Financial Assets and Trading

Outline

▪ Major Financial Securities

▪ Intro. Indonesian Stock Market
▪ Securities Trading Mechanism
▪ Margin Trading
▪ Short Sales
1. Major Financial Securities

▪ Debt
– Money market instruments
– Bonds
▪ Common stock
▪ Preferred stock
▪ Derivative securities
Markets and Instruments

▪ Money Market
– Debt Instruments : CP (commercial paper), CD
(certificate of deposit), RP(repurchase
agreements)
– Derivatives
▪ Capital Market
– Bonds
– Equity
– Derivatives
Capital Market - Fixed Income Instruments

▪ Publicly Issued Instruments

– US Treasury Bonds and Notes
– Agency Issues (Fed Gov)
– Municipal Bonds
– SUN,(surat hutang negara) ORI (oligasi ritel
Indonesia)
▪ Privately Issued Instruments
– Corporate Bonds
– Mortgage-Backed Securities
Corporate Bond

▪ Coupon?
– Coupon bond
– Zero-coupon bond
– Permanent bond
▪ Callable ?
– Callable bond vs. non-callable bond
▪ Secure ?
– Secure vs. unsecure bond (debenture)
Stocks

▪ Common stocks, also known as Equities,

represent ownership shares of a corporation.
– Minority shareholders participation in management?
▪ Two important characteristics:
– residual claim and
– limited liability;
▪ Sources of returns: dividends and capital gains;
Stocks

▪ Some determinants of stock returns:

– Firm-specific condition: management, productivity, earnings,
growth-potential, market-liquidity,
– Market condition: market indices (volatility, volume etc.), e.g.
Nasdaq, SP500, IHSG, FTSE etc.
– Economic condition: macro-economic variables, e.g. GDP-
growth, inflation, employment rate, business cycles, liquidity,
interest rates etc.
▪ Some important empirical evidence:
– Patterns in the cross-section of stock return: value (value vs.
growth), size (small vs. large), momentum (low vs. high);
– Time-series behavior of stock returns: time-varying expected
returns, predictability, stochastic volatility etc.
Structure of Security Markets

▪ Primary Market
– Issuing new securities to financing companies financial
needs
– Private placement vs. public placement
– Investment Bank
▪ Underwriter
▪ Firm commitments vs. best efforts
– IPO (Initial Public Offering), Seasoned equity offering,
unseasoned equity offering, stock split, reverse stock split
– How to determine the IPO price?
▪ One of the most important and difficult problem
▪ Conflicts of interest of many different related parties
Secondary Market

▪ Trading market for already issued securities at

the primary market
▪ Function
– Increase liquidity, function of collateral
– Estimate fair price
– Benchmark for new issuing
II. Indonesian Stock Market
Development of IDX
Development of IDX (cont’)
Register requirement in IDX
Examples of Indexes

▪ Dow Jones Industrial Average (30 Stocks)

▪ Standard & Poor’s 500 Composite
▪ NASDAQ Composite
▪ Jakarta Composite Index
▪ LQ 45
Construction of Indexes

▪ How are stocks weighted?

– Price weighted (DJIA)
– Market-value weighted (S&P500, NASDAQ, JCI)
– Equally weighted (Value Line Index)
▪ How returns are averaged?
– Arithmetic (DJIA and S&P500)
– Geometric (Value Line Index)
Jakarta Composite Index (JCI)
▪

– Initial JCI
▪ The basis for the JCI's calculation is the Aggregate Market
Value of the total listed stocks on 10 August 1982.
▪ Aggregate Market Value is the total of the multiplication of
each listed shares with each price in the IDX on that day.
– Adjustment of Base value
▪ The adjustment will be done if there is an addition of new issuer,
rights offering, partial/company listing, stock exchange originating
from warrants and convertible bonds as well as delisting.
▪
Example of Value Weighted Index
Share Share Market
Date Company Outstanding Price Capitalization Weight Index

3-Jan-19 Company A 10,000,000 5 50,000,000 21.28

Company B 5,000,000 7 35,000,000 14.89

Company C 15,000,000 10 150,000,000 63.83

Total 30,000,000 22 235,000,000 100.00 100.00

Base Value 235,000,000

4-Jan-19 Company A 10,000,000 6 60,000,000 22.64

Company B 5,000,000 5 25,000,000 9.43

Company C 15,000,000 12 180,000,000 67.92

Total 30,000,000 23 265,000,000 100.00 112.77

Example of Value Weighted Index (cont’)
Share Share Market
Date Company Weight Index
Outstanding Price Capitalization

