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Chapter 12

Chapter 12. Securities Markets. Security Markets. The primary markets Secondary markets -- stocks Secondary markets -- bonds. The Primary Market -- Two Forms of Issues. Initial public offerings (IPO) -- the very first shares ever issued by a company.

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Chapter 12

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  1. Chapter 12 Securities Markets

  2. Security Markets • The primary markets • Secondary markets -- stocks • Secondary markets -- bonds

  3. The Primary Market -- Two Forms of Issues • Initial public offerings (IPO) -- the very first shares ever issued by a company. • Seasoned new issues -- new shares being issued by a company that is already publicly traded. • Investment bankers serve as underwriters.

  4. Secondary Markets • Trade previously owned shares of stock. • Consist of organized exchanges and an over-the-counter market.

  5. Secondary Markets: The Organized Exchanges • Are used to facilitate trading between investors • New York Stock Exchange (NYSE) • American Stock Exchange (AMEX) • Regional stock exchanges

  6. Regional Stock Exchanges • Pacific Stock Exchange • Chicago Stock Exchange • Philadelphia Stock Exchange • Cincinnati Stock Exchange • Intermountain Stock Exchange • Spokane Stock Exchange • Boston Stock Exchange

  7. Make-up of the New York Stock Exchange • Over 200 years old • Limited to 1,366 seats since 1953; highest price of a seat was $2.6 million. • Over 3,000 listed companies • $12.3 trillion (that’s 12 zeros) worth of shares • 80% of typical trading volume

  8. Requirements for NYSE Listing, 1999 • Profitability -- $2.5 million before tax earnings • Size -- $40.0 million net tangible assets • Market value -- $40.0 million publicly held stock • Public ownership -- 1.1 million publicly held common shares

  9. Make-up of the American Stock Exchange • 600 seats • 780 firms listed • Trading only 3% of the volume of the NYSE. • Daily dollar trading less than some regional exchanges.

  10. Secondary Markets: Over-the-Counter (OTC) Market • Consists of an electronic network of dealers used to execute trades

  11. Secondary Markets: Over-the-Counter (OTC) Market • Trades executed by: • “Pink sheets” • National Association of Securities Dealer Automated Quotations System (NASDAQ) • National Market System (NASDAQ/NMS) • Handles 35,000 smaller, less frequently traded securities with no listing requirements

  12. Secondary Markets -- Bonds • No organized secondary bond market, as little demand among individual investors. • Individual investors must work through a broker, who buys or sells with a bond dealer. • Government bond trading is dominated by investment houses, commercial banks, and the Federal Reserve.

  13. International Markets • International bond market exceeds $25 trillion • To buy international stocks • NYSE, AMEX, NASDAQ trade some companies • Trade American depository receipts (ADRs) -- international shares are held on deposit by foreign banks and the ADRs are sold to investors as a representative ownership of the shares • Invest directly through www.intltrader.com

  14. Regulation of the Securities Markets • Securities and Exchange Commission (SEC) regulation. • Securities Act of 1933 -- requires disclosure of relevant information in a timely manner. • Securities Exchange Act of 1934 -- established the SEC.

  15. Regulation of the Securities Markets (cont’d) • Investment Advisors Act of 1940 – regulates advisor activity. • Investor Protection Act of 1970 -- (SIPC) provides investor insurance similar to FDIC bank deposit insurance.

  16. Self-Regulation • “Circuit breakers” -- triggers that momentarily stop trading to prevent disastrous market slides. • Insider trading and market abuses • insider trading -- use of non-public information for personal gain in the market • churning -- excessive trading without benefit to the client used to increase commissions.

  17. How Securities are Traded • Specialists • Buy and sell orders • Brokers • Brokerage services • Cash and margin accounts

  18. Role of the Specialist in an Organized Exchange • To maintain order in the market. To reduce fluctuation, NYSE specialists represent almost 20% of the share volume traded. • To track and process buy and sell orders. • To maintain an inventory of assigned stock. • To maintain bid and ask prices of their assigned stock.

  19. Order Characteristics • Order sizes • Time period for which the order will remain outstanding • Order types

  20. Order Sizes • Round lots -- orders of 100 shares • Odd lots -- orders of 1 to 99 shares • Discretionary account: Broker authorized to make trades for you. Exercise caution, or avoid.

