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Investments (Finance) Course - Session 3&4
Investments (Finance) Course - Session 3&4
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Investments
Equity Raising – Primary Offerings FINN 353
IPO Advantages
Better Access to Capital Markets
Shareholders Gain Liquidity
Original Owners can Diversify
Monitoring and Information Provided Externally
Enhances Firm’s Credibility
Full Disclosure of Information
Secondary Markets
IPO Disadvantages
Expensive
Actual Cost
Offering at a Discount
Costs of Dealing with Shareholders
Public Information – Competitors
Public Pressure
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Investments
Equity Raising – Primary Offerings FINN 353
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Investments
Equity Raising – Primary Offerings FINN 353
Underwriting Process:
Origination
Advise on Type of Security, Timing, and Price
Paper-work
Underwriting Syndicate
Distribution – Selling
Risk Bearing
Certification
Underwriting Agreement:
What
How Much
Price
Underwriting Spread
Over allotment/Green Shoe Option
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Investments
Securities Trading – Types of Markets FINN 353
Brokered Markets:
Active trading
Brokers find it profitable to offer services
Brokers specialize in the goods/items being sold
Brokers match buyers and sellers
Example: real estate; primary markets for capital raising is a brokered market with
the Investment Bank as the broker
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Investments
Securities Trading – Types of Markets FINN 353
Dealer Markets:
Trading activity is large for the asset/good
Dealers specialize in the asset/good
Dealers buy and sell from their own account
The “spread” between the buy (“bid”) and sell (“ask”) price is dealer’s profit
These market save traders on search costs as go directly to various dealers and
compare prices
Example: over the counter (OTC) financial markets, new cars
Auction Markets:
Most integrated
All traders meet at one place to buy or sell an asset
No need to search across dealers to find the best price
As buyer and seller in the same place, no buy-sell price spread
Example: stock exchanges, farmers’ wholesale market
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Investments
Securities Trading – Types of Orders FINN 353
Market Orders:
Buy or sell orders to be executed immediately at the market price
Buy/Bid price: the price at which a dealer or other trader would buy the security and
the investor would sell the security
Sell/Ask price: the price at which a dealer or other trader would sell the security and
the investor would buy the security
Bid – Ask prices quoted are generally for a given volume and would change with
trading (prices increase if orders to buy > orders to sell and vice versa)
Depending on the order size, generally market orders are completed/executed over
multiple price points
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Investments
Securities Trading – Types of Orders FINN 353
Price-contingent Orders:
Investors specify the price at which the order is to be executed
Limit Buy Order:
Order to buy at or below a specified price
Limit Sell Order:
Order to sell at or above a specified price
Limit order book: collection of limit orders waiting to be executed
Stop-Loss Order:
Orders to sell if price drops below a specified price
Done to stop losses
Stop-Buy Order:
Orders to buy if price rises above a specified price
Accompany “short sales” to curtail losses
Condition
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Investments
Securities Trading – Trading Mechanisms FINN 353
Investors place orders with a brokerage firm, who are members of an exchange
Brokers would then arrange the trade for a commission through one of the following three
trading systems:
1. Dealer Markets:
Over-the-Counter (OTC) markets – An informal network of brokers and dealers who
negotiate sales of securities
Broker contact the “dealers” who quote price and buy or sell from their inventory
Used to be manual with dealers quoting prices and brokers negotiating directly
But now is through an automated electronic system
Example: NASDAQ
2. Electronics Communication Networks (ECN):
Electronic trading systems in which brokers put in all limit orders, the limit orders are
automatically matched and executed
As there is direct execution, no dealer is required and thus no bid-ask spread
Low cost, fast and investor anonymity is maintained
Example: All major non OTC markets, PSE, NYSE, LSE
3. Specialist Market:
A “specialist” for each security is assigned the responsibility of maintaining the limit
order book, crosses/executes the trades and makes market for that security
If not enough orders, then also acts like a dealer and buys and sells from own
inventor
NYSE used to be a specialist market, but role now mostly taken over by ECNs
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Investments
Securities Trading – New Strategies FINN 353
Now, the various ECN’s compete with each other on their “Latency”:
The time it takes to accept, process and deliver a trading order
1. Algorithm Trading:
It is estimated that about half of the volumes in US now is from algorithm trading
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Investments
Securities Trading – New Strategies FINN 353
3. Dark Pools:
Large traders seek anonymity because of the fear that prices may move against them
if information is made public
Large trades (>10,000 shares), called “block” trades, were traditionally brokered by
“block houses” – experts in matching large buyers and sellers, discreetly outside the
public purview
Dark pool – ECNs where participants can anonymously trade large block of securities
But “dark pools” can become controversial as moving large trades out of the main
market can thin it out
One strategy is to split the order into small lots and trade on any ECN
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Investments
Securities Trading – Buying on Margin FINN 353
Broker’s call loans - Loan/debt obtained from brokers to purchase securities, carrying an
interest and service charge costs
Buying on Margin - Buying securities by partially paying through a broker’s call loan
Initial Margin Requirement – Set by the regulators, it is the minimum amount of the
purchase price that has to be paid by the investor
Example: If 50% is the initial margin, then investor has to be pay at least Rs. 200 for
buying a share trading at Rs. 400
All securities purchased on margin remain with the brokerage firm under its name as the
securities are collateral for the loan
If MV < Brokers loan/debt, margin/net-worth is negative and there is not enough value to
cover the loan
To avoid this, brokers set a “maintenance margin”, the minimum margin that needs to be
maintained in the portfolio:
If the percentage margin < maintenance margin; brokers issue a “margin call”,
whereby the investor will have to pay additional cash or the broker will sell the shares
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Investments
Securities Trading – Short Selling FINN 353
Short sale:
i. Borrow shares through a broker
ii. Sell them to obtain cash upfront
iii. Upon decline of price, buy the shares at a lower price (cover the short position)
iv. Return the shares and keep the profit
The cash obtained from sale of shares remains with the broker so as to cover the buy back
of shares
List the major indexes from the world, highlighting their salient features in tabular
form, with special focus on the indexes employed in Pakistan
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