Chapter 11 Securities Markets © 2000 John Wiley & Sons, Inc.
Chapter Outcomes <ul><li>Describe the processes and institutions used by businesses to distribute new securities to the in...
Primary Security Markets <ul><li>Primary versus secondary securities markets </li></ul><ul><li>Initial Public Offerings (I...
Functions of Investments Banks <ul><li>Three Main Functions: </li></ul><ul><ul><li>Origination </li></ul></ul><ul><ul><li>...
Investment Bank Functions, continued <ul><li>Underwriting </li></ul><ul><ul><li>“Carrying the risk” </li></ul></ul><ul><ul...
Investment Bank Functions, continued <ul><li>Selling </li></ul><ul><ul><li>Syndicate </li></ul></ul><ul><ul><li>Tombstone ...
The Costs of Raising Capital <ul><li>The costs of issuing stocks and bonds are called “flotation costs.” </li></ul><ul><ul...
What else do Investment Banks do? <ul><li>Commercial paper </li></ul><ul><li>Mergers and acquisitions </li></ul><ul><li>Ma...
Secondary Securities Markets <ul><li>Organized Exchange versus Over-the-Counter (OTC) </li></ul><ul><li>Organized Exchange...
Trading on the NYSE floor <ul><li>Members own “seats” </li></ul><ul><li>Commission brokers </li></ul><ul><li>Floor brokers...
Ways to Trade Stock <ul><li>Market order </li></ul><ul><li>Limit order </li></ul><ul><li>Stop order </li></ul><ul><li>Shor...
Buying on Margin <ul><li>“Buying on margin” means to use some of your money (equity) and some borrowed funds to purchase a...
Margin’s effect on trading profits Assume: 60% margin <ul><li>Initially buy securities worth $50,000 </li></ul><ul><li>  I...
More investing terms <ul><li>Margin call </li></ul><ul><li>Maintenance margin </li></ul><ul><li>Round lot </li></ul><ul><l...
Over-The-Counter Market (OTC) <ul><li>NASDAQ </li></ul><ul><li>Not just for small firms </li></ul><ul><ul><li>Intel, Apple...
Other Secondary Markets <ul><li>Third Market </li></ul><ul><ul><li>Large blocks (10,000 shares) traded OTC </li></ul></ul>...
Commissions <ul><li>Commission affected by: </li></ul><ul><li>Type of broker </li></ul><ul><ul><li>Full service brokers </...
How’s the Market Doing? <ul><li>Security Market Indexes are used to track overall market and sector performance </li></ul>...
Wandering from Home: Investing Overseas <ul><li>Diversification benefits </li></ul><ul><li>Harder to do trades </li></ul><...
Insider Trading <ul><li>An insider: someone with access to important non-public information </li></ul><ul><li>can be a cor...
What will the future hold? <ul><li>Electronic and on-line trading </li></ul><ul><li>Continued globalization </li></ul><ul>...
Learning Extension 11A Introduction to Futures and Options <ul><li>What is a derivative security? </li></ul><ul><li>Why do...
What is a derivative security? <ul><li>A derivative security has its value determined by, or derived from, the value of an...
Why do derivatives exist? <ul><li>Shift risk from those who don’t want to carry risk to those who are willing to do so.  <...
Futures contracts <ul><li>A futures contract  obligates  the owner to purchase the underlying asset at a specified price (...
Types of futures contracts <ul><li>Corn, wheat, soybeans… </li></ul><ul><li>Stock indexes, interest rates, foreign currenc...
Options <ul><li>An options contract gives the owner the  choice  of trading the underlying asset at a specified price (the...
Two basic types of options <ul><li>Call option: an option to  buy  the underlying asset at the strike price </li></ul><ul>...
Call Options <ul><li>Suppose you buy an option to buy 100 shares of Exxon stock at $75 a share.  How much is the option wo...
Put Options <ul><li>Suppose you buy an option to sell 100 shares of Exxon stock at $75 a share.  How much is the option wo...
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Chapter 11 Securities Markets © 2000 John Wiley

  1. 1. Chapter 11 Securities Markets © 2000 John Wiley & Sons, Inc.
