Salaar - Finance

Investments

BSC
Summer Semester 2009
Lahore School of Economics

Salaar Farooq – Assistant Professor

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Securities

Markets

Chapter 5
Lecture
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Chapter 4
Securities Markets

Summary

Why are Financial Markets Important?

What are Primary Markets?

What are Secondary Markets?

What are Types Markets?
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How Securities are Traded

Learning Objectives

What is a Secondary Market?

Where are Securities Traded?

Types of Orders?

What are Brokers?

What is a Margin?

Price Efficiency?

Transaction Costs?
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Financial Markets?
Secondary Markets

Markets where existing securities are traded

For investments to be attractive…

they must have…

“LIQUIDITY” & SECONDARY markets provide that

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Financial Markets?

Secondary Markets

Function of Secondary Markets?

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Financial Markets?

Secondary Markets

Function of Secondary Markets

Provides info on Value of Security

Indicates Consensus price

Shows how well the Firm is using funds

Gives an idea of how NEW issues would be received

Provides Liquidity to the markets

Allows for investments to change ownership easily
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Financial Markets?
US Securities Markets for Equities
Where are these exchanges?
Equity
NYSE
AMEX
NASDAQ
ECN’S
KSE
BONDS
NYSE & AMEX Bond markets
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Financial Markets?

US Securities Markets for Equities

Equity
NYSE (New York Stock Exchange)
AMEX (American Stock Exchange)
NASDAQ (National Association of Securities Dealers)
ECN’S (Electronic Communications Network)
KSE (Karachi!)
BONDS
NYSE & AMEX Bond markets
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Financial Markets?
US Securities Markets for Equities

Equity
NYSE – 1366 seats (1.5mil$)-2800 co’s valued 13 trillion-Dvol 1.5Bil
AMEX – 807 seats – 760 companies – 2% of ttl value – 200mil vol
NASDAQ- 3843 co’s – 1bil vol – computerized mkt network
ECN’S (Electronic Communications Network)-linked to all
OTC – Not listed but registered, 3000 co’s – dealer network linked
KSE: 200 seats, 163 active, 658 co’s, 35B MCap, 350m! vol, 100 co’s =90% Mcap
BONDS
NYSE & AMEX Bond markets
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Perfect Markets?
Conditions Required?
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Perfect Markets?
Conditions Required
1. Large no. of buyers & sellers & no one is significant. (LIQUIDITY)
2. Everyone is a price taker
3. Price is determined by pure Supply-Demand
4. No frictions exist (COSTS)

Frictions
Costs & barriers to affecting Buyers/sellers payoffs
Eg.
Commisions
Bid-ask spreads
Taxes etc
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Financial Markets?
Securities Markets for Equities

Bid price

Offer Price

Block trades

Program trading
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Financial Markets?
Securities Markets for Equities

Bid price
Px some one will buy for

Offer Price
Px someone will sell for

Block trades
Trades of 10,000 or more

Program trading
Computer generated buy & sell signals for $1 mil or more
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Financial Markets?

Securities Markets for Equities

OTC (Over the counter mkts)

ECN’s

After Hours Trading

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Financial Markets?
Securities Markets for Equities

OTC (Over the counter mkts)

Stocks not listed on an exchange but traded on closed computer networks

ECN’s
Computerized trading network for large traders & brokers – computer matched orders

After Hours Trading

Normal hrs: 9.30 – 1600
AHT hrs: 1600-2000
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Financial Markets?
Securities Markets for Equities

Dow Jones Industrial Average

Standard & Poor’s (S&P 500)

Nasdaq
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Financial Markets?

Securities Markets for Equities

Dow Jones Industrial Average

30 Blue chip stocks – stock price weighted average

Standard & Poor’s (S&P 500)

500 stock composite

Nasdaq
100 Large cap companies
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KSE 30
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• The Dow Jones Industrial Average consists of the

