10 Investor Monitoring

and Stock Offerings

CHAPTER OBJECTIVES
The specific objectives of this chapter are to:

■ describe the private equity market,

■ describe investor participation in the stock markets,
■ describe the process of initial public offerings,
■ describe the process of secondary offerings;
■ explain how the stock market is used to monitor and control
firms, and
describe the globalization of stock markets.
 Private Equity

Private equity (private firm) is a business that is privately held and the
equity is not traded in public stock exchange.
Some business owners hope to go public so that:
❖ They can obtain financing to support the firm’s growth
❖ They can “cash out” by selling their original equity investment to others.
A public offering is feasible if:
➔ The owners want to sell at least $50 million in stock.
➔ The shareholder base will be large enough to support an active secondary
market.
FINANCING BY VENTURE CAPITAL FUNDS
Private firms that need a large equity investment but are not yet in a position to go public may attempt to obtain
funding from a venture capital (VC) fund. Such funds receive money from:

A. wealthy investors and

B. from pension funds that are willing to maintain the investment for a long-term period, such as 5 or 10 years.

These investors are not allowed to withdraw their money before a specified deadline.

Venture capital funds have participated in a number of businesses that ultimately went public and became
very successful, including
1. Apple,
2. Microsoft, and
3. Oracle Corporation.
Private Equity Financing by Venture Capital
Funds (cont.)
● Venture Capital Market
➔ Brings together the private businesses that need equity funding and
the VC funds that can provide funding.
Terms of a Venture Capital Deal
When a VC fund decides to invest in a business, it will negotiate the terms of its investment,
including the amount of funds it is willing to invest.

➢ The VC fund will set out requirements for the business and VC fund managers
may serve as advisers to the business.

Exit Strategy of VC Funds

One common exit strategy is to sell its equity stake to the public after the business engages in a
public stock offering.

Financing by Private Equity Funds Private equity funds pool money provided by institutional
investors (such as pension funds and insurance companies) and invest in businesses.
Financing by Private Equity Funds
❏ Private equity funds pool money provided by institutional investors (such
as pension funds and insurance companies) and invest in businesses.
❏ They also rely heavily on debt to finance their investments.
❏ Unlike VC, private equity funds take over businesses and manage them.
Their target are overvalued and mismanaged.
❏ They sell their stake in the business after several years.
PUBLIC EQUITY….

When a firm goes public, it issues stock in the primary market in exchange for cash.

Going public has two effects on the firm.

it changes the firm's ownership it changes the firm's capital

structure by increasing the structure by increasing the
number of owners. equity investment in the firm,

➔ The secondary market allows investors to sell the stock they previously
purchased to other investors.
Ownership and Voting Rights
. Normally, only the owners of common stock are permitted to vote on certain key
matters concerning the firm, such as the

1. election of the board of directors,

2. authorization to issue new shares of common stock,
3. approval of amendments to the corporate charter,
4. and adoption of bylaws.
Public Equity

❖ Preferred stock - represents an equity interest in a firm that usually does

not allow for significant voting rights.
➢ Preferred shareholders share the ownership of the firm with common
shareholders and are therefore compensated only when earnings
have been generated.
➢ A cumulative provision on most preferred stock prevents dividends
from being paid on common stock until all preferred stock dividends
have been paid.
➢ Because the dividends on preferred stock can be omitted, a firm
assumes less risk when issuing it than when issuing bonds.
➢ Dividends are not tax-deductible for the firm, making preferred stock
less desirable than bonds.
Participation in Stock Markets

Investors can be classified as

1. individual - The investment by individuals in a large corporation commonly exceeds

50 percent of the total equity.

2. institutional. -various types of institutional investors that participate in the stock

markets are summarized in Exhibit 10.2.
Exhibit 10.2 Institutional Use of Stock
TYPE OF FINANCIAL INSTITUTION
Markets
PARTICIPATION IN STOCK MARKETS
Commercial banks • Issue stock to boost their capital base.
• Manage trust funds that usually
contain stocks.

