Investments - Mba 825 - Chapter 2

Front 1

Types of Markets

Back 1

- Money Markets: the market where short-term securities are bought and sold

- Capital Market: the market where long-term securities such as stocks and bonds are bought and sold

- Primary Market: the market in which new issues of securities are sold to the public

- Secondary Market: the market in which securities are traded after they have been issued

Front 2

Initial Public Offering (IPO)

Back 2

- First public sale of a company’s stock

- Requires SEC approval

Front 3

Three Choices to Market Securities in Primary Market

Back 3

- Public offering

- Rights offering

- Private Placement

Front 4

Going Public: The IPO Process - 1) Underwriting the offering:

Back 4

promoting the stock and facilitating the sale of the company’s shares

Front 5

Going Public: The IPO Process - 2) Prospectus:

Back 5

registration statement describing the issue and the issuer

Front 6

Going Public: The IPO Process - 3) Red Herring:

Back 6

preliminary prospectus available during the waiting period

Front 7

Going Public: The IPO Process - 4) Quiet Period:

Back 7

time period after prospectus is filed when company must restrict what is said about the company

Front 8

Going Public: The IPO Process - 5) Road Show:

Back 8

series of presentations to potential investors

Front 9

The Investment Banker’s Role - Underwriting the Issue:

Back 9

purchases the security at agreed-on price and bears the risk of reselling it to the public

Front 10

The Investment Banker’s Role - Underwriting Syndicate:

Back 10

group formed by investment banker to share the financial risk of underwriting

Front 11

The Investment Banker’s Role - Selling Group:

Back 11

other brokerage firms that help the underwriting syndicate sell issue to the public

Front 12

The Investment Banker’s Role - Tombstone:

Back 12

public announcement of issue and role of participants in underwriting process

Front 13

The Investment Banker’s Role - Investment Banker Compensation:

Back 13

typically in the form of a discount on the sale price of the securities

Front 14

Secondary Market:

Back 14

the market in which securities are traded after they have been issued

Front 15

Role of Secondary Markets

Back 15

- Provides liquidity to security purchasers

- Provides continuous pricing mechanism

Front 16

Securities Exchanges:

Back 16

forums where buyers and sellers of securities are brought together to execute trades

Front 17

Nasdaq Market:

Back 17

employs an all-electronic trading platform to execute trades

Front 18

Over-the-counter (OTC) Market:

Back 18

involves trading in smaller, unlisted securities

Front 19

Broker Markets:

Back 19

Consists of national and regional securities exchanges

- 60% of the total dollar volume of all shares in U.S. stock market trade here

- New York Stock Exchange (NYSE) is largest and most well-known

- Trades are executed when a buyer and a seller are brought together by a broker and the trade takes place directly between the buyer and seller

Front 20

Dealer Markets:

Back 20

Consists of both the Nasdaq market and the OTC market

- Trades are executed with a dealer (market maker) in the middle. Sellers sell to a market maker at a stated price. The market maker then offers the securities to a buyer.

Front 21

Broker Market - New York Stock Exchange (NYSE)

Back 21

- Largest stock exchange—over 2,700 companies

- Over 350 billion shares of stock traded in 2005

- Accounts for 90% of stocks traded on exchanges

- Specialists make transactions in key stocks

- Strictest listing policies

Front 22

Broker Market - NYSE Amex (formally American Stock Exchange)

Back 22

- More than 500 companies listed

- Major market for Exchange Traded Funds

- Typically smaller and younger companies who cannot meet stricter listing requirements for NYSE

Front 23

Broker Market - Regional Stock Exchanges

Back 23

- Typically lists between 100–500 companies, usually with local and regional appeal

- Listing requirements are more lenient than NYSE

- Often include stocks that are also listed on NYSE or NYSE Amex

- Best-known: Midwest, Pacific, Philadelphia, Boston, and Cincinnati

Front 24

Broker Market - Options Exchanges

Back 24

- Allows trading of options

- Best-known: Chicago Board Options Exchange (CBOE)

Front 25

Broker Market - Futures Exchanges

Back 25

- Allows trading of financial futures

- Best-known: Chicago Board of Trade (CBT

Front 26

Dealer Markets

Back 26

- No centralized trading floor; comprised of market makers linked by telecommunications network Both IPOs and secondary distributions are sold on OTC
40% of the total dollar volume of all shares in U.S. stock market trade here
Both IPOs and secondary distributions are sold on OTC

- Bid Price: the highest price offered by market maker to purchase a given security

- Ask Price: the lowest price at which a market maker is willing to sell a given security

