Chapter 2: Securities Markets and Transactions
Where are Both IPOs and secondary distributions are sold on?
OTC
Example of margin trading
On $4,445 purchase with 50% margin requirement, investor puts up $2,222.50 and broker will lend remaining $2,222.50
What was the Insider Trading and Fraud Act of 1988
Prohibited insider trading on nonpublic information
What are Indirect Ways to Invest in Foreign Securities?
Purchase shares of U.S.-based multinational with substantial foreign operations
What was the Securities Act of 1933
Required full disclosure of information by companies
When are trades executed in a broker market?
Trades are executed when a buyer and a seller are brought together by a broker and the trade takes place directly between the buyer and seller
When are trades executed in a dealer market?
Trades are executed with a dealer (market maker) in the middle. Sellers sell to a market maker at a stated price. The market maker then offers the securities to a buyer.
What is Insider Trading?
Use of nonpublic information about a company to make profitable securities transactions
What does margin trading use to purchase securities?
Uses borrowed funds to purchase securities
What is a Bull Market?
-Favorable markets -Rising prices -Investor/consumer optimism -Economic growth and recovery -Government stimulus
What does it mean to "short sell"?
-Investor sells securities they don't own -Investor borrows securities from broker -Broker lends securities owned by other investors that are held in "street name" -"Sell high and buy low" -Investors make money when stock prices go down
(DM) Nasdaq
-Largest dealer market -Lists large companies (Microsoft, Intel, Dell, eBay) and smaller companies
(BM) New York Stock Exchange (NYSE)
-Largest stock exchange—over 2,700 companies -Over 350 billion shares of stock traded in 2005 -Accounts for 90% of stocks traded on exchanges -Specialists make transactions in key stocks -Strictest listing policies
What are the disadvantages to short selling?
-Limited return opportunities: stock price cannot go below $0.00 -Unlimited risks: stock price can go up anunlimited amount -If stock price goes up, short seller still needs to buy shares to pay back the "borrowed" shares to the broker -Short sellers may not earn dividends
(DM) Over-the-counter (OTC) Bulletin Board
-Lists smaller companies that cannot or don't wish to be listed on Nasdaq -Companies are regulated by SEC
What are the disadvantages of marginal trading?
-Magnifies losses -Interest expense on margin loan -Margin calls
International Investment Performance
-Opportunities for high returns -Foreign securities markets do not necessarily move with the U.S. securities market -Foreign securities markets tend to be more risky than U.S. markets
What are the roles of the secondary markets?
-Provides liquidity to security purchasers -Provides continuous pricing mechanism
What are the Three Choices to Market Securities in Primary Market?
1.) Public Offering 2.) Rights Offering 3.) Private Placement
What % of the total dollar volume of all shares in U.S. stock market trade on the dealer market?
40% of the total dollar volume of all shares in U.S. stock market trade here
What % of the total dollar volume of all shares in U.S. stock market trade on the broker market?
60% of the total dollar volume of all shares in U.S. stock market trade here
How does a broker execute their trades in a dealer market?
A broker executes the trade on behalf of others
What is a Private Placement?
an offering of a company's securities that is not registered with the Securities and Exchange Commission (SEC) and is not offered to the public at large.
What is a Rights offering?
an offering of a new issue of stock to existing stockholders, who may purchase new shares in proportion to their current ownership
What is a Public offering?
an offering to sell to the investing public a set number of shares of a firm's stock at a specified price
What does it mean that dealer markets have no centralized trading floor?
comprised of market makers linked by telecommunications network Both IPOs and secondary distributions are sold on OTC
What do dealer markets consist of?
consists of both the Nasdaq OMX market and the OTC market
What do broker markets consist of?
consists of national and regional securities exchanges
Why do large institutional investors uses a fourth market as a trading system?
deal directly with each other to bypass market makers
What was the Maloney Act of 1938
Allowed self-regulation of securities industry through trade associations such as the National Association of Securities Dealers (NASD)
What can margin trading be used for ?
Can be used for common stocks, preferred stocks, bonds, mutual funds, options, warrants and futures
What are the advantages to short selling?
Chance to profit when stock price declines
What was the Investment Company Act of 1940
Created & regulated mutual funds
What are Currently owned securities used as collateral for?
Currently owned securities used as collateral for margin loan from broker
What do the Margin requirements set by Federal Reserve Board determine?
Determines the minimum amount of equity required
What was the Securities Act of 1934
Established SEC as government regulatory body
What do institutional investors receive using the third market as a trading system?
Institutional investors (mutual funds, life insurance companies, pension funds) receive reduced trading costs due to large size of transactions
What are blue sky laws intended to prevent?
Intended to prevent investors from being sold nothing but "blue sky"
What are Blue Sky Laws?