Stock-owned savings institutions • Issue stock to boost their capital base.

Savings banks • Invest in stocks for their investment
portfolios.
Finance companies • Issue stock to boost their capital base.

Stock mutual funds • Use the proceeds from selling shares

to individual investors to invest in stocks.
Securities firms • Issue stock to boost their capital base.
• Place new issues of stock.
• Offer advice to corporations that consider
acquiring the stock of other companies.
• Execute buy and sell stock transactions of
investors.

Insurance companies • Issue stock to boost their capital base.

• Invest a large proportion of their premiums in
the stock market.

Pension funds • Invest a large proportion of pension fund

contributions in the stock market.
How Investor Decisions Affect Stock Prices
1. When there is a shift in the demand for shares or the supply of shares for
sale, the equilibrium price changes.

Investors market price is market price is means

below their above their
valuation, valuation,

buy ✅ undervalued.

sell ✅ overvalued.

2. Overall, the prevailing market price is determined by the participation of

investors in aggregate.
Investor Reliance on information
Investors respond to the release of new information that affects their opinions about
a firm's future performance.

❖ news about a firm's ❖ firm's stock is

performance

❖ favorable news ❖ undervalued at its prevailing

price

❖ Unfavorable news ❖ overvalued at its prevailing price

INITIAL PUBLIC OFFERINGS
A corporation first decides to issue stock to the public in order to raise funds.

-which is a first-time offering of shares by a specific firm to the public.

- commonly used not only to obtain new funding but also to offer some
-founders and
-VC funds a way to cash out their investment
Process of Going Public
● Developing a Prospectus - The issuer must develop a prospectus
containing detailed information about the firm, including financial
statements and a discussion of risks. The prospectus is filed with the
Securities and Exchange Commission (SEC). Road show
● Pricing - the offer price at which the shares will be offered at the time
of the IPO.
● Allocation of IPO Shares: Most of shares are sold to institutional
investors.
● Costs of IPO - Usually 10% of the funds raised.
Underwriter Efforts to Ensure Price Stability
● Underwriters may attempt to stabilize the stock’s price by purchasing
shares that are for sale in the secondary market shortly after the IPO.
❏ Lockup
❏ Prevents the original owners of the firm and the VC firms from
selling their shares for a specified period (usually 6 months from
the date of IPO).
Timing of IPOs
Initial public offerings tend to occur more frequently during bullish stock
markets.
Initial Returns of IPOs
The initial (first-day) return of IPOs in the United States has averaged about 20 percent over the last
30 years.

Facebook’s IPO
On May 18, 2012, Facebook engaged in an IPO that generated $16 billion.

Facebook’s opening price was $38/share. The price fluctuated throughout the day with a high of
about $43 and ended at $38.23.

Three months after the opening, the price fell to $20/share.

On Feb 20, 2015, $79.89.

Abuses in the IPO Market
IPO have received NEGATIVE PUBLICITY DUE TO
SEVERAL ABUSES
➢ 2003, regulators issued NEW GUIDELINES
○ COMMON ABUSES :
■ SPINNING
■ LADDERING
■ EXCESSIVE COMMISSIONS
Long-Term Performance Following IPOs
➔ There is strong evidence that, on average, IPOs of firms perform
poorly over a period of a year or longer.

➔ From a long-term perspective, many IPOs are overpriced at the

time of the issue.
Stock Offerings and Repurchases
-issue more stock or repurchase some stock

Secondary Stock Offerings

● Is a new stock offering by a specific firm whose stock is already publicly
traded.
● Corporations sometimes direct their sales of stock toward their existing
shareholders by giving them preemptive rights.
Stock Repurchases
★ Firms tend to repurchase some of their shares when share prices are at
very low levels.
★ Many stock repurchase plans are viewed as a favorable signal.
Stock Exchanges
- Any shares of stock that have been issued as a result of an IPO or a
secondary offering can be traded by the investors in the secondary
market

