New Report 1SummaryFrom the USA Today article, Sprea.docx

New Report 1
Summary:
From the USA Today article, “Spread the Wealth: It’s Not Just
‘Popular’ Stocks that Go Up”, Adam
Shell illustrates that current investors are largely “attached” to
Wall Street’s high-profile company
stocks; companies such as Tesla, Apple, and Facebook from the
technology sector receive the
most buy orders from investors because these companies “get
the most press coverages, the most
PR, and the most adulation.” The author emphasized that
although these technology giants have
the most spotlight on the stock market, investors should not
overlook less-glamorous corporate
stocks from other sectors because often times, the stocks from
these “less-notable” companies go
under the radar and quietly rise in value.
This year so far, is a perfect example, according to Adam Shell,
when auto parts makers were up
more than 25 percent, the gaming industry and casinos have
returns of more than 50 percent, and
homebuilding stocks jumped 30 percent. In addition, the hotel
and resort industry has booked
gains 25 percent, stocks of health care equipments increased by
25 percent, and airlines have also
experienced growth, with the help of lower fuel costs. Shell
suggested that these gains from
different sectors are viewed as healthy, as it implies that the
investors are now investing in

companies that are not largely in the technology sector, which
has been the market leader so far in
2017.
Relation to Text:
The article that I had chosen above relates to several concepts
discussed in Chapter 8 from Bodie,
Kane, and Marcus’ Finance - Essentials of Investment. Chapter
8: Efficient Market Hypothesis,
describes that stock prices should follow the notion of random
walk, that is, changes in stock prices
(fluctuations) should be random and unpredictable. Intelligent
investors should equipment
themselves with relevant and up-to-date information on which
to buy or sell stocks before the rest
of the market becomes aware of that same set of information.
This applies to investors who are
vigorously investing largely in technology companies in the
technology sector; they should also
diversify their investments into other sectors (based on relevant
and helpful information) to reduce
risks. Technical analysis and the momentum effect were likely
the dominant cause of investment
concentrations from investors. Technical analysis, the search on
recurrent and predictable patterns
in stock prices and on proxies for buy and sell pressure in the
market, allows investors to
strengthen their investment positions on a certain company in a
certain stock market sector; the
investment trend is further bolstered due to the momentum
effect, which states that the tendency of
poorly performing and well-performing stocks in one period to
continue that abnormal performance
in the following periods.

Active and passive management and risk-return trade-off are
part of the topics described in
chapter 1 from the text and these concepts also relate to the
article that I had selected. Because
passive management illustrates the buying and holding of a
diversified portfolio without attempting
to identify mispriced securities, the investors described in the
article do not fit into this description
as much as active management strategy. In active management,
investors would attempt to
identify mispriced mispriced securities or to forecast broad
market trends, that is, for example,
“increasing one’s commitment to stocks when one is bullish on
the stock market” (11). This
attributes more appropriately to the investors whose portfolio
are not considered as diverse and
has large commitments on stocks of technology companies in
the technology sector because their
stocks have been ever rising. While these investors have large
commitments on these specific
technology companies, they must have also taken the risk-return
trade-off factor into account with
their investment, as the risk-return trade-off factor portrays the
idea that assets with higher
expected returns entails greater risks.
Reflection
I agree with the author’s view on diversifying investment
portfolios and not have all or even most of
the eggs in one basket, that is, in the technology sector. Though
I understand the reason and
causes of this investment trend: due to the fact that the world is

more and more technologically
advanced and incorporated and that technology companies such
as Tesla, Facebook, Snapchat,
Apple, Microsoft, etc are receiving most of the media
coverages, it is natural that the investment
trend would be more directed towards these technology
companies. However, in order to receive
greater returns and minimizing potential risks, an intelligent
investor would have to diversify his or
her investment portfolios and invest in other sectors on the
stock market, as growth in other
sectors are apparent as described in the article.
The title of the article caught my eye when I was browsing
potential news articles on USA Today to
write about, and as I was reading the article, concepts that I
have retained from reading the
textbook constantly appeared in my mind. Although the article
did not specifically cover news of a
particular company and its future projections based on some
cause and effects, the article
provided real and genuine advice on stock investment while
covering market trends of specific
sectors.
Reference (Article):
https://www.usatoday.com/story/money/markets/2017/07/12/spr
ead-wealth-its-not-just-popular-
stocks-go-up/469534001/ (Links to an external site.)Links to an
external site. (July 12, 2017).
Behavioral Finance and Technical Analysis
9

