"Markets: An Overview" by Jimmy Gentry


Published on

Jimmy Gentry presents "Markets: An Overview" during Reynolds Business Journalism Week 2013.

Reynolds Business Journalism Week is an all-expenses-paid seminar for journalists hoping to enhance their business coverage, and for professors hoping to enhance or create business journalism courses at their schools.

For more information about business journalism training, please visit businessjournalism.org.

Published in: Career
  • Be the first to comment

  • Be the first to like this

No Downloads
Total views
On SlideShare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide

"Markets: An Overview" by Jimmy Gentry

  1. 1. Markets:An OverviewStrictly Financials Jan. 2, 2013
  2. 2. Donald W. Reynolds National Center for Business Journalism at Arizona State University Strictly Financials 2
  3. 3. n  James K. Gentry, Ph.D.n  Clyde M. Reed Teaching Professorn  School of Journalism and Mass Communicationsn  University of Kansasn  jgentry@ku.edu Strictly Financials 3
  4. 4. Risk-Return Relationship Strictly Financials 4
  5. 5. Basic Types of Riskn  Systematic or marketn  Unsystematic or nonmarket. Also called “business risk.” Can be diversified away. 5
  6. 6. Specific Types of Riskn  Financial risk, credit risk, default riskn  Market riskn  Interest-rate riskn  Purchasing power or inflation riskn  Event riskn  Exchange-rate or foreign-exchange riskn  Liquidity riskn  Political or sovereign riskn  Tax risk 6
  7. 7. Types of Businessesn  Sole proprietorshipn  Partnershipn  Corporation n  Limited liability n  Greater access to capital n  Permanency n  Flexibility n  Double taxation 7
  8. 8. Types of Structuresn  Private corporationsn  Public corporationsn  Nonprofits Strictly Financials 8
  9. 9. Types of Investmentsn  Stocksn  Bondsn  Other n  Options, futures, commodities, real estate, collectibles, currencies Strictly Financials 9
  10. 10. Types of Marketsn  Equity: Stocksn  Credit: Bonds, debt or fixed incomen  Others n  Derivatives (such as options and futures), commodities, real estate, collectibles, currenciesn  Historically, the amount of long-term debt financing issued in the U.S. greatly exceeds the volume of equity financing. 10
  11. 11. Stockn  Stockholders want: n  Stock price to increase n  Dependable dividend stream n  Increase in size of dividend Strictly Financials 11
  12. 12. Types of Stockn  Common stockn  Preferred stock Strictly Financials 12
  13. 13. Common Stockn  Risk: Lose your money if company faltersn  Reward: Owners share in success when company does well. n  Appreciation n  Dividends Strictly Financials 13
  14. 14. Dividendsn  Represent a return on capital invested by shareholders.n  Board must declare dividend for it to be paid.n  Dividend payment is not a business expense. It is an after-tax expense.n  Usually relationship between company’s age and size, and the dividends it pays. Strictly Financials 14
  15. 15. Preferred Stockn  Reduced risk, but reward may be limitedn  Dividend amount is stated and is paid before dividends on common.n  If company is liquidated, holders are preferred over common holders.n  Dividends don’t necessarily increase if company prospers. Strictly Financials 15
  16. 16. Bondn  Bond is debt a company owesn  Individual or company “loans” money to the company by buying a bondn  Bond pays interest over a fixed period of timen  Principal is repaid to the lender or holder of the bond at end of the termn  Interest rate is typically fixed when the bond is sold (i.e., fixed-income security)n  Interest rate is comparable to what other bonds, with that rating, are paying Strictly Financials 16
  17. 17. Bond Terminologyn  Interest rate: Fixed percentage of the bond’s purchase price that is paid annually to the bond holdern  Yield: Return on investment if bond is held to maturity. Equals interest rate. If bond is traded before maturity date, yield could change, although interest rate stays the same.n  Par value: Dollar amount paid for bond at time of issuen  Maturity date: When bond comes due Strictly Financials 17
  18. 18. Issuers Prefer Bondsn  When companies need to raise funds, they can issue stock or sell bonds.n  They often prefer bonds, in part because issuing more stock can dilute the value of shares investors already own.n  Bonds also may have income-tax advantages. Strictly Financials 18
  19. 19. A Quasi-Bond?n  Is preferred-stock debt (i.e., a bond) in disguise?n  Preferred holders have a “guaranteed” dividend. Is that like the fixed interest rate of a bond?n  Why do investors pick common, preferred or bonds? Strictly Financials 19
  20. 20. Risk and Reward Strictly Financials 20
  21. 21. Yield Curve Yield Maturity Strictly Financials 21
  22. 22. Equity or Securities Marketsn  Primary market n  Go public n  Private placementn  Secondary market Strictly Financials 22
