Lecture 10 -equity

Question 1

Role of a stock exchange

Answer 1

Regulation of company listings, a price formation mechanism, the supervision of trading, authorisation of members, settlement of transactions, publication of trade data and prices

Question 2

Shares

Answer 2

Shareholding in companies with reward by way of dividend - usually called equity

Question 3

Stocks

Answer 3

Fixed interest securities, for example bonds, debentures, preference shares

Question 4

Dark pool

Answer 4

Everyone should be able to see the price of stocks
The price is adjusted according to demand and supply

• system that allows stock market traders to transact large blocks of shares anonymously, with prices posted publicly only after deals are done
• big transactions
• avoids high-frequency traders
• investors do not have all the information
  1 aims - confidentiality to big traders
  Issue - distortion of prices

Question 5

Global

Answer 5

Major stock markets of the world are in descending order, the USA, Japan, China, Europe and the UK

Question 6

Stock market characteristics

Answer 6

Total value of trading
Total turnover
Equity turnover
Number of companies listed
Country’s relative importance measure in dollars is affected by the current state of its stock market and the performance of its currency
- a depreciation of country’s currency against the US dollar will reduce the dollar value of its stock market
- an appreciation of country’s currency against the US dollar will increase the dollar value of its stock market

Question 7

Solnik (1991) identified a number of ways in which stock markets differ

Answer 7

Public versus private exchanges
Cash versus forward markets
Fixed versus continuous quotation - high degree of liquidity with quote on continuous basis by market-maker, auction process with owner price per day
Computerised versus floor trading

Question 8

Investors

Answer 8

People and institutional bodies that buy and sell stock either on their own behalf or on the behalf of other investors

Question 9

Instructional investors

Answer 9

Such as pensions funds, insurance funds, unit trusts, mutual funds, hedge funds and like the account for the majority of trades this days

Question 10

Brokers

Answer 10

Act as agents on behalf of their clients, and will attempt to execute trades at the best possible price. In addition brokers may offer investment advice and sell research services

Question 11

Market-makers

Answer 11

Provide bid-ask quotes for shares on a continual basis, if they are unable to find counterparties for a buy sell order that have to be prepared to take on an open position in the stock themselves or conduct an offsetting trade with another market-maker

Question 12

Indices

Answer 12

Shares indices usually based on market capitalisation
Weighed indices: take into account the size of the companies
Modern indices: are based on taking the number of shares and multiplying by the price. This gives proper weight to the companies worth the largest capitalisation

Question 13

Primary market

Answer 13

Deals with the listings of new companies on the exchange
Listing on the exchange to raise new finance for the company - an initial offering IPO
the sale of the existing statues by existing owners (Ex: Privatisation)

Privatisation: Sale of state owned enterprises to the private sector, often through the sale of shares to the public and instructions

Listing requirements: the set of conditions and standards that a company must meet in order to gain and then maintain stock exchange listing.

Question 14

Secondary market

Answer 14

Buying and selling of existing stocks and shares

Question 15

Going public

Answer 15

Handling issues of shares of new companies coming to the market
Why?
New capital for expansions
To produce a price for the shares and a market
In a takeover situation

Question 16

Public offer (IPO)

Answer 16

Offer receives wide publicity and investors are invited to submit applications, a bank/stockbroker underwrites the issue for 1.5-2% fee of the value underwritten; if undersubscribed the underwriters purchase the issue if market is weak, a planned issue is withdrawn

Question 17

Private placement

Answer 17

Brokers contact investment clients with details and shares are sold with public offering

Question 18

Introduction

Answer 18

Firm quoted on a foreign stock exchange to be admitted to the list of firms traded on a domestic exchange; normally, no new money being raised at this time

Question 19

Rights issue

Answer 19

They are underwritten when market price is lower than the price of a new issue
Issuance of new shares by an existing listed company to raise finance
The shares are offered to current shareholders first in proportion to the number of shares that they own
New shares offered at a discount to the existing shares. The effect of dilution the price of the issue.

Question 20

Analysts ratio

Answer 20

Pricing when a firm goes public
What price to ask for its shares - divided by the value of the firm by the number of shares
Price/earnings ratio

Question 21

Scrip issue

Answer 21

A free issue of shares to exiting holders, bonus isuen

Question 22

A par

Answer 22

The nominal value of a security

Question 23

Scrip vs par

Answer 23

The scrip issue doesn’t change the par value, gives additional shares free. A split does not alter the TOTAL par value owned but the par value of each share

Question 24

Scrip dividend

Answer 24

To offer the choice between cash dividends or more shares

Question 25

Reverse split or consolidation

Answer 25

Because a price too low might be a sign of weakness
Thus
Share buy-backs
Company buys back their own shares

Question 26

International equity

Answer 26

Multinational companies listed on several foreign stock exchanges
In order to attract a wider investor market

Consequences:
Large expansion in primary market issues
Secondary market trading in non domestic equities

Companies have to satisfy rules of both markets large new equities are now offered on an international basis and there have been many involving national telephone companies

Question 27

Trading in the medium and long run who owns the share Stock?

Answer 27

Small investors vs institutions
Share of individual investors declining, US: 3.5%, UK 11.5%

Pension funds
Influence the activity on the equity market
Provided by private funds or the state; funded or paid by current taxation and contributions

Equity investment
Choice for a pension funds: to invest into equity or bonds, tend towards bonds

Question 28

Active vs passive management

Answer 28

Active - reorganisation of the portfolio
Passive - investment of all the stocks in a well-known index and leaves the fund to perform
Usually a mix of both

Question 29

Order driven systems - dealing systems

Answer 29

An intermediary matches buy and sell orders at a given price, system driven by orders
Shares will not be bought unless there is a counter party with the equivalent deal on the other side

Question 30

Broker

Answer 30

An agent for buying and selling securities or intermediary for a loan or sell of foreign exchange

Question 31

Quote-driven systems

Answer 31

Markets where there is someone called a market maker who continuously quotes bid and offer prices at which they will buy or sell shares

Question 32

Market maker - dealing system

Answer 32

The dealers in stocks and shares as principals, that is, taking the risk in their own name. The difference is the spread, that is, their profit margin.
The system therefore tends to be driven by the quotations
They can sell short: to sell stock that they don’t actually own but will now have to go out no buy

Question 33

Example of selling short

Answer 33

An investor (who thinks some shares are at a too high price) requests his broker to borrow the shares from an existing holder. The stock is then on sold to a buyer. 
The seller subsequently covers his position by purchasing the shares at some future date (hopefully at a lower price) for delivery to the party that lent the stock.

Question 34

Hybrid systems

Answer 34

Both order driven and quite driven features
In New York, each share is allocated so a specialist:
Acts like a broker, executing orders for other brokers on a commission basis
Can also act for their own account (like a market maker)

Question 35

Interdealer brokers

Answer 35

In some markets like London transaction b/w market dealers are facilitated by interdealer brokers
Publish anonymously large potential deals at bid and offer prices; another dealer might see the quotation and decide to make a trade

Question 36

Clearing and settlement. Trading process

Answer 36

Clearing - all activities that take place in between making a committee to to undertake a transaction until it is paid for
Settlement - basic question of paying money and receiving stock or money and delivering stock

Question 37

Settlement risk

Answer 37

Risk that the transaction will not be paid
Rolling settlement
Account period

Question 38

Custodians

Answer 38

An organisation that will store the original documentations for, say, bonds or equities and will look after settlement

Question 39

Role of exchanges

Answer 39

The regulation of a companies listing
, price formation mechanism,
supervision of trading
Authorisation of members