Bodie, Kane, and Marcus
Essentials of Investments, 9th Edition
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc.
All rights reserved.
9.1 Behavioral Critique
Behavioral Finance
Financial market model emphasizing potential implications of
psychological factors affecting investor behavior
Existence of irrational investors is not sufficient to render
capital markets inefficient
9-‹#›
9.1 Behavioral Finance
Information Processing
Forecasting errors
People overvalue recent experience compared to prior belief
when forecasting
Overconfidence
People overestimate precision of beliefs or forecasts, and
overestimate abilities
9-‹#›
Information Processing
Conservatism bias

Investors too slow in updating beliefs in response to recent
evidence
Sample size neglect and representativeness
People prone to believe small sample is representative of
population, infer patterns too quickly
9-‹#›
Behavioral Biases
Framing
Decisions affected by how choices are posed, i.e. gains relative
to low baseline level or losses relative to higher baseline
Mental accounting
Form of framing; people segregate certain decisions
9-‹#›
Behavioral Biases
Regret avoidance
People blame themselves for unconventional choices that turn
out badly, avoid regret by making conventional decisions
Prospect theory
Investor utility depends on gains/losses from starting position,
rather than levels of wealth
9-‹#›

Limits to Arbitrage
Fundamental risk
Market changes or irrationality can eliminate profits
Implementation costs
Exploiting overpricing is difficult; costs and time limits can
eliminate profits
Model risk
Inaccurate models generate inaccurate stock values
9-‹#›
Figure 9.1A Conventional Utility Function
9-‹#›
Figure 9.1B Utility Function under Prospect Theory
9-‹#›
Limits to Arbitrage and Law of One Price
“Siamese twin” companies
Dual-listed companies can appear to violate Law of One Price
Equity carve-outs
Can violate Law of One Price due to inability to short sell

9-‹#›
9-‹#›
Figure 9.2 Pricing of Royal Dutch Relative to Shell
9-‹#›
Bubbles and Behavioral Economics
Evidence of irrational investor behavior
Easier to identify once over
Evaluating Behavioral Critique
No coherent theory
Most empirical support from one time period: late ‘90s
9-‹#›
9.2 Technical Analysis and Behavioral Finance
Trends and Corrections
Moving average
Average price over given interval, interval updated over time
Attempts to identify underlying price directions

9-‹#›
Figure 9.3 Share Price, 50-Day Moving Average for Intel
9-‹#›
Figure 9.4 Moving Averages
9-‹#›
Table 9.1 Stock Price History
9-‹#›
Point and figure charts
Traces significant upward/downward movements in prices
without regard to timing
X denotes price increase, O denotes decrease
Sell/Buy signals generated when stock penetrates previous
lows/highs
Congestion area: Horizontal band of Xs/Os created by price
reversals

9-‹#›
Figure 9.5 Point and Figure Chart for Table 9.1
9-‹#›
Figure 9.6 Point and Figure Chart for Atlantic Richfield
9-‹#›
Breadth
Extent to which broad market index movements affect
individual stock prices
Relative Strength
Recent performance of given stock/industry compared to that of
broad market index
9-‹#›
Figure 9.7 Market Diary

9-‹#›
Table 9.2 Breadth
9-‹#›
Sentiment Indicators
Trin statistic
Ratio of average volume in declining issues to average volume
in advancing issues
Confidence index
Ratio of top-rated corporate bond yield to intermediate-grade
bond yield
9-‹#›
Sentiment Indicators
Short interest
Total number of shares currently short-sold in market
Put/call ratio
Ratio of put options to call options outstanding on stock
9-‹#›

A Warning
People perceive patterns where none exist
Data mining generates apparent patterns within limited data sets
When evaluating rules, ask whether rule would be reasonable
before looking at data
9-‹#›
Figure 9.8A Actual Stock Price Levels, 52 Weeks
9-‹#›
Figure 9.8B Simulated Stock Price Levels, 52 Weeks
9-‹#›
Figure 9.9A Actual Weekly Stock Price Changes, 52 Weeks
9-‹#›
Figure 9.9B Simulated Weekly Stock Price Changes, 52 Weeks

9-‹#›
McGraw
-
Hill/Irwin
Copyright
©
2013 by The McGraw
-
Hill Companies, Inc. All rights reserved.
Behavioral Finance and
Technical Analysis
9
Bodie
, Kane, and Marcus
Essentials of Investments,
9
th
Edition
The Efficient Market Hypothesis
8
McGraw-Hill/Irwin
1
8.1 Random Walks and Efficient Market Hypothesis