Front 27

Dealer Markets - Nasdaq

Back 27

- Largest dealer market

- Lists large companies (Microsoft, Intel, Dell, eBay) and smaller companies

Front 28

Dealer Markets - Over-the-counter (OTC) Bulletin Board

Back 28

- Lists smaller companies that cannot or don’t wish to be listed on Nasdaq

- Companies are regulated by SEC

Front 29

Dealer Markets - Over-the-counter (OTC) Pink Sheets

Back 29

- Lists smaller companies that are not regulated by SEC

- Liquidity is minimal or almost non-existent

- Very risky; many nearly worthless stocks

Front 30

Alternative Trading Systems

Back 30

- Third Market
Large institutional investors go through market makers that are not members of a securities exchange
Institutional investors (mutual funds, life insurance companies, pension funds) receive reduced trading costs due to large size of transactions

- Fourth Market
Large institutional investors deal directly with each other to bypass market makers
Electronic Communications Networks (ECNs) allow direct trading
ECNs most effective for high-volume, actively traded securities

Front 31

General Market Conditions

Back 31

- Bull Market
Favorable markets
Rising prices
Investor/consumer optimism
Economic growth and recovery
Government stimulus

- Bear Market
Unfavorable markets
Falling prices
Investor/consumer pessimism
Economic slowdown
Government restraint

Front 32

Globalization of Securities Markets

Back 32

- Diversification: the inclusion of a number of different investment vehicles in a portfolio to increase returns or reduce risks

- Use of International Securities Improves Diversification

- International Investment Performance

- Indirect Ways to Invest in Foreign Securities

- Direct Ways to Invest in Foreign Securities

Front 33

Risks of International Investing

Back 33

- Usual Investment Risks Still Apply

- Government Policies Risks

- Currency Exchange Rate Risks

Front 34

Trading Hours of Securities Markets

Back 34

- Regular Trading Session for U.S. Exchanges and Nasdaq
9:30 A.M. to 4:00 P.M. Eastern time

- Extended-Hours Electronic-Trading Sessions
NYSE: 4:15 to 5:00 P.M. Eastern time
Nasdaq: 4:00 P.M. to 6:30 P.M. Eastern time
Regional exchanges also have after-hours trading sessions
Orders only filled if matched with identical opposing orders

Front 35

Regulation of Securities Markets

Back 35

- Insider Trading
Use of nonpublic information about a company to make profitable securities transactions

- Blue Sky Laws
Laws imposed by individual states to regulate sellers of securities
Intended to prevent investors from being sold nothing but “blue sky”

- Securities Act of 1933
Required full disclosure of information by companies

- Securities Act of 1934
Established SEC as government regulatory body

- Maloney Act of 1938
Allowed self-regulation of securities industry through trade associations such as the National Association of Securities Dealers (NASD)

- Investment Company Act of 1940
Created & regulated mutual funds

- Investment Advisors Act of 1940
Required investment advisers to make full disclosure about their backgrounds and their investments, as well as register with the SEC

- Securities Acts Amendments of 1975
Abolished fixed-commissions and established an electronic communications network to make stock pricing more competitive

- Insider Trading and Fraud Act of 1988
Prohibited insider trading on nonpublic information

- Sarbanes-Oxley Act of 2002
Tightened accounting and audit guidelines to reduce corporate fraud

Front 36

Basic Types of Securities Transactions - Long Purchase

Back 36

- Investor buys and holds securities

- “Buy low and sell high”

- Make money when prices go up

Front 37

Basic Types of Securities Transactions - Margin Trading

Back 37

- Uses borrowed funds to purchase securities

- Currently owned securities used as collateral for margin loan from broker

- Margin requirements set by Federal Reserve Board
Determines the minimum amount of equity required
On $4,445 purchase with 50% margin requirement, investor puts up $2,222.50 and broker will lend remaining $2,222.50

- Can be used for common stocks, preferred stocks, bonds, mutual funds, options, warrants and futures

Front 38

Margin Trading - Advantages and Disadvantages

Back 38

- Advantages
*Allows use of financial leverage
*Magnifies profits
- Disadvantages
*Magnifies losses
*Interest expense on margin loan
*Margin calls

Front 39

Basic Margin Formula

Back 39

Margin = (Value of Security - Debit balance)/Value of Securty

Front 40

Basic Types of Securities Transactions - Short Selling

Back 40

- Investor sells securities they don’t own

- Investor borrows securities from broker

- Broker lends securities owned by other investors that are held in “street name”

- “Sell high and buy low”

- Investors make money when stock prices go down

Front 41

Short Selling - Advantages and Disadvantages

Back 41

- Advantages
*Chance to profit when stock price declines

- Disadvantages
*Limited return opportunities: stock price cannot go below $0.00
*Unlimited risks: stock price can go up anunlimited amount
*If stock price goes up, short seller still needs to buy shares to pay back the “borrowed” shares to the broker
*Short sellers may not earn dividends