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  • 1. Securities MarketsEconomics 71aSpring 2007Mayo, Chapter 3Lecture notes 2.3
  • 2. OutlineMarketsOrdersPositionsInformation
  • 3. MarketsPrimary marketsNew issues (IPO’s, corporate and publicdebt)Secondary marketsTrading old stuffIn many cases most activity in secondary
  • 4. Money and Capital MarketsMoney marketsShort term securities (1 year or less)Capital marketsLonger term
  • 5. Money Market Securities Treasury billsU.S. government debtShort term (less than 1 year) Commercial paperShort term corporate borrowing Discount pricingBuy for $10, get paid $11 in futureNo interest payments
  • 6. Capital Market SecuritiesBonds (longer term borrowing)U.S. TreasuryMunicipal (tax free)CorporateMore later
  • 7. Capital Market SecuritiesStocksCommon stockPreferred stockInternationalMore later
  • 8. Trading and SecondaryMarketsStock marketsBond marketsDerivativesForeign Exchange
  • 9. U.S. Stock MarketsNew York Stock Exchange (NYSE)National Association of SecuritiesDealers Automated Quotation (Nasdaq)American Stock Exchange (AMEX)
  • 10. Continuous TradingMarket typesSpecialistElectronic dealerOpen outcryOver the counterNASDAQUpstairs (negotiated)ECN (electronic crossing network)
  • 11. ECN’s: Electronic CrossingNetworks Internet based trade networks Customers can meet directly (no broker) Used mostly by professional moneymanagers Advantage: fewer intermediaries Disadvantage: less liquidity(Fewer people to trade with) Fastest growing markets
  • 12. Other MarketsFutures/OptionsForeign ExchangeSpot versus forwardBond
  • 13. International MarketsMany major international stock marketsLondonTokyoChinamany moreUS accounts for only 36% of thecompanies listed on stock marketsaround the world
  • 14. International Investments Purchase stocks or bonds in foreign countries Purchase shares in foreign firms in U.S.(American Depository Receipts) ($/English) Bonds can be issued in different currenciesEurobond: Intel issues $ denominated bond inJapan
  • 15. Trading Hours Most U.S. stock markets9:30-4:00 Extended hours on electronic tradingnetworks “After hours trading” International markets (local times) Foreign exchange markets (24 hours) Hours increasing : toward a 24 hour market
  • 16. OutlineMarketsOrdersPositionsInformation
  • 17. Types of OrdersMarket orderLimit order
  • 18. Market OrderBuy or sell at the current market priceNo restrictions“Buy 50 shares at market”
  • 19. Limit Orders Buy when price drops below a limit Sell when price moves above a limit ExampleLimit buy at 50 (price at 60)Stock moves to 55 (nothing happens)Stock moves to 49 (order executed) AdvantageMight end up with a better price DisadvantageOrder might end up unfilled
  • 20. Brokers Enable trading of financial services Dealer function AccessMailPhoneInternet
  • 21. Types of Brokers Full serviceExtensive researchMerrill Lynch Premium discountLimited researchCharles Schwab Basic discountNo researchE*trade Classification is difficult
  • 22. Transaction CostsCommissionsBid/ask spreads
  • 23. Costs of TradingCommissionsFixedNegotiatedVarying structures (fixed + varying)$20 + shares * CBid/ask spreadBuy at the askSell at the bid
  • 24. Bid/ask SpreadExample:Ask = 88.5 (buy)Bid = 88 (sell)Spreads may changeOver timeOver stocksReveal the ease of trading a stock“Liquidity” again
  • 25. Order Books Order bookList of current limit buy and sell orders If you want to buyCan “hit” limit sell ordersWalk up the bookHigher price for more stock If you want to sellCan “hit” limit buy ordersWalk down the book ECN’s and visible order books
  • 26. Settlement and DeliverySettlement datesUsually trade date + 3 daysTake delivery or leave shares withbroker (street name)
  • 27. OutlineMarketsOrdersPositionsInformation
  • 28. Long PurchaseStraight purchase of a securitySpeculate that price will increaseBuy at 100Sell at 11010% return
  • 29. Margin Purchase“Buying on margin”Borrow money to buy stockBuy at 75% margin75% of money in investment is yours25% is borrowed from broker or bankPurchase $100 of stock at 75% marginYou put in $75, and you borrow $25
  • 30. Basic Margin FormulaMargin=Totalvalue−BorrowedfundsTotalvalue
  • 31. Margins and MagnificationExample stock: Price = $100Up: Price = $150Down: Price = $75If you purchased with your own money$100 total investmentUp: + $50Down: - $25
  • 32. Margins and MagnificationBuy on 50% margin (zero interestcharges)$100 own, and $100 borrowed (needsto be paid back)Purchase $200/$100 shares = 2 shares$100 total investmentUp: 2*150 - 100 - 100 = $100 (50)Down: 2*75 - 100 - 100 = $-50 (-25)