Random Walk
Notion that stock price changes are random
Efficient Market Hypothesis (EMH)
Prices of securities fully reflect available information
8-‹#›
2
Figure 8.1 Cumulative Abnormal Returns before Takeover
Attempts: Target Companies
8-‹#›
3
Figure 8.2 Stock Price Reaction to CNBC Reports
8-‹#›
4
Competition as Source of Efficiency
Investor competition should imply stock prices reflect available

information
Investors exploit available profit opportunities
Competitive advantage can verge on insider trading
8-‹#›
5
Versions of EMH
Weak-form EMH
Stock prices already reflect all information contained in history
of trading
Semistrong-form EMH
Stock prices already reflect all public information
Strong-form EMH
Stock prices already reflect all relevant information, including
inside information
8-‹#›
6
8.2 Implications of the EMH
Technical Analysis
Research on recurrent/predictable price patterns and on proxies
for buy/sell pressure in market
Resistance Level
Unlikely for stock/index to rise above
Support Level

Unlikely for stock/index to fall below
8-‹#›
Implications of the EMH
Fundamental Analysis
Research on determinants of stock value, i.e. earnings, dividend
prospects, future interest rate expectations and firm risk
Assumes stock price equal to discounted value of expected
future cash flow
8-‹#›
Implications of the EMH
Active versus Passive Portfolio Management
Passive investment strategy
Buying well-diversified portfolio without attempting to find
mispriced securities
Index fund
Mutual fund which holds shares in proportion to market index
representation
8-‹#›
8.2 Implications of the EMH
Role of Portfolio Management in Efficient Market
Active management assumes market inefficiency
Passive management consistent with semistrong efficiency
Inefficient market pricing leads to inefficient resource
allocation

8-‹#›
8.3 Are Markets Efficient?
Issues
Magnitude issue
Efficiency is relative, not binary
Selection bias issue
Investors who find successful investment schemes are less
inclined to share findings
Observable outcomes preselected in favor of failed attempts
Lucky event issue
Lucky investments receive disproportionate attention
8-‹#›
Weak-Form Tests: Patterns in Stock Returns
Returns over short horizons
Momentum effect: Tendency of poorly- or well-performing
stocks to continue abnormal performance in following periods
Returns over long horizons
Reversal effect: Tendency of poorly- or well-performing stocks
to experience reversals in following periods
8-‹#›
Predictors of Broad Market Performance
1988—Fama and French: Return on aggregate stock market

tends to be higher when dividend yield is low
1988—Campbell and Shiller: Earnings yield can predict market
returns
1986—Keim and Stambaugh: Bond market data (spread between
yields) can predict market returns
8-‹#›
Semistrong Tests: Market Anomalies
Anomalies
Patterns of returns contradicting EMH
P/E effect
Portfolios of low P/E stocks exhibit higher average risk-
adjusted returns than high P/E stocks
8-‹#›
Small-firm effect
Stocks of small firms can earn abnormal returns, primarily in
January
Neglected-firm effect
Stock of little-known firms can generate abnormal returns
Book-to-market effect
Shares of high book-to-market firms can generate abnormal
returns
8-‹#›

Post-earnings announcement price drift
Sluggish response of stock price to firm’s earnings
announcement
Abnormal return on announcement day, momentum continues
past market price
Bubbles and market efficiency
Speculative bubbles can raise prices above intrinsic value
Even if prices are inaccurate, it can be difficult to take
advantage of them
8-‹#›
Figure 8.3 Average Annual Return: Ten Size-Based Portfolios,
1926-2010
8-‹#›
19.78011904761903 16.95595238095238 16.60130952380953
15.91940476190477 15.24011904761905
15.05333333333335 14.58809523809525
13.52785714285714 12.8902380952381
10.95428571428572
Size decile: 1 = small, 10 = large
Annual return (%)
Figure 8.4 Average Annual Return as Function of Book-to-

Market Ratio, 1926-2010
8-‹#›
10.98940476190477 11.81130952380952 11.70809523809524
11.68761904761905 13.10595238095238
13.39833333333333 13.4352380952381
15.48714285714287 16.08428571428573
17.32440476190477
Book-to-market decile: 1 = low, 10 = high
Annual return (%)
Figure 8.5 Cumulative Abnormal Returns after Earnings
Announcements
8-‹#›
Interpreting Anomalies
Risk premiums or inefficiencies?
Fama and French: Market phenomena can be explained as
manifestations of risk premiums
Lakonishok, Shleifer, and Vishny: Market phenomena are
evidence of inefficient markets
8-‹#›

