Topic 1.

The concept and classification of the Stock Exchange transactions

1. Definition and structure of the stock-exchange transactions;

2. Stock-exchange transactions handled in the international practice;

3. Transactions with primary financial securities;

4. Transactions with derivatives;

5. Types of stock-exchange transactions from the investor’s motivation point of view.

=1=

Generally speaking, transaction can be defined as a convention between two or more parts,
through which certain rights are passed, or a commercial exchange is made.

Stock exchange transactions are seen as contracts of purchase of titles and of other
financial assets, concluded on the secondary capital market, with the agents de change from the
respectively authorized societies of financial intermediation as a go-between. These transactions
are to be handled according to the law on securities from the respective country and to the
regulations of the implied institutions (Stock exchange Market, OTC, etc.).

The interpretations of the notion of stock exchange transactions have gradually evolved
over time, especially recently, so that, if traditionally stock exchange transactions were considered
only that contracts concluded inside the Stock exchange and during the trade, now the only
condition to be accepted as such is for them to be registered at the Stock exchange. Besides, this
occurred as a result of the bourse delocalization phenomenon, the globalization one as well as the
OTC market’s appearance.

=2=

There is a big diversity of types of stock exchange transactions. Regardless to their nature,
the transactions’ technique is marked by the way of their settlement and the price at which these
are realized. This way, two big categories occur:

 Spot transactions;

 Time bargain (forward);

According to their object, stock exchange transactions can be:

 Transactions with primary financial securities;

 Transactions with derivatives;

As what concerns the transactions with primary financial securities the attention is focused
on two models of transactions:

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 • American;

• European;

According to the American model, transactions can be:

• For cash;

• On margin;

• Short selling;

The European model includes the following types of transactions (according to the French
securities market model):

• Au comptant (spot);

• Au reglement mensuel (time bargain);

• A prime (conditional operations).

Transactions with financial derivatives are represented by futures and options.

Main categories of stock exchange transactions

Transactions with primary Transactions with derivatives

financial securities

Transactions Transactions Futures Options

according to according to the
the European
American model:
model: 1. au comptant;
1. for cash; 2. au reglement
2. on mensuel;
margin; 3. a prime.
3.short

Fig.1. Types of stock exchange transactions

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 =3=

As what concerns the transactions with primary financial securities the attention is focused on the
transactions according to the American model (which are specific to the Asian stock exchange, too) and
to the European model.

Transactions according to the American model

Transactions for cash are those market operations in which the buyer has to pay for all the
securities he is going to buy, entirely with cash, and respectively the seller has to own them and
immediately to deliver them to the broker who had placed the order.

On the stock exchanges corresponding to the American model, according to the moment of the
execution of the contract, can be met the following types of transactions:

 Cash delivery- when the execution (delivery/payment of the securities) takes place
in the same day with the entering into the contract;

 Regular settlement- where the execution of the contract is made after/in a certain
number of days from the moment of entering into the contract;

 Agreement based settlement – usually executed at a date arranged by parts, but

not later than 60 days after concluding the contract;

 When issued- for financial securities that had not been yet issued, but it is known
the date of their issue.

In order to execute such transactions, the investor has firstly to open a simple investment
account or a cash account at the agency of a broker that acts as an intermediary. Through this account the
evidence of transactions, of owned securities, of prices and others is held.

Transactions on margin are those in which the investor has the possibility to obtain credits
from the agency of the broker he works with, in order to enter into and execute the transactions. To
benefit of such a credit, the investor has to open a special account named margin account. Through this
account the evidence of titles traded on credit, of their price, as well as the evidence of the obtained
credits and of their guarantee payment, are held. In order to operate with his margin account, the investor
must put money in advance, because the agency of the broker or the investment bank does not finance the
entire sum necessary for the operation, and here is where the guaranties are needed. This way, the
necessary sum is composed from the investors guarantee and the obtained credit. This guarantee can be
granted in money or in value papers accepted by the agency of the broker. As long as the agency does not
bear the risk of the investment, the value papers are to be evaluated, according to their risk, at a value of
collateral. Until the loan is refunded, this titles of collateral are kept in an agency’s account (service also
known as “street name”). Of course, the investor remains the owner of these titles and benefits of all the
rights that result from their ownership (interests, dividends), but he can sell them only after paying the
loan.

