Investment Analysis - Ch 3 (Quiz 2)

Initial Public Offerings Issuer and underwriter put on

"road show" • Purpose: Bookbuilding and pricing

If Equity / Market value < MMR, then

margin call occurs

The spreads between dealers' buy

(or "bid") prices and sell (or "asked") prices are a source of profit.

Which are costs of trading a security?

- Broker's commission - Dealer's bid-ask spread - The price concession an investor may be forced to make for trading in quantities greater than those associated with the bid-ask quote

Which of the following statements are true about buying on margin?

- Buying on margin means the investor buys securities using funds borrowed from his broker. - Limitations on the initial margin are set by the Federal Reserve System.

Which of the following statements are true about private placements?

- In private placements, the company sells its share directly to a small group of institutional investors. - Private placements usually have a lower liquidity compared to publicly traded securities, since they do not trade in public markets. - Private placements are a type of primary market transaction.

You decide to sell short 280 shares at a price of $77.78 each. The inital margin is 50%. If the price rises to $89.99 after 5 months, what is the new percentage margin?

0.2965

The price of Facebook stock is currently $38.48 and you decide to buy 120 shares on margin. The inital margin is 60%. If the price falls to $34.02, what is the new percentage margin in the account?

0.548

You buy 390 shares on margin at a price of $12.79 each. Your broker requires you to add $2,943 of your own money. 1. What is the initial margin requirement?

0.59

You decide to sell short 280 shares at a price of $77.78 each. The inital margin is 50%. How much money do you have to contribute to the account?

10,889.2

The price of Facebook stock is currently $38.48 and you decide to buy 120 shares on margin. The inital margin is 60%. How much money will you borrow from the broker if you borrow as much as possible?

1847.04

The price of Facebook stock is currently $38.48 and you decide to buy 120 shares on margin. The inital margin is 60%. If the broker's maintenance margin is 40%, what is the minimum value the stock price can take before you are issued a margin call?

25.65

You are very bullish about the stock of Amway Inc. and want to buy as many shares as possible. The current stock price is $12.62 and you have $21,000 to invest. The initial margin requirement is 60% 1. What is the maximum number of shares you can buy?

2773.36

specialist

A company that makes a market in the shares of one or more firms and that maintains a "fair and orderly market" by trading for its own inventory of shares.

prospectus

A description of the firm and the security it is issuing.

high-frequency trading

A subset of algorithmic trading that relies on computer programs to make very rapid trading decisions.

auction market

An exchange or electronic platform where all traders can convene to buy or sell an asset.

over-the-counter (OTC) market

An informal network of brokers and dealers who negotiate sales of securities.

limit buy (sell) order

An order specifying a price at which an investor is willing to buy or sell a security.

Direct Search Markets

Buyers and sellers locate one another on their own

electronic communication networks (ECNs)

Computer networks that allow direct trading without the need for market makers.

Privately Held

Definition: Ownership help by a small group of investors Shareholders: Up to 2000 shareholders Financial Statements: Fewer obligations to release financial statements to public Primary Offering: Sold Directly to a Small group of Investors

Publicly Traded

Definition: Securities sold to the general public; investors to trade shares Shareholders: Unlimited number Financial Statements: Obligated to release financial statements to the public Primary Offering: group of Investors Sold to the Public (often with an Underwriter)

margin

Describes securities purchased with money borrowed in part from a broker. The margin is the net worth of the investor's account.

initial public offering (IPO)

First public sale of stock by a formerly private company.

BROKERED MARKETS

In markets where trading in a good is active, brokers find it profitable to offer search services to buyers and sellers. - A good example is the real estate market, where economies of scale in searches for available homes and for prospective buyers make it worthwhile for participants to pay brokers to organize the searches. - Brokers in particular markets develop specialized knowledge on valuing assets traded in that market. - The primary market, where new issues of securities are offered to the public, is another example of a brokered market.

blocks

Large transactions in which at least 10,000 shares of stock are bought or sold.

secondary market

Market for already-existing securities.

primary market

Market for new issues of securities.

A margin call will occur when:

Market value < (borrowed / 1 - MMR)

dealer markets

Markets in which traders specializing in particular assets buy and sell for their own accounts.

• Maintenance Margin Requirement (MMR)

Minimum amount equity can be before additional funds must be put into account Exchanges mandate minimum 25%

Initial Margin Requirement (IMR)

Minimum set by Federal Reserve under Regulation T, currently 50% for stocks Minimum % initial investor equity 1 − IMR = Maximum % amount investor can borrow

Some of the biggest ECNs today are

NASDAQ, BATS, and NYSE Arca.

Shares of publicly listed firms trade continually on well-known markets such as the

New York Stock Exchange or the NASDAQ stock market.

inside information

Nonpublic knowledge about a corporation possessed by corporate officers, major owners, or other individuals with privileged access to information about the firm.

• Margin Call

Notification from broker that you must put up additional funds or have position liquidated

private placement

Primary offerings in which shares are sold directly to a small group of institutional or wealthy investors.

