Chapter 3: Equities <ul><li>What are equities? What are some features of equities? </li></ul><ul><li>How are equities sold...
What are equities? <ul><li>Equity means partial ownership </li></ul><ul><ul><li>Of house or company </li></ul></ul><ul><li...
Why own equities? <ul><li>Entitled to after-tax earnings of firm </li></ul><ul><ul><li>Earnings are after everyone else is...
Some basic terminology <ul><li>Authorized  shares is the maximum number of shares that the board of directors has agreed t...
Basic terminology p.2 <ul><li>Classified  stock (e.g. Class A shares, Class B shares, etc.) may vary in terms of ownership...
Dividends <ul><li>Payments to shareholders in cash or securities typically made quarterly </li></ul><ul><li>Dividends are ...
Stock splits / reverse splits <ul><li>In a  stock split , firm redefines shares into smaller units </li></ul><ul><ul><li>T...
Why do firms sell stock? <ul><li>Firms need additional capital to fund activities and need for cash goes beyond borrowing ...
How do firms sell stock? <ul><li>An  underwriter  is the investment bank / broker that assists in selling securities </li>...
Securities and Exchange Commission (SEC) <ul><li>Administers securities laws </li></ul><ul><li>Companies must register all...
Other types of sales <ul><li>Subscription right  is an offer to existing shareholders who get a “discount” from the offer ...
Trading Shares of Stock <ul><li>What happens after shares are issued? </li></ul><ul><li>How does someone sell their shares...
Market types <ul><li>Direct search market - buyers and sellers must find each other </li></ul><ul><li>Brokered market - br...
Continuous market vs. Call market <ul><li>Continuous market is when prices reflect the continuous order flow </li></ul><ul...
Price vs. Order driven <ul><li>In a price driven market, market makers compete and are placed between buyers and sellers <...
Yes, more terminology <ul><li>Transparency  means no closed door deals </li></ul><ul><ul><li>Everyone gets to see what the...
Some Secondary Markets <ul><li>New York Stock Exchange (NYSE) </li></ul><ul><li>American Stock Exchange (Amex) </li></ul><...
Stock Exchanges <ul><li>Stock exchange is where members trade for themselves and their clients </li></ul><ul><ul><li>There...
Who works in the markets? <ul><li>Brokers  are agents of an investing client and they take no position in securities </li>...
Bid-Ask spread <ul><li>Bid is the highest amount that a buyer will pay for the security </li></ul><ul><li>Ask is the lowes...
NASDAQ <ul><li>National Association of Securities Dealers Automated Quotations </li></ul><ul><ul><li>A.k.a. the over-the-c...
NASDAQ Trading <ul><li>NASDAQ uses a dealer system </li></ul><ul><li>Market makers post a bid and ask price for any stock ...
NASDAQ Subscriptions <ul><li>Subscribers have three levels of price data </li></ul><ul><li>Level 1 </li></ul><ul><ul><li>g...
NYSE Trading <ul><li>1. Customer calls local broker </li></ul><ul><li>2. Local broker routes order to member broker on tra...
The specialist <ul><li>Specialist is appointed by the exchange as the only market maker for a particular security </li></u...
Fragmented market <ul><li>Orders may now be placed at various places </li></ul><ul><ul><li>NYSE, regional exchange, OTC </...
Electronic Communication Networks (ECNs) <ul><li>Not really stock exchanges, but only provide a link between buyers and se...
I want stock - how do I place an order? <ul><li>Round lot  is “standard” number of shares </li></ul><ul><ul><li>Usually 10...
Ticker symbol <ul><li>Ticker symbol is the code identifier for a security assigned by exchange </li></ul><ul><ul><li>NYSE,...
Types of Orders <ul><li>Preferential trading rules says that trader should act for his or her client before their own  </l...
More orders <ul><li>Stop order </li></ul><ul><ul><li>Get out of market as it moves against you </li></ul></ul><ul><ul><li>...