  23. 23. Going Publicn  Entrepreneurs have an idea. Company grows with an investment from the private-equity market (venture capital).n  Owners decide to “go public.”n  Register with SEC to make an initial public offering or IPO.n  Investment bankers typically underwrite the offering through a syndicate. Strictly Financials 23
  24. 24. Going Public (cont.)n  Company prepares a prospectus, which is a detailed analysis of the company’s financial history, its products and services, as well as management’s background and experience.n  Prospectus should identify and assess risk factors the company faces. Strictly Financials 24
  25. 25. IPO Termsn  Prospectusn  Road shown  Quiet periodn  Lockup period Strictly Financials 25
  26. 26. Shelf Registrationn  Firm can file one registration statement for a relatively large block of stock and sell parts over a two-year period.n  This can reduce red tape and costs, and because stock can be sold directly to institutional investors, can eliminate the underwriting fee. Strictly Financials 26
  27. 27. Private Placementn  New issues can be sold in large lots to a small group of buyers. Lets start-up firms show appeal by raising capital on their own.n  Additional shares later can be offered through an underwriter.n  Many debt issues are placed privately, usually to large buyers such as insurance companies. Strictly Financials 27
  28. 28. Secondary Offeringn  If company already is public, it can sell more stock through a secondary offering. n  Causes dilutionn  Major owners sell their shares. They get the funds, so no dilution. Strictly Financials 28
  29. 29. New York Stock Exchangen  In March 1792, Wall Street leaders met to establish an improved auction market.n  In May 1792, 24 men signed an agreement to trade securities only among themselves, maintain fixed commission rates and avoid other auctions.n  Considered the origination of NYSE Strictly Financials 29
  30. 30. NYSE (cont.)n  Until March 2006, was owned by 1,366 seat-holding membersn  Highest price ever paid for a seat was $4 million.n  Price was determined by auction. Strictly Financials 30
  31. 31. NYSE Membersn  Floor brokers n  House brokers n  Independent brokersn  Specialists n  Manage auction process n  Execute orders for brokers n  Serve as catalysts n  Provide capital n  Stabilize prices Strictly Financials 31
  32. 32. Making an Ordern  Tell your broker or “registered representative” to buy or sell a stock at the current price, or market price. Called a market order.n  If you name the price to buy or sell, you’re making a limit order.n  Tell your broker to buy or sell once the price hits a specific price, you’re placing a stop order at a stop price. Strictly Financials 32
  33. 33. Trading on the NYSE Floorn  Trading occurs in the “Big Room.”n  Numerous stations, each with a roughly figure-eight shape, with counters and screens above. Called “trading posts.”n  Each counter is a “specialist’s” post. Strictly Financials 33
  34. 34. NYSE Floor (cont.)n  Order comes to the booth that is rented by a brokerage house.n  Floor broker takes order to appropriate specialist’s post.n  Specialist keeps a list of unfilled orders. Processes orders as prices move.n  Specialist’s job is to maintain an orderly market in the stock (match buyers/sellers). Strictly Financials 34
  35. 35. NYSE Floor (cont.)n  Stocks or groups of stocks are traded at trading posts near the specialists’ positions.n  Floor brokers can use a specialist or trade between themselves, called trading in the “crowd.”n  Terminals display the stock’s activity.n  After every trade, a reporter records the stock symbol, price and initiating broker.n  Successful trades are confirmed. Strictly Financials 35
  36. 36. NYSE Floor (Then & Now) Strictly Financials 36
  37. 37. Round or Odd Lotsn  Round lots: Buying or selling stock in multiples of 100 sharesn  Odd lots: Buying or selling stock in other quantities Strictly Financials 37
  38. 38. Who Holds Your Stock?n  Virtually all investors leave shares in their brokerage account in what’s called the street name. Investor retains beneficial ownership, though.n  This offers safe storage.n  You can get tangible certificates if you want them. Typically, you must pay for them. Strictly Financials 38
  39. 39. SuperDOT Systemn  Super Designated Order Turnaround Systemn  Allows orders to be sent electronically to specialist rather than phoned to floor trader.n  Can handle trades of 100,000 shares or less. Priority to orders of 2,100 shares or less.n  More than three-fourths of NYSE executed orders involve SuperDOT system.n  Originally for small trades. Increasingly big role in portfolio or basket trading. Strictly Financials 39
  40. 40. American Stock Exchangen  Non-members of NYSE couldn’t afford office space, so traded in the streetn  1842: New York Curb Exchangen  By late 1870s ,known as “curbstone brokers,” and their market was known as the Curb.n  Merged with NASDAQ in 1998n  Acquired by NYSE Euronext in 2009 Strictly Financials 40