  21. Time Period the Order Will Remain Outstanding • Day orders -- good until the end of the trading day. • Open orders (GTC) -- good until filled or canceled. • Fill or kill orders -- must be filled or canceled immediately.

  22. Order Types • Market orders -- an order to sell or buy a specific number of shares at the best available price. • Limit orders -- an order to sell or buy a specific number of shares at a certain price or better.

  23. Order Types (cont’d) • Stop (or stop-loss) orders -- an order to sell a specific number of shares if the stock falls below a certain price or buy a specific number of shares if the stock rises above a certain price. • Use care to set prices to safeguard against major fluctuations.

  24. Short Selling -- Sell High and Buy Low • An almost reverse investment strategy which involves selling stock you don’t own and then buying it back later -- at a lower price. • Desirable when the market is expected to drop.

  25. Short Selling -- Sell High and Buy Low (cont’d) • Must meet margin requirement. • Because you sold the broker’s stock, you must repurchase the stock and you also must repay any dividends to the original owner.

  26. Dealing with Brokers • Brokerage accounts • Types of brokers; choosing one • Cash versus margin accounts • Registration: street name or your name • Joint accounts • Brokers and individual investors • The cost of trading • On-line trading

  27. Asset Management Account • Brokerage firm comprehensive financial services package: • Checking account • Credit card and loans • Money market mutual fund • Brokerage services

  28. Types of Brokerage Firms • Full service brokers • Discount service brokers – 50% to70% discount • Deep discount brokers – 90% discount • On-line discount and deep discount brokers – Low cost, immediate trading

  29. Account Types • Cash accounts -- use your money to pay for the purchase in-full within 3 business days • Margin accounts -- use the brokerage firm’s money to purchase part of the stock. This can amplify both gains and losses. • Maintenance margin • Margin call

  30. Account Types (cont’d) • Automated Clearing House (ACH) Network -- electronic payment system among 14,000 financial institutions that can be linked to your brokerage firm.Cheap, convenient, fast payment.

  31. Accounts Types (cont’d) • Street name registration -- shares of stock remain in the broker’s custody. May be charged “maintenance fee” for dormant accounts. • Joint accounts -- shares owned with a spouse or partner • Joint tenancy with the right of survivorship • Tenancy-in-common

  32. Working With a Broker • Remember Axiom 12: The Agency Problem in Personal Finance. • Do your homework and take responsibility. • Keep transaction costs to a minimum. • Use a discount broker or consider mutual funds. • For bonds, go full service or buy direct.

  33. Choosing a Broker • Integrity, intelligence, and efficiency • Experience in both up- and down-markets • Someone who understands your investment philosophy • Reputation for allowing customers to say no without undue pressure • Up front regarding costs and commissions

  34. The Cost of Trading • Commissions • Transaction fees • Inactive account fees • Annual fees • Maintenance fees

  35. On-line Trading • Cheap, easy trading, but do your investment homework. • For fast moving stocks, use limit orders not market orders.

  36. On-line Trading (cont’d) • Make sure all cancellations were processed. • If your account falls below the maintenance margin requirement, your securities can be sold without a margin call. • No regulations govern the time for executing a trade.

  37. Day-trading Cautions • Be prepared for financial losses. • Don’t confuse day trading with investing – it’s speculating. • Don’t believe claims of easy profits. • Watch out for “hot tips” and “expert advice” for day traders.

  38. Sources of Investment Information • Corporate sources of information • Brokerage firm reports • The press • The Wall Street Journal • Magazines • Investment publications • Internet sources • Investment clubs

  39. Summary • Primary securities markets • Initial public offerings • Seasoned new issues • Secondary securities markets • New York Stock Exchange • American Stock Exchanges • Regional Exchanges • Over-the-counter markets

  40. Summary (cont’d) • Securities market regulation • Order size, duration, and type • Round lots and odd lots • Day, GTC, or fill-or-kill orders • Market, limit, and stop orders • Cash or margin accounts

  41. Summary (cont’d) • Types of brokerage firms, services, and fees • Work with a broker or trade on-line? • Day trading cautions • Sources of investment information

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