Even more orders <ul><li>Good through order lasts for a number of days </li></ul><ul><ul><li>Most other orders last only a...
Commissions <ul><li>Discount brokers only execute trades </li></ul><ul><ul><li>Commissions are less </li></ul></ul><ul><li...
Some institutional investor terminology <ul><li>They are now big players in markets </li></ul><ul><ul><li>Insurance compan...
Circuit breakers <ul><li>Result of 1987 crash to attempt to stop panic / euphoria </li></ul><ul><ul><li>Adopted in 1988 </...
Buying on margin <ul><li>If you borrow some of the money to buy a security, you are buying on margin </li></ul><ul><ul><li...
The margin account <ul><li>Your margin is deposited into an account </li></ul><ul><li>Due to falling prices, if your accou...
Buy low, sell high … or the reverse <ul><li>When buying, you expect the price to increase </li></ul><ul><li>If you expect ...
Uptick rules <ul><li>To prevent price instability, there are rules as to when one can short sell </li></ul><ul><li>Uptick ...
Stock Market Index <ul><li>Provide snapshot of stock market movement </li></ul><ul><ul><li>Is the market up or down? </li>...
Price Weighted Index <ul><li>Arithmetic average of securities in index </li></ul><ul><li>P it  is price of asset i at time...
Value Weighted Index <ul><li>Based on change in total market value of all stocks </li></ul><ul><li>Where Q it  is the numb...
Geometric or Unweighted index <ul><li>Look at geometric average of percentage changes in prices </li></ul><ul><li>Value li...
Other Indices <ul><li>Nasdaq composite </li></ul><ul><ul><li>MVW, all stocks on NASDAQ (over 5,000) </li></ul></ul><ul><li...
Summary <ul><li>Equities are ownership of company </li></ul><ul><li>Securities are usually sold through brokers </li></ul>...
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PowerPoint Lecture on Equities

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PowerPoint Lecture on Equities

  1. 1. Chapter 3: Equities <ul><li>What are equities? What are some features of equities? </li></ul><ul><li>How are equities sold? </li></ul><ul><ul><li>In the primary market? </li></ul></ul><ul><ul><li>In the secondary market? </li></ul></ul><ul><li>How do stock markets operate? </li></ul><ul><li>What are some of the ways that we can invest in stocks? </li></ul>
  2. 2. What are equities? <ul><li>Equity means partial ownership </li></ul><ul><ul><li>Of house or company </li></ul></ul><ul><li>Common stock (or common shares) are ownership in firms </li></ul><ul><ul><li>Owners are called shareholders or shareowners </li></ul></ul>
  3. 3. Why own equities? <ul><li>Entitled to after-tax earnings of firm </li></ul><ul><ul><li>Earnings are after everyone else is paid off </li></ul></ul><ul><ul><li>After bondholders and other claimholders (“residual”) </li></ul></ul><ul><li>Receive dividends (usually) </li></ul><ul><li>Expect stock price to increase </li></ul><ul><ul><li>Future earnings prospects determine stock price </li></ul></ul><ul><li>Right to vote and participate in decisions of firm </li></ul><ul><li>Limited liability </li></ul>
  4. 4. Some basic terminology <ul><li>Authorized shares is the maximum number of shares that the board of directors has agreed to sell </li></ul><ul><li>Outstanding shares is the number of authorized shares that has actually been sold </li></ul><ul><li>Treasury shares are repurchased shares by the firm </li></ul><ul><ul><li>Do not have voting rights nor earn dividends </li></ul></ul>
  5. 5. Basic terminology p.2 <ul><li>Classified stock (e.g. Class A shares, Class B shares, etc.) may vary in terms of ownership rights </li></ul><ul><ul><li>Usually difference is in voting rights and dividends </li></ul></ul><ul><li>Even though shareholders own the firm, the worst they can do is lose the amount invested due to limited liability </li></ul>
