><li>below 125% of $10,000 loan </li></ul></ul><ul><ul><li>get a margin call </li></ul></ul>
  31. 32. Institutional trading <ul><li>vs. retail trades </li></ul><ul><ul><li>institutional trades are larger </li></ul></ul><ul><ul><li>special execution </li></ul></ul><ul><ul><li>over 50% of NYSE share volume </li></ul></ul>
  32. 33. block trades <ul><li>large # shares in one stock </li></ul><ul><li>executed in “upstairs” market </li></ul><ul><ul><li>other firms directly take other side of trade </li></ul></ul><ul><li>remainder executed on trading floor or Nasdaq (downstairs) </li></ul>
  33. 34. program trades <ul><li>large # shares, different stocks </li></ul><ul><li>used by mutual funds for asset allocation </li></ul><ul><li>want </li></ul><ul><ul><li>low commissions </li></ul></ul><ul><ul><li>prevent frontrunning </li></ul></ul>
  34. 35. what is frontrunning? <ul><li>brokers trade ahead of program trade </li></ul><ul><ul><li>to benefit from anticipated price movements </li></ul></ul><ul><ul><li>due to large trade </li></ul></ul>
  35. 36. example <ul><li>broker buys ahead of large buy order </li></ul><ul><ul><li>broker buys first </li></ul></ul><ul><ul><li>large buy order pushes up price </li></ul></ul><ul><ul><li>broker’s holdings increase in value </li></ul></ul><ul><li>result </li></ul><ul><ul><li>frontrunning starts to push up price, so firm does not get best price </li></ul></ul>
  36. 37. agency basis <ul><li>brokers bid for trade by commission </li></ul><ul><li>low commission, but </li></ul><ul><li>frontrunning likely </li></ul>
  37. 38. agency incentive agreement <ul><li>set benchmark value for trade </li></ul><ul><ul><li>based on last day’s prices </li></ul></ul><ul><li>if broker does better </li></ul><ul><ul><li>gets commission + bonus </li></ul></ul><ul><li>higher commission, but </li></ul><ul><li>frontrunning less likely </li></ul>
  38. 39. III. Stock market indicators <ul><li>measure average performance of a group of stocks </li></ul><ul><li>different indexes are highly correlated: </li></ul><ul><ul><li>DJIA & S&P 500 .991 (1990s) </li></ul></ul><ul><ul><li>DJIA & NYSE .95 </li></ul></ul>
  39. 40. indexes differ due to <ul><li>stocks included in the index </li></ul><ul><li>weighting of stocks </li></ul><ul><ul><li>equal, price, value </li></ul></ul><ul><li>average </li></ul><ul><ul><li>arithmetic </li></ul></ul><ul><ul><li>geometric </li></ul></ul>
  40. 41. stock exchange index <ul><li>includes all stocks listed on exchange </li></ul><ul><li>NYSE Composite </li></ul><ul><li>Nasdaq Composite </li></ul><ul><li>(both value weighted) </li></ul>
  41. 42. subjectively selected index <ul><li>organization picks group of stocks to measure </li></ul><ul><li>Dow Jones Industrial average </li></ul><ul><li>S&P 500 </li></ul>
  42. 43. DJIA <ul><li>price weighted </li></ul><ul><li>30 large blue chip companies </li></ul><ul><ul><li>cross section of industries </li></ul></ul><ul><ul><li>leaders </li></ul></ul><ul><li>large movements in DJIA may halt trading on NYSE </li></ul>
  43. 44. S&P 500 <ul><li>500 large blue chip companies </li></ul><ul><li>value weighted </li></ul><ul><li>most popular benchmark for index funds </li></ul>
  44. 45. objectively selected index <ul><li>inclusion of stock based on objective criteria </li></ul><ul><ul><li>market value </li></ul></ul><ul><li>Wilshire 5000 </li></ul><ul><ul><li>all publicly traded stocks </li></ul></ul><ul><li>Russell 2000 </li></ul><ul><ul><li>largest 3000 companies, then take </li></ul></ul><ul><ul><li>smallest 2000 of those </li></ul></ul>
  45. 46. IV. Pricing Efficiency of the Stock Market <ul><li>what information is reflected in current stock prices? </li></ul><ul><ul><li>what implications does this have for active vs. passive investment strategies? </li></ul></ul>
  46. 47. 3 levels of price efficiency <ul><li>what are they? </li></ul><ul><li>implication? </li></ul><ul><li>evidence for U.S. stock markets? </li></ul>
  47. 48. Weak form efficiency <ul><li>current stock prices reflect </li></ul><ul><ul><li>information about past prices </li></ul></ul><ul><ul><li>and trading history </li></ul></ul>
  48. 49. implication <ul><li>if markets are weak-form efficient </li></ul><ul><ul><li>using past price/trading pattern to predict future stock prices will not work </li></ul></ul><ul><ul><li>so, technical analysis will fail to beat the market </li></ul></ul>
  49. 50. evidence <ul><li>U.S. stock market is weak-form efficient </li></ul><ul><li>technical analysts do not beat the market </li></ul><ul><ul><li>especially after trading costs </li></ul></ul>
  50. 51. Semi strong form efficiency <ul><li>current stock prices reflect </li></ul><ul><ul><li>all publicly available information </li></ul></ul><ul><ul><li>relevant to stock </li></ul></ul><ul><ul><li>-- economic data </li></ul></ul><ul><ul><li>-- financial statements </li></ul></ul>
  51. 52. implication <ul><li>using public info to predict future stock prices will not work </li></ul><ul><ul><li>fundamental analysis will fail to beat market </li></ul></ul>
  52. 53. evidence <ul><li>mixed </li></ul><ul><li>Yes </li></ul><ul><ul><li>most actively managed portfolios do not outperform randomly selected portfolios </li></ul></ul>
  53. 54. <ul><li>No. </li></ul><ul><ul><li>certain pricing anomalies persist for long periods of time </li></ul></ul><ul><ul><li>January effect </li></ul></ul><ul><ul><li>size effect </li></ul></ul>
  54. 55. Strong form efficiency <ul><li>current stock prices reflect all information </li></ul><ul><ul><li>public and private </li></ul></ul>
  55. 56. implication <ul><li>impossible to predict future stock prices </li></ul><ul><ul><li>stock prices are a random walk </li></ul></ul>
  56. 57. evidence <ul><li>U.S. stock market is not strong form efficient </li></ul><ul><li>why? </li></ul><ul><ul><li>corporate insiders consistently outperform market </li></ul></ul><ul><ul><li>& they have access to private info </li></ul></ul>
  57. 58. active strategy <ul><li>using fundamental or technical analysis to select stocks to buy/sell </li></ul><ul><li>growth, sector, value funds </li></ul><ul><li>trading on this info increases </li></ul><ul><ul><li>trading costs </li></ul></ul><ul><ul><li>tax consequences </li></ul></ul><ul><li>odds of working are low </li></ul>
  58. 59. passive strategy <ul><li>believe market is efficient, just capture long-run returns of market </li></ul><ul><li>buy-and-hold diversified portfolio </li></ul><ul><ul><li>index funds </li></ul></ul><ul><li>lower expenses, defer taxes </li></ul><ul><li>index funds outperform most actively managed funds </li></ul>
  1. A particular slide catching your eye?

    Clipping is a handy way to collect important slides you want to go back to later.

×