Interpreting Anomalies
Anomalies or data mining?
Some anomalies have not shown staying power after being
reported
Small-firm effect
Book-to-market effect
8-‹#›
Figure 8.6 Return to Style Portfolio as Predictor of GDP Growth
8-‹#›
8.4 Mutual Fund and Analyst Performance
Stock Market Analysis
Analysts are overly positive about firm prospects
Womack: Positive changes associated with 5% increase,
negative with 11% decrease
Jegadeesh, Kim, Kristie, and Lee: Level of consensus is
inconsistent predictor of future performance
Barber, Lehavy, McNichols, and Trueman: Firms with most-
favorable recommendations outperform firms with least-
favorable recommendations
8-‹#›

Mutual Fund Managers
Today’s conventional model: Fama-French factors plus
momentum factor
Wermers: Funds show positive gross alphas; negative net alphas
after controlling for fees, risk
Carhart: Minor persistence in relative performance across
managers, largely due to expense/transaction costs
8-‹#›
Berk and Green: Skilled managers with abnormal performance
will attract new funds until additional cost, complexity drives
alphas to zero
Chen, Ferson, and Peters: On average, bond mutual funds
outperform passive bond indexes in gross returns, underperform
once fees subtracted
8-‹#›
Kosowski, Timmerman, Wermers, and White: Stock-pricing
ability of minority of managers sufficient to cover costs;
performance persists over time
Samuelson: Records of most managers show no easy strategies
for success

8-‹#›
Figure 8.7 Mutual Fund Alphas Computed Using Four-Factor
Model, 1993-2007
8-‹#›
Figure 8.8 Persistence of Mutual Fund Performance
8-‹#›
Figure 8.9 Risk-Adjusted Performance in Ranking Quarter,
Following Quarter
8-‹#›
So, Are Markets Efficient?
Enough that only differentially superior information will earn
money
Professional manger’s margin of superiority likely too slight for
statistical significance
8-‹#›

McGraw
-
Hill/Irwin
Copyright
©
2013 by The McGraw
-
The Efficient Market
Hypothesis
8
Bodie
, Kane, and Marcus
9th Edition
Mutual Funds and Other Investment Companies
4
McGraw-Hill/Irwin
4.1 Investment Companies
Functions
Record keeping and administration
Diversification and divisibility
Professional management
Lower transaction costs
Definitions

Investment company: Financial intermediaries
Net asset value (NAV): Assets minus liabilities per share
The McGraw-Hill Companies, © 2013
‹#›
4-‹#›
4.2 Types of Investment Companies
Unit Investment Trusts
Money pooled from many investors is invested in portfolio
fixed for life of fund
Managed Investment Companies
Open-end fund: Issues or redeems shares at net value
Closed-end fund: Shares can’t be redeemed, are traded at prices
different than NAV
Load: Sales commission charged on mutual fund
‹#›
4-‹#›
Open-End and Closed-End Funds: Key Differences
Shares Outstanding
Closed-end: No change unless new stock offered
Open-end: Changes when new shares are sold or old shares are
redeemed
Pricing

Open-end: Fund share price = Net asset value (NAV)
Closed-end: Fund share price may trade at premium or discount
to NAV
‹#›
4-‹#›
Figure 4.1 Closed-End Mutual FundsFundNAVMkt
PricePrem/Disc %52 Wk Return %Adams Express Company
(ADX)12.8911.11−13.8126.13Advent/Clay Enhcd G&I
(LCM)12.1611.58−4.7723.52BlackRock Equity Div
(BDV)10.6510.03−5.8227.39BlackRock Str Eq Div Achv
(BDT)11.810.68−9.4926.17Cohen & Steers CE Oppty
(FOF)14.6413.46−8.0625.17Cohen & Steers Dvd Mjrs
(DVM)14.7013.82−5.9949.28Eaton Vance Tax Div Inc
(EVT)18.7517.19−8.3229.89Gabelli Div & Inc Tr
(GDV)18.6416.58−11.0543.52Gabelli Equity Trust
(GAB)6.086.100.3348.48General Amer Investors
(GAM)32.7128.26−13.6030.93Guggenheim Enh Eq Inc
(GPM)9.589.650.7338.93
‹#›
4-‹#›
Other Investment Organizations

Commingled Funds
Partnership of investors pooling funds; designed for
trusts/larger retirement accounts to get professional
management for fee
Real Estate Investment Trusts (REITs)
Similar to closed-end funds, invests in real estate/real estate
loans
Hedge Funds
Private speculative investment pool, exempt from SEC
regulation
‹#›
4-‹#›
4.3 Mutual Funds
Investment Policies
Money market funds
Commercial paper, repurchase agreements, CDs
Equity funds
Invest in stock, some fixed-income, or other securities
Specialized sector funds
Concentrate on particular industry
Bond funds
Specialize in fixed-income (bonds) sector
‹#›