Laws imposed by individual states to regulate sellers of securities
What does the Nasdaq Market employ?
employs an all-electronic trading platform to execute trades
What are Securities Exchanges?
forums where buyers and sellers of securities are brought together to execute trades
What is Underwriting Syndicate?
group formed by investment banker to share the financial risk of underwriting
What are ECNs most effective for?
high-volume, actively traded securities
What does the Over-the-counter (OTC) Market involve?
involves trading in smaller, unlisted securities
What is the New York Stock Exchange (NYSE)?
is largest and most well-known (but after book went to press, NYSE acquired by IntercontinentalExchange of Atlanta)
What is the Selling Group?
other brokerage firms that help the underwriting syndicate sell issue to the public
What is the Red Herring of the IPO process?
preliminary prospectus available during the waiting period
What is the underwriting the offer of the IPO process mean?
promoting the stock and facilitating the sale of the company's shares
What is a Tombstone?
public announcement of issue and role of participants in underwriting process
What is Underwriting the Issue?
purchases the security at agreed-on price and bears the risk of reselling it to the public
What is the Prospectus of the IPO process?
registration statement describing the issue and the issuer
What is the Road Show of the IPO process?
series of presentations to potential investors
(DM) What is the Bid Price?
the highest price offered by market maker to purchase a given security
What is Diversification?
the inclusion of a number of different investment vehicles in a portfolio to increase returns or reduce risks
(DM) What is the Ask Price?
the lowest price at which a market maker is willing to sell a given security
What is the primary market?
the market in which new issues of securities are sold to the public
What is a secondary market?
the market in which securities are traded after they have been issued
What is the Quiet Period of the IPO process?
time period after prospectus is filed when company must restrict what is said about the company
Why do large institutional investors uses a third market as a trading system?
to go through market makers that are not members of a securities exchange Fourth Market Large institutional investors
What is an Investment Banker Compensation?
typically in the form of a discount on the sale price of the securities
(BM) Futures Exchanges
-Allows trading of financial futures -Best-known: Chicago Board of Trade (CBT)
(BM) Options Exchanges
-Allows trading of options -Best-known: Chicago Board Options Exchange (CBOE)
What are the advantages of marginal trading?
-Allows use of financial leverage -Magnifies profits Disadvantages
What do Long Purchases mean?
-Investor buys and holds securities -"Buy low and sell high" -Make money when prices go up
(DM) Over-the-counter (OTC) Pink Sheets
-Lists smaller companies that are not regulated by SEC -Liquidity is minimal or almost non-existent -Very risky; many nearly worthless stocks
How does the Use of International Securities Improves Diversification?
-More industries and securities available -Securities denominated in different currencies -Opportunities in rapidly expanding economies
(BM) NYSE Amex (formally American Stock Exchange)
-More than 500 companies listed -Major market for Exchange Traded Funds -Typically smaller and younger companies who cannot meet -stricter listing requirements for NYSE
What are Direct Ways to Invest in Foreign Securities?
-Purchase securities on foreign stock exchanges -Buy securities of foreign companies that trade on U.S. stock exchanges -Buy American Depositary Receipts (ADRs): dollar denominated receipts for stocks of foreign companies held in vaults of banks
(BM) Regional Stock Exchanges
-Typically lists between 100-500 companies, usually with local and regional appeal -Listing requirements are more lenient than NYSE -Often include stocks that are also listed on NYSE or NYSE Amex -Best-known: Midwest, Pacific, Philadelphia, Boston, and Cincinnati
What is a Bear Market?
-Unfavorable markets -Falling prices -Investor/consumer pessimism -Economic slowdown -Government restraint
What are examples of Government Policies Risks?
-Unstable foreign governments -Different laws in trade, labor or taxation -Different economic and political conditions -Less stringent regulation of foreign securities markets
Risks of International Investing
-Usual Investment Risks Still Apply -Government policies risks -Currency exchange rate risks
What are examples of Currency Exchange Rate Risks?
-Value of foreign currency fluctuates compared to U.S. dollar -Value of foreign investments can go up and down with exchange rate fluctuations
What are alternative trading systems?
-third market -fourth market
What does the IPO Process involve to go public?
-underwriting the offer -prospectus -red herring -quiet period -road show
What was the Securities Acts Amendments of 1975
Abolished fixed-commissions and established an electronic communications network to make stock pricing more competitive
What is an initial public offering (IPO)?
First public sale of a company's stock
Who sets the margin requirements?
Margin requirements set by Federal Reserve Board
What was the Investment Advisors Act of 1940
Required investment advisers to make full disclosure about their backgrounds and their investments, as well as register with the SEC
What does an IPO require?
Requires SEC approval
What was the Sarbanes-Oxley Act of 2002
Tightened accounting and audit guidelines to reduce corporate fraud
How does a seller execute their trades in a dealer market?
a dealer trades on their own behalf.
What does Electronic Communications Networks (ECNs) allow?
direct trading
What is the secondary market?
the market in which securities are traded after they have been issued
What is the capital market?
the market where long-term securities such as stocks and bonds are bought and sold
What are Money Markets?
the market where short-term securities are bought and sold