  6. 6. Dividends <ul><li>Payments to shareholders in cash or securities typically made quarterly </li></ul><ul><li>Dividends are not an obligation of the firm </li></ul><ul><li>Declaration date is made by board </li></ul><ul><li>Ex-dividend date is the date that the stock begins trading without the right to the declared dividend </li></ul><ul><ul><li>Drops in value </li></ul></ul><ul><li>Payable date is when firm pays dividend </li></ul>
  7. 7. Stock splits / reverse splits <ul><li>In a stock split , firm redefines shares into smaller units </li></ul><ul><ul><li>Total market value of firm is unaffected </li></ul></ul><ul><ul><li>Can be 2-for-1, 3-for-1, 3-for-2, etc. </li></ul></ul><ul><ul><li>Example of a 2-for-1 stock split: A shareholder with 100 shares at $60 per share will have 200 shares at $30 per share </li></ul></ul><ul><li>Reverse splits consolidate shares </li></ul><ul><li>Argument for stock splits: firms want prices that are most accessible </li></ul>
  8. 8. Why do firms sell stock? <ul><li>Firms need additional capital to fund activities and need for cash goes beyond borrowing </li></ul><ul><li>They sell in the primary market </li></ul><ul><li>Firms use an initial public offering (IPO) to sell stock to investors for the first time </li></ul><ul><li>Firms who sell stock who have already gone public make a “seasoned offering” </li></ul>
  9. 9. How do firms sell stock? <ul><li>An underwriter is the investment bank / broker that assists in selling securities </li></ul><ul><ul><li>Set offer price after gathering information about demand for security </li></ul></ul><ul><li>Firm issues prospectus which details information about the security, the company, its management, and history </li></ul><ul><li>Red herring is a prospectus that is stamped in red “not yet registered with SEC” </li></ul>
  10. 10. Securities and Exchange Commission (SEC) <ul><li>Administers securities laws </li></ul><ul><li>Companies must register all securities with SEC </li></ul><ul><li>Makes sure companies provide necessary disclosure information to investors </li></ul><ul><li>Firms must subsequently file financial reports </li></ul>
  11. 11. Other types of sales <ul><li>Subscription right is an offer to existing shareholders who get a “discount” from the offer price </li></ul><ul><li>Private placement is when an entire issue is bought by some large investor </li></ul><ul><ul><li>Avoids SEC registration </li></ul></ul><ul><ul><li>There are restrictions on buyers </li></ul></ul><ul><li>Standby commitment is when underwriter steps in to buy unsold shares of an issue </li></ul>
  12. 12. Trading Shares of Stock <ul><li>What happens after shares are issued? </li></ul><ul><li>How does someone sell their shares? </li></ul><ul><li>What are the institutional details of buying and selling stock? </li></ul>
  13. 13. Market types <ul><li>Direct search market - buyers and sellers must find each other </li></ul><ul><li>Brokered market - brokers provide search services </li></ul><ul><li>Dealer market - dealers buy and sell on their own account </li></ul><ul><li>Auction market - buyers and seller converge at one location </li></ul><ul><li>Primary vs. secondary markets </li></ul>
  14. 14. Continuous market vs. Call market <ul><li>Continuous market is when prices reflect the continuous order flow </li></ul><ul><li>In a call market, orders are collected until there is an auction </li></ul><ul><ul><li>Auctions happen periodically through the day </li></ul></ul><ul><ul><li>Market price determined from the auction </li></ul></ul>
  15. 15. Price vs. Order driven <ul><li>In a price driven market, market makers compete and are placed between buyers and sellers </li></ul><ul><ul><li>NASDAQ and London </li></ul></ul><ul><li>In an order driven market, buyers and sellers come together directly </li></ul><ul><ul><li>Germany, France, Canada </li></ul></ul><ul><li>US and Japan use order driven market with market makers to ensure continuous trading </li></ul>