4-‹#›
4.3 Mutual Funds
Investment Policies
International funds
Global funds invest in securities worldwide, including U.S.
International funds invest outside U.S.
Regional funds focus on particular part of world
Emerging market funds invest in developing nations
‹#›
4-‹#›
4.3 Mutual Funds
Investment Policies
Balanced funds
Hold both equities and fixed-income securities in stable
proportion
Life-cycle funds: Asset mix ranges from aggressive to
conservative
Static allocation funds maintain stable mix across stocks and
bonds
Targeted maturity funds become more conservative as investor
ages
Funds of funds: Mutual funds that primarily invest in other
mutual funds
‹#›

4-‹#›
4.3 Mutual Funds
Investment Policies
Asset allocation and flexible funds
Stocks and bonds—proportion varies according to market
forecast
Index funds
Try to match performance of broad market index
Buy shares in securities included in particular index in
proportion to security’s representation in index
‹#›
4-‹#›
Table 4.1 U.S. Mutual Funds by Investment ClassificationAssets
($ billion)Percent of Total Assets Number of FundsEquity
FundsCapital appreciation
focus2,91224.2%3,037World/international1,66013.8%968Total
return1,95016.2%762 Total equity
funds6,52254.2%4,767Bond FundsCorporate3012.5%293High
yield1571.3%206World840.7%122Government2031.7%301Strat
egic income5604.7%370Single-state
municipal1561.3%451National municipal2181.8%224 Total
bond funds1,67914.0%1,967Hybrid (bond/stock)
funds7135.9%488Money market
fundsTaxable2,64222.0%548Tax-exempt4653.9%259 Total
money market funds3,10725.8%807Total12,021100.0%8,029

‹#›
4-‹#›
4.4 Costs of Investing in Mutual Funds
Fee Structure
Operating expenses: Costs incurred by mutual fund in operating
portfolio
Front-end load: Commission or sales charge paid when
purchasing shares
Back-end load: “Exit” fee incurred when selling shares
12b-1 charges: Annual fees charged by mutual fund to pay for
marketing/distribution costs
‹#›
4-‹#›
Fees, Loads, and Performance
Gross performance of load funds is statistically identical to
gross performance of no-load funds
Funds with high expenses tend to be poorer performers
12b-1 charges should be added to expense ratios
Compare costs with Morningstar

‹#›
4-‹#›
NAV and Effective Load
Cost to initially purchase one share of load fund = NAV +
Front-end load (%) (if any)
Stated loads typically range from 0 to 8.5%
Load is designed to offset expenses of marketing the fund; it
goes to broker who sells fund to investor
Effective load greater than stated load
‹#›
4-‹#›
Avoiding the Load
Choose different class of fund shares
Notes:
a Depending on size of investment.
b Depending on years until holdings are sold.
c Including service fee of .25%.
‹#›

4-‹#›
Fees and Mutual Fund Returns
Soft dollars: Value of research services brokerage house
provides “free of charge” in exchange for business
‹#›
4-‹#›
Table 4.2 Impact of Costs on Investment Performance
Notes: Fund A is no-load with .5% expense ratio, Fund B is no-
load with 1.5% total expense ratio, and Fund C has an 8% load
on purchases and a 1% expense ratio. Gross return on all funds
is 12% per year before expenses.
* After front-end load, if any.
‹#›
4-‹#›
4.5 Taxation of Mutual Fund Income

General Tax Rules
Fund not taxed if diversified and income distributed
Investor taxed on capital gain and dividend distributions
Turnover: Ratio of trading activity to assets of portfolio
Portfolio turnover may affect investor’s tax liability
‹#›
4-‹#›
4.5 Taxation of Mutual Fund Income
Implications of Fund Turnover
Fund pays commission costs on portfolio purchases and sales—
charged against NAV
Turnover rate measured as annual total asset value bought or
sold in a year divided by average total asset value
‹#›
4-‹#›
4.6 Exchange-Traded Funds
Exchange-Traded Funds: Offshoots of mutual funds that allow
investors to trade index portfolios
Potential Advantages
Trade continuously throughout day
Can be sold or purchased on margin
Potentially lower tax rates

Lower costs (no marketing, lower fund expenses)
‹#›
4-‹#›
4.6 Exchange-Traded Funds
Potential Disadvantages
Small deviations from NAV possible
Brokerage commission to buy ETF
‹#›
4-‹#›
Table 4.3 ETF Sponsors and Products
‹#›
4-‹#›
Figure 4.2 Assets in ETFs

‹#›
4-‹#›
Figure 4.3 Investment Company Assets under Management,
2010 ($ Billion)
‹#›
4-‹#›
4.7 Mutual Fund Investment Performance
On average, mutual fund performance less than broad market
performance
Evidence suggests some persistence in positive performance
over certain horizons
‹#›
4-‹#›
Figure 4.4 Average Returns on Diversified Equity Funds vs.