How Firms Issue Securities: Primary vs. Secondary

Primary: New Issue Created/Sold & Issuer Receives Proceeds from Sale Secondary: Current owner sells to another party & Issuer Does Not Receive Proceeds from Sale

Short Sales

Sale of shares not owned by investor but borrowed through broker • Mechanics: - Borrow stock from broker; must post margin - Broker sells stock, and deposits proceeds/margin in margin account - Covering or closing out position: Buy stock; broker returns title to original party

stock exchanges

Secondary markets where already-issued securities are bought and sold by members.

What is a primary market for stocks?

The IPO and SEO markets

NASDAQ Stock Market

The computer-linked price quotation and trade execution system.

bid-ask spread

The difference between the bid and asked prices.

bid price

The price at which a dealer or other trader is willing to purchase a security.

ask (or asked) price

The price at which a dealer or other trader will sell a security.

short sale

The sale of shares not owned by the investor but borrowed through a broker and later purchased to replace the loan.

latency

The time it takes to accept, process, and deliver a trading order.

algorithmic trading

The use of computer programs to make rapid trading decisions.

underwriters

Underwriters purchase securities from the issuing company and resell them to the public.

Dark pools

are trading venues that preserve anonymity but also affect market liquidity - Electronic trading networks where participants can anonymously buy or sell large blocks of securities..

The New York Stock Exchange (NYSE) is an example of an

auction market

The most integrated market is an

auction market

a limit sell instructs the

broker to sell if and when the stock price rises above a specified limit

Market orders are

buy or sell orders that are to be executed immediately at current market prices.

Types of Markets

direct search markets, brokered markets, dealer markets, and auction markets.

Dealer markets save traders on search costs because market participants can

easily look up the prices at which they can buy from or sell to dealers.

The NYSE is an _____ and NASDAQ is a _____.

exchange; dealer market

A limit order has _____.

execution uncertainty, but not price uncertainty

A procedure in which the underwriter (investment bank) enters into a written agreement with the issuer of the securities to purchase the securities and then to resell them to the public is called _____ underwriting.

firm commitment

Market orders get executed _____ at _____.

immediately; the current price in the market

Selling stocks to the investing public for the first time is called a/an _____, while selling additional shares at a later date is called a/an _____.

initial public offering; seasoned equity offering

A limit buy order may

instruct the broker to buy some number of shares if and when they may be obtained at or below a stipulated price.

A direct search market is the

least organized market. - Buyers and sellers must seek each other out directly. - An example of a transaction in such a market is the sale of a used television where the seller advertises for buyers on Craigslist. - Such markets are characterized by sporadic participation and nonstandard goods. - It would not pay for most people or firms to specialize in such markets.

A collection of limit orders waiting to be executed is called a

limit order book.

two types of orders

market orders and orders contingent on price.

IPO long term position is

negative

Privately held firms have fewer

obligations to release financial statements and other information to the public. -This saves money and frees the firm from disclosing information that might be helpful to its competitors.

there are three trading systems employed in the United States:

over-the-counter dealer markets, electronic communication networks, and specialist markets.

Most bonds trade in

over-the-counter dealer markets.

When private firms wish to raise funds, they sell shares directly to a small number of institutional or wealthy investors in a

private placement.

When the statement is in final form and approved by the SEC, it is called the

prospectus

A seasoned equity offering is the

sale of additional shares in firms that already are publicly traded. For example, a sale by Apple of new shares of stock would be considered a seasoned new issue.

Dealers specialize in various assets, purchase these assets for their own accounts, and later

sell them for a profit from their inventory.

the securities are "on the shelf," ready to be issued, which has given rise to the term

shelf registration.

An advantage of auction markets over dealer markets is

that one need not search across dealers to find the best price for a good. If all participants converge, they can arrive at mutually agreeable prices and save the bid-ask spread.

firm commitment

the investment bankers purchase the securities from the issuing company and then resell them to the public. The issuing firm sells the securities to the underwriting syndicate for the public offering price less a spread that serves as compensation to the underwriters

SPECIALIST MARKETS

these systems, exchanges such as the NYSE assign responsibility for managing the trading in each security to a specialist. Brokers wishing to buy or sell shares for their clients direct the trade to the specialist's post on the floor of the exchange.

Companies issue new shares with the help of _____

underwriters

• Auction Markets

• Brokers and dealers trade in one location • Trading is more or less continuous

Market order:

• Execute immediately at best price • Bid price: price at which dealer will buy security • Ask price: price at which dealer will sell security

• Price-contingent order:

• Limit buy/sell order: specifies price at which investor will buy/sell • Stop order: not to be executed until price point hit

Why would a firm use Rule 415?

• Overall purpose: Facilitate low-cost investment • Bring together buyers and sellers at low cost • Provide adequate liquidity •Minimize time to trade •Promotes price continuity • Set and update prices of financial assets • Reduce information costs associated with investing

Underpricing

• Post-initial sale returns average 10% or more—"winner's curse" • Easier to market issue → costly to issuing firm

SEC Rule 415

• Security is preregistered • Offered at any time within the next two years • 24-hour notice: Any or all of preregistered amount may be offered • Introduced in 1982

• Dealer Markets

• Third party acts as intermediate buyer/seller

Brokered Markets

• Third-party assistance in locating buyer or seller