Organized Exchanges
❏ Each organized exchange has a trading floor where floor traders
execute transactions in the secondary market for their clients.
❏ New York Stock Exchange (NYSE)
❏ Floor brokers [commision / independent broker ]
❏ Specialists
Over-the-Counter Market
❖ Stocks not listed on the organized exchanges are traded in the over-
the-counter (OTC) market.
❖ Nasdaq - National Association of Securities Dealers Automatic
Quotations (Nasdaq), which is an electronic quotation system that
provides immediate price quotations.
❖ OTC Bulletin Board - lists stocks that have a price below $1 per share,
which are sometimes referred to as penny stocks.
❖ Pink Sheets - The OTC market has where even smaller stocks are
traded. Some of the stocks have very little trading volume and may not
be traded at all for several weeks.
Stock Exchanges Extended Trading
Sessions
-The NYSE and Nasdaq market offer extended trading sessions beyond
normal trading hours.

-Market liquidity during the extended trading sessions is limited.

Stock Quotations Provided by Exchanges
➔ 52-Week Price Range - The stock’s highest price and lowest price over
the previous 52 weeks
➔ Symbol - Each stock has a specific symbol that is used to identify the
firm.
➔ Dividend - The annual dividend.
➔ Dividend Yield - Annual dividend per share as a percentage of the
stock’s prevailing price.
➔ Price-Earnings Ratio - stock price per share divided by the firm’s
earnings per share generated over the last year.
➔ Volume - the volume of shares traded on the previous day. The volume
is normally quoted in hundreds of shares.
Closing Price.quotations
Stock Index Quotations
❖ Dow Jones Industrial Average - value-weighted average of stock prices
of 30 large U.S. firms in NYSE.
❖ Standard & Poor’s a value-weighted index of stock prices of 500 largest
U.S. firms.
❖ Wilshire 5000 Total Market Index - contains more than 5,000 stocks; is
the broadest index of the U.S. stock market.
❖ New York Stock Exchange Indexes - The Composite Index is the
average of all stocks traded on the NYSE.
❖ Nasdaq Stock Indexes - indexes of stocks traded on the Nasdaq.
Finance.yahoo.com
MONITORING PUBLICLY TRADED
COMPANIES

A publicly traded firms managers serve as agents for

shareholders bt making decisions that are supposed to
maximize the stock's price.
Private Stock Exchanges
Prior to an IPO, some private firms list their private shares on a private stock
exchange.
Advantages -
● Allows owners to obtain cash
● Purchasers may be able to pay a lower price than when a firm goes with
IPO.
Disadvantages
➢ Investors need to register with the private exchange and prove that they
have sufficient income
➢ Limited information available to investor
➢ Trading volume is limited
Globalization of Stock Markets
Methods Used to Invest in Foreign Stocks.
● Direct Purchases - Investors can easily invest in stocks of foreign
companies that are listed on the local stock exchanges.
● American Depository Receipts - certificates representing shares of non-
U.S. stock. Many non-U.S. companies establish ADRs in order to develop
name recognition in the United States.
● International Mutual Funds - portfolios of international stocks created and
managed by various financial institutions.
● International Exchange-Traded Funds - Passive funds that track a specific
index. International ETFs represent international stock indexes, and they
have become popular in the last few years.
Chapter 11 Valuation
and Risk of Stocks
CHAPTER OBJECTIVES
The specific objectives of this chapter are to:
■ explain methods of valuing stocks,
■ explain how to determine the required rate of return on stocks,
■ identify the factors that affect stock prices,
■ explain how to measure the risk of stocks, and
■ explain the concept of stock market efficiency.
 STOCK VALUATION METHODS

Making investment decision

Investing = stocks are undervalued

Selling = stocks are overvalued

Methods of valuing methods

● FUNDAMENTAL ANALYSIS -

○ relies on fundamental financial characteristics (such as earnings) of the firm and its
corresponding industry that are expected to influence stock values.

● TECHNICAL ANALYSIS -

○ relies on stock price trends to determine stock values.