  • 33. Margin Buying Borrowing money to buy stocks Magnifies gains and losses Can lose more than you put inBuy $200 of stock$100 your own$100 borrowedStock goes to zeroLose $100 of own investment, andOwe $100 of borrowed money too
  • 34. Maintenance MarginsMargin required for investor to maintainIf margin falls below this level investorsmust add more of their own money“Margin call”Common margin callPrices fallMargin risesInvestor needs to come up with more funds
  • 35. Margin RequirementsCommon stock: 50%Bonds: 50%Options: 20% stock valueFutures: 2-10% of the contract value
  • 36. Short SalesHolding negative stockSell stock you don’t have (borrow)Buy it back laterPay dividends yourself in betweenKey issueMake money on a price fallLose money on a riseBetting against a stock
  • 37. The Mechanics of a Short Tell broker you want to sell 100 shares of IBMshort (price = $50) Broker “borrows” shares of 100 shares of IBMowned by another client Sells it to someone for 50*100=5000, andpays this to you You must keep this amount on account withbroker When dividends are to be paid, you paybroker, and broker pays the other client
  • 38. The Mechanics of a Short IBM goes down to $40 per share You “buy” your 100 shares to take you back to zero,pay broker 40*100=4000. Broker buys at market, and puts the shares back inthe other person’s account You make 5000-4000 = 1000 (less dividends) Make money when price falls Lose money when price rises
  • 39. The Mechanics of a Short IBM goes up to $60 per share You “buy” your 100 shares to take you back to zero,pay broker 60*100=6000. Broker buys at market, and puts the shares back inthe other person’s account You lose 5000-6000 = -1000 (less dividends)
  • 40. Margins and Shorts Broker requires additional funds to coverpossible losses Fraction of additional sale amount ExampleSell $5000 worth of stock at 50% marginNeed to keep 1.5*5000 = 7500 on account withthe brokerWhen the price goes up, need to increase this“Margin call”
  • 41. Oddities About Shorts Can lose unbounded amounts of moneyNormally only lose what you put inWith short price can go up forever, and your losses keepincreasing Also, broker can get in trouble if you defaultOther customer could lose original sharesOften insured for this
  • 42. Short InterestFraction of shares sold shortMeasure of market pessimism in astockCommon market indicatorMeasures market pessimism
  • 43. Squeeze PlayAssume Microsoft has a large numberof short sellersPrice starts to riseShort sellers losing moneyGet nervousBuy stock to close out their short positionsPrices rise more, more buying .. (etc. etc)
  • 44. OutlineMarketsOrdersPositionsInformation
  • 45. Information Sources PrivateQuicken and Yahoo financeWall St. Journal (fee)Value line and Standard and Poors (fee)Brokerage firmsCorporations GovernmentFederal ReserveSEC
  • 46. Information SourcesKey publicationsEconomic informationFederal reserve bulletins (economic info)Firm/investment dataValue Line SurveyStandard and Poor’s HandbookSecurity firm reportsFirm annual reports
  • 47. The Internet and InvestingCheap and accessible informationInvestor toolsChartsScreeningCalculatorsOnline trading
  • 48. Investment Information on theWebNews articlesNY timesCBS Market watchCNN financial
  • 49. More Investment InformationStock informationYahooGoogleQuickenHistorical informationYahooDatastream (fee)Bloomberg (fee)
  • 50. Warnings on InternetInformationDon’t use information to trade tofrequentlyDon’t believe everything you see on theweb
  • 51. More (biased) InformationFirm annual reports and accounting infoAnalyst informationAnalysts recommend (buy, sell, hold)Problems:Firms often are biased in what they tell analystsAnalysts are biased since stocks they analyzecan be their own clients
  • 52. Internet ToolsEducationCalculators
  • 53. Internet ToolsStock screeningQuickenYahooGooglePlotting/graphics
  • 54. Market Indices Summarize market movements ExamplesDow Jones Industrial (30 stocks)NYSE CompositeS&P 500 Composite (500 stocks)NASDAQ CompositeNikkei (Japan)Wilshire 5000Sector indices
  • 55. Index Construction Weighted sum Weighting optionsEqual w = (1/N)Relative value of the firm (S&P, NASDAQ)Value weightingOdd (Dow Jones)Pt,I = wj Pt,jj=1N∑1= wjj=1N∑
  • 56. Index UsesSummary of the marketInvestor benchmark (performancecheck)Compare own result to indexInvestment targetIndex mutual fund
  • 57. Index ProblemsIndex is not constantAdditions and removalsChanging weightsAs stock increases in value, share inindex increasesIndex can drift towards growing sectorsin the market