Wilshire 5000 Index
‹#›
4-‹#›
Diversified equity funds 1971.0 1972.0 1973.0 1974.0
1975.0 1976.0 1977.0 1978.0 1979.0 1980.0
1981.0 1982.0 1983.0 1984.0 1985.0 1986.0
1987.0 1988.0 1989.0 1990.0 1991.0 1992.0
1993.0 1994.0 1995.0 1996.0 1997.0 1998.0
1999.0 2000.0 2001.0 2002.0 2003.0 2004.0
2005.0 2006.0 2007.0 2008.0 2009.0 2010.0
0.1859 0.0916 -0.2494 -0.2533 0.3232 0.2448
0.0129 0.1112 0.2869 0.3348 -0.0133 0.2503
0.2023 -0.0209 0.2717 0.1339 0.005 0.1444
0.2399 -0.0627 0.3561 0.0889 0.1251 -0.0168
0.3108 0.1948 0.2436 0.1452 0.2711 -0.003
-0.092 -0.216 0.329 0.121 0.066 0.126
0.062 -0.375 0.295 0.157 Wilshire return
1971.0 1972.0 1973.0 1974.0 1975.0 1976.0
1977.0 1978.0 1979.0 1980.0 1981.0 1982.0
1983.0 1984.0 1985.0 1986.0 1987.0 1988.0
1989.0 1990.0 1991.0 1992.0 1993.0 1994.0
1995.0 1996.0 1997.0 1998.0 1999.0 2000.0
2001.0 2002.0 2003.0 2004.0 2005.0 2006.0
2007.0 2008.0 2009.0 2010.0 0.1768
0.179801155676411 -0.185156908361483 -
0.283880776438143 0.384726473782957 0.265873334224718 -
0.0263710109004873 0.0927480888426015
0.255620784825039 0.336698064971826 -
0.037497683259132 0.187102589314979 0.234659083065284
0.0304718510650193 0.325644732951571

0.160949646706379 0.02274469851465
0.179415591689717 0.291738145685687 -
0.061809884830447 0.342044055604255 0.0896752045525809
0.11281435229884 -0.000646080027976947
0.364486071384618 0.212112189182184
0.312911398760268 0.234309530573113
0.235592880428093 -0.108941349037946 -
0.109740290574871 -0.208597239990032
0.316406769579471 0.1247871143034
0.0637651302649613 0.157733742423515
0.0561525514313723 -0.372347524553752
0.283040614450055 0.171643765978194
Rate of return (%)
Table 4.4 Consistency of Investment Results
‹#›
4-‹#›
4.8 Information on Mutual Funds
Sources of Information on Mutual Funds
Morningstar (www.morningstar.com)
Fund prospectus
Yahoo!
The Wall Street Journal
Investment Company Institute (www.ici.org)
American Institute of Individual Investors
Brokers

‹#›
4-‹#›
0
0
1
NAV
on
distributi
gains
Capital
Income
NAV
NAV
return
of
Rate
+
+
-
=
McGraw
-
Hill/Irwin
Copyright
©

2013 by The McGraw
-
Mutual Funds and Other
Investment Companies
4
Bodie
, Kane, and Marcus
9
th
Edition
Securities Markets
3
McGraw-Hill/Irwin
1
3.1 How Firms Issue Securities
Primary vs. Secondary Market Security Sales
Primary
New issue created/sold
Key factor: Issuer receives proceeds from sale
Public offerings: Registered with SEC; sale made to investing
public
Private offerings: Not registered; sold only to limited number of

investors with restrictions on resale
Secondary
Existing owner sells to another party
Issuing firm doesn’t receive proceeds, is not directly involved
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2
Privately Held Firms
Up to 499 shareholders
Fewer obligations to release financial statements to public
Private placement: Primary offerings sold directly to a small
group of investors
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3
Publicly Traded Companies
Sell securities to the general public; allow investors to trade
shares in securities markets
Initial public offering: First sale of stock by a formerly private
company
Underwriters: Purchase securities from issuing company and
resell them
Prospectus: Description of firm and security being issued

