Upload
sharleen-french
View
224
Download
0
Tags:
Embed Size (px)
Citation preview
FINA 2802: Investments and Portfolio FINA 2802: Investments and Portfolio AnalysisAnalysis
Securities MarketsSecurities Markets
Dragon Yongjun TangDragon Yongjun Tang
January 21 & 23, 2010January 21 & 23, 2010
22
Lecture 4 & 5: Lecture 4 & 5: Securities MarketsSecurities Markets Reading: Chapter 3Reading: Chapter 3 Practice Problem Sets: Practice Problem Sets:
1,2,3,4,6,7,8,9,10,12,13,14,18,20,1,2,3,4,6,7,8,9,10,12,13,14,18,20,2121
33
Learning Objectives
Role of investment bankers in primary issues
Identify the various security markets
Describe the role of brokers
Compare trading practices in exchanges vs dealer markets
Buy Stock on Margin and Sell Stock Short
44
Life Cycle of a Life Cycle of a CompanyCompany
Private(Entrepreneur + VC)
Public(NYSE/Nasdaq)
Investment Bank
Buy Sell
Buy on Margin Sell Short
DealerMarket Maker
BrokerCommission
Commission
Bid-ask Spread
CommissionPrimary
Secondary
55
Investment Bankers:
•Assist firms in issuing securities
•Firm Commitment (Take a risk in underwriting)
•Best efforts (issuer bears the risk of not placement)
Primary Market:•Initial Public Offering (IPO)•Seasoned Equity Offering (SEO)
How Firms Issue How Firms Issue SecuritiesSecurities
66
Figure 3.1 Relationship Among a Firm Figure 3.1 Relationship Among a Firm Issuing Securities, the Underwriters Issuing Securities, the Underwriters and the Publicand the Public
77
Figure 3.2 A Tombstone Figure 3.2 A Tombstone AdvertisementAdvertisement
88
Allows firms to register securities and sell them gradually to the public for two years.
SEC Rule 415
Shelf RegistrationShelf Registration
99
Private Private PlacementsPlacements Firms sell shares directly to a Firms sell shares directly to a
small group of institutional or small group of institutional or wealthy investorswealthy investors
Cheaper: No need to register to Cheaper: No need to register to SEC (Rule 144A)SEC (Rule 144A)
Smaller offeringsSmaller offerings
1010
Road shows, bookbuildingCost: commissions (7%) + underpricingInvestment bankers tend to underprice new issuesIPO prices tend to rise after IPO (“Money left on the
table”)IPO are usually poor long-term investmentsInternet Auction
Initial Public Offering Initial Public Offering (IPO)(IPO)
IPO Underpricing:IPO Underpricing:A dramatic example (VA A dramatic example (VA Linux)Linux) IPO price: $30IPO price: $30 First day closing price: First day closing price:
$239.25$239.25 Today’s price: $1.00Today’s price: $1.00
Replicate this picture Replicate this picture using finance.yahoo.com using finance.yahoo.com (LNUX)(LNUX)
1111
Last Trade: 1.00251y Target Est: 1.59
Day's Range: 1.00 - 1.04
52wk Range: 0.32 – 2.18
Volume: 28,795Avg Vol (3m): 270,871
Market Cap: 64.31MP/E (ttm): N/AEPS (ttm): -0.055Div & Yield: N/A (N/A)
1212
Figure 3.3 Average Initial Returns for Figure 3.3 Average Initial Returns for IPOs in Various CountriesIPOs in Various Countries
1313
Figure 3.4 Long-term Relative Figure 3.4 Long-term Relative Performance of Initial Public Performance of Initial Public OfferingsOfferings
1414
Where Securities Are Where Securities Are TradedTraded
Secondary MarketSecondary Market
Organized exchangesOrganized exchanges– NYSE (or the Big Board); AMEX; regional NYSE (or the Big Board); AMEX; regional
exchangesexchanges Over the counter (OTC)Over the counter (OTC)
– Nasdaq: market makers; three levelsNasdaq: market makers; three levels– Bond tradingBond trading
Directly between the two partiesDirectly between the two parties– Electronic Communication Networks (ECN)Electronic Communication Networks (ECN)
1515
•Established by Exchange Act of 1975
•Intent was to link firms electronically
•Resulted in Consolidated Tape
National Market System
1616
Bond TradingBond Trading
Major concern: LiquidityMajor concern: Liquidity
Automated Bond System Automated Bond System (ABS)(ABS)
OTC marketOTC market
1717
Trading on Trading on ExchangesExchanges
The participants:The participants: InvestorsInvestors Brokerage firms (owns a Brokerage firms (owns a
“seat” on the exchange)“seat” on the exchange) Commission brokersCommission brokers Floor brokersFloor brokers
1818
The specialist (or market maker):