  41. 41. NASDAQn  National Association of Securities Dealers Automated Quotations systemn  NASDAQ is a computer network with no physical location for trading.n  Uses a multiple market-maker system, not the specialist systemn  About 4,000-plus companies Strictly Financials 41
  42. 42. Trading on the NASDAQn  Trading is through an open-market, multiple- dealer system, with many market makers and broker-dealers competing for transactions.n  Computer network checks for matches, which can be handled instantly.n  Market makers buy and sell, and maintain an inventory of shares.n  Broker-dealers are “independent” firms and business units of banks and investment firms. Strictly Financials 42
  43. 43. In Which Market?n  In general, but with exceptions: n  NYSE: Oldest, largest, best known n  AMEX: Smaller, younger n  NASDAQ: Youngest, least experienced n  Some of NYSE’s most actively traded stocks are also quoted on the NASDAQ. Strictly Financials 43
  44. 44. ECNsn  Electronic Communications Networksn  Are basically websites that allow investors to trade directly with one anothern  Eliminates trading through an exchangen  Archipelago and Instinet best knownn  BATS Trading Strictly Financials 44
  45. 45. NYSE - Archipelago Marriagen  Merged in March 2006 to create NYSE Group Inc., a publicly held company.n  Largest merger ever between securities exchanges.n  Combined leading equities market with most successful electronic exchange.n  Archipelago: low fees, user-friendly technology
  46. 46. NYSE Euronextn  Merged April 2007n  Operates world’s largest, most liquid exchange with diverse products and servicesn  Six equities exchanges in five countries and six derivatives exchanges
  47. 47. Deutsche Borse PurchaseOf NYSE Euronext Blockedn  Worked on a deal since early 2011.n  Would have created world’s largest trading entity.n  EU blocked the merger on Feb. 1, 2012, fearing the new company would be a near monopoly.
  48. 48. NYSE ‘Hybrid Market’n  Floor trading and automated tradingn  Specialists or Archipelago strengthsn  Why? Customers’ desire for faster access to liquidity and greater anonymity Strictly Financials 48
  49. 49. NASDAQ Responsen  NASDAQ acquired Instinet Group Inc., another ECN Strictly Financials 49
  50. 50. Exchanges v. OTC Marketn  Stocks in almost 10,000 companies aren’t listed on any exchanges.n  They are traded “over the counter” (OTC)n  Typically handled by phone or computern  Generally, comparatively inexpensive and infrequently, or “thinly,” traded Strictly Financials 50
  51. 51. BATS Global Marketsn  Newer exchange, founded in 2005n  Located in Kansas Cityn  Competes on technology and costn  Developed its own software platformn  Also offers an options-trading platformn  An ECN Strictly Financials 51
  52. 52. U.S Equities Market Share 2012 2011n  NYSE 23% 27.5% n  Arca 12% 14% n  Floor 11% 13.5%n  NASDAQ 19% 21.5%n  BATS 13% 12%n  Direct Edge 9% 8% October 2012 Strictly Financials 52
  53. 53. Direct Edgen  Another ECNn  Has exchange status Strictly Financials 53
  54. 54. Dark Poolsn  Also “Dark Liquidity” or “Dark Pool Liquidity”n  Lightly regulated trading not open to the public.n  Mostly involves block trades by institutions away from public exchanges so trades are anonymous.n  Main advantage to institutional investors: Can buy or sell in large blocks without other investors knowing since neither size of trade or trader’s identity are revealed. Prices are reported after trades completed.n  Also means some market participants are disadvantaged since they can’t see trades executed and prices paid, so this market is not transparent. Strictly Financials 54
  55. 55. High-Frequency Tradingn  Also known as “high-speed trading.”n  Electronic-trading strategies driven by statistics and algorithms.n  WSJ reported in 2011 that by some measures, such firms make up 5 of every 10 stock trades in the U.S. each day. Strictly Financials 55
  56. 56. High-Frequency Tradingn  Research has shown that algorithmic trading broadly makes prices less volatile and reduces the overall cost of trading.n  These firms’ ability to buy and sell large blocks of securities in fractions of a second has raised fears that ordinary investors are being left behind. Much criticism. Strictly Financials 56
  57. 57. Second Marketsn  Markets where illiquid assets are traded.n  Employees or investors can sell private company stock or options, bankruptcy claims, restricted stock, structured products, loans.n  Examples: Facebook, Zynga, Groupon.n  Buyers: Hedge funds, private equity funds, individuals.n  Largest are Second Market, SharesPost Strictly Financials 57
  58. 58. Stock Ownershipn  In 2011, 54% of Americans said they had money in the stock market, either in an individual stock, a mutual fund or self-directed 401(k) or IRAn  This was down from 56% in ‘10 and 57% in ‘09. High in the 21st Century was 67% in ‘02 and 65% in ‘07. n  Gallup, April 2011 Strictly Financials 58