Price-Earnings (PE) Method
❖ The price-earnings (PE) method assigns the mean PE ratio based on
expected earnings of all traded competitors to the firm’s expected earnings for
the next year

❖ VALUATION PER SHARE=(EXPECTED EARNINGS OF FIRM PER SHARE)

X (MEAN INDUSTRY PE RATIO RATIO)

➢ Assumes future earnings are an important determinant of a firm’s value

➢ Assumes that the growth in earnings in future years will be similar to
that of the industry
❏ Price-earnings (PE) method (cont’d)
❏ Reasons for different valuations
➔ Investors may use different forecasts for the firm’s earnings
or the mean industry earnings
➔ Investors disagree on the proper measure of earnings

❏ Limitations of the PE method

➔ May result in inaccurate valuation for a firm if errors are made in
forecasting future earnings or in choosing the industry composite
➔ Some question whether an investor should trust a PE ratio
Valuing A Stock Using the PE Method
A firm is expected to generate earnings of $2 per share next year. The mean
ratio of share price to expected earnings of competitors in the same industry is
14. What is the valuation of the firm’s shares according to the PE method?

VALUATION PER SHARE=(EXPECTED EARNINGS OF FIRM PER SHARE)

X (MEAN INDUSTRY PE RATIO RATIO)

=$2X14=$28
Stock Valuation Methods (cont’d)
★ Dividend discount model John Williams (1931)
● stated that the price of a stock should reflect the present value of the
stock’s future dividends:

t = period
Dt = dividend in period t
k = discount rate
Stock Valuation Methods (cont’d)
➔ Dividend discount model (cont’d)
◆ For a constant dividend, the cash flow is a perpetuity:

◆ For a constantly growing dividend, the cash flow is a growing

perpetuity:
 Using the Dividend Discount Model
◆ For a constant dividend, the cash flow is a perpetuity:

Example 1: A firm is expected to pay a dividend of $2.10 per share every year in
the foreseeable future. Investors require a return of 15% on the firm’s stock.
According to the dividend discount model, what is a fair price for the firm’s
stock?

dt= dividend in period t

k= discount rate
 Using the Dividend Discount Model
◆ For a constantly growing dividend, the cash flow is a growing
perpetuity:

Example 2: A firm is expected to pay a dividend of $2.10 per share in one year.
In every subsequent year, the dividend is expected to grow by 3 percent
annually. Investors require a return of 15% on the firm’s stock. According to the
dividend discount model, what is a fair price for the firm’s stock?
dt= dividend in period t

k= discount rate

g=rate which dividend is

expected to grow
Relationship between dividend discount model and PE
ratio

■ The PE multiple is influenced by the required rate of return and the

expected growth rate of competitors
■ The inverse relationship between required rate of return and value
exists in both models
■ The positive relationship between a firm’s growth rate and its value
exists in both models
 ADJUSTED DIVIDEND DISCOUNT MODEL
From the investor’s perspective, the value of the stock is equal to

1. The present value of the future dividends to be received over the

investment horizon plus
2. The present value of the forecasted price at which the stock will be sold at
the end of the investment horizon .
n
Forecasted earnings in n years= E(1+G)
G= expected growth rate of earnings
n= # of years until the stock is to be sold
If investors expect that the earnings per share will grow by 2 percent annually and expect to sell
the firm’s stock in 3 years, the earnings per share in 3 years are forecast to be
3
Earnings in 3 years = $12 x (1+0.02)
= $12 x 1.0612
= $ 12.73

The forecasted earnings per share can be multiplied by the PE ratio of the firms industry

If the mean PE ratio of all other firms in the same industry is 6 , the stock price in 3 years can be
forecast as follows:

Stock price in 3 years= (earnings in three years) x (PE ratio of industry)

=$12.73 x 6
=$ 76.38
Parker is expected to pay a dividend of $4 per share over the next 3 years.
Investors require a return of 14% on their investment, then the present value of
expected cash flows to be received by the investor is

1 2 3 3

PV = $4/(1.14) + $4/(1.14) + $4/(1.14) + $ 76.38 / (1.14)

=$3. 51 + $ 3.08 + $ 2. 70 + $ 51. 55

= $ 60.84
FREE CASH FLOW MODEL

- Based on the present value of future cash flows .