  16. 16. Yes, more terminology <ul><li>Transparency means no closed door deals </li></ul><ul><ul><li>Everyone gets to see what the deal was </li></ul></ul><ul><li>Information based trade is when a trade is made because of some informed investor </li></ul><ul><li>Informationless trade or noise trade is one done for liquidity purposes </li></ul><ul><li>Making a trade has an execution cost if it affects the price that would have existed had the trade not been made </li></ul>
  17. 17. Some Secondary Markets <ul><li>New York Stock Exchange (NYSE) </li></ul><ul><li>American Stock Exchange (Amex) </li></ul><ul><li>Regional exchanges </li></ul><ul><ul><li>Pacific (LA) </li></ul></ul><ul><ul><li>Midwest (Chicago) </li></ul></ul><ul><ul><li>Philadelphia </li></ul></ul><ul><ul><li>Boston </li></ul></ul><ul><ul><li>Cincinnati </li></ul></ul><ul><li>NASDAQ </li></ul>
  18. 18. Stock Exchanges <ul><li>Stock exchange is where members trade for themselves and their clients </li></ul><ul><ul><li>There are several exchanges in the US </li></ul></ul><ul><li>In order to trade on the exchange, you must have a “seat” (Seats are tradable assets, too) </li></ul><ul><li>In order for a stock to be “listed” on an exchange, it must meet certain requirements </li></ul><ul><ul><li>Market cap, number of shares, income, number of shareholders, etc. </li></ul></ul>
  19. 19. Who works in the markets? <ul><li>Brokers are agents of an investing client and they take no position in securities </li></ul><ul><li>Dealers keep their own inventory </li></ul><ul><ul><li>Supplies immediacy </li></ul></ul><ul><li>Market maker is a dealer who guarantees to be ready to buy or sell </li></ul>
  20. 20. Bid-Ask spread <ul><li>Bid is the highest amount that a buyer will pay for the security </li></ul><ul><li>Ask is the lowest price they are willing to sell </li></ul><ul><li>Bid-ask spread is difference between the prices </li></ul><ul><li>It is a cost of transacting </li></ul><ul><ul><li>Lower spread means more efficiency </li></ul></ul>
  21. 21. NASDAQ <ul><li>National Association of Securities Dealers Automated Quotations </li></ul><ul><ul><li>A.k.a. the over-the-counter market (OTC) </li></ul></ul><ul><li>Began as the way to buy non-listed stocks </li></ul><ul><li>It has grown to include many listed stocks, as well as many bonds </li></ul><ul><li>Many new stock issues start here </li></ul>
  22. 22. NASDAQ Trading <ul><li>NASDAQ uses a dealer system </li></ul><ul><li>Market makers post a bid and ask price for any stock they wish </li></ul><ul><li>Buyers and sellers choose dealer and then contact directly </li></ul><ul><ul><li>Usually through broker </li></ul></ul><ul><li>Competition among many dealers </li></ul>
  23. 23. NASDAQ Subscriptions <ul><li>Subscribers have three levels of price data </li></ul><ul><li>Level 1 </li></ul><ul><ul><li>get best buy/sell price (called bid-ask), last price, market summary </li></ul></ul><ul><li>Level 2 </li></ul><ul><ul><li>Level 1 plus quotes for all market makers </li></ul></ul><ul><li>Level 3 </li></ul><ul><ul><li>Level 2 plus ability to enter prices </li></ul></ul>
  24. 24. NYSE Trading <ul><li>1. Customer calls local broker </li></ul><ul><li>2. Local broker routes order to member broker on trading floor </li></ul><ul><li>3. Member broker goes to the “post” on the floor where specific stock is trading </li></ul><ul><li>4. Trade with other brokers waiting by post (or wait) </li></ul>
  25. 25. The specialist <ul><li>Specialist is appointed by the exchange as the only market maker for a particular security </li></ul><ul><ul><li>One per security </li></ul></ul><ul><li>Assures that market is fair and orderly </li></ul><ul><ul><li>Must step in and transact if others are not willing </li></ul></ul><ul><ul><li>Must post bid and ask prices </li></ul></ul><ul><li>Aside from being market maker, he or she sets the opening and closing prices </li></ul><ul><li>Small orders go through computer (SuperDOT) directly to specialist </li></ul><ul><li>Specialist keeps order book and has a lot of information </li></ul>