•Makes a market•The brokers’ broker•Maintains the limit order book•Maintains a fair and orderly market
NYSE is an example
Trading on ExchangesTrading on Exchanges
1919
New York Stock New York Stock Exchange (NYSE)Exchange (NYSE)
2020
Trading on ExchangesTrading on Exchanges
Types of orders:Types of orders:
MarketMarket LimitLimit DayDay Good-till-canceledGood-till-canceled Stop-loss orders; stop-buy ordersStop-loss orders; stop-buy orders
2121
Figure 3.5 Limit Order Book for Figure 3.5 Limit Order Book for Intel Intel on Archipelagoon Archipelago
2222
Figure 3.6 Price-Contingent Figure 3.6 Price-Contingent OrdersOrders
2323
Block orders - at least 10,000 shares
DOT & SuperDOT - direct to specialist
Settlement – three business days
Shares “In Street Name”. Shares keptby the broker after a transaction
Trading on ExchangesTrading on Exchanges
2424
•Negotiated market
•No specialist
•NASDAQ computer system
Trading on OTC Trading on OTC MarketsMarkets
2525
NasdaqNasdaq
Market Structures in Market Structures in Other CountriesOther Countries
London - predominately electronic London - predominately electronic tradingtrading
Euronext – market formed by Euronext – market formed by combination of the Paris, combination of the Paris, Amsterdam and Brussels exchangesAmsterdam and Brussels exchanges
Tokyo Stock ExchangeTokyo Stock Exchange Hong Kong Stock ExchangeHong Kong Stock Exchange Shanghai Stock ExchangeShanghai Stock Exchange
2626
2727
Broker’s commissions:Explicit
“Hidden” costs: Bid-Ask Spread
Price Concession
Cost of TradingCost of Trading
Impact of trading costs on returns
Return =capital gains+ current income - all broker' s fees
initial investment + initial broker' s fees
Cost of TradingCost of Trading
2929
Example: You bought a stock for $70 and later sold it for $80 You received $8 in dividends, paid an initial broker’s fee of $1% of purchase price, and paid another $1% of selling price when you sold the stock. What is your return on this investment (ignoring taxes)?
Cost of TradingCost of Trading
3030
• Should you use a full-service or a discount broker?
• What is the value of the full-service broker’s advice?
Placing an OrderPlacing an Order
3131
Student LoanStudent Loan
You think your value will go upYou think your value will go up You want to make the most out of You want to make the most out of
itit So you borrow So you borrow moneymoney to finance to finance
educationeducation
3232
Buying on MarginBuying on Margin
Borrow to buy securities (make Borrow to buy securities (make use of the use of the Broker call’s loanBroker call’s loan))
Securities stay with the broker Securities stay with the broker as collateralas collateral
3333
Buying on MarginBuying on Margin
InvestorInvestor’’s account:s account:
AssetsAssetsLiabilitiesLiabilities
Value of stocks purchased Value of stocks purchased Loan Loan from Brokerfrom Broker
EquityEquityCost of setting up a margin strategy
Buying on Buying on MarginMargin
At time 0:At time 0:
At any future timeAt any future time
0
00 securities of ueMarket val
equity sinvestor' InitialMargin Initial
t
tt securities of ueMarket val
equity sinvestor' ActualMargin Actual
3535
• The Federal Reserve System sets minimum initial margin requirements currently 50%
• All exchanges set a minimum maintenance margin requirement currently around 30%
Buying on Buying on MarginMargin
3636
Example: What is the initial margin if the investor purchases 100 shares of stock at $100 per share using $6,000 of her own money and borrows the rest?
Buying on MarginBuying on Margin
3737
Example (continued): If the value of the above stock fell to $70 per share, what is now the actual margin?
Buying on MarginBuying on Margin
3838
Example (continued): If the value of the above stock fell to $50 per share, what is now the actual margin?
Buying on Margin
Margin Call
Pmin= the lowest price a share can fall to without a call
L = the loan value
M = the margin requirement
N = the number of shares
Buying on Margin
4040
Margin Call Example: An investor purchases 100 shares of stock at $100 per share using $6,000 of her own money and borrows the rest. If the maintenance margin is 30%, what is the lowest price a share can fall without a call?