  2. 2. Chapter Outcomes <ul><li>Describe the processes and institutions used by businesses to distribute new securities to the investing public. </li></ul><ul><li>Outline the recent difficulties and changes in structure of the investment banking industry. </li></ul><ul><li>Describe how securities are traded among investors. </li></ul><ul><li>Identify the regulatory mechanisms by which the securities exchanges and the over-the-counter markets are controlled. </li></ul><ul><li>Explain influences that affect broker commissions. </li></ul>
  3. 3. Primary Security Markets <ul><li>Primary versus secondary securities markets </li></ul><ul><li>Initial Public Offerings (IPOs) </li></ul><ul><li>Investment Banks </li></ul>
  4. 4. Functions of Investments Banks <ul><li>Three Main Functions: </li></ul><ul><ul><li>Origination </li></ul></ul><ul><ul><li>Underwriting </li></ul></ul><ul><ul><li>Selling </li></ul></ul><ul><li>Origination </li></ul><ul><ul><li>Public Offering </li></ul></ul><ul><ul><li>Private Placement </li></ul></ul><ul><ul><li>Prospectus </li></ul></ul>
  5. 5. Investment Bank Functions, continued <ul><li>Underwriting </li></ul><ul><ul><li>“Carrying the risk” </li></ul></ul><ul><ul><li>Best efforts </li></ul></ul><ul><ul><li>Shelf registration </li></ul></ul><ul><ul><li>Private placement </li></ul></ul><ul><ul><li>Rights offerings </li></ul></ul><ul><ul><li>Competitive bids </li></ul></ul>
  6. 6. Investment Bank Functions, continued <ul><li>Selling </li></ul><ul><ul><li>Syndicate </li></ul></ul><ul><ul><li>Tombstone Ad </li></ul></ul><ul><ul><li>Aftermarket </li></ul></ul>
  7. 7. The Costs of Raising Capital <ul><li>The costs of issuing stocks and bonds are called “flotation costs.” </li></ul><ul><ul><li>Out-of-pocket costs </li></ul></ul><ul><ul><li>Spread </li></ul></ul><ul><ul><li>Underpricing </li></ul></ul><ul><li>The sum of these costs can total 20-30%..or more...of the funds raised </li></ul><ul><li>Hot/cold IPO markets </li></ul>
  8. 8. What else do Investment Banks do? <ul><li>Commercial paper </li></ul><ul><li>Mergers and acquisitions </li></ul><ul><li>Manage investment funds (e.g., company pension funds) </li></ul>
  9. 9. Secondary Securities Markets <ul><li>Organized Exchange versus Over-the-Counter (OTC) </li></ul><ul><li>Organized Exchange: NYSE </li></ul>
  10. 10. Trading on the NYSE floor <ul><li>Members own “seats” </li></ul><ul><li>Commission brokers </li></ul><ul><li>Floor brokers </li></ul><ul><li>Registered traders </li></ul><ul><li>Specialists </li></ul><ul><li>Companies need to meet listing requirements, pay fees </li></ul>
  11. 11. Ways to Trade Stock <ul><li>Market order </li></ul><ul><li>Limit order </li></ul><ul><li>Stop order </li></ul><ul><li>Short sale </li></ul><ul><ul><li>Uptick rule </li></ul></ul><ul><ul><li>67 15/16 67 15/16 68 68 68 </li></ul></ul><ul><ul><li>68 1/8 68 1/8 68 68 68 </li></ul></ul>
  12. 12. Buying on Margin <ul><li>“Buying on margin” means to use some of your money (equity) and some borrowed funds to purchase a security </li></ul><ul><li>Margin: investor’s equity position </li></ul><ul><li>Margin requirements: minimum percentage of the purchase price that the investor must pay from his/her funds </li></ul>
  13. 13. Margin’s effect on trading profits Assume: 60% margin <ul><li>Initially buy securities worth $50,000 </li></ul><ul><li> Initial </li></ul><ul><li>position t=1 t=2 </li></ul><ul><li>Mkt value $50,000 $55,000 $45,000 </li></ul><ul><li>Less: borrowed </li></ul><ul><li>funds 20,000 20,000 20,000 </li></ul><ul><li>Equity $30,000 $35,000 $25,000 </li></ul>
  14. 14. More investing terms <ul><li>Margin call </li></ul><ul><li>Maintenance margin </li></ul><ul><li>Round lot </li></ul><ul><li>Odd lot </li></ul><ul><li>Program trading </li></ul>
  15. 15. Over-The-Counter Market (OTC) <ul><li>NASDAQ </li></ul><ul><li>Not just for small firms </li></ul><ul><ul><li>Intel, Apple, Microsoft </li></ul></ul><ul><li>Centralized versus non-centralized location </li></ul><ul><li>Specialists versus dealers </li></ul>
