Chapter 1 Web Extension 1C

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Chapter 1Web Extension 1C

• A Closer Look at the Stock Markets

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Topics in Web Extension

• Stock indexes
• Regulation
• Overview of investment banking
• Stock trading

3
Stock Indexes

• Stock indexes try to measure some aspect of the
  market
• The differ with respect to
• Composition (types of stock in the index)
• Weighting (how the individual stocks are
  aggregated into an index)

(More . .)
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Index Composition

• Replicate a particular exchange
• Measure a countrys most important stocks
• Measure a particular business sector
• Measure a particular investment style
• Measure an international region

(More . .)
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Composition by Exchange

• NYSE Composite
• Nasdaq Composite

(More . .)
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Composition by Business Sector

• Many different index providers, such as
• Dow Jones
• Amex
• Morgan Stanley
• Many different sectors, such as
• Airlines
• Biotechnology
• Chemicals
• Consumer retailers
• Technology

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Composition by Style

• Two important investment styles are by the size
  of the firm and by its growth prospects. Growth
  is measure by high-expected sales growth and high
  price-book ratios (value stocks have lower growth
  and lower price-book ratios)
• Examples
• Russell 1000 Growth
• Russell Midcap Value

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Composition by International Region

• Morgan Stanley Capital International (MSCI)
• EAFE (Europe, Asia, Far East) Index
• Emerging Markets Index
• Pacific Index

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Stock Weighting in Indexes

• Price weighted
• DJIA
• Market-value weighted
• SP500
• Nasdaq Composite
• Equally weighted
• Value Line Index

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Regulation of Securities Markets

• Government Regulation such as SEC.
• Insider trading oversight (SEC)
• Margin oversight (Federal Reserve)
• Self-regulation such as NASD.
• Circuit Breakers automatic halt in trading if
  stock prices have exceptional changes.

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Public vs. Private Offerings

• Public offerings registered with the SEC and
  sale is made to the investing public.
• Shelf registration (Rule 415, since 1982) allows
  firms to register an offering and sell parts of
  the offering over time.
• Private offering Sale to a limited number of
  sophisticated investors not requiring the
  protection of registration.
• Dominated by institutions.
• Very active market for debt securities.
• Not as active for stock offerings.

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Investment Banking and Security Offerings

• Underwritten vs. Best Efforts
• Underwritten firm commitment on proceeds to the
  issuing firm.
• Best Efforts no firm commitment.
• Negotiated vs. Competitive Bid
• Negotiated issuing firm negotiates terms with
  investment banker. Usually a 7 spread.
• Competitive bid issuer structures the offering
  and secures bids (more common in bonds than
  stocks).

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Initial Public Offerings

• Initial Public Offerings (IPOs)
• UnderpricingAverage increase is 14 on first
  day.
• Performance Underperforms similar stock during
  three years after IPO.

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Costs of Trading

• Commission fee paid to broker for making the
  transaction
• Spread cost of trading with dealer
• Bid price dealer will buy from you
• Ask price dealer will sell to you
• Spread ask - bid
• Price Impact Large sales or purchase might
  cause prices to change.
• Payment for Order Flow Exchange will pay
  brokers to direct orders to them.

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The Specialist at the NYSE

• Handles around 10-20 stocks (one per specialist)
• Stocks trade at the specialists post
• Makes a market by matching buyers/seller and by
  buying/selling from own inventory
• Goal is to maintain a fair and orderly market
  so that price changes are smooth
• Specialist loses money when smoothing the market,
  but makes it back during normal conditions

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Trading Away from Exchanges

• Third Market trading listed stocks but not
  through exchange
• Institutional market to facilitate trades of
  larger blocks of securities.
• Involves services of dealers and brokers
• Fourth Market institutions trading with
  institutions
• No middleman involved in the transaction

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Margin Trading

• Investor uses only a portion of own capital for
  an investment.
• Borrows remaining component.
• Margin arrangements differ for stocks and futures.

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Stock Margin Trading

• Maximum initial margin
• Currently 50
• Set by the Fed
• Maintenance margin
• Minimum level of equity margin if prices change
• Margin call
• Call for more equity funds

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Short Sales Mechanics

• Opening a short position
• Borrow stock through a dealer.
• Sell it
• Deposit proceeds and margin in account.
• Closing out the position
• Buy the stock
• Return to the party from which it was borrowed.

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Short Sales Purposes and Features

• Purpose to profit from a decline in the price
  of a stock or security.
• Must pay the broker the equivalent of any
  dividends paid by the stock
• Uptick restrictions can only sell short when
  the ask price of a stock is higher than the last
  transaction
• Unlimited loss potential