How Security are traded - 3 trading systems
- 1. How Securities are Traded
- 2. What is Financial Market • A market that brings buyers and sellers together • To trade in financial assets • Most commonly used: money markets and capital markets
- 3. Money Market VS. Capital market • Capital market – Buyers and sellers engage in trade of financial securities – Participants - individuals and institutions. • Money market – Securities and financial instruments with short- term maturities are traded – Financial assets like treasury bills, certificates of deposits, commercial paper and bankers' acceptance
- 4. How Firm Issue Securities • Primary market Issue of new securities to public through underwriter Receive proceeds from sale • Secondary market Trading of already- issued securities among investors Doesn't receive proceeds from sale
- 5. • Primary market issuing bonds -Public offering Issue of bonds sold to general investing public that can then traded on secondary market -Private placement Issue that usually is sold to one or few institutional investors
- 6. Investment Banking • Underwriter Investment bankers who market the public offerings Help securities issuers lessen their risk • Red herring - Preliminary prospectus • Prospectus Final form of statement accepted by the SEC Offered price of securities announced
- 7. Shelf Registration – SEC Rule 415: – Allows firms to register securities – Gradually sell them for two years – Can be sold in short notice
- 8. Private Placement • Sells share directly to small group of institutional • Far cheaper than public offering • Less suitable for large offering Don’t trade in secondary market which reduce their liquidity
- 9. How Securities are Traded • Types of market • Direct Search Markets Buyers and sellers seek each other For e.g. Sale of used refrigerator • Brokered Markets Brokers search out buyers and sellers For e.g. Primary market (Investment bankers)
- 10. • Dealers Markets Dealers have inventories of assets from which they buy and sell Profit from Bid- ask spread For e.g. OTC securities market • Auction Markets Traders converge at one place to trade For e.g. NYSE
- 11. Bid & Ask Price • Bid price - Maximum price that a buyers are willing to pay • Ask price - Minimum price that a sellers are willing to receive • Spread – key indicator of the liquidity of the asset
- 12. Types of Order • Market Orders - Buy/sell orders –executed immediately at current market price • Price Contingent order Traders specify buying/selling price Limit orders and stop orders
- 13. Limit orders 1. Limit buy order: Specifies maximum price investors willing to pay 2. Limit sell order Specifies the minimum price willing to sell Stop orders trade not to be executed unless stock hits a price limit 1. Stop loss order 2. Stop buy order
- 15. Trading Mechanism • There are 3 trading systems. They are: – Over the counter dealer markets – Electronic Communications networks – Formal exchanges (Specialist Markets)
- 16. Trading Cost 1. Brokerage Commission: fee paid to broker for making the transaction – Explicit cost of trading – Full Service vs. Discount brokerage 2. Spread: Difference between the bid and asked prices – Implicit cost of trading
- 17. Circuit Breaker • Refers to any of the measures used by stock exchanges during large sell-offs to avert panic selling • After an index has fallen a certain percentage, the exchange might activate trading halts or restrictions on program trading
- 18. Long vs. Short sale • Long Position – Purchase of security – Suitable when price is expected to rise (bullish) – Buy – Hold – Sell – Buying on Margin • Short Position – Sale of security – Suitable when price is expected to decline (bearish) – Sell – Hold – Buy – Short Selling
- 19. Margin Trading Buying on Margin – Borrowing part of the total purchase price of a stock from the broker - Broker’s call Loan • Purchase Price = Borrowed Loan + Margin – Margin = the portion of the purchase price contributed by the investor
- 20. Two types of account with the brokerage firm: Cash Account – A regular brokerage account in which the customer is required to pay for securities by cash when a purchase is made. Margin Account – An account that needs to be maintained to purchase security in margin from the broker
- 21. Margin Call Margin Call Price/Trigger Price – The price below or above which there will be a Margin call – Depends on long and short position • For Long Position – Margin call is made if price falls below a Margin Call Price/Trigger Price • How far the price will have to fall for a Margin call? – The broker issues margin call at that price when IM=MM – Lets see an example
- 22. Example:Tata Motors (bullish) • Beginning InvestmentValue=$10000 (100 shares @ $100 each) • Investors invest price increase by 30% • Borrowed Loan =$10000 @ 9% p.a. • Total InvestmentValue =$20000 (200 shares) • Ending InvestmentValue =$26000 (1.3*$20000) • Interest on loan = $900(9% of $10000) • Total Payment = $10900 • Ending InvestmentValue after paying loan =$26000- $10900 =$15100 • What is the rate of return earned by the investor? If maintenance margin 30% when investor would get a margin call?