Chapter 3: How Securities are traded? Flashcards
Primary Market
- Market for newly-issued securities
- Firms issue new securities through underwriter (investment banker) to public
Secondary Market
Investors trade previously issued securities among themselves
Privately Held Firms
- Up to 499 shareholders
- Middlemen have formed partnerships to buy shares and get around the 499-investor restrictions
- Raise funds through private placement
- Lower liquidity of shares
- Have fewer obligations to release financial statements and other information
Publicly Traded Companies
- Raise capital from a wider range of investors through initial public offering, IPO
- Seasoned equity offering: The sale of additional shares in firms that already are publicly traded
- Public offerings are marketed by investment bankers or underwriters
- Registration must be filed with the SEC
Initial Public Offerings
- Road shows to publicize new offering
- Bookbuilding to determine demand for the new issue
- Degree of investor interest in the new offering provides valuable pricing information
Initial Public Offerings (Cont.)
- Underwriter bears price risk associated with placement of securities:
- IPOs are commonly underpriced compared to the price they could be marketed (ex.: Groupon)
- Some IPOs, however, are well overpriced (ex.: Facebook); others cannot even fully be sold
Market Order: Executed immediately Trader receives current market price Price-contingent Order: Traders specify buying or selling price A large order may be filled at multiple prices Trade Execution: http://www.sec.gov/investor/pubs/tradexec.htm Payment for order flow Best Execution Price improvement
- Executed immediately
- Trader receives current market price
Price-contingent Order:
- Traders specify buying or selling price
- A large order may be filled at multiple prices
Trade Execution:
- Payment for order flow- As a way to attract orders from brokers, some regional exchanges or third market makers will pay your broker for routing your order to that exchange or market maker—perhaps a penny or more per share for your order.
- Best Execution- your broker has a duty to seek the best execution that is reasonably available for its customers’ orders
- Price improvement-
Price Contingent Orders
Page 66 in book Figure 3.5
Brokerage Commission: (Trading Cost)
- fee paid to broker for making the transaction
a. ) Explicit cost of trading
b. ) Full Service vs. Discount brokerage
Spread: (Trading Cost)
Difference between the bid and asked prices
Implicit cost of trading
Bid Price
- Bids are offers to buy.
- In dealer markets, the bid price is the price at which the dealer is willing to buy.
- Investors “sell to the bid.”
- Bid-asked spread is the profit for making a market in a security.
Ask Price
- Asked prices represent offers to sell.
- In dealer markets, the asked price is the price at which the dealer is willing to sell.
- Investors must pay the asked price to buy the security.
Direct search ( Types of Market)
Buyers and sellers seek each other
Brokered markets ( Types of Market)
Brokers search out buyers and sellers
Dealer markets ( Types of Market)
Dealers have inventories of assets from which they buy and sell
Auction markets ( Types of Market)
Traders converge at one place to trade
Trading Mechanisms
Dealer markets
Electronic communication networks (ECNs)- True trading systems that can automatically execute orders
Specialists markets- Maintain a “fair and orderly market”
Have been largely replaced by ECNs
Algorithmic Trading
The use of computer programs to make trading decisions
High-Frequency Trading
Special class of algorithmic with very short order execution time
Dark Pools
Trading venues that preserve anonymity, mainly relevant in block trading
Buying on Margin
Borrowing part of the total purchase price of a position using a loan from a broker
- Investor contributes the remaining portion
- Margin refers to the percentage or amount contributed by the investor
- You profit when the stock rises
Buying on Margin (Continued)
-Initial margin is set by the Fed
Currently 50%
Maintenance margin- Minimum equity that must be kept in the margin account
Margin call if value of securities falls too much
Short Sales
- Purpose
a. ) To profit from a decline in the price of a stock or security - Mechanics:
a. ) Borrow stock through a dealer Sell it and deposit proceeds and margin in an account - Closing out the position:
a. ) Buy the stock and return to the party from which it was borrowed
