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Chapter 3


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Chapter 3

  1. 1. Primary vs. Secondary Security Sales <ul><li>Primary Market </li></ul><ul><ul><li>New issue </li></ul></ul><ul><ul><li>Issuer receives the proceeds from the sale </li></ul></ul><ul><li>Secondary Market </li></ul><ul><ul><li>Existing owner sells to another investor </li></ul></ul><ul><ul><li>Issuing firm receives nothing; is not involved </li></ul></ul>
  2. 2. Investment Banking and Underwriting <ul><li>Investment banker—specialist in issuing securities </li></ul><ul><ul><li>advice—concerning market conditions </li></ul></ul><ul><ul><li>underwriting—take risk of issuing securities </li></ul></ul><ul><ul><li>distribution—syndicates (diversification) </li></ul></ul><ul><li>Prospectus—documents the new issue; indicates the terms of the issue, use of funds, and so forth </li></ul>
  3. 3. Investment Banking Arrangements <ul><li>Types of Arrangements: </li></ul><ul><ul><li>Negotiated purchase—issuing firm negotiates terms with investment banker </li></ul></ul><ul><ul><li>Competitive bid purchase—investment bankers bid on the issue </li></ul></ul><ul><ul><li>Best Efforts—investment banker sells on a contingency basis; gives a “best effort” to sell the issue, but there is no firm commitment that the entire amount will be sold </li></ul></ul>
  4. 4. Public Versus Private Placements <ul><li>Public placements (offerings)—must register with the SEC; sold to the public </li></ul><ul><ul><li>Initial Public Offerings (IPOs)—first time a sells stock to the investing public </li></ul></ul><ul><ul><ul><li>IPOs generally are underpriced </li></ul></ul></ul><ul><ul><ul><li>Investment bankers generally are involved in the market after the initial offering of the stock </li></ul></ul></ul><ul><li>Private placements—sell to a limited number of sophisticated investors; not registered </li></ul><ul><ul><li>Institutional investors </li></ul></ul><ul><ul><li>Market is more active for debt than equity </li></ul></ul>
  5. 5. Stock (Bond) Markets <ul><li>Organized exchanges—physical locations </li></ul><ul><ul><li>NYSE </li></ul></ul><ul><ul><li>AMEX </li></ul></ul><ul><li>OTC market—electronic network </li></ul><ul><ul><li>NASDAQ </li></ul></ul><ul><li>Third market—trading exchange-listed stocks on the OTC </li></ul><ul><ul><li>Institutional investors with large blocks </li></ul></ul><ul><li>Fourth market—direct trades of exchange-listed stocks </li></ul><ul><ul><li>Institutional investors with large blocks </li></ul></ul><ul><ul><li>Electronic Communications Networks (ECNs) </li></ul></ul>
  6. 6. Types of Orders <ul><li>Orders represent instructions to brokers (agents) as to how to execute transactions </li></ul><ul><li>Market order —transact at the best possible price when the order reaches the market </li></ul><ul><li>Limit order —execute the order only if a specified price, or a better price, exists </li></ul><ul><li>Stop loss order —initiate a market order when a specifies price is reached </li></ul><ul><li>Time order —establish time limits </li></ul><ul><ul><li>day order—the order “dies” (expires) at the end of the day </li></ul></ul><ul><ul><li>good 'til canceled (GTC)—the order stays alive until canceled </li></ul></ul>
  7. 7. Stock Market Participants—Exchange Seats <ul><li>Commission Broker —works for a company with a seat on the exchange </li></ul><ul><li>Floor Broker —independent, freelance broker; “farms out” to others </li></ul><ul><li>Registered (floor) Trader —trades only for his or her own private account </li></ul><ul><li>S pecialist —market maker; specializes in certain types of stocks (industries) </li></ul>
  8. 8. Margin Trading <ul><li>Borrow to purchase financial assets </li></ul><ul><li>Important computations: </li></ul>
  9. 9. Margin Trading <ul><li>Example: An investor wishes to buy 100 shares of IBM, which currently is trading at $100. The brokerage firm imposes a margin requirement equal to 60%, with a maintenance margin of 35%. </li></ul><ul><li>The market value of the purchase is $10,000 = $100 × 100 </li></ul><ul><li>The investor must have $6,000 = $10,000 × 0.60 of funds to purchase 100 shares of IBM </li></ul><ul><li>$4,000 = $10,000 - $6,000 = $10,000 × 0.40 is the amount borrowed from the brokerage firm. </li></ul>
  10. 10. Margin Trading <ul><li>A margin call will be issued if the price of IBM drops below $61.54: </li></ul>