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