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 Due to various techniques and types of transactions the investor can gain profit from an increase
in price as well as from a decrease. This is characteristic for the transactions on margin, too. On the
securities markets in the USA, according to the position of the investor towards the market evolution,
there are 2 types of margin account: long margin account (M) and short margin account (V).

Transactions in the long margin account (M) are transactions made when an increase in market
price occur. In this situation, to obtain profit, the investor firstly executes a purchase transaction, and after
a certain period he sells that value papers at a higher price. All the details about this process are recorded
in the long margin account. Theoretically thinking, this type of transaction offers the possibility to the
investor of an unlimited profit, whilst its risk is limited to the loss of the invested amount of money (in
the worst case, the price of bought titles can reach zero).
Transactions in the short margin account (V) are transactions executed when market price is
decreasing. Here, the investor (speculator, more appropriate) borrows the value papers and sells them at
the market price of that day, hoping that after all he will buy them at a lower price in order to give them
back. Here we firstly deal with a sale, and after with a purchase, so that the idea of making profit is the
same as in the long margin account (M), but the transactions order is inverse. The main difference is that
this type of transactions can lead to theoretical unlimited losses (thinking that the purchase price of the
borrowed value papers can increase infinitely), whilst the possible profit gaining is limited (the maximum
profit is the value cashed from the sale).
Thus, short sale can be defined as the procedure used in securities markets, in which a speculator
has the possibility to sell value papers that he doesn’t own at the moment of transaction, but borrows from
the agency of a broker, in order to give them back at a certain future date. The return means the purchase
of these value papers at the market price in the settling day, price that is estimated by the investor to be
lower than the one from the moment of sale, so that the difference represents his profit.

Short sales main motivation is the profit gaining through speculation, anticipating the decreases in
prices or speculating on the temporary price fluctuations. If the gaining possibilities are big, the risk at
short sales is theoretically unlimited, as it is explained higher. As a measure of protection against such
risks, special stock exchange products, like options can be used.

Transactions with value papers according to the European model

Transactions on EU securities markets are divided in two main categories: spot transactions and
time bargain (forward transactions). Forward transactions are also divided, thus they can be firm or
conditional.

Spot transactions (fr. au comptant) are the transactions in which the contract (payment and
delivery of the titles) is settled immediately or in a very short period. Their equivalent on the American
stock exchanges, are cash delivery transactions. The main conditions for these transactions to unfold well
are: first that the investor, in the same time when placing the order, to transfer the sum of money in the
account, and secondly, the seller must deliver the titles to the broker and simultaneously or in a very short
period place the sale order.

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 The spot transactions weight from the total amount of stock exchange transactions is relatively
low, mainly because these kind of transactions cannot be settled if at that moment its initiator doesn’t
have, on one hand the necessary sum of money, and on the other, the value papers.
A special category of transactions are the public secondary offers, and they can be of three main
types:

• Purchasing offer – the investor that announces it is willing to buy securities;

• Selling offer – the investor has the intention to sell titles;

• Swap offer – similar to the purchasing offer, but in return to the given titles the investor
requires another ones.

The main objectives, when initiating such offers, are:

 For an investor to take over the corporate control;

 To obtain a majority of voting stock.

Usually, such take over’s, resulting from public offers, are settled in a friendly way, but there also
are situations with aggressive purchasing offers, with the help of which their initiator tends to buy certain
securities no matter the price.

Time bargain transactions (forward)

Time bargain are transactions with securities, handled on stock exchanges, which are to be settled
at a certain date and at a certain rate. The rate, the settling day and the rest of the conditions are stipulated
in the forward contract, handled at the moment of transactions initiation.

Through forward transactions can be marketed shares, bonds, Treasury bill, etc., and in the settling
day it is received/delivered exactly what had been negotiated, respectively the value of that titles, unlike
the future contracts, where the object of negotiations is the contract itself.

Time bargain with primary titles can be firm or conditional.

Firm transactions represent the forward transactions that are entered into at a certain moment and
must be executed after a period of time, in the settling day. This time period differs from a stock exchange
to another, and it is usually regulated in each country separately (for example, in France, it is applied the
monthly regulation, called “reglement mensuel”).

