CHAPTER 3...–investment bank purchases securities from the issuing company and then resells them to the public –investment bank carries price risk •Shelf Registration –SEC

INVESTMENTS | BODIE, KANE, MARCUS

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

CHAPTER 3

How Securities are Traded


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How Firms Issue Securities

• Primary Market

– Firms issue new securities through

underwriter to public

– Investors get new securities; firm gets

funding

• Secondary Market

– Investors trade previously issued securities

among themselves

– Ownership is transferred, no new securities


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How Firms Issue Securities (Ctd.)

• Stocks

– IPO

– Seasoned offering

• Bonds

– Public offering

– Private placement


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Investment Banking

• Underwriting: investment bank helps the

firm to issue and market new securities

• Prospectus: Describes the issue and the

prospects of the company.

– Pre-file with SEC - Red herring

– Once registration is final and accepted by

SEC - Red Herring turns into Prospectus

– Registration does not mean approval


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Figure 3.1 Relationship Among a Firm Issuing

Securities, the Underwriters, and the Public


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Investment Banking

• Firm commitment

– investment bank purchases securities

from the issuing company and then

resells them to the public

– investment bank carries price risk

• Shelf Registration

– SEC Rule 415 (1982): Allows firms to

register securities, and then gradually sell

them to the public for two years


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Investment Banking (Ctd.)

• Private placements

– Firm uses underwriter to sell securities

to a small group of institutional or

wealthy investors.

– Cheaper than public offerings

– Suitability concerns

– Not traded in secondary markets


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Initial Public Offerings (IPOs)

• Process

– 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

– IPO Shares allocated based on interest

• Caveats: high ethics are required during IPO process


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Figure 3.3 Long-term Relative Performance of Initial Public Offerings


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Types of Markets:

• Direct search

– Buyers and sellers seek each other

• Brokered markets

– Brokers search out buyers and sellers


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Types of Markets:

• Dealer markets – Dealers buy for their own account

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

– Example: Corporate bonds

• Auction markets

– traders converge at one place to trade


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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-Ask 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


Limit and Stop orders

• Limit order – Order to buy/sell X shares at price P or better

– “Sell X shares of Facebook at 25 (or better)”

– “Buy X shares of Apple at 600 (or better)

– Guarantees price but not execution

• Stop order – Order to sell X shares once a stock hits a price trigger

– “Sell X shares of FB at stop price of 15”

– “Buy X shares of Apple at stop price of 700”

– Once price trigger is hit, it guarantees execution, as it

turns into market order, but does not guarantee price

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Figure 3.5 Price-Contingent Orders


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Price-Contingent Orders: Sell-Stop


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Price-Contingent Orders: Sell-Stop


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Price-Contingent Orders: Buy-Stop


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Price-Contingent Orders: Buy-Stop


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Price-Contingent Combined Orders:

Sell-Stop-Limit


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Price-Contingent Combined Orders:

Sell-Stop-Limit

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CHAPTER 3...–investment bank purchases securities from the issuing company and then resells them to the public –investment bank carries price risk •Shelf Registration –SEC