  26. 26. Fragmented market <ul><li>Orders may now be placed at various places </li></ul><ul><ul><li>NYSE, regional exchange, OTC </li></ul></ul><ul><li>When orders are not traded in the same way, the market is called “fragmented” </li></ul><ul><li>SEC established a national market system for securities </li></ul><ul><ul><li>Centralized reporting and quotation system </li></ul></ul>
  27. 27. Electronic Communication Networks (ECNs) <ul><li>Not really stock exchanges, but only provide a link between buyers and sellers </li></ul><ul><ul><li>Essentially a chat room for trading stocks </li></ul></ul>
  28. 28. I want stock - how do I place an order? <ul><li>Round lot is “standard” number of shares </li></ul><ul><ul><li>Usually 100 shares for each round lot </li></ul></ul><ul><li>Odd lot is some fraction of a round lot </li></ul><ul><li>Broken lot is a few small shares </li></ul><ul><li>Berkshire Hathaway sells exclusively in odd and broken lots </li></ul><ul><li>Commissions are usually higher for odd lots </li></ul>
  29. 29. Ticker symbol <ul><li>Ticker symbol is the code identifier for a security assigned by exchange </li></ul><ul><ul><li>NYSE, Amex has up to 3 characters, NASDAQ has 4 or sometimes 5 characters </li></ul></ul><ul><li>MSFT is Microsoft, F is Ford, IBM is IBM </li></ul>
  30. 30. Types of Orders <ul><li>Preferential trading rules says that trader should act for his or her client before their own </li></ul><ul><li>Market order </li></ul><ul><ul><li>Execute immediately at the best possible price </li></ul></ul><ul><ul><li>Delay may mean movement in prices </li></ul></ul><ul><li>Limit order </li></ul><ul><ul><li>Execute at a given price or better </li></ul></ul><ul><ul><li>May never be executed </li></ul></ul><ul><li>Limit order book is kept by specialist and orders are executed as market dictates </li></ul>
  31. 31. More orders <ul><li>Stop order </li></ul><ul><ul><li>Get out of market as it moves against you </li></ul></ul><ul><ul><li>Becomes market order when stop price is met </li></ul></ul><ul><li>Market-if-touched order </li></ul><ul><ul><li>Stop order but limit is on the other side </li></ul></ul><ul><ul><li>Becomes market order if level is met </li></ul></ul><ul><li>Stop limit order </li></ul><ul><ul><li>Stop order that becomes a limit order if level is met </li></ul></ul>
  32. 32. Even more orders <ul><li>Good through order lasts for a number of days </li></ul><ul><ul><li>Most other orders last only a day </li></ul></ul><ul><li>Open order a.k.a. good ‘til canceled </li></ul><ul><li>All-or-none vs. any-part </li></ul><ul><ul><li>Can a portion of the order be executed? </li></ul></ul><ul><li>Fill-or-kill must be filled immediately or else </li></ul>
  33. 33. Commissions <ul><li>Discount brokers only execute trades </li></ul><ul><ul><li>Commissions are less </li></ul></ul><ul><li>Full service broker may provide other services </li></ul><ul><ul><li>Most important is advice </li></ul></ul><ul><li>Commission charge (%) decreases with the size of trade </li></ul>
  34. 34. Some institutional investor terminology <ul><li>They are now big players in markets </li></ul><ul><ul><li>Insurance companies, pension funds, trusts </li></ul></ul><ul><li>Block trades are when over 10,000 shares or $200,000 are traded </li></ul><ul><ul><li>Can put strain on specialist </li></ul></ul><ul><li>Program trades involve transactions of many securities simultaneously </li></ul><ul><li>Frontrunning is when broker knows of a deal and trades on their own account </li></ul>