To handle a transaction, the investor gives a purchasing/selling order to his broker, at an

established rate; on its basis, the bourse will look for a counterpart, i.e. a seller/buyer who would accept
the quantity and price conditions. This way, the client who is buying takes on the pledge to pay the seller
for the certain amount of titles at the established rate, in the settling day. Respectively, the seller engages
to deliver to the buyer the fixed amount of securities at the established price, in the settling day.

Conditional transactions are also forward transactions, but unlike the firm ones, these allow the
buyer to choose between two possibilities: to execute the contract or to give up on it, in exchange to
prime paid to the seller. These transactions have an extremely speculative character and can be handled
only with certain value papers.

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 There are two main categories of conditional transactions:

a) Premium transaction;

b) Straddle;

Premium transaction are stock exchange operations, through which the buyer gets the possibility
to cancel the contract, if the settling of it would bring losses, by paying a bonus to the seller.

The value of the bonus is established by the market, but it cannot exceed a certain percent
according to the price of the title at that moment (for example, on the French bourse it must be lower than
10%). Premium transaction are mainly practiced with a view to speculating or hedging. Their main
characteristic is that the buyer’s loss cans maximum reach the value of the bonus.

Premium transaction bring profits, usually when the market is disturbed. But on the modern
markets, which are extremely equilibrated, this type of transactions has been replaced by the straddle
transactions, which evolved very well in last years.

Straddle are that conditional transactions through which the buyer has the right to choose the
position of the buyer, or of the seller at one of the settling day. In such a contract there are established two
prices (for example 15.000/20.000), which means that the initiator (buyer), in the settling day, will
purchase the securities at the highest price or will sell them at the lowest. If in the settling day, the price
will be besides these limits (less than 15.000 or greater than 20.000) the initiator (buyer) wins. In the case
when in the settling day the price is lower than 15.000, the initiator gains profit if he chooses the position
of the seller, respectively when the price is higher than 20.000 he wins by taking the position of the buyer.
In the case when the price is between these limits, the advantage is taken by the seller.

The reason of entering into such transactions is either a speculative one, or hedging. The investor
will complete a straddle as a buyer with those titles, that are considered to be volatile and for which it is
impossible to predict the sense of their evolution (increase or decrease). The partner of this straddle, i.e.
the seller, enters into when foresees a small variation in price.

=4=

Futures

Futures are firm contracts, between two parts, to sell, respectively to buy certain values, at an
established price, in a future date. One of their characteristic is that they have a standardized form.

The contract in which are stipulated the obligations of parts, the futures, is negotiable and on
bourses where such transactions are held. This way, each part has two alternatives:

a) The buyer can wait the settling day and accept the normal settlement, or to sell the contract to
another person;

b) The seller can deliver the assets in the settling day, or can cover his position of debtor by
purchasing the same type of contract from the market.

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 The futures value is given by the market, their price being established by confronting their
demand and supply. This price of futures is related to the assets that this contract has as object of the
transaction, but it doesn’t strictly depend on it.

For futures, to open a position on the market, it is needed a minimum guarantee deposit, that is,
the transactions with futures are handled with a trading margin, which supposes a high gearing effect, that
is attractive for speculators in search of big profits.

It important to notice that not receiving or the delivery of the values that make the object of the
contract is the main objective when entering into futures transactions, but obtaining profit from the
differences between the moments of entering into the contract and the settling day.

Futures transactions can be:

a) Commercial (especially characteristic for the market of goods);

b) with financial instruments:

• with currency;

• with interest rate for different value papers (bonds, treasury bonds, etc.);

• with bourse indices.

From the presented characteristics, we may notice that futures can be assimilated to some financial
titles (that are negotiable and have a market value) and represent a good investment for the clients.

Options transactions

Options give the buyer the right, and not the obligation, in exchange to a bonus, to sell or buy
some values (until) in a certain future date, at an initially established price.

Options appeared a few centuries ago and were offering the possibility of entering into
transactions that didn’t require the obligation of settling them, but only if it were necessary.

Until 1973, there were only classical options, that couldn’t be passed to somebody else. At this
date, Chicago Option Exchange (CBOE) realizes a decisive financial innovation: negotiable options. If at
classical options the buyer and the seller stood linked by the contract till the settling day, then the
negotiable options give the possibility buy/sell them from/to third party, thus, the implied parties can
close their positions until the settling day, independently.