  16. 16. Other Secondary Markets <ul><li>Third Market </li></ul><ul><ul><li>Large blocks (10,000 shares) traded OTC </li></ul></ul><ul><li>Fourth Market </li></ul><ul><ul><li>Electronic trading </li></ul></ul>
  17. 17. Commissions <ul><li>Commission affected by: </li></ul><ul><li>Type of broker </li></ul><ul><ul><li>Full service brokers </li></ul></ul><ul><ul><li>Discount brokers </li></ul></ul><ul><ul><li>On-line brokers </li></ul></ul><ul><li>Size of trade, security price </li></ul><ul><li>Liquidity of securities traded </li></ul>
  18. 18. How’s the Market Doing? <ul><li>Security Market Indexes are used to track overall market and sector performance </li></ul><ul><li>Well-known stock market indexes: </li></ul><ul><ul><li>Dow Jones Industrial Average </li></ul></ul><ul><ul><ul><li>Based on price </li></ul></ul></ul><ul><ul><li>Standard & Poor’s (S&P) 500 </li></ul></ul><ul><ul><ul><li>Based on market value </li></ul></ul></ul>
  19. 19. Wandering from Home: Investing Overseas <ul><li>Diversification benefits </li></ul><ul><li>Harder to do trades </li></ul><ul><ul><li>Liquidity </li></ul></ul><ul><ul><li>Currency differences </li></ul></ul><ul><ul><li>Regulations, tax laws </li></ul></ul><ul><li>Solutions: </li></ul><ul><ul><li>American Depository Receipts </li></ul></ul><ul><ul><li>Global Depository Receipts </li></ul></ul><ul><ul><li>Mutual funds--professional investing </li></ul></ul>
  20. 20. Insider Trading <ul><li>An insider: someone with access to important non-public information </li></ul><ul><li>can be a corporate officer, investment banker, major shareholder </li></ul><ul><li>blue-collar workers, too (e.g., printing press operators) </li></ul>
  21. 21. What will the future hold? <ul><li>Electronic and on-line trading </li></ul><ul><li>Continued globalization </li></ul><ul><li>Security prices in tenths </li></ul><ul><li>Can the NYSE survive? </li></ul>
  22. 22. Learning Extension 11A Introduction to Futures and Options <ul><li>What is a derivative security? </li></ul><ul><li>Why do they exist? </li></ul><ul><li>Future Contracts </li></ul><ul><li>Options </li></ul>
  23. 23. What is a derivative security? <ul><li>A derivative security has its value determined by, or derived from, the value of another investment vehicle. </li></ul><ul><li>They represent a contract on an underlying security or asset </li></ul>
  24. 24. Why do derivatives exist? <ul><li>Shift risk from those who don’t want to carry risk to those who are willing to do so. </li></ul><ul><li>Bring additional information into the market from hedgers, speculators, market expectations. </li></ul><ul><li>Lower commissions and margin requirements than in spot market </li></ul>
  25. 25. Futures contracts <ul><li>A futures contract obligates the owner to purchase the underlying asset at a specified price (the exercise or strike price) on a specified date </li></ul>
  26. 26. Types of futures contracts <ul><li>Corn, wheat, soybeans… </li></ul><ul><li>Stock indexes, interest rates, foreign currency values… </li></ul><ul><li>Gold, copper, silver, oil… </li></ul><ul><li>Coffee, sugar, cocoa... </li></ul>
  27. 27. Options <ul><li>An options contract gives the owner the choice of trading the underlying asset at a specified price (the exercise or strike price) on or before a specified date or expiration date. </li></ul>
  28. 28. Two basic types of options <ul><li>Call option: an option to buy the underlying asset at the strike price </li></ul><ul><li>Put option: an option to sell the underlying asset at the strike price </li></ul>
  29. 29. Call Options <ul><li>Suppose you buy an option to buy 100 shares of Exxon stock at $75 a share. How much is the option worth if on the expiration date the price of Exxon is: </li></ul><ul><li>a) $60 a share? </li></ul><ul><li>b) $75 a share? </li></ul><ul><li>c) $80 a share? </li></ul>
  30. 30. Put Options <ul><li>Suppose you buy an option to sell 100 shares of Exxon stock at $75 a share. How much is the option worth if on the expiration date the price of Exxon is: </li></ul><ul><li>a) $60 a share? </li></ul><ul><li>b) $75 a share? </li></ul><ul><li>c) $80 a share? </li></ul>
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