  35. 35. Circuit breakers <ul><li>Result of 1987 crash to attempt to stop panic / euphoria </li></ul><ul><ul><li>Adopted in 1988 </li></ul></ul><ul><li>Some activity is reduced if price movements in the Dow Jones Industrial Average index are “large” </li></ul><ul><li>Ranges from cutting off computerized trading to closing the market </li></ul>
  36. 36. Buying on margin <ul><li>If you borrow some of the money to buy a security, you are buying on margin </li></ul><ul><ul><li>The security is collateral </li></ul></ul><ul><li>The margin is the percentage that you contribute </li></ul><ul><ul><li>Margin requirements are set by Federal Reserve </li></ul></ul><ul><li>The investment is leveraged so profit and loss scenarios are magnified </li></ul>
  37. 37. The margin account <ul><li>Your margin is deposited into an account </li></ul><ul><li>Due to falling prices, if your account falls below a maintenance margin, you must contribute additional funds </li></ul><ul><li>The requirement for depositing more funds is called a margin call </li></ul>
  38. 38. Buy low, sell high … or the reverse <ul><li>When buying, you expect the price to increase </li></ul><ul><li>If you expect the price to fall, you can “short sell” </li></ul><ul><li>Here you do not own the shares but borrow them from someone else </li></ul><ul><li>You cover your position by purchasing the securities at a later date </li></ul><ul><li>Short seller must pay the dividends to owner </li></ul><ul><li>You must post 150% margin, maintain 130% </li></ul>
  39. 39. Uptick rules <ul><li>To prevent price instability, there are rules as to when one can short sell </li></ul><ul><li>Uptick trade rule allows short sales only after the last price change was positive </li></ul><ul><li>Zero uptick trade rule allows short trades when last price change was zero, but the prior price change was positive </li></ul>
  40. 40. Stock Market Index <ul><li>Provide snapshot of stock market movement </li></ul><ul><ul><li>Is the market up or down? </li></ul></ul><ul><li>Different indices will look at different “parts” of the market </li></ul><ul><ul><li>Large companies, small companies, technology </li></ul></ul>
  41. 41. Price Weighted Index <ul><li>Arithmetic average of securities in index </li></ul><ul><li>P it is price of asset i at time t, D t is the divisor at time t, and n is the number of securities in the index </li></ul><ul><li>Divisor is adjusted for stock splits </li></ul><ul><li>The Dow Jones Industrial Average is a price weighted index of 30 industrial companies (large blue chips) </li></ul>
  42. 42. Value Weighted Index <ul><li>Based on change in total market value of all stocks </li></ul><ul><li>Where Q it is the number of outstanding shares and P i0 and Q i0 are the starting date values </li></ul><ul><li>May be dominated by large market value firms </li></ul><ul><li>S&P 500 is 400 industrials, 40 utilities, 40 financials, and 20 transportation </li></ul>
  43. 43. Geometric or Unweighted index <ul><li>Look at geometric average of percentage changes in prices </li></ul><ul><li>Value line is a geometric index </li></ul>
  44. 44. Other Indices <ul><li>Nasdaq composite </li></ul><ul><ul><li>MVW, all stocks on NASDAQ (over 5,000) </li></ul></ul><ul><li>Russell 2000 </li></ul><ul><ul><li>MVW, small stocks </li></ul></ul><ul><li>Wilshire 5000 </li></ul><ul><ul><li>MVW, total market index (over 7,000 stocks) </li></ul></ul><ul><li>International </li></ul><ul><ul><li>Hang Seng, Nikkei, FTSE </li></ul></ul>
  45. 45. Summary <ul><li>Equities are ownership of company </li></ul><ul><li>Securities are usually sold through brokers </li></ul><ul><li>Secondary markets include NYSE, NASDAQ </li></ul><ul><li>There are different types of orders </li></ul><ul><li>Several ways to invest in stock </li></ul><ul><ul><li>On margin, short sell </li></ul></ul>
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