Salaar - Finance Capital Markets Winter Semester 2009 Lahore School of Economics Salaar Farooq – Assistant Professor

Salaar - FinanceSalaar - Finance

Capital MarketsCapital Markets

Winter Semester 2009Winter Semester 2009

Lahore School of EconomicsLahore School of Economics

Salaar Farooq – Assistant Professor


LectureLecture

Securities FirmsSecurities Firms&&

Investment banksInvestment banks


Securities Firms & Investment Banks

Learning Objectives

Underwriting?

Broker-dealer-IPO’s

Investment Banking?

Secondary markets?

Mechanics of Markets?


Primary MarketsLearning Objectives

What are Primary Markets & IPO’s?

What is an Investment Banker?

How securities are issued: Process?

What is Arbitrage?

What are private placements?

What are some SEC regulations?

World Capital Mkts considerations


Financial Markets?Primary Markets

Primary Market

Initial Public Offering (IPO)


Financial Markets?Primary Markets

Primary Market

Market for new issues of securities (investment bankers)

Issuers receive funds (raise capital)

Buyers receive financial claims

Initial Public Offering (IPO)Process of initial sale of new securities

After initial sale, securities trade in the secondary markets


Financial Markets?Investment Banker

Investment Banker

Firm specializing in the sale of new securities to the public

Key Role of Investment BanksAssist in obtaining funds for Corporations, Govts, & Foreign Entities.

And for Investors, act as brokers or dealers in buying & selling securities.


INVESTMENT BANKERS

• Specialize in design & sale of securities in the primary market

• Work with issuers to bring a new issue of securities to market—legal, accounting, pricing, and so forth

• Involved in other matters, such as advising firms on mergers and acquisitions, or reorganizations


INVESTMENT BANKING

• Investment bankers form a syndicate to sell new securities--multiple investment bankers working together

• Investment bankers underwrite an issue, purchasing securities from issuer & assuming risk of reselling

• Investment bankers profit from the spread between price they pay & price they sell the issue


Financial Markets?Investment Banking

Performed by 2 groups:

Securities Firms

Firm specializing in the distribution of new securities to the public & also in secondary mkts as brokers & dealers

Commercial BanksAlso underwrite securities.


Investment Banking

How they make money?

Commissions

Fees

Spread Income

Also from:

Money management

Mergers & Acquisitions

Trading of securities etc.


Financial Markets?Investment Banker

Investment Banker

Firm specializing in the sale of new securities to the public

Underwriting – Buying of securities from issuerProcess by which investment bankers purchase an issue of securities from a firm and resell it to the public

PROSPECTUS: Provides info about the IPO to the customers


Financial Markets?

Under-writing Process

3 Main Areas:

1. Advising the issuer on terms & timing of offering

2. Buying Securities from issuer

3. Distributing the securities to public


Financial Markets?Under-writing Process

Buying securities:

Firm Commitment:

Investment Bank agrees to buy from issuer at fixed price

Best efforts under-writing

When the IB does not buy the securities but provides expertise

Gross Spread – Discount (4-7%)

Difference b/w price paid to issuer & price received from public


issuer

Originating investment banker

Underwriting Syndicate (group of invest bankers)

Selling group (syndicate + selected retail brokers)

INVESTORS BUYING IN PRIMARY MKT

MARKETING MUSCLE CRITICAL


Privatization?


Privatization?

Offering securities of Govt owned companies to public…

Thereby liquidating Govt ownership

Also performed by Investment Banks


Arbitrage?Another activity of Investment Banks


Arbitrage?Another activity of Investment Banks

Trading discrepancies in same security at different locations…

Example…

JNJ at 51.83-.90 in NY

JNJ at 51.95-99 in LDN

Locking a profit with no risk


Financial Markets?Global Investment Banking &

Private Placements

Global Investment Banker

Private Placements


Financial Markets?Global Investment Banking &

Private Placements

Global Investment Banker

Firm specializing in the sale of new international securities to the public

Private PlacementsSecurities are issued directly to financial institutions bypassing the open market. - typically insurance, pension funds and investment companies

No SEC filing required

Investment banking fees is saved


OTHER PRIMARY MARKET ISSUES

• Investment banking is a global operation now,

…as firms raise capital around the world in order to reduce costs


Financial Markets?Regulation of Issuance of Securities

Underwriting is regulated by the SEC

Some rules:

Registration statement of intent to issue

Part I: Prospectus

Part II: Supplemental Info

Responsibility of Due Diligence is with underwriter

Shelf Registration rule : can sell in the market (not allowed before)


Continued…Regulation of Issuance of Securities

Underwriting is regulated by the SEC

Some rules:

Continued Reporting

Rule 144A:

Privately placed securities CAN be sold immediately

(not allowed before)


Raising Capital outside domestic market

4 main reasons:


Raising Capital outside domestic market

4 main reasons:

1. Local market may not be large enough

2. Reduced cost of funding

3. To diversify source of funding

4. To manage foreign exchange risks


Financial Markets?Secondary Markets

Markets where existing securities are traded

For investments to be attractive…

they must have…

“LIQUIDITY” & SECONDARY markets provide that


Financial Markets?

Secondary Markets

Function of Secondary Markets?


Financial Markets?

Secondary Markets

Function of Secondary Markets

Provides info on Value of Security

Indicates Consensus price

Shows how well the Firm is using funds

Gives an idea of how NEW issues would be received

Provides Liquidity to the markets

Allows for investments to change ownership easily


Financial Markets? US Securities Markets for Equities

Where are these exchanges?

