Accounting Response
jandreg
davenport_week_1_pp2.pptx1
Chapter 1 Web Extension 1B
A Closer Look at the Stock Markets
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Topics in Web Extension
Stock indexes
Regulation
Overview of investment banking
Stock trading
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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 country’s 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
S&P500
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)
Underpricing—Average 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 “specialist’s 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
