2. • Terms and securities account opening process.
• Primary Market and Secondary Market.
• The mechanism of the transaction on the Stock Exchange (flowchart).
• Remote trading (scripless trading).
• Reading layout regular trade.
• The formation process of the auction market (bid-over).
3. A. Major Assets that Trade in
Money and Capital markets
• Major Markets and Instruments:
• Money Market
• Market for short-term, liquid, low-risk debt securities
• Fixed Income Capital market
• Market for longer-term, higher risk debt securities
• Equity Markets
• Market for common and preferred stocks
• Derivative Markets
• Market for options, futures, forwards, and other types of
“derived” instruments
4. B. Understand the Market Mechanics of
Primary and Secondary Trading
• 1. Primary Markets
• Initial sales of securities
• Funds are received by the issuing company
• 2. Secondary Markets
• Resale of securities to others
• No funds are received by issuing company
5. • Public offerings
• Registered with the SEC and sale is made to the
investing public. May be initial or follow-up
offerings
• Shelf registration allows firms to register more
shares, and sell them over time (on the shelf)
• Initial Public Offerings (IPOs)
• First offerings by the company
• Evidence of under-pricing initially; however,
generally have been poor long-term performers
• Private Placements
• Sale to a limited number of sophisticated investors
• Dominated by large-scale institutions
Key Terminology for Primary Markets
6. Order Information Flow
for the Primary Market
Lead
Underwriter
Underwriting
Syndicate
Investment
Banker B
Investment
Banker A
Investment
Banker C
Investment
Banker D
Private Investors and Institutions
Issuing Firm
7. Trading of Primary Issues
• Primary Issues
• New issue: Issuer receives the proceeds from the sale, less the
expense paid to the underwriters
• There is a major “beauty pageant” among investment bankers as
they compete for the business
• Being the lead underwriter not only brings huge fees (sometimes 1-
5% of the offering), it also brings substantial “bragging rights” and
prestige to the lead firm
8. How IPO’s are Sold
• Investment bank gets the mandate
• Research is prepared
• Road Shows are planned and taken
• Indications of Interest are given to the Underwriting Syndicate (book building)
• Pricing and Shares Offered are finalized
• Firm orders and prices are placed
• Syndicate confirms sales and shares issue
9. Investment Banking Arrangements
• Underwritten vs. “Best Efforts”
• Underwritten: Firm commitment on proceeds to the issuing firm. If can’t sell,
has to buy shares.
• Best Efforts: No firm commitment.
• Negotiated vs. Competitive Bid
• Negotiated: Issuing firm negotiates terms with investment banker
• Competitive bid: Issuer structures the offering and secures bids from various
investment banks, then picks most competitive bid.
10. 2. Understand Market Mechanics of
Secondary Trading
•Key terminology for Secondary Offerings
• Secondary Security Sales
• Existing owner sells to another party
• Issuing firm doesn’t receive proceeds and is not directly
involved
• In most cases its an electronic entry in a share registry,
although in smaller markets overseas, it is still delivery of
share certificates
11. Secondary Security Sales (continued)
• Why does firm care about its share price when
it gets no new money?
• Prestige
• Publicity
• Ability to raise new capital in the future
• Managers options/salaries are sometimes tied to
share price
• Note: If I ever saw a Reuters or Bloomberg terminal on
the CEO’s desk when visiting companies, I took it a
negative sign. It showed that he/she was more worried
about the price of the stock than running the company!
12. Private Investor Order Information
Flow for the Secondary Market
3. Confirms Trade
1. Place Order, regardless of type, to the broker or
through the computer
2. Submits Order
3. Confirms trade
2. Confirms trade
4. Confirms trade
5. Mails conformation statement
Stock
Exchange
Brokerage
Operations and
Accounting
YOU
13. Institutional Order Information Flow for the
Secondary Market
3. Confirms Order
1. Place Order, regardless of type
3. Submits Order
4. Confirms trade
4. Confirms trade
6. Confirms trade execution
7. Mails conformation statement
Company
Traders
2. Combines orders and submits
5. Confirms trade
Stock
Exchange
Brokerage
Operations and
Accounting
Portfolio
Manager
14. Types of Share Orders
(Secondary Markets)
Instructions to the brokers on how to complete the order
• Market Order
• Buy/sell at the current market price
• Limit Order
• Buy/sell at a specified price
• GTC Order
• Buy/sell at a specific price until the order is
cancelled
• Stop loss
• Buy/sell only if the price reaches a specified level
• Program trades
• Buy/sell and entire portfolio at a specified price
15. 1. Organized Exchanges
• Auction markets with centralized order flow
• Largest of all the markets
• Dealership function
• Can be competitive or assigned by the exchange
(specialists)
• Securities
• Stocks, futures contracts, options, and to a lesser
extent, bonds
• Examples: NYSE, AMEX, London, Tokyo
• Generally, these exchanges are somewhat archaic
16. 2. OTC Market
• Dealer market without centralized order flow
• Generally the direction of future stock markets
• Price quotation market rather than trading market:
• Information system for individuals, brokers and
dealers
• Securities
• Stocks, bonds and some derivatives
• Example: NASDAQ (largest organized stock market for
OTC trading)
17. 3. Third Market
• Trading of listed securities OTC away from the organized exchange
• Organized originally due to high fixed NYSE trading costs
• Institutional market
• To facilitate trades of larger blocks of securities
• Involves services of dealers and brokers
18. 4. Fourth Market
• Institutions trading directly with institutions
• No middleman involved in the transaction
• Organized information and trading systems
• Through ECNs: Electronic Trading Networks
• Example: INSTINET, Island ECN (53bn shares in 2000 worth $1 trillion)m
REDIbook, Archipelago
19. Costs of Trading
• Explicit
• 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: difference between the ask - bid
• Combination: on some trades both a
commission and spread are paid. You are
responsible to watch and make sure you are
getting the best execution
20. Costs of Trading (continued)
• Implicit
• Market impact: increase (or decrease) in price resulting from the
the size of the order versus the average daily trading volume. This
can often be greater than all other costs—Beware!
21. Margin Trading
• Margin Trading:
• Using borrowed money to finance an investment or
to add leverage an existing investment
• You put up a portion of the funds and borrow remaining
component. Margin arrangements differ for stocks and
futures
• Maximum margin: currently 50% (set by the Fed); you can
borrow up to 50%
• Maintenance margin: minimum amount equity in trading
can be before additional funds must be put into the
account
• Margin call: notification from broker that you must put up
additional funds
22. Short Sales
• Short Selling
• The process of borrowing shares and selling them
with the intent to buy them back later at a lower
price after an expected decline in the price of a
stock or security, thereby making a profit from the
decline in price
• Mechanics
• Borrow stock from another investor through a
dealer
• Sell it and deposit proceeds and margin in a
brokerage account (of the broker)
• Close out the position: buy the stock and return it
to the party from which is was borrowed including
reimbursing for any dividends paid
