BusAd 551 Corporate Financial Decisions

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Cleary / Jones Investments Analysis and
Management
CHAPTER FIVE How Securities Are Traded
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Learning Objectives

• To explain the role of brokerage firms and
  stockbrokers
• To describe how brokerage firms operate
• To outline how orders to buy and sell securities
  are executed
• To discuss the regulation of the Canadian
  securities industry
• To explain the importance of margin trading and
  short selling to investors

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Brokerage Operations

• Brokerage firms earn commissions on executed
  trades, sales loads on mutual funds, profits from
  securities sold from inventory, underwriting fees
  and administrative account fees
• Full-service brokers offer order execution,
  information on markets and firms, and investment
  advice
• Discount brokers offer order execution

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Account Types

• Cash account Investor pays 100 of purchase
  price for securities
• Margin account Investor borrows part of the
  purchase price from the broker
• Wrap account Brokers match investors with
  outside money managers all costs are wrapped in
  one fee

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Fees and Costs

• Brokerage commissions differ by security, broker,
  and investor
• Institutional investors have greatest negotiating
  power
• On-line trading offers significantly lower
  commission rates to individual investors
• Dividend reinvestment plans (DRIPs) permit
  reinvestment of dividends in additional stock

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Orders on Organized Exchanges

• The TSE introduced the worlds first
  computer-assisted trading system (CATS) in 1977
• The NYSE continues to make use of the specialist
  system
• Specialists maintain the limit order book
• Specialists keep a fair and orderly market by
  providing liquidity

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Orders in OTC Markets

• Dealers are ready to either buy or sell
• Bid price is highest offer price to buy
• Ask price is lowest price willing to sell
• Ask price - Bid price gt0 (dealer spread)
• Dealer makes a market in the security
• More than one dealer for each security in
  over-the-counter markets

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Types of Orders

• Market order Authorizes immediate transaction at
  best available price
• Limit order Specifies a particular market price
  before a transaction is authorized
• Stop order Specifies a particular market price
  at which a market order is authorized

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Clearing Procedures

• Settlement dates for stocks are three business
  days after the trade date
• Legal ownership transferred and financial
  arrangements settled with brokerage firm
• Transfer of securities and funds between exchange
  members facilitated by a clearinghouse The
  Canadian Depository for Securities (CDS)

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Canadian Regulatory Environment

• Self-Regulatory Organizations (SROs) regulate
  their own activities
• Canadian Investor Protection Fund (CIPF)
  established to protect investors
• Investment Dealers Association of Canada (IDA) is
  the national trade association for the investment
  industry

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Margin Accounts

• Exchanges set minimum required deposits of cash
  or securities
• Investor pays part of investment cost, borrows
  remainder from broker
• Margin is percent of total value that cannot be
  borrowed from broker
• Margin call occurs when the actual margin
  declines below the margin requirement

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Short Selling

• Investor borrows stock from a third party
• Borrowed security sold in open market, to be
  repurchased later at an expected price lower than
  sale price
• Investor liable for declared dividends
• Short sale proceeds held by broker
• Investor responsible for borrowed shares