L2 - How Securities are Traded Flashcards
How Firms Issue Securities?
- Primary market: new company issuing equity or debt in return for funds - done through a investment bank
- E.g. IPO, Seasoned equity offering (SEO), Public Debt Offering Private Placement
- Secondary market:
- Stock is transferred on exchanges or OTC between public owners/investors without the issuing firm being involved
- Provides liquidity
What are IB known for?
IBs specialise in underwriting (help a firm go public), advising and marketing public offerings
How much do IB receive for their underwriting?
They usually receive fees of (2%-7%) for their underwriting services
The bigger the company the smaller the underwriting fee
Fees –> US > China > Europe
What services do IB provide during an IPO?
- Valuation - DCF, valuation is hard though as companies are new and don’t have many records/statements to ‘value’
- Marketing plan - convince investors to buy yours stock
- Roadshow - Introduce your company to the world,
- Book building - keep a record of who is interested who has concerns to help price the stock
- Pricing - under-price shares below fair value to sell most if not all of the new shares - induce potential investor to submit interest in the book building process
- Allocation - decide who can get the IPO shares
- Price support in aftermarkets - buy back your shares if the stock prices falls too much after the IPO to maintain price stability
Magnitude of IPO under-pricing?
Between July 1st 2009 to June 30th 2019 the average first day return on U.S. IPOs was 16%
(Prof. Jay Ritter’s website)
This is higher for venture capital backed IPOs - 21%
Largest IPOs in history?
All Asian companies –> more active, young firms going public
–Saudi Aramco (Oil), US$29.4 billion (2019)
The Alibaba group (2014) –> US$25 billion
SoftBank Group, US$23.5 billion (2018)
Largest IPO markets?
- Ranked by total funds raised
- Hong Kong main board
- NASDAQ
- Saudi Stock Exchange
- NYSE
Why do firms accept under-pricing phenomena?
- Firms dont have a choice but to use IB
- Want first trading day to look good –> boost morale from high stock price growth
- Prefer to sell all the shares
- Owners shares are sold later so IPO price isnt an issue to them
What is an ICO?
ICO (initial coin offering)- instead of equity a new firm issues a new crypto currency to raise capital
These can be used to buy new products and services in the future
DOES NOT REQUIRE UNDERWRITING SERVICE - problem for IB
Do ICO companies still exist now?
Although most of the ICO firms dont exist now - most are fraudulent, legit ones didnt raise enough capital as the public didnt want any coins
What is a Private Placement?
- Second most common way to raise capital
- Sales to a small number of institutions or sophisticated investors
- Does not require registration to government e.g. SEC
- Quicker but dont raise as much money
- More active for debt securities than equity (opposite in China)
What is an organised exchange?
- Auction markets –> all trade converge at one place to buy or sell an asset
- There is an auction officer (called specialist) for each stock) –> most important market maker
- Specialist (can be a group of people) is in charge of all trading order of a particular stock
- There is an auction officer (called specialist) for each stock) –> most important market maker
- Electronic or face-to-face
How are OTC markets traded?
Trades are all accomplished trade through an electronic communication network (ECNs)
Who provides liquidity in OTC markets?
- Dealers - most important market maker
- They are investment companies that buy and sell on the network
- They also buy and sell from their own inventories to household investors or other dealers
- Sell and buy their own inventory to provide liquidity if the market isn’t trading
- Usually, there is more than one dealer that is responsible for a stock –> compete by setting their own bid/ask spread
Different Market Makers?
- Dealer
- Broker
