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Chapter 1 Web Extension 1C

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Chapter 1 Web Extension 1C A Closer Look at the Stock Markets – PowerPoint PPT presentation

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Title: Chapter 1 Web Extension 1C


1
Chapter 1 Web Extension 1C
  • A Closer Look at the Stock Markets

2
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 . .)
4
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 . .)
5
Composition by Exchange
  • NYSE Composite
  • Nasdaq Composite

(More . .)
6
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

7
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

8
Composition by International Region
  • Morgan Stanley Capital International (MSCI)
  • EAFE (Europe, Asia, Far East) Index
  • Emerging Markets Index
  • Pacific Index

9
Stock Weighting in Indexes
  • Price weighted
  • DJIA
  • Market-value weighted
  • SP500
  • Nasdaq Composite
  • Equally weighted
  • Value Line Index

10
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.

11
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.

12
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).

13
Initial Public Offerings
  • Initial Public Offerings (IPOs)
  • UnderpricingAverage increase is 14 on first
    day.
  • Performance Underperforms similar stock during
    three years after IPO.

14
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.

15
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

16
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

17
Margin Trading
  • Investor uses only a portion of own capital for
    an investment.
  • Borrows remaining component.
  • Margin arrangements differ for stocks and futures.

18
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

19
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.

20
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
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