Investments Chapter 2

Return on Invested Capital

(Income - Interest + Market Value of Securities at Sale - Market Value of Securities at Sale) / Amount of Equity at Purchase

Long purchase:

--transaction in which investors buy securities, usually in the hope they will increase in value and can be sold at a later date for profit. --Object is to "buy low and sell high" --Most common type of transaction --Return comes from any dividends or interest received during the ownership period, plus the difference (capital gain or loss) between the purchase and selling prices.

Securities Acts Amendments of 1975

Abolished fixed-commissions and established an electronic communications network to make stock pricing more competitive

Essentials of Margin trading

Advantages: --Magnifies returns --Allows investors to spread their limited capital over a larger number of investments which promotes diversification Disadvantages: --Magnifies losses --Cost of margin loan: the vehicle through which the borrowed funds are made available ---Interest rate usually 1% to 3% above the prime rate: the interest rate charged to creditworthy business borrowers.

Maloney Act of 1938

Allowed self-regulation of securities industry through trade associations such as the National Association of Securities Dealers (NASD)

Bear Market:

Conditions in security markets normally associated with falling prices, investor pessimism, economic slowdown, and government restraint.

Bull market:

Conditions in security markets normally associated with rising prices, investor optimism, economic recovery, and government stimulus.

Investment Company Act of 1940

Created & regulated mutual funds

Securities Exchange Act of 1934

Established SEC as government regulatory body

The Over-the-Counter Market

Includes mostly smaller companies that either cannot or do not wish to comply with Nasdaq's listing requirements. Companies traded on the OTC Bulletin Board (OTCBB) are regulated and required to file audited financial statements and comply with federal securities law. Companies traded on the OTC Markets Group are not required to file with the SEC. There are three tiers. --OTC Pink: unregulated; small, risky companies --OTC QB: companies must provide SEC, bank, or insurance reporting and be current in their disclosures. --OTC QX: reserved for companies that choose to provide audited financial statements and other required information.

The Investment Banker's Role

Investment Banker: financial intermediary that specializes in assisting companies in issuing new securities and advising firms with regard to major financial transactions. For IPOs, their main role is underwriting. -Underwriting: purchases the security at agreed-upon price and bears risk of selling it to the public. For large security issues, forms an underwriting syndicate. -Underwriting Syndicate: group formed to share the financial risk of underwriting. -Selling group: other brokerage firms that help the underwriting syndicate sell the issue to the public. Compensation typically in the form of a discount on the sale price of the securities.

Margin trading:

Investors use funds borrowed from brokerage firms to make securities purchases. Margin requirement: the minimum amount of equity that must be in the margin investor's own funds. The margin requirement for stocks has been 50% for some time; set by the Federal Reserve Board.

Nasdaq:

Largest dealer market Listed companies include Microsoft, Intel, Cisco Systems, eBay, Google, Yahoo!, Apple, Starbucks, and Staples.

Blue sky laws

Laws imposed by individual states to regulate sellers of securities Intended to prevent investors from being sold nothing but "blue sky"

The Basic Margin Formula

Margin = (Value - Debit Balance) / Value of Securities

Making Margin Transactions

Margin account: established to execute a margin transaction, an investor must contribute a minimum of $2,000 in equity or 100% of the purchase price, whichever is less, in the form of cash or securities. Initial margin: minimum amount of equity that must be provided by the investor Restricted account: account with equity less than the initial margin requirement Maintenance margin: absolute minimum amount of margin (equity) that an investor must maintain in the margin account at all times --Margin call: Investor receives this when an insufficient amount of maintenance margin exists and then has a short period of time (few hour to few days) to bring equity up above the maintenance margin. Debit balance: amount of money being borrowed in the margin loan

Types of Securities Markets

Money market: the market where short-term debt securities are bought and sold. Capital Market: the market where long-term securities, such as stocks and bonds, are bought and sold; classified as primary or secondary. Securities and Exchange Commission (SEC): Federal agency that regulates the securities markets.

