1. 03@Modern Portfolio Theory and Investment Analysis
Hongfei Yan
March 7, 2017

2. Contents @ Modern Portfolio Theory and Investment Analysis, 9th Edition
Part 1: Introduction
Chapter 1: Introduction
Chapter 2: Financial Securities
Chapter 3: Financial Markets
Part 2: Portfolio Analysis
Part 3: Models of Equilibrium in the Capital Markets
Part 4: Security Analysis and Portfolio Theory
Part 5: Evaluating The Investment Process
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3. 03 Financial Markets
In this chapter we will discuss how securities are traded and the nature of the markets in which they are traded.
The characteristics of markets can influence trading costs, the speed with which information is reflected in prices, and the accuracy with which prices reflect available information.
Thus characteristics of markets can determine how often one should trade as well as the degree of mispricing of a security (or suboptimality of a portfolio) before a trade could be profitable.
市场特点能影响交易成本、信息反映到价格的速度以及价格反映有效信息的精确程度。因而，市场特点能够决定交易的频繁程度以及在交易能获利前的证券定价错位程度（或投资组合的次优性）。

4. 03 Financial Markets
3.1 Trading Mechanics 3.2 Margin 3.3 Markets 3.4 Trade Types and Costs

5. Trading Mechanics
An individual wishing to buy or sell a security would first establish an account with a brokerage firm and then submit (by phone or computer) an order. The order specifies
the security the investor wishes to trade (e.g., the 2 3/4 % coupon U.S. Treasury bond maturing on February 15, 2019, or General Motors common stock)
the direction of the order (buy or sell)
the order size (e.g., five $10,000-par bonds or 400 shares of stock)
whether the order is market or limit (and related qualifications)
Structure: Coupon or no coupon/discount
Investors in Treasury notes (which have shorter-term maturities, from 1 to 10 years) and Treasury bonds (which have maturities of up to 30 years) receive interest payments, known as coupons, on their investment. The coupon rate is fixed at the time of issuance and is paid every six months.
Other Treasury securities, such as Treasury bills (which have maturities of one year or less) or zero-coupon bonds, do not pay a regular coupon. Instead, they are sold at a discount to their face (or par) value; investors receive the full face value at maturity. These securities are known as Original Issue Discount (OID) bonds, since the difference between the discounted price at issuance and the face value at maturity represents the total interest paid in one lump sum.

6. Order types
Market Orders
Limit Orders
Short Sale
Stop Orders

7. Market Orders
A market order directs the broker to buy or sell the security at the best available price.
A broker who accepts a market order has the responsibility to execute the order as quickly as possible.
The difference between the bid and ask prices is the spread.
The spread can be considered a part of the overall trading cost.
An investor who buys and then immediately sells using market orders, paying the ask and receiving the bid, will lose the spread (plus commissions).
实际上这两个bid是买价，ask是卖价。
quote
英 [kwəʊt]  美 [kwoʊt] 
vt.& vi.引述，引用；
vt.报价； 引述；
vi.引用；
n.引用； 报价； 引号；
bid
英 [bɪd]  美 [bɪd] 
考研  /  CET6  /  GRE  /  IELTS
n.出价，投标； 努力争取； 喊价； 叫牌
commission
英 [kəˈmɪʃn]  美 [kəˈmɪʃən] 
    
 考研  /  CET6  /  CET4  /  GRE  /  TOEFL  /  IELTS
n.委员会，委员； [商]佣金，手续费； 任命，委任； 委任状
vt.委任，授予； 使服役； 使（船）服役；

8. Limit Orders
With a limit order, the customer states a price that specifies the worst acceptable terms of trades.
Unless otherwise specified, unexecuted limit orders are usually cancelled at the end of the day.
Customers can direct, however, a time in force (such as 10 seconds or one hour).

