Capital Market

Securities Markets
2021-2022

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 Securities Markets
Overview

• My opinion: the most important function is to allocate

resources to more efficient areas.
• How this function work? Through primary market.
Note: in most situations, we refer to secondary market
when we are talking about the stock market.

Primary Secondary
New Issue Created/Sold Current owner sells to
another party

Issuer Receives Issuer Does Not Receive

Proceeds from Sale Proceeds from Sale

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 Securities Markets
How Firms Issue Securities: Private vs. Public

Primary Market
Privately Held Publicly Traded
Definition Ownership help by a Securities sold to the
small group of investors general public;
investors to trade
shares
Shareholders Up to 2000 Unlimited number
shareholders
Financial Statements Fewer obligations to Obligated to release
release financial financial statements to
statements to public the public
Primary Offering Sold Directly to a Small Sold to the Public (often
group of Investors with an Underwriter)

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 Securities Markets
How Firms Issue Securities: Private vs. Public

• Publicly Traded Companies

• Initial public offering (IPO): First sale of stock by
a formerly private company
• Underwriters: Purchase securities from issuing
company and resell them
• Prospectus: Description of firm and security
being issued

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 Securities Markets
How Firms Issue Securities: IPO

• Initial Public Offerings

• Issuer and underwriter put on “road show”

• Purpose: Bookbuilding and pricing

• Why would an investor reveal her true interest?*

• Underpricing
• Post-initial sale returns average 10% or more or
“winner’s curse”
• Easier to market issue à costly to issuing firm

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Securities Markets
How Firms Issue Securities: IPO

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Securities Markets
How Firms Issue Securities: IPO

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 Securities Markets
How Firms Issue Securities: Shelf Registration*

• SEC Rule 415

• Pre-requirement: Security is preregistered
• Offered at any time within the next two years
• 24-hour notice: Any or all of preregistered amount
may be offered
• Introduced in 1982

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 Securities Markets
How Securities Are Traded: Secondary Financial Markets

• Overall purpose: Facilitate low-cost investment

• Bring together buyers and sellers at low transaction
cost
• Provide adequate liquidity
•Minimize time to trade
•Promotes price continuity
• Set and update prices of financial assets
• Reduce information costs associated with investing

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 Securities Markets
How Securities Are Traded: Market Types

• Direct Search Markets

• Buyers and sellers locate one another on their own
• Brokered Markets
• Third-party assistance in locating buyer or seller
• Dealer Markets
• Third party acts as intermediate buyer/seller
• Auction Markets
• Brokers and dealers trade in one location
• Trading is more or less continuous

Note: most modern exchanges in the world are auction markets,

combining some characteristics of other types of market (e.g.,
Dealer markets). Apartment New York Madrid
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 Securities Markets
How Securities Are Traded: Order Types

• Market order:
• Execute immediately at best price
• Bid price: price at which dealer will buy security
• Ask price: price at which dealer will sell security
• Bid-ask spread: Ask price - Bid price
• Market Depth?

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 Securities Markets
How Securities Are Traded: Order Types

• Price-contingent order:
• Limit buy/sell order: specifies price at which investor
will buy/sell
• Stop order: not to be executed until price point hit

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 Securities Markets
How Securities Are Traded: Trading Mechanisms

• Dealer markets
• Over-the-counter (OTC) market: Informal network of
brokers/dealers who negotiate securities sales
• NASDAQ stock market: Computer-linked price quotation
system for OTC market
• Electronic communication networks (ECNs)
• Computer networks that allow direct trading
• Specialist markets
• Specialist: Makes market in shares of one or more firms;
maintains “fair and orderly market” by dealing personally

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 Securities Markets
US Markets

• NASDAQ
• Approximately 3,000 firms
• New York Stock Exchange (NYSE)

• Stock exchanges: Secondary markets where already-

issued securities are bought and sold
• NYSE is largest U.S. Stock exchange
• ECNs
• Latency: Time it takes to accept, process, and deliver a
trading order

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 Securities Markets
US Markets

• NASDAQ
• Approximately 3,000 firms
• New York Stock Exchange (NYSE)

• Stock exchanges: Secondary markets where already-

issued securities are bought and sold
• NYSE is largest U.S. Stock exchange
• ECNs
• Latency: Time it takes to accept, process, and deliver a
trading order

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Securities Markets
US Markets

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 Securities Markets
New Trading Strategies

• Algorithmic Trading
• Use of computer programs to make rapid trading decisions
• High-frequency trading: Computer programs make very rapid
trading decisions for very small profits. The Hummingbird Project
Hacked AP tweet
“We are a technology firm. We are a platform.”
---- Lloyd Blankfein (Goldman Sachs CEO)
• Dark Pools
• ECNs where participants can buy/sell large blocks of securities
anonymously
• Blocks: Transactions of at least 10,000 shares