Buying on MarginBuying on Margin
4141
Margin Trading - Initial Margin Trading - Initial ConditionsConditions
X CorpX Corp $70$70
50%50% Initial MarginInitial Margin
40%40% Maintenance MarginMaintenance Margin
10001000 Shares PurchasedShares Purchased
Initial PositionInitial Position
Stock $70,000 Borrowed $35,000Stock $70,000 Borrowed $35,000
Equity 35,000Equity 35,000
4242
Margin Trading - Maintenance Margin Trading - Maintenance MarginMargin
Stock price falls to $60 per shareStock price falls to $60 per share
New PositionNew Position
Stock $60,000 Borrowed $35,000Stock $60,000 Borrowed $35,000
Equity 25,000Equity 25,000
Margin% = $25,000/$60,000 = Margin% = $25,000/$60,000 = 41.67%41.67%
4343
Margin Trading - Margin Margin Trading - Margin CallCall
How far can the stock price fall before How far can the stock price fall before aamargin call?margin call?
(1000P - $35,000)(1000P - $35,000)** / 1000P = 40% / 1000P = 40%
P = $58.33P = $58.33
* 1000P - Amt Borrowed = Equity* 1000P - Amt Borrowed = Equity
4444
Problem 3, Chapter 3 (p. Problem 3, Chapter 3 (p. 93)93)
Dee Trader opens a brokerage account, and purchases 300 shares of Dee Trader opens a brokerage account, and purchases 300 shares of Internet Dreams at $40 per share. She borrows $4,000 from her broker to Internet Dreams at $40 per share. She borrows $4,000 from her broker to help pay for the purchase. The interest rate on the loan is 8%.help pay for the purchase. The interest rate on the loan is 8%.
a. What is the margin in Dee’s account when she first purchases the stock?a. What is the margin in Dee’s account when she first purchases the stock?
b. If the share price falls to $30 per share by the end of the year, what is the b. If the share price falls to $30 per share by the end of the year, what is the remaining margin in her account? If the maintenance margin requirement is remaining margin in her account? If the maintenance margin requirement is 30%, will she receive a margin call?30%, will she receive a margin call?
c. What is the rate of return on her investmentc. What is the rate of return on her investment
4545
Problem 7, Chapter 3 (p. Problem 7, Chapter 3 (p. 94)94)
You are bullish on Telecom stock. The current market price is $50 per You are bullish on Telecom stock. The current market price is $50 per share, and you have $5,000 of your own to invest. You borrow an share, and you have $5,000 of your own to invest. You borrow an additional $5,000 from your broker at an interest rate of 8% per year and additional $5,000 from your broker at an interest rate of 8% per year and invest $10,000 in the stock.invest $10,000 in the stock.
a. What will be your rate of return if the price of Telecom stock goes up by a. What will be your rate of return if the price of Telecom stock goes up by 10% during the next year? (Ignore the expected dividend.)10% during the next year? (Ignore the expected dividend.)
b. How far does the price of Telecom stock have to fall for you to get a b. How far does the price of Telecom stock have to fall for you to get a margin call if the maintenance margin is 30% of the value of the short margin call if the maintenance margin is 30% of the value of the short position? Assume the price all happens immediately.position? Assume the price all happens immediately.
Return on Total Investment ROAincome
total investment( )
Return on Equity ROEincomeequity
( )
Borrowing magnifies ROE (risky strategy)
Why buy on margin?Why buy on margin?
4747
Leverage and Leverage and ROEROE
SR
E
L
ROE
LS RR
LS RR
4848
Borrow Securities to sell them
Sell first -- then buy!
Margin is required (cost of short selling)
Short position must be covered
Investor expects price to decline
Short SalesShort Sales
4949
Short SellingShort Selling
Broker
Original Stock Holder
New Stock Holder
Short Seller100 Shares 100 Shares
100 Shares
Return on
Short SaleShort Sale Price Buy Back Price
Per Share Investment ( margin )
Short SalesShort Sales
5151
Example: An investor sells short 100 shares of stock at $100 per share. The margin requirement is 50% of the short sale.
a. If the investor covers her short sale when the stock price declines to $70 per share, what is the return on the short sale?
b. What is the return if there is no margin requirement?
Short SalesShort Sales
5252
Example: An investor sells short 100 shares of stock at $100 per share. The margin requirement is 50% of the short sale.
c. If the investor covers her short sale when the stock price increases to $130 per share, what is the return on the short sale?
Short SalesShort Sales
Short Sales-Initial Short Sales-Initial MarginMargin
Investor’s account at time 0:Investor’s account at time 0:
AssetsAssets LiabilitiesLiabilitiesValue of stocks sold Value of stocks sold Value of Value of
Stocks owedStocks owedInitial Margin (EInitial Margin (E00) ) Equity Equity (Current (Current
Margin)Margin)
Percentage Initial Margin=Percentage Initial Margin=
As time elapses, the value of stocks owed As time elapses, the value of stocks owed changes, affecting the %Margin!changes, affecting the %Margin!