following 30 companies:
• 3M Co. (NYSE: MMM) (conglomerates, • Honeywell International, Inc. (NYSE: HON)
"manufacturing") (conglomerates)
• ALCOA Inc. (NYSE: AA) (aluminium) • Intel Corp. (NYSE: INTC) (semiconductors)
• Altria Group, Inc. (NYSE: MO) (tobacco, foods) • International Business Machines Corp. (NYSE: IBM)
(diversified computer systems)
• American International Group, Inc. (NYSE: AIG) • JPMorgan Chase and Co. (NYSE: JPM) (money
(property & casualty insurance) center banks)
• American Express Co. (NYSE: AXP) (credit • Johnson & Johnson Inc. (NYSE: JNJ) (consumer and
services) health care products conglomerate)
• AT&T Inc. (NYSE: T) (telecoms) • McDonald's Corp. (NYSE: MCD) (restaurant
• Boeing Co., The (NYSE: BA) (aerospace/defense) franchise)
• Caterpillar, Inc. (NYSE: CAT) (farm & construction
• Merck & Co., Inc. (NYSE: MRK) (drug
equipment) manufacturers)
• Citigroup, Inc. (NYSE: C) (money center banks) • Microsoft Corp. (NYSE: MSFT) (software)
• Coca-Cola Co. (NYSE: KO) (beverages) • Pfizer, Inc. (NYSE: PFE) (drug manufacturers)
• E.I. du Pont de Nemours & Co. (NYSE: DD) • Procter & Gamble Co. (NYSE: PG) (consumer
(chemicals) goods)
• Exxon Mobil Corp. (NYSE: XOM) (major • United Technologies Corp. (NYSE: UTX)
integrated oil & gas) (conglomerates)
• General Electric Co. (NYSE: GE) (conglomerates,• Verizon Communications (NYSE: VZ) (telecoms)
media) • Wal-Mart Stores, Inc. (NYSE: WMT) (discount,
• General Motors Corporation (NYSE: GM) (auto variety stores)
manufacturers) • Walt Disney Co., The (NYSE: DIS) (entertainment)
• Hewlett-Packard Co. (NYSE: HPQ) (diversified
computer systems)
• Home Depot, Inc. (NYSE: HD) (home
improvement stores)
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Brokerags vs Dealers?

Brokers = middle-men

Dealers = shopkeepers (MARKET MAKERS)

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Brokerage Firms

Full Service Brokers

Discount Brokers

Online Discount Brokers

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Brokerage Firms

Full Service Brokers

Offer Full Range of services including info and advice.

Discount Brokers
offers execution services

Online Discount Brokers

offers platforms on the net
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Types of Brokerage Accounts

Cash Account

Margin Account

Asset Management Account

Wrap Account

Commissions

Drip (Dividend Reinvestment Plan)
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Types of Brokerage Accounts

Cash Account
Only cash transactions

Margin Account
Allows cash and debt transactions

Asset Management Account

Offers investment of cash balances and Cheque writing

Wrap Account
all fees are wrapped into one

Commissions

Drip (Dividend Reinvestment Plan)
free reinvestment by companies

DOLLAR COST AVERAGING - illustrate

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How Orders Work

Organize Exchanges (NYSE, NASDAQ)

Super Dot (NYSE)

NASDAQ System of dealers

Decimalization of stock prices
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How Orders Work

Organize Exchanges (NYSE, NASDAQ)

Super Dot (NYSE)
Electronic system for NYSE

NASDAQ System of dealers

Through computer market making firms

Decimalization of stock prices

Jan 2001 stocks were decimalized, average spread five cents (NOW 1c)
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Types of Orders

Market Order

Limit Order

Stop Order
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Types of Orders

Market Order
Best price on the floor – ENSURES EXECUTION NOT PX

Limit Order (new position)

specified or better price – ENSURES PX – NOT EXECUTION

Stop Order (existing position)

Automatic execution at specified price

BUY STOP – PROTECTS PROFITS

SELL STOPS – PROTECT LOSSES
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Investor Protection

Government Regulation

SEC

Self Regulation

NASD
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Investor Protection

Government Regulation

SEC
1934

Self Regulation
stock exchanges monitor and regulate

NASD
Also monitor
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Margin

Margin

Initial Margin

Maintenance Margin

Margin Call
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Margin (Leveraged Positions)

Margin
part of transaction value which is customers equity

Initial Margin
the part the customer must pay to initiate a transaction – 50%

Maintenance Margin
%age of securities value which must be on hand as equity – 25%

Margin Call
demand from broker for cash if actual M < maintenance M
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Margin

Margin
part of transaction value which is customers equity

Initial Margin
amount investor puts up / value of transaction

Maintenance Margin
%age of securities value which must be on hand as equity

Margin Call
MARKED TO MARKET EVERYDAY

Actual margin =
(current value of stock – amount borrowed) / current value
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Short Sales

Being Long

Being Short

Short Sale

Short Interest Ratio
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Short Sales

Being Long
normal position of buying stock

Being Short
having sold stock not owned

Short Sale
selling stock not owned but borrowed

Short Interest Ratio

shares short to average daily volume
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Market Efficiency

Markets absorb & reflect all new information

into security prices

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Chapter 5
How Securities are Traded

Learning Summary

What are brokerage transactions?

How Orders Work?

What is Investor Protection?

What is Margin?

What are Short Sales?
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