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Primary vs. Secondary Security Sales
• Primary•
• Secondary•
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Investment Banking Arrangements
• Underwritten vs. “Best Efforts”• Underwritten: • Best Efforts:
• Negotiated vs. Competitive Bid• Negotiated: • Competitive bid:
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• Public offerings: registered with the SEC and sale is made to the investing public• Shelf registration (Rule 415, since 1982)
• Initial Public Offerings (IPOs)•
Public Offerings
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Private placement: sale to a limitednumber of sophisticated investors notrequiring the protection of registration• Allowed under Rule 144A• Dominated by institutions• Very active market for debt securities• Not active for stock offerings
Private Placements
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Organization of Secondary Markets
• Organized exchanges• OTC market• Third market• Fourth market
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Organized Exchanges
• Auction markets with centralized order flow
• Dealership function: can be competitive or assigned by the exchange (Specialists)
• Securities: stock, futures contracts, options, and to a lesser extent, bonds
• Examples: NYSE, AMEX, Regionals, CBOE
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OTC Market• Dealer market without centralized order flow• NASDAQ: largest organized stock market for
OTC trading; information system for individuals, brokers and dealers• National Market System• Nasdaq SmallCap Market
• Lower volume securities• OTC Bulletin Board• Pink Sheets from NASD
• Securities: stocks, bonds and some derivatives• Most secondary bond transactions
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Third Market
• Trading of listed securities away from the exchange
• Institutional market: to facilitate trades of larger blocks of securities
• Involves services of dealers and brokers
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Fourth Market
• Investors trading directly with other investors
• Originally developed for institutional trading
• Trading now on ECNs• Technological developments leading to
individual investors trading directly
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Electronic Computer Networks (ECNs)
• Major ECNs• Island ECN• Instinet• REDIBook• Archipeligo
• Competing with Nasdaq and NYSE for volume
• Leads to some fragmentation of markets
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Costs of Trading
• Commission: fee paid to broker for making the transaction
• Spread: cost of trading with dealer• Bid: price dealer will buy from you• Ask: price dealer will sell to you• Spread: ask - bid
• Combination: on some trades both are paid
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Types of Orders
Instructions to the brokers on how tocomplete the order• Market• Limit• Stop loss
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Margin Trading
• Using only a portion of the proceeds for an investment
• Borrow remaining component• Margin arrangements differ for stocks
and futures
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Stock Margin Trading• Maximum margin is currently 50%;
• • Maintenance margin:
• Margin call:
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Margin Trading - Initial Conditions
X Corp $70
50% Initial Margin
40% Maintenance Margin
1000 Shares Purchased
Initial Position
Stock $70,000 Borrowed $35,000
Equity 35,000
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Margin Trading - Maintenance Margin
Stock price falls to $60 per share
New Position
Stock $60,000 Borrowed $35,000
Equity 25,000
Margin% =
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Margin Trading - Margin Call
How far can the stock price fall before amargin call?
(1000P - $35,000)* / 1000P = 40%
P =
* 1000P - Amt Borrowed = Equity
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Short SalesPurpose: to profit from a decline in the
price of a stock or securityMechanics•
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Short Sale - Initial Conditions
Z Corp 100 Shares
50% Initial Margin
30% Maintenance Margin
$100 Initial Price
Sale Proceeds $10,000
Margin & Equity 5,000
Stock Owed
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Short Sale - Maintenance Margin
Stock Price Rises to $110
Sale Proceeds $10,000
Initial Margin 5,000
Stock Owed 11,000
Net Equity 4,000
Margin %
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Short Sale - Margin Call
How much can the stock price rise before a margin call?
($15,000* - 100P) / (100P) = 30%P =
* Initial margin plus sale proceeds
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Regulation and Trends in Markets
• ECNs present new challenges in regulation
• Global markets with alliances are developing
• Current Issues with• Agency problems associated with
investment banking and research• Insider trading violations