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 Securities Markets
How Securities Are Traded: Trading Cost

• Commission: Fee paid to broker for making transaction

• Spread: Cost of trading with dealer

• Bid: Price at which dealer will buy from you

• Ask: Price at which dealer will sell to you

Spread = Price Ask - Price Bid

• Combination: On some trades both are paid

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 Securities Markets
How Securities Are Traded: Buying on Margin

• Margin Trading: Initial Conditions

• X Corp: Stock price = $70

• 50%: Initial margin

• 40%: Maintenance margin Requirement (MMR)

• 1000 shares purchased

Margin Call occurs

Market Value - Borrowed
£ MMR
Market Value
Initial Position
Stock $70,000 Borrowed $35,000
Equity $35,000

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 Securities Markets
How Securities Are Traded: Buying on Margin

• Stock price falls to $60 per share

• Position value – Borrowing + Additional cash

• Margin %: $25,000/$60,000 = 41.67% >40%.

• No margin call.

New Position 1
Stock $60,000 Borrowed $35,000
Equity $25,000

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 Securities Markets
How Securities Are Traded: Buying on Margin

• How far can price fall before margin call?

• Market value = $35,000/(1 – .40) = $58,333

• $58,333/1,000 = $58.33 à Marginal call.

New Position 2
Stock $58,333 Borrowed $35,000
Equity $23,333

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 Securities Markets
How Securities Are Traded: Buying on Margin

• To restore initial margin requirement, how much extra

money/equity you need to add
• Equity = ½ x $58,333 = $29,167; ½ is the original
margin%.

New Position 3
Stock $58,333 Borrowed $35,000
Equity $29,167

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 Securities Markets
How Securities Are Traded: Buying on Margin

• Assuming the investor buys $20,000 worth of stock by

borrowing $10,000 at an interest rate of 9% per year.
(Leverage)

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 Securities Markets
How Securities Are Traded: Short Sales

• Sale of shares not owned by investor but borrowed

through broker.

• Mechanics
• Borrow stock from broker; must post margin
• Broker sells stock, and deposits proceeds/margin in
margin account
• Covering or closing out position: Buy stock; broker
returns title to original party

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 Securities Markets
How Securities Are Traded: Short Sales

• Comparison between purchase of stock and short sale of

stock

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 Securities Markets
How Securities Are Traded: Short Sales

•Sell 100 short shares of stock at $60 per share

•$6,000 must be pledged to broker

•Pledge 50% margin, or $3,000
•Now there is $9,000 in margin account
• Short sale equity = Total margin account – Market value

• Market value = Total margin account / (1 + Margin %)

• Margin % = (Total margin account - Market value)/

Market value
Initial Position
Total margin account $9000 Borrowed (from broker) $3,000
Equity (Your own money) $6,000
Market value $6000
Short sale equity $3000 Margin % (9000-6000)/6000 = 50%
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 Securities Markets
How Securities Are Traded: Short Sales

• Maintenance margin is 30% market value.

• You need to keep 30% * 6000 = 1800 in your
short sale equity account. That is, you have 3000
– 1800 = 1200 excess margin (the broker allows
you to lose $1200.).
• What is your margin % if the price of the stock
increases from $60 to $65? Position 1
• When price for marginal call? Position 2
• What if you want to restore 50% initial margin?
Position 3

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 Securities Markets
How Securities Are Traded: Short Sales

• What is your margin % if the price of the stock

increases from $60 to $65?

Position 1
Total margin account $9000 Borrowed (from broker) $3,000
Your own money $6,000
Market value $65*1000=6500
Short sale equity $2500 Margin % (9000-6500)/6500=
38.46%

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 Securities Markets
How Securities Are Traded: Short Sales

• When price for marginal call?

Position 2
Total margin account $9000 Borrowed (from broker) $3,000
Your own money $6,000
Market value ?*100=?
Short sale equity ? Margin % (9000-?)/? = 30%

Position 2
Total margin account $9000 Borrowed (from broker) $3,000
Your own money $6,000
Market value 69.23*100=6923
Short sale equity 9000-6923 = 2077 Margin % (9000-6,923)/6,923
= 30%

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 Securities Markets
How Securities Are Traded: Short Sales

• What if you want to restore 50% initial margin?

Position 3
Total margin account $9000+? Borrowed (from broker) $3,000
Your own money $6000+?
Market value 6923
Short sale equity 2077+? Margin % (2077+?)/6,923 = 50%

Position 3
Total margin account $9000+1384.5 = 10384.5 Borrowed (from broker) $3,000
Your own money $6000+1384.5
Market value 6923
Short sale equity 2077 + 1384.5 Margin % (2077+1384.5)/6,923 =
50%

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