1st = estimate the free cash flows that will result from operations
2nd= subtract existing liabilities to determine the value of the firm
3rd= divide the value of the firm by the # of shares to derive a value per share

LIMITATIONS
- Difficulty of obtaining an accurate estimate of free cash flow per period.
Determining the Required Rate of Return to Value Stocks
➢ The capital asset pricing model:

-Used to estimate the required rate of return for any firm with publicly
traded stock

○ Assumes that the only important risk is systematic risk

○ Is not concerned with unsystematic risk
○ Suggests that the return on an asset is influenced by the prevailing
risk-free rate, the market return, and the covariance between a stock’s
return and the market’s return:
A. The capital asset pricing model (cont’d)
a. Estimating the risk-free rate and the market risk premium
i. The yield on newly issued T-bonds is commonly used as a proxy for the risk-free rate
ii. The terms within the parentheses measure the market risk premium
iii. Historical data over 30 or more years can be used to determine the average market
risk premium over time
b. Estimating the firm’s beta

i. Beta reflects the sensitivity of the stock’s return to the market’s overall return

ii. Beta is typically measured with monthly or quarterly data over the last four years or so
Using the CAPM
The beta of the stock for vaxon, inc is estimated as 1.2 according to the
regression analysis just explained. The prevailing risk-free rate is 6 percent, and
the market risk premium is estimated to be 7 percent based on historical data. A
stock’s risk premium is computed as the market risk premium multiplied by the
stock’s beta, so vaxon stock’s risk premium (above the risk-free rate
) is 0.07 x 1.2 = 8.4 percent. Therefore, the required rate of return on vaxon
stock is

= 6%+1.2(7%)

= 14.4%
Factors That Affect Stock Prices
A. Economic factors
❖ Impact of economic growth
➢ An increase in economic growth increases expected cash flows
and value
➢ Indicators such as employment, GDP, retail sales, and personal
income are monitored by market participants
❖ Impact of interest rates
➢ Given a choice of risk-free Treasury securities or stocks, stocks
should only be purchased if they offer a sufficiently high expected
return
Factors That Affect Stock Prices (cont’d)
❖ Impact of the dollar’s exchange rate value
■ The value of the dollar affects U.S. stocks because:
● Foreign investors purchase U.S. stocks when the dollar is
weak
● Stock prices are affected by the impact of the dollar’s changing
value on cash flows
● Some U.S. firms are involved in exporting U.S.-based MNCs
have some earnings in foreign currencies
● Exchange rates may affect expectations of other economic
factors
Factors That Affect Stock Prices (cont’d)

A. Market-related factors
a. Investor sentiment
i. In some periods, stock market performance is not highly correlated with existing
economic conditions
ii. Stocks can exhibit excessive volatility because their prices are partially driven by fads
and fashions
iii. A study by Roll found that only one-third of the variation in stocks returns can be
explained by systematic economic forces
b. January effect

i. Many portfolio managers invest in riskier small stocks at the beginning of the year and
shift to larger companies near the end of the year

ii. Places upward pressure on small stocks in January

Factors That Affect Stock Prices (cont’d)
A. Firm-specific factors
a. Some firms are more exposed to conditions within their own industry
than to general economic conditions, so participants monitor:
i. industry sales forecasts
ii. Entry into the industry by new competitors
iii. Price movements of the industry’s products

b. Market participants focus on announcements that signal information

about a firm’s sales growth, earnings, or characteristics that cause a
revision in the expected cash flows
FIRM-SPECIFIC FACTORS
○ Change in Dividend policy
■ An increase in dividends may reflect the firm’s expectation that it can more easily
afford to pay dividends
○ Earnings surprises

■ When a firm’s announced earnings are higher than expected, investors may raise their
estimates of the firm’s future cash flows

○ Acquisitions and divestitures

■ Expected acquisitions typically result in an increased demand for the target’s stock
and raise the stock price The effect on the acquiring firm is less clear

