CHAPTER 3 HOW SECURITIES ARE...

Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

CHAPTER 3

HOW SECURITIESARE TRADED

Mr.Mohammed Alhato

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Types of Markets:

■ Dealer markets

– Dealers have inventories of assets from which they buy and sell

■ Auction markets

– traders converge at one place to

trade

NOTES:

• NASDAQ-Lists about 3,200 firms

• New York Stock Exchange--Lists about 2,800 firms

• ECNs: Private computer networks that directly link buyers with sellers for

automated order execution

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Bid and Asked Prices

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.

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Types of Orders

■ 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

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1. limit order is an order to buy or sell a stock at a specific price or better.

• A buy limit order can only be executed at the limit price or lower

• a sell limit order can only be executed at the limit price or higher.

2. Stop orders is an order to buy or sell a stock once the price of the stock reaches

a specified price

• stop-loss orders, the stock is to be sold if its price falls below a stipulated level.

• stop-buy orders specify that a stock should be bought when its price rises above

a limit.

Types of Orders

Textbook page 66

True or False

1. If You want to buy 100 shares of Nike Inc. at the best possible price as

quickly as possible, you would most likely place a stop-loss order ( )

False—a market order because a market order is for immediate execution at

the best possible price.

2. The use of the Internet to trade and underwrite securities increases

underwriting costs for a new security issue. ( )

False—decreases underwriting costs for a new security issue

3. The secondary market consists of transactions on the organized

exchanges and in the OTC market ( )

True

4. With a limit-buy order, the stock would be purchased if the price increased

to a specified level, thus limiting your loss. ( )

False—a stop-buy order

5. Most bond trading takes place in the OTC market among bond dealers ( )

True

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6. Active managers are looking for mispriced securities ( )

True

7. IPOs (Initial Public Offerings) are traded in the primary market for wealthy

people ( )

False— to the public/any investor

8. Dealers purchase securities for their own accounts, and later sell them for

a profit from their inventory ( )

True

9. In stop-loss orders, the stock is to be bought if its price goes above a

stipulated level ( )

False—a stop-buy order

10. A Market order is the one by which investors may place orders specifying

prices at which they are willing to buy or sell a security ( )

False— the Price-contingent Order

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Buying on Margin

■ Margin trading—allows the investor to buy more securities than the

cost of their capital (by) 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.

■ A maintenance margin % is the minimum amount of equity that must

be maintained in a margin account (determined by the broker)

■ If the percentage margin falls below the maintenance level, the

broker will issue a margin call, which requires the investor to add new

cash or securities to the margin account.

Q1: Buying on Margin

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a.How much the investor will borrow from the broker / How much the

broker will pay?

c. If the stock price declines to $70/share, show the account balance and

the new margin?

b. What is the initial Margin?

■ Suppose that an investor initially pays $ 6000 towards the purchase of $10,000 stock value (100 shares)

d. Suppose the maintaince margin is 30%, How far could the stock price

falls before the investor get a margin call?

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Change in stock

price

End of year value

of shares

Repayment of

principal and

interest *

Investor’s rate of

return

30% increase $26,000 $10,900 ?

No change 20,000 10,900 9%

30% decrease 14,000 10,900 ?

• Assuming the investor buys $20,000 worth of stock, borrowing $10,000 of the purchase

price at an interest rate of 9% per year.

See example:

Textbook p.77

Q2: Buying on Margin

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■ Suppose that you’ve borrowed $20,000 on margin to buy

1,000 shares in Samsung Inc. which is now selling at $40

per share. Your account starts at the initial margin

requirement of 50%. The maintenance margin is 35%. Two

days later, the stock price falls to $35 per share.

a.Will you receive a margin call?

b. How low can the price of Samsung shares fall before you

receive a margin call?

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Short Selling

■ Short Selling: to profit from a decline in the price of a stock or security.

■ Process

1. Borrow stock through a dealer

2. Sell it and deposit gains and margin in an account

3. Finally, buy the stock and return to the party from which it was borrowed (at a lower price)

The short-seller anticipates the stock price will fall, so that

the share can be purchased later at a lower price than it

initially sold for; if so, the short-seller will reap a profit.

Q3: Short selling (3 marks)

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■ Suppose that you deposit $100,000 cash in

the brokerage account and short sell

$200,000 on margin. At what stock price

you will receive a broker call when

maintenance margin is 30%? (with 1000

shares outstanding)

Notes

■ Long ="buy." If you're "going long" in a stock, it means you're

buying it because you believe its value will increase.

■ If you go long or buy, then you are bullish

يعني متفائل انو قيمة ما سوف تشتريه راح تزيد =bullish

■ Shorting, =“short-selling." when you sell at a high price and

hope to buy back at a lower price

■ If you go short or sell, then you are bearish

يعني تتوقع انو قيمة ما بعته راح تنزل = bearish

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Q2

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Q3