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4
Figure 3.1 Relationship among a Firm Issuing Securities, the
Underwriters, and the Public
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5
Shelf Registration
SEC Rule 415
Security is preregistered and then may be offered at any time
within the next two years
24-hour notice: Any or all of preregistered amount may be
offered
Introduced in 1982
Allows timing of issues
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6

Initial Public Offerings
Issuer and banker put on “road show”
Purpose: Bookbuilding and pricing
Underpricing
Post-initial sale returns average 10% or more—“winner’s curse”
problem?
Easier to market issue; costly to issuing firm
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7
7
Figure 3.2 Average First-Day Returns for European IPOs
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8
Figure 3.2 Average First-Day Returns for Non-European IPOs
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3.2 How Securities Are Traded
Functions of Financial Markets
Overall purpose: Facilitate low-cost investment

Bring together buyers and sellers at low cost
Provide adequate liquidity by minimizing time and cost to trade
and promoting price continuity
Set and update prices of financial assets
Reduce information costs associated with investing
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10
Types of Markets
Direct Search Markets
Buyers and sellers locate one another on their own
Brokered Markets
Third-party assistance in locating buyer or seller
Dealer Markets
Third party acts as intermediate buyer/seller
Auction Markets
Brokers and dealers trade in one location
Trading is more or less continuous
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11
Types of Orders
Market order: Execute immediately at best price

Bid price: price at which dealer will buy security
Ask price: price at which dealer will sell security
Price-contingent order: Buy/sell at specified price or better
Limit buy/sell order: specifies price at which investor will
buy/sell
Stop order: not to be executed until price point hit
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12
Figure 3.3 Average Market Depth for Large (S&P 500) and
Small (Russel 2000) Firms
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Figure 3.4 Limit Order Book for Intel on the NYSE Arca
Market, July 22, 2011
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14

Trading Mechanisms
Dealer markets
Over-the-counter (OTC) market: Informal network of
brokers/dealers who negotiate securities sales
NASDAQ stock market: Computer-linked price quotation
system for OTC market
Electronic communication networks (ECNs)
Computer networks that allow direct trading without market
makers
Specialist markets
Specialist: Makes market in shares of one or more firms;
maintains “fair and orderly market” by dealing personally
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15
Figure 3.5 Price-Contingent Orders
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16
3.3 The Rise of Electronic Trading
Timeline of Market Changes
1969: Instinet (first ECN) established
1975: Fixed commissions on NYSE eliminated
Congress amends Securities and Exchange Act to create

National Market System (NMS)
1994: NASDAQ scandal
SEC institutes new order-handling rules
NASDAQ integrates ECN quotes into display
SEC adopts Regulation Alternative Trading Systems, giving
ECNs ability to register as stock exchanges
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17
3.3 The Rise of Electronic Trading
Timeline of Market Changes
1997: SEC drops minimum tick size from 1/8 to 1/16 of $1
2000: National Association of Securities Dealers splits from
NASDAQ
2001: Minimum tick size $.01
2006: NYSE acquires Archipelago Exchanges and renames it
NYSE Arca
SEC adopts Regulation NMS, requiring exchanges to honor
quotes of other exchanges
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Figure 3.6 Effective Spread vs. Minimum Tick Size

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19
3.4 U.S. Markets
NASDAQ
Approximately 3,000 firms
New York Stock Exchange (NYSE)
Stock exchanges: Secondary markets where already-issued
securities are bought and sold
NYSE is largest U.S. Stock exchange
ECNs
Latency: Time it takes to accept, process, and deliver a trading
order
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20
Figure 3.7 Market Share of Trading in NYSE-Listed Shares
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21
3.5 New Trading Strategies

Algorithmic Trading
Use of computer programs to make rapid trading decisions
High-frequency trading: Uses computer programs to make very
rapid trading decisions in order to compete for very small
profits
Dark Pools
ECNs where participants can buy/sell large blocks of securities
anonymously
Blocks: Transactions of at least 10,000 shares
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22
Figure 3.8 Market Capitalization of Major World Stock
Exchanges, 2011
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23
3.6 Globalization of Stock Markets
Moving to automated electronic trading
Current trends will eventually result in 24-hour global markets
Moving toward market consolidation