For the options to become negotiable and get this way the characteristics of a financial title, it was
needed to standardize the terms of the contract and to set up a clearing institution that would issue and
record the contracts, guaranteeing that the parties will carry out their obligations.

Like futures, negotiable options (further just options) are derivative bourse products because they
are made on basis of other assets. These assets, which are the object of the contract, can be currencies,
primary financial titles, stock exchange indexes or even futures.

There are two types of options: call (purchasing) and put (selling).
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 Those investors who wish to enter into transactions with options can take one of the four
positions:

1. long position (as a buyer):

a) long call;

b) long put;

2. short position (as a seller):

a) short call;

b) short put.

The buyer of a call option (long call) obtains the right to buy certain assets (an amount of
securities) at a predetermined rate, within a certain time period. He foresees that in future the value of the
assets will grow over that rate, thus obtaining profit from their selling at the market price.

On the other hand, the seller of the call option (short call), in exchange to the bonus got from the
buyer, is committing to deliver the assets at the agreed price. Taking a bearish position, he is expecting
that the market will not grow and the buyer won’t use his right over the call contract, and he gets the
maximum profit that can from such a transaction – the bonus.

The operations in the case of put options are symmetrical and follow the same logic.

Related to these options, as regards the market, the investor can take the following attitudes:

• Bullish – when expecting a growth in the price of the object, this is specific to the long
call and short put positions.

• Bearish – when expecting a decrease in the price of the object, and it is characteristic to
the short call and long put positions.

The execution of an option can be done in the following ways:

1. Through its liquidation;

2. Through its settlement;

3. Through its expiration.

1. The liquidation of the option means closing the initial position by an inverse operation.
This way, the buyer of a call option will close his position by selling a call option, whilst the seller of a
call option – by purchasing such an option. In the case of put options, the logic is the same. Through this
closing of positions the losses, from one position, are compensated with the gaining from the other, this
way obtaining a reduced profit or loss.

2. Through its settlement, the buyer of the option exerts his rights over the object of the
option, and respectively the seller will deliver the titles whilst the buyer will pay them at the established
price. For this operation to take place, the clearing institution will find the correspondent positions that
will execute the transaction.

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 3. The options expiration means actually the abandon, and takes place only when the price of
the assets didn’t evolve according to the investor’s expectations. The buyer will give up the option, letting
it lose its validity. In this case he loses the bonus given to the seller.

The main rationale of the options is hedging against risks. Besides this, options are considered
to be a special tool that helps to making the investments more advantageous and obtaining big profits due
to its speculative character.

=5=

The final goal of the stock exchange operations is, in fact, the investment in value papers.

Such placements have five main forms:

1. Simple placements;

2. Exchange speculations;

3. Arbitrage in securities;

4. Hedging;

5. Technical transactions;

Simple placements are investments of available capital (of private persons or firms) on stock
exchanges by buying or selling securities. These value papers are represented by titles with variable
revenue (shares), with fixed revenue (bonds), as well as other stock exchange products.
These placements goal is to obtain revenue such dividends, interest and/or capital gain.

An investor who places his available capital on stock exchanges is expecting to fructify as
much as possible this capital, in the same time knowing the typical risk of these placements and that is
usually bigger as the investment is more rentable. The main solution when diminishing this risk is
diversification. This means that a reasonable investor will place his money in more different titles, not in
single typed ones, this way compensating eventual losses obtained from ones with revenues obtained
from another. This is how he builds his investment portfolio, the evolution of which he will follow
permanently, and will modify its composition when the initial conditions will change.

Exchange speculations are successive buy-sell operations with financial titles, through which
the investor tends to obtain profits from the differences of rates. The basic principle of the exchange
speculations is the one of every business: buy low, sell high. Exchange speculations are characterized by
the profits aimed by the speculator and the risk that this assumes, knowing all conditions. This risk comes
from the fact that the speculator cannot precisely forecast the evolution of the rate.

Often it is hard to make the difference between the simple placements and speculations. Of
course, the aimed objectives are different. Through simple placements it is aimed to obtain revenues and
safety of the investment. Although through a simple placement titles are bought for keeping them, it
becomes a speculation if these are soon sold with the aim of making profit. This way and vice- versa, as

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the great speculator and financial expert George Soros was saying: “an unsuccessful speculation becomes
an investment”.