  59. 59. Stock Ownershipn  87% of upper-income Americans ($75,000 or more annually) own stocks.n  83% of postgraduates and 73% of college graduates own stocks.n  64% of Republicans hold stocks, compared with half of Democrats and independents.n  Ages 50 to 64 are most likely to say they have money in the stock market. n  Gallup, April 2011 Strictly Financials 59
  60. 60. Institutional Investorsn  Organizations that invest their own assets or pool those they hold in trust for others.n  Examples: Investment companies (including mutual funds), pension systems, insurance companies, universities and banks.n  Trade regularly and in tremendous volume.n  Must buy or sell at least 10,000 shares for a transaction to be an “institutional trade.” Strictly Financials 60
  61. 61. Changing Attitudesn  Institutional investors who own large blocks of stock are increasingly demanding a say in corporate management.n  Socially or environmentally conscious individual shareholders also are becoming more involved. Strictly Financials 61
  62. 62. Stock Market Averagesn  Dow Jones Industrial Average: Best known and most widely reported market indicatorn  Made up of 30 industrial companiesn  Dow Jones Transportation Average: 20 airlines, railroads and trucking companiesn  Dow Jones Utility Average: 15 gas, electric and power companiesn  Dow Jones 65 Composite Average: all 65 companies in the other three averages Strictly Financials 62
  63. 63. Stock Market Indexesn  NYSE Composite Index: All stocks traded on the NYSE.n  Standard & Poor’s 500 Index: Broad base of 500 stocks. Considered benchmark for large- stock investors.n  NASDAQ Stock Market Composite Index: Stocks traded through its electronic system. Often more volatile because of types of companies it covers. Strictly Financials 63
  64. 64. Market Indexes (cont.)n  AMEX Composite: Companies on the AMEX.n  Russell 2000: Follows smallest two-thirds of the 3,000 largest U.S. companies. Includes many IPOs of past few years. Benchmark for small-company stocks.n  Value-Line: 1,700 common stocks.n  Wilshire 5000: Broadest index, including nearly all stocks traded in U.S. markets. Strictly Financials 64
  65. 65. Reg FD, Disclosureand Guidancen  Regulation Fair Disclosure, October 2000n  Bars public issuers from selectively revealing material nonpublic information to securities analysts, broker-dealers, investment advisers, and institutional investors, before disclosing it to the public.n  Tension: Guidance vs. disclosure Strictly Financials 65
  66. 66. Stock Splitn  If stock price increases significantly, a company might do a split to lower the price, which it expects to stimulate trading.n  In a split, more shares are available, but total market value is still the same.n  Price may move up after split, therefore increasing the value of your stock.n  Reverse split: Exchange more shares for fewer, say 10 for five. To boost share price. Strictly Financials 66
  67. 67. Credit or Debt Marketsn  Historically, the amount of long-term debt financing issued in the U.S. greatly exceeds the volume of equity financing.n  Short-term or “money market”n  Bond market Strictly Financials 67
  68. 68. Money Marketn  Commercial papern  Bankers’ acceptancen  Repurchase agreementsn  Certificates of depositn  Municipal notesn  Treasury billsn  Money-market mutual funds Strictly Financials 68
  69. 69. Who Issues Bondsn  Issued by U.S. companiesn  Issued by the U.S. Treasuryn  Issued by federal, state and local government agenciesn  Issued by overseas companies and governments. When sold in dollars, are sometimes called Yankee Bonds. Strictly Financials 69
  70. 70. Issuers Prefer Bondsn  When companies need to raise money, they can issue stock or sell bondsn  They often prefer bonds, in part because issuing more stock tends to dilute the value of shares investors already own.n  Bonds also may have income-tax advantages Strictly Financials 70
  71. 71. Treasury Issuesn  Life, or term, is fixed at time of issuen  Treasury bill: One year or lessn  Treasury note: One to 10 yearsn  Treasury bond: 10 years or moren  Generally, the longer the term, the higher the interest rate Strictly Financials 71
  72. 72. How Bonds Are Tradedn  Most already issued bonds are traded over the counter.n  Bonds also can be purchased from the inventory of a brokerage firm that might make a market in the bonds.n  Commissions and markups Strictly Financials 72
  73. 73. Rating Bondsn  Standard & Poor’s, Moody’s Investors Services and Fitch are best known.n  Corporate, international and municipal bonds are rated.n  Credit ratings influence interest rates.n  If a company’s rating is downgraded, investors demand a higher yield. Strictly Financials 73
  74. 74. Bond Rating Coden  Aaa/AAA: Best qualityn  Aa/AA: High qualityn  A/A: High-medium qualityn  Baa/BBB: Medium qualityn  Ba/BB: Some speculative elementn  B/B: Future default riskn  Caa/CCC: Poor quality, default dangern  Ca/CC: Highly speculativen  C/C: Lowest rated, poor prospects Strictly Financials 74