Equity

NYSE

AMEX

NASDAQ

ECN’S

KSE

BONDSNYSE & AMEX Bond markets


Financial Markets?

US Securities Markets for Equities

Equity

NYSE (New York Stock Exchange)

AMEX (American Stock Exchange)

NASDAQ (National Association of Securities Dealers)

ECN’S (Electronic Communications Network)

KSE (Karachi!)



Financial Markets?US Securities Markets for Equities

Equity

NYSE – 1366 seats (1.5mil$)-2800 co’s valued 13 trillion-Dvol 1.5Bil

AMEX – 807 seats – 760 companies – 2% of ttl value – 200mil vol

NASDAQ- 3843 co’s – 1bil vol – computerized mkt network

ECN’S (Electronic Communications Network)-linked to all

OTC – Not listed but registered, 3000 co’s – dealer network linked

KSE: 200 seats, 163 active, 658 co’s, 35B MCap, 350m! vol, 100 co’s =90% Mcap



Perfect Markets?Conditions Required?


Perfect Markets?Conditions Required

1. Large no. of buyers & sellers & no one is significant. (LIQUIDITY)

2. Everyone is a price taker

3. Price is determined by pure Supply-Demand

4. No frictions exist (COSTS)

Frictions

Costs & barriers to affecting Buyers/sellers payoffs

Eg.Commisions

Bid-ask spreads

Taxes etc


Financial Markets?Securities Markets for Equities

Bid price

Offer Price

Block trades

Program trading



Bid price

Px some one will buy for

Offer PricePx someone will sell for

Block tradesTrades of 10,000 or more

Program tradingComputer generated buy & sell signals for $1 mil or more


Financial Markets?

Securities Markets for Equities

OTC (Over the counter mkts)

ECN’s

After Hours Trading



OTC (Over the counter mkts)

Stocks not listed on an exchange but traded on closed computer networks

ECN’sComputerized trading network for large traders & brokers – computer matched orders

After Hours TradingNormal hrs: 9.30 – 1600

AHT hrs: 1600-2000



Dow Jones Industrial Average

Standard & Poor’s (S&P 500)

Nasdaq


Financial Markets?

Securities Markets for Equities

Dow Jones Industrial Average30 Blue chip stocks – stock price weighted average

Standard & Poor’s (S&P 500)500 stock composite

Nasdaq100 Large cap companies


KSE 30


Brokerags vs Dealers?

Brokers = middle-men

Dealers = shopkeepers (MARKET MAKERS)


Brokerage Firms

Full Service Brokers

Discount Brokers

Online Discount Brokers


Brokerage Firms

Full Service BrokersOffer Full Range of services including info and advice.

Discount Brokers

offers execution services

Online Discount Brokers

offers platforms on the net


Types of Brokerage Accounts

Cash Account

Margin Account

Asset Management Account

Wrap Account

Commissions

Drip (Dividend Reinvestment Plan)


Types of Brokerage Accounts

Cash AccountOnly cash transactions

Margin AccountAllows cash and debt transactions

Asset Management AccountOffers investment of cash balances and Cheque writing

Wrap Accountall fees are wrapped into one

Commissions Drip (Dividend Reinvestment Plan)

free reinvestment by companies

DOLLAR COST AVERAGING - illustrate


How Orders Work

Organize Exchanges (NYSE, NASDAQ)

Super Dot (NYSE)

NASDAQ System of dealers

Decimalization of stock prices


How Orders Work

Organize Exchanges (NYSE, NASDAQ)

Super Dot (NYSE)Electronic system for NYSE

NASDAQ System of dealersThrough computer market making firms

Decimalization of stock pricesJan 2001 stocks were decimalized, average spread five cents (NOW 1c)


Types of Orders

Market Order

Limit Order

Stock Order


Types of Orders

Market OrderBest price on the floor – ENSURES EXECUTION NOT PX

Limit Order (new position)specified or better price – ENSURES PX – NOT EXECUTION

Stop Order (existing position)Automatic execution at specified price

BUY STOP – PROTECTS PROFITS

SELL STOPS – PROTECT LOSSES


Investor Protection

Government Regulation

SEC

Self Regulation

NASD


Investor Protection

Government Regulation SEC

1934

Self Regulationstock exchanges monitor and regulate

NASDAlso monitor


Margin

Margin

Initial Margin

Maintenance Margin

Margin Call


Margin (Leveraged Positions)

Marginpart of transaction value which is customers equity

Initial Marginthe part the customer must pay to initiate a transaction – 50%

Maintenance Margin%age of securities value which must be on hand as equity – 25%

Margin Calldemand from broker for cash if actual M < maintenance M


Margin

Marginpart of transaction value which is customers equity

Initial Marginamount investor puts up / value of transaction

Maintenance Margin%age of securities value which must be on hand as equity

Margin Call

MARKED TO MARKET EVERYDAY

Actual margin =

(current value of stock – amount borrowed) / current value


Short Sales

Being Long

Being Short

Short Sale

Short Interest Ratio


Short Sales

Being Longnormal position of buying stock

Being Shorthaving sold stock not owned

Short Saleselling stock not owned but borrowed

Short Interest Ratioshares short to average daily volume


Market Efficiency

Markets absorb & reflect all new information

into security prices


Securities Firms & Investment Banks

Learning Objectives

Underwriting?

Broker-dealer-IPO’s

Investment Banking?

Secondary markets?

Mechanics of Markets?

Documents

Salaar - Finance Capital Markets Winter Semester 2009 Lahore School of Economics Salaar Farooq – Assistant Professor