○ Expectations

■ Investors attempt to anticipate new policies so they can make their move before other
investors
Integration of factors affecting stock prices

❏ Whenever economic indicators signal the expectation of higher

interest rates, there is upward pressure on the required rate of return
❏ Firms’ expected future cash flows are influenced by economic
conditions, industry conditions, and firm- specific conditions
Role of Analysts in Valuing Stocks
● Many investors rely on opinions of stock analysts employed by securities
firms or other financial firms
● Many analysts are assigned to specific stocks and issue ratings that can
indicate whether investors should buy or sell the stock
● A 2001 study by Thomson Financial determined that analysts at the largest
brokerage firms typically recommended “sell” for less than 1 percent of all
the stocks for which they provided ratings
Role of Analysts in Valuing Stocks (cont’d)
➔ Conflicts of interest
◆ Many analysts are employed by securities firms that have other
investment banking relationships with rated firms
◆ Some analysts may own the stock of some of the firms they rate
➔ Impact of disclosure regulations
◆ In October 2000, the SEC enacted Regulation FD, which requires firms
to disclose any significant information simultaneously to all market
participants
➔ Unbiased analyst rating services
◆ Popular rating services include Morningstar, Value Line, and Investor’s
Business Daily
◆ Analyst rating services typically charge subscribers between $100 and
$600 per year
Stock Risk
❏ reflects the uncertainty about future returns such that the actual return may
be less than expected
❏ The holding period return is measured as:

❏ The main source of uncertainty is the price at which the stock can be sold
❏ Dividends tend to be much more stable than stock price
Stock Risk (cont’d)

● Measures of risk
○ The volatility of a stock:
■ May indicate the degree of uncertainty surrounding the stock’s
future returns
■ Reflects total risk because it reflects movements in stock prices for
any reason
 Stock Risk (cont’d)
Measures of risk (cont’d) The volatility of a stock portfolio depends on: The
volatility of the individual stocks in the portfolio

The correlations between returns of the stocks in the portfolio

The proportion of total funds invested in each stock

A portfolio containing some stocks with low or negative correlation will

exhibit less volatility
Stock Risk (cont’d)
★ Measures of risk (cont’d)
○ The beta of a stock portfolio:
■ Is useful for investors holding more than one stock
■ Can be measured as a weighted average of the betas of stocks in the portfolio, with
the weights reflecting the proportion of funds invested in each stock:

● The risk of a high-beta portfolio can be reduced by replacing some of the high-
beta stocks with low-beta stocks
Forecasting Stock Price Volatility and Beta
(cont’d)
● Forecasting a stock portfolio’s volatility
○ Portfolio volatility can be forecast by first deriving forecasts of
individual volatility levels
○ Next, the correlation coefficient for each pair of stock in the portfolio is
forecast by estimating the correlation in recent periods
● Forecasting a stock portfolio’s beta
○ First forecast the betas of the individual stocks and then take a
weighted average
Stock Market Efficiency
➔ Forms of efficiency
◆ Weak-form efficiency suggests that security prices reflect all trade-
related information
◆ Semistrong-form efficiency suggests that security prices fully reflect all
public information
● Includes announcements by firms, economic news or events, and
political news or events
● If semistrong-form efficiency holds, weak-form efficiency holds as
well
◆ Strong-form efficiency suggests that security prices fully reflect all
information, including private or insider information
Stock Market Efficiency (cont’d)
● Tests of the efficient market hypothesis
○ Test of weak-form efficiency
■ Tested by searching for a nonrandom pattern in security prices
■ Studies have generally found that historical price changes are
independent over time
■ There is some evidence that stocks:
● Have performed better in January (January effect)
● Have performed better on Fridays than on Mondays (weekend
effect)
● Have performed well on the trading days just before holidays
(holiday effect)
 Foreign Stock Valuation, Performance, and
Efficiency (cont’d)
❖ Measuring performance from investing in foreign stocks
➢ The performance measurement should control for general market
movements and exchange rate movements in the region where the
portfolio managers has been assigned to invest funds
Foreign Stock Valuation, Performance, and
Efficiency (cont’d)
★ Performance from global diversification
○ Stock investors can benefit by diversifying internationally
■ Economies do not move in tandem
■ Stock markets across countries may respond to some of the same
expectations
■ In general, correlations between stock indexes have been higher in
recent years than they were several years ago
Foreign Stock Valuation, Performance, and
Efficiency (cont’d)
➢ Performance from global diversification (cont’d)
○ Integration of markets during the 1987 crash
■ There was a high correlation among country stock markets during the crash
■ This suggests that the underlying cause of the crash systematically affected all markets
○ Integration of markets during mini-crashes
■ On August 27, 1998 (“Bloody Thursday”) most stock markets around the world experienced
losses
■ Illustrates that even a well-diversified international portfolio is not insulated from some
events
○ Diversification among emerging stock markets
■ These markets have lower correlations with developed countries, but also higher risk
Foreign Stock Valuation, Performance, and
Efficiency (cont’d)
● International market efficiency
○ Some foreign markets are inefficient because of the small number of
analysts and portfolio managers
○ Market inefficiencies are more common in small foreign stock markets
○ Insider trading is more prevalent in many foreign markets
○ Political and exchange rate risk may be high in some foreign markets
Chapter 12:
Market Microstructure and
Strategies
Chapter 12: Market Microstructure and Strategies
❏ A process by which securities such as stocks are traded.