)( 0 NP
owed Stocks of Value
Equity
)( 0 NP
Short Sales-Short Sales-MarginMarginInvestor’s account at time t:Investor’s account at time t:
AssetsAssets LiabilitiesLiabilitiesValue of stocks sold Value of stocks sold Value of Stocks owedValue of Stocks owedInitial Margin (EInitial Margin (E00) ) DIVIDENDS DUEDIVIDENDS DUE
Equity Equity (E(Ett=Current Margin)=Current Margin)
Percentage Margin=Percentage Margin=
As time elapses, the value of stocks owed As time elapses, the value of stocks owed changes, affecting the %Margin!changes, affecting the %Margin!
)( NPt
owed Stocks of Value
margin)current (Equity
)( 0 NP
Short Sales -Short Sales -MarginMarginHow high can the price of stock go before a How high can the price of stock go before a
margin call is issued?margin call is issued?
Actual marginActual margin==
We want actual margin > required margin.We want actual margin > required margin.
Solve forSolve for
NP
NPENP
t
t 00
t
t
owedstock of Value
Equity
tP
Margin call price:
trequiremenmargin
short sold shares ofnumber
margin initial
saleshort of at time shareper price
callmargin without shareper price
0
0
max
M
N
E
P
maximumP
100
max
MN
ENPP
Short SalesShort Sales
5757
Example: An investor sells short 100 shares of stock at $100 per share. The initial margin requirement is 50% of the short sale. If the maintenance margin is 30%, what is the maximum stock price without a margin call on the short sale?
Short SalesShort Sales
5858
Short Sale - Initial Short Sale - Initial ConditionsConditions
Z CorpZ Corp 100 Shares100 Shares
50%50% Initial MarginInitial Margin
30%30% Maintenance MarginMaintenance Margin
$100$100 Initial PriceInitial Price
Sale ProceedsSale Proceeds $10,000$10,000
Margin & EquityMargin & Equity 5,000 5,000
Stock Owed Stock Owed 10,000 10,000
5959
Short Sale - Maintenance Short Sale - Maintenance MarginMargin
Stock Price Rises to $110Stock Price Rises to $110
Sale ProceedsSale Proceeds $10,000$10,000
Initial MarginInitial Margin 5,000 5,000
Stock OwedStock Owed 11,000 11,000
Net EquityNet Equity 4,000 4,000
Margin % (4000/11000)Margin % (4000/11000) 36% 36%
6060
Short Sale - Margin Short Sale - Margin CallCall
How much can the stock price rise How much can the stock price rise before a margin call?before a margin call?
($15,000($15,000** - 100P) / (100P) = 30% - 100P) / (100P) = 30%
P = $115.38 P = $115.38
* Initial margin plus sale proceeds* Initial margin plus sale proceeds
6161
Problem 4, Chapter 3 (p. Problem 4, Chapter 3 (p. 93)93)
Old Economy Traders opened an account to short sell 1,000 shares of Old Economy Traders opened an account to short sell 1,000 shares of Internet Dreams from Question 3. The initial margin requirement was 50%. Internet Dreams from Question 3. The initial margin requirement was 50%. (The margin account pays no interest.) A year later, the price of Internet (The margin account pays no interest.) A year later, the price of Internet Dreams has risen from $40 to $50, and the stock has paid a dividend of $2 Dreams has risen from $40 to $50, and the stock has paid a dividend of $2 per share.per share.
a. What is the remaining margin in the account?a. What is the remaining margin in the account?
b. If the maintenance margin requirement is 30%, will Old Economy b. If the maintenance margin requirement is 30%, will Old Economy receive a margin call?receive a margin call?
c. What is the rate of return on the investment?c. What is the rate of return on the investment?
6262
Problem 8, Chapter 3 (p. Problem 8, Chapter 3 (p. 94)94)
You are bearish on Telecom and decide to sell short 100 shares at the You are bearish on Telecom and decide to sell short 100 shares at the current market price of $50 per share. current market price of $50 per share.
a. How much in cash or securities must you put into your brokerage a. How much in cash or securities must you put into your brokerage account if the broker’s initial margin requirement is 50% of the value of account if the broker’s initial margin requirement is 50% of the value of the short position?the short position?
b. How high can the price of the stock go before you get a margin call if b. How high can the price of the stock go before you get a margin call if the maintenance margin is 30% of the value of the short position?the maintenance margin is 30% of the value of the short position?
6363
Securities Act of 1933
Securities Exchange Act of 1934
Securities Investor Protection Act of 1970
Blue Sky Laws
Circuit Breakers
Main Concern: Insider Trading
Trading scandals and reactions: Sarbanes-Oxley ActTrading scandals and reactions: Sarbanes-Oxley Act
Regulations of Regulations of Securities MarketsSecurities Markets
6464
SummarySummary
Issuing securitiesIssuing securities TradingTrading Buying on margin and short salesBuying on margin and short sales Next class: Mutual FundsNext class: Mutual Funds