Top four securities markets

NYSE Nasdaq London Stock Exchange Tokyo Stock Exchange

Broker Markets:

New York Stock Exchange (NYSE) is the largest stock exchange in the world. --In 2015, more than 2,400 firms with an aggregate market value of greater than $19 trillion were listed on the NYSE. --Designated market maker (DMM): an exchange member who specializes in making transactions in one or more stocks ; job is to manage the auction process. --Listing requirements are a minimum stock price of $2-$3 and a value of shares available to trade greater than $15 million. Regional Stock Exchanges --Modeled after the NYSE, but membership and listing requirements are more lenient. --Majority of securities listed here are also listed on NYSE

Dealer Markets:

No centralized trading floor; comprised of market makers linked via a mass electronic network.

Broker Markets:

Options Exchanges --Allows trading of options --Dominant exchange is Chicago Board Options Exchange (CBOE) Futures Exchanges --Allows trading of futures --Dominant exchange is the CME Group

The Primary Market

Primary market: the market in which new issues of securities are sold to investors. Initial Public Offering (IPO): the first public sale of a company's stock

Insider Trading and Fraud Act of 1988

Prohibited insider trading on nonpublic information

The Primary Market

Public offering: securities offered for sale to public investors. Rights offering: shares are offered to existing shareholders on a pro rata basis Private placement: securities sold directly to select groups of private investors

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 Shares (ADSs): foreign stocks trading on U.S. exchanges, created to permit U.S. investors to hold shares of non-U.S. companies and trade them on U.S. stock exchanges

Indirect Ways to Invest in Foreign Securities

Purchase shares of U.S.-based multinational with substantial foreign operations

Trading Hours of Securities Markets

Regular Trading Session for U.S. Exchanges and Nasdaq: 9:30 A.M. to 4:00 P.M. Eastern time

Regulation Fair Disclosure (2000)

Required companies to disclose material information to all investors at the same time

Securities Act of 1933

Required full disclosure of information by companies

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

Securities Markets

The goal of securities markets is to permit financial transactions to be made quickly and at a fair price markets that allow buyers and sellers of securities to make financial transactions

Sarbanes-Oxley Act of 2002

Tightened accounting and audit guidelines to reduce corporate fraud

Going Public: The IPO Process

Underwriting: promoting the stock and facilitating the sale of the company's shares. Prospectus: registration statement describing the issue and the issuer. Quiet period: time period after prospectus is filed when company must restrict what is said about the company. Red Herring: preliminary prospectus available during the waiting period. Road show: series of presentations to potential investors

Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010

aims to promote the financial stability of the U.S. by improving accountability and transparency; Created the Bureau of Consumer Financial Protection

Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010

aims to promote the financial stability of the U.S. by improving accountability and transparency; Created the Bureau of Consumer Financial Protection.

Broker Market:

consists of national and regional securities exchanges. 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.

Third market:

consists of over-the-counter transactions made in securities listed on the NYSE or one of the other exchanges. Large institutional investors go through market makers that are not members of a securities exchange Institutional investors (mutual funds, life insurance companies, pension funds) receive reduced trading costs due to large size of transactions

Fourth Market:

consists of transactions made through a computer network, rather than on an exchange, directly between large institutional buyers and sellers of securities.

Sarbanes-Oxley Act of 2002

focuses on eliminating corporate fraud related to accounting and other information releases

Dealer Market:

made up of the Nasdaq OMX and OTC trading venues. 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.

crossing markets:

orders are only filled if they can be matched most after-markets

Short selling

practice of selling borrowed securities Investor borrows securities from a broker Broker lends securities owned by other investors that are held in "street name" Investor must make a deposit with the broker equal to the initial margin requirement applied to short-sale proceeds; broker retains proceeds from the short sale. "Sell high and buy low" Investors make money when stock prices go down

Currency exchange risk:

risk caused by the varying exchange rates between the currencies of two countries.

Bid price:

the highest price offered to purchase a given security

Diversification:

the inclusion of a number of different securities in a portfolio to increase returns and reduce risk

Ask price:

the lowest price offered to sell a given security.

Secondary market (aftermarket):

the market in which securities are traded after they have been issued Role: --Provides liquidity to security purchasers --Provides continuous pricing mechanism Major segments: --National Securities Exchanges: markets in which the buyers and sellers of listed securities come together to execute trades. --Over-the-counter (OTC) Market: involves trading in smaller, unlisted securities.

Pyramiding

uses the paper profits in margin accounts to partly or fully finance the acquisition of additional securities. --Excess margin: more equity in the account than required --Constraint: when additional securities are purchased your margin account must be at or above the required initial margin level. --Risk associated with possible price declines in the margined securities