Stock Market Transaction

1. In placing an order the investor communicates the order to the
broker by specifying:
i. Name of the Stock
ii. Buy or sell
iii. Number of shares bought or sold
iv. Whether the order is market or a limit order
a. Market Order - the transaction at the best possible
price.
b. Limit Order - placed on the price at which a stock
can be purchased or sold.
Stop Loss Order
1. Limit Order
a. The investor specifies a selling price that is below the
current market price of the stocks. pg.278
2. Market Order
a. When the stock price drops to the specified level.
pg.278
Stop Buy Order
1. Limit Order
a. The investor specifies a purchase price that is
above the current market price.
2. Market Order
a. When the stocks price rises to the specified level.
Margin Trading
When the investors place an order, they may consider purchasing
the stocks on margin. In that case, to purchase stock margin ,
investors must establish an account ( called Margin Account )

A Margin Call - from brokerage firm and will have to deposit cash to
the account i n order to boost the equity.

Impact on Returns
R = SP - INV- LOAN +D
INV
Where: o
SP - selling price of the stock
INV - initial investment by investor, not including borrowed funds
LOAN - bOrrowed funds D - Dividend payments
Short Selling
❏ Investors place an order to sell a stock that they do not own.

Measuring the Short Position of a stock

❏ The number of shares sold short is disclosed and compared to
the corresponding number a month earlier. ( The Wall Street
Journal )

Using a Stop Buy Order to Offset Short Selling

❏ Investors who have established a short position commonly use
a stop buy order to limit their losses.
❏ Concerns about Short Selling
❏ Restrictions on Short Selling
How Stock Transactions are executed:
❏ Transactions on the stock exchanges and the NASDAQ are
facilitated by floor brokers and market makers. \
a. Floor Brokers - floor of a stock exchange
b. Market Makers - specialist can serve the broker
function by matching up buy and sell orders PSE.

The Spread on Stock Transaction

1. Order Cost - cost of processing orders
2. Inventory Costs - maintaining an inventory of a particular stock
3. Competition Cost - more market makers are competing to sell a particular stock
4. Volume Cost - more liquid have less chance of experiencing an abrupt change in
price
5. Risk - stock has relatively risky operations, it's stock price is normally more volatile.
Regulation of Stock Trading
❏ Circuit Breakers
❏ Trading Halts
❏ Securities and Exchange Commissions
❏ SEC Oversight of Corporate Disclosure

Trading International Stocks

❏ Reduction in Transaction Costs
❏ Reduction in Information Costs
❏ Reduction in Exchange Rate Risk