3-Jan-14 Company A 10,000,000 6 60,000,000 18.75%

Company B 5,000,000 7 35,000,000 10.94%

Company C 15,000,000 13 195,000,000 60.94%

Company F 10,000,000 3 30,000,000 9.38%

Total (Old) 30,000,000 290,000,000

Total (New) 40,000,000 320,000,000 100.00

New Base
Value 259,310,344 123.40
III. Securities Trading Mechanism

www.idx.co.id
Lot Size, Price Fraction

www.idx.co.id
Auto Rejection

www.idx.co.id
Price Determination Mechanism

▪ Trading Priority
1. Price priority
Higher bids have more priority than lower bids. On the contrary,
lower asks have more priority than higher asks.
2. Time Priority
If the bids and asks are on the same price, JATS will give priority to
the first submitted bids and asks.
▪ How markets work to determine price?
Order-Driven Market and Open-Auction System in IDX

▪ What is the spread of BCCA?

Order-Driven Market and Open-Auction System in IDX
Key Features of a Double Auction

▪ Both sellers and buyers call out prices

– Buyers “bid” and sellers “ask”
▪ Trading takes place during a trading period
▪ A trade take place when
– a buyer accepts a sellers ask
– a seller accepts a buyers bid
Buyers

▪ Each buyer has a “marginal benefit” table for

the good
▪ Gain or reward is the difference between
marginal benefit and the price
– try to get a low price, but compete with other
buyers
▪ Any new bid must be higher than outstanding
bid
Sellers

▪ Each seller has a “marginal cost” schedule for

the good
▪ Seller’s gain or reward is the difference
between the price and the marginal cost
– try to get a high price, but must compete with
other sellers
▪ Any new ask must be lower than outstanding
ask
Observe Actual Double Auction

▪ Notice sellers and buyers first examine

marginal costs and marginal benefits
▪ During the trading period
– Notice how bids, asks, and trades are posted on
the board
– Notice how the price changes during the trading
period
Bid and Asked Prices, Spread
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-Asked 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.
Order types

▪ Market Order:  Price-contingent Order:

Executed  Traders specify buying
immediately or selling price

– Trader receives
current market price
Trading Costs

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
IV. Margin Trading

▪ Trading in margin
– Borrowing part of the total purchase price of a position
using a loan from a broker.
▪ Margin
– refers to the percentage or amount contributed by the
investor.
▪ Initial margin is set by the Fed
– Currently 50%
▪ Maintenance margin
– Minimum equity that must be kept in the margin account
– Margin call if value of securities falls too much
Margin Trading: Initial Conditions

Share price $100

60% Initial Margin
30% Maintenance Margin
100 Shares Purchased

Initial Position (t=0)

Stock $10,000 Borrowed $4,000
Equity $6,000
Maintenance Margin

Stock price falls to $70 per share (t=1)

New Position
Stock $7,000 Borrowed $4,000
Equity $3,000
Margin% = $3,000/$7,000 = 43%
Margin Call

How far can the stock price fall before a margin call?
Let maintenance margin = 30%
Equity = 100P - $4000
Percentage margin = (100P - $4,000) / 100P
(100P - $4,000) / 100P = 0.30
Solve to find:
P = $57.14
Why do investors invest on margin?

▪ Let say investor A invest to IBM with the price

of $100 with $10,000
▪ Investor B invest to IBM with the price of $100
with 20,000 (50% on margin).
▪ Profits with margin
V. Short Selling

▪ Purpose: to profit from a decline in the price of a

stock or security
▪ Mechanics
– Borrow stock through a dealer
– Sell it and deposit proceeds and margin in an account
– Closing out the position: buy the stock and return to the
party from which it was borrowed
Short Sales : Initial Conditions

Short sales for Dot Bomb 1000 Shares

50% Initial Margin
30% Maintenance Margin
$100 Initial Price

B/S after short selling (t=0)

Dot Bomb falls to $70 per share (t=1)

Assets Liabilities
$100,000 (sale proceeds) $70,000 (buy shares)
$50,000 (initial margin)

Equity
$80,000

Profit = ending equity – beginning equity

= $80,000 - $50,000 = $30,000
= decline in share price x number of shares sold short
Short Sale - Margin Call

How much can the stock price rise before a margin call?

Percentage Margin
= ($150,000* - 1000P) / (1000P)
= 30%
P = $115.38

* Initial margin plus sale proceeds

Questions ?