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3.7 Trading Costs
Commission: Fee paid to broker for making transaction
Spread: Cost of trading with dealer
Bid: Price at which dealer will buy from you
Ask: Price at which dealer will sell to you
Spread: Ask — bid
Combination: On some trades both are paid
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25
3.8 Buying on Margin
Margin: Describes securities purchased with money borrowed in
part from broker
Net worth of investor's account
Initial Margin Requirement (IMR)
Minimum set by Federal Reserve under Regulation T, currently
50% for stocks
Minimum % initial investor equity
1 − IMR = Maximum % amount investor can borrow
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26

Equity
Position value – Borrowing + Additional cash
Maintenance Margin Requirement (MMR)
Minimum amount equity can be before additional funds must be
put into account
Exchanges mandate minimum 25%
Margin Call
Notification from broker that you must put up additional funds
or have position liquidated
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27
(Market value –
market value
A margin call will occur when:
Market value = Borrowed/(1 − MMR)
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28
Margin Trading: Initial Conditions
X Corp: Stock price = $70

50%: Initial margin
40%: Maintenance margin
1000 shares purchasedInitial
PositionStock$70,000Borrowed$35,000Equity$35,000
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29
Stock price falls to $60 per share
Position value – Borrowing + Additional cash
Margin %: $25,000/$60,000 = 41.67%
How far can price fall before margin call?
Market value = $35,000/(1 – .40) = $58,333New
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30
With 1,000 shares, stock price for margin call is $58,333/1,000
= $58.33
Margin % = $23,333/$58,333 = 40%
To restore IMR, equity = ½ x $58,333 = $29,167New

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31
Buy at $70 per share
Borrow at 7% APR interest cost if using margin; use full
amount margin
APRs (365-day year)Buy at $70Sell at $72 in 90 daysSell at $68
in 90 daysNo
margin11.59%−11.59%Margin16.17%−30.17%Leverage
factor1.4x2.6x
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32
Table 3.1 Illustration of Buying Stock on Margin
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33
3.9 Short Sales
Sale of shares not owned by investor but borrowed through
broker and later purchased to replace loan
Mechanics
Borrow stock from broker; must post margin

Broker sells stock, and deposits proceeds/margin in margin
account (you cannot withdraw proceeds until you “cover”)
Covering or closing out position: Buy stock; broker returns title
to party from which it was borrowed
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34
3.9 Short Sales
Round Trips
Long position
Buy first, sell later
Bullish
Short position
Sell first, buy later
Bearish
“Round trip” is a purchase and a sale
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35
3.9 Short Sales
Required initial margin: Usually 50%
More for low-priced stocks
Liable for any cash flows
Dividend on stock
Zero tick, uptick rule
Eliminated by SEC in July 2007

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36
3.9 Short Sales
Short-sale maintenance margin requirements
(equity)PriceMMR< $2.50 $2.50 $2.50-$5.00 100%
market value $5.00-$16.75 $5.00> $16.75 30% market value
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37
3.9 Short Sales
Example
You sell 100 short shares of stock at $60 per share
$6,000 must be pledged to broker
You must also pledge 50% margin
You put up $3,000; now you have $9,000 in margin account
Short sale equity = Total margin account – Market value
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38
3.9 Short Sales

Example
Maintenance margin for short sale of stock with price > $16.75
is 30% market value
30% x $6,000 = $1,800
You have $1,200 excess margin
What price for margin call?
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39
3.9 Short Sales
Example
Equity = Total margin account – Market value
When Market value = Total margin account / (1 + MMR)
Market value = $9,000/(1 + 0.30) = $6,923
Price for margin call: $6,293/100 shares = $69.23
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40
3.9 Short Sales
Example
If this occurs:
Equity = $9,000 − $6,923 = $2,077
Equity as % market value = $2,077/$6,923 = 30%
To restore 50% initial margin:
($6,923/2) − $2,077 = $1,384.50

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41
Table 3.2 Cash Flows from Purchasing vs. Short-
SellingPurchase of StockTimeActionCash Flow*0Buy share−
Initial price1Receive dividend, sell shareEnding price +
DividendProfit = (Ending price + Dividend) – Initial priceShort
Sale of StockTimeActionCash Flow*0Borrow share; sell it+
Initial price1Repay dividend and buy share to replace share
originally borrowed− (Ending price + Dividend)Profit = Initial
price – (Ending price + Dividend)
*Note: A negative cash flow implies a cash outflow.
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42
3.10 Regulation of Securities Markets
Self-Regulation
The Sarbanes-Oxley Act
Insider Trading
Inside information: Nonpublic knowledge about a corporation
possessed by officers, major owners, etc., with privileged
access to information
3-‹#›

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