There are different types of speculators:

a) Those who speculate rate variations from one day to another;

b) Those who speculate rate fluctuations according to the registered average for a certain
period;

c) Long- term speculators, who regard rate variations over linger time periods (months,
years);

d) Permanent speculators;

Each speculators objective is to obtain profit from each and every transaction he concludes
and expects that this happens because of the assumed risk. Due to this fact the speculator won’t take into
account ethical problems and, for example, will “get rid of” those titles which he doesn’t trust anymore
and will sell them to less acknowledged investors.

In practice there are two big types of speculations according to the way of titles rate evolution:

a) Bull speculations- when the speculator stakes on the increase of rates, their profit being the
difference gained because of the fact that he bought cheaper and sold expensive.

b) Bear speculations- when the speculator stakes on the decrease of rates, their profit being
represented by the positive difference gained when selling at higher rates and buying back
at lower.

In fact, it is better when on stock exchanges act well informed speculators. Their intervention
diminishes bourse fluctuations and thanks to them, the investors interested in placements or sales have the
possibility to find easier the opposite position. Speculation is necessary on the stock exchanges and it is
ethical because the profit earned by the speculator is not for free, but is the result of the assumed risks.

It is important to make the difference between the speculator and player. Usually, the
speculator is a well informed person, with deep knowledge concerning stock exchanges and who are
based on rational forecasts. The player, gambler, goes on hazard and in this case, handled transactions
seem more like to a gamble, roulette, etc.

Agiotage is also a false speculation and it is a work through which it is aimed the artificial
increase/decrease of the rates by hawking false news about the situation of a certain company. For
example, those who practice agiotage artificially decreases the price and when it reaches the wanted level,
sufficiently low, buy and subsequently sell them at a higher price after also they will increase it.

Arbitrage in securities

Through arbitrage an investor aims obtaining profits through successive placements, but of
different senses and it actually consists from buying one value paper from one stock exchange, where its
price is lower and then sell it simultaneously or immediately on a market where the price of the respective
value is higher.

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 Arbitrage is considered to be riskless and owing to this the investor may remain with low
revenues. Unlikely the speculation, the arbitrage is based on already known rates and not on forecasts and
this way the only result for the investor is the gain. Before handling an arbitrage an investor has to study
attentively besides the titles rates, a number of other factors that could annihilate the expected earnings,
given by the certain differences between rates. Hence, when handling an arbitrage the next must be taken
into account:

• Firstly, the rate of the securities on different markets, in order to establish the
differences;

• Transactions expenditures and the commissions payed to intermediaries;

• Currency rates and their converting (if the arbitrage takes place on international
markets);

• Insurance expenditures;

It is important to underline that arbitrage is not accessible to everyone, but only to the
stock exchange transactions specialists or even more to those from the interior of the bourse system. This
is because in order to obtain profits arbitrage, it is necessary to be very well informed, always knowing
the rates variations and to have the possibility of operating on more stock exchanges, that is to issue buy
and sell orders.

Hedging

Hedging operations are those bourse operations through which the person who initiate
them aims to cover his investment against the risks of changes in his titles rates. In fact, hedging means
investors securities protection in the conditions of an instable market, and not earning profits. This way,
through hedging are avoided losses, but also are canceled the chances of obtaining profits.

Even if the purpose of the hedging differs from the one of speculators, the technique of its
realization is the same. As in the case of a speculation, where one of the partners implied in transaction
wins whilst the other loses, in the case of hedging the loss, along with the gain, are transferred.

Practically, the hedging takes place this way: parallel to the buy-sell bourse operations
exposed to risks, the one who wishes to cover will initiate speculative transactions of the same type and in
the same conditions (sum, settling day), but of different sense. This way, the buyer of securities becomes
in the same time a speculator seller for the same titles, respectively the seller becomes also a speculator
buyer.

On one of those two positions on which he is (in the initial transaction, or in the
speculative one that he initiated), the hedging initiator will win and will lose on the other. So, for him it is
equal if the risk takes place or not. More, if the events evolve in a favorable way the investor has canceled
any chance to obtain the profit, losing on speculative contracts that he signed. But, this is the price of
protecting his securities against the depreciation.

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