9. Short Sale (1/2)
Investors can sell securities they do not own. This type of trade is referred to as a short sale.
When an investor short sells a security, a security is physically sold.
Because the investor does not own the security, the brokerage firm borrows it from another investor or lends the security to the investor itself.
The securities borrowed normally come from the securities held at the brokerage firm for other investors.
Securities kept at a brokerage firm by investors are referred to as securities registered in street name.

10. Short Sale (2/2)
At a future time the short seller repurchases the shares and replaces the shares that were borrowed.
Thus capital gains and losses are equal in magnitude but opposite in sign to a short seller compared to a purchaser of the shares.
the short seller expects the shares to decline in value and wishes to profit from the decline.
The principal one is to decrease the sensitivity of a portfolio to market movements.
Securities rise and fall because of general market conditions as well as events specific to the security or a subset of securities.
Because the return on short sales is the opposite of the return on a long purchase, a portfolio that includes short sales as well as long purchases reduces the exposure to market movements.

11. Stop Orders
A fourth type of order is one that is activated only when the price of the stock reaches or passes through a predetermined limit.
The price that activates the trade is called a stop price.
Once a trade takes place at the stop price, the order becomes a market order.
Stop loss orders are used to attempt to lock in a gain.
A stop loss order might be appropriate if the investor believes that
the stock is overpriced and might decline
but believes it is likely to rise even more before other investors reach the same conclusion.
A stop buy order is often used in conjunction with a short sale. Recall that a short sale is a sale of a security one does not own.

12. Length of Time an Order is Outstanding
For orders other than market orders, an investor must specify the length of time the order is to be outstanding.
A day order instructs the broker to fill the order by the end of the day.
If the order is not filled by the end of the day, the order is automatically canceled.
If the investor does not specify the length of time the order is to be outstanding, it is assumed to be a day order.
A week or month order instructs the broker to fill the order by the end of the week or month or cancel the order.
Good-until-canceled orders remain outstanding until the investor specifically cancels the order.
Finally, fill-or-kill orders instruct the broker to fill the order immediately or to kill the order.

13. 03 Financial Markets
3.1 Trading Mechanics 3.2 Margin 3.3 Markets 3.4 Trade Types and Costs

14. 3.2 Margin
3.2.1 Margin Long Purchase Initial Margin Long Purchase Maintenance Margin Long Purchase Effect of Margin on Return Margin Requirements for Short Sales

15. Margin（保证金） (1/2)
Investors can buy securities either with cash or with part cash and part borrowing.
If the investor utilizes borrowing as well as cash, the investor is said to purchase the securities on margin.
An investor utilizing margin borrows money from the brokerage firm, which in turn borrows the money from a bank.
The securities purchased serve as collateral for both the brokerage firm and the bank.
Thus an investor utilizing margin must leave the securities with the brokerage firm rather than take delivery (called leaving securities in “street name”).
In addition, the investor signs a hypothecation agreement that allows the brokerage firm to use the customer’s securities as collateral for its own loans and to lend the securities to others.
hypothecation
英 [haɪˌpɒθɪ'keɪʃən]  美 [haɪˌpɒθɪ'keɪʃən] 
n.不转移占有的抵押； 对抵押财产的索赔权；
抵押hypothecation 质押

16. Margin (2/2)
The amount the customer can borrow to finance a purchase or short sale is carefully regulated; these regulations are referred to as initial margin requirements.
There are separate regulations that monitor the amount of the loan relative to the value of the assets at each point in time; these are called maintenance margin requirements.
Finally, the way margin is defined for an account with long purchases is different from the way margin is defined for an account with short sales.
Thus an account with both long purchases and short sales must meet both sets of margin requirements.

17. 3.2.1 Margin Long Purchase

18. As time passes, the margin in the account will vary as security prices change. For example, if AT&T were to increase to $70 a share, the account would be

19. 3.2.2 Initial Margin Long Purchase (1/2)
The minimum amount of margin that must be in the account immediately after a security is purchased is called initial margin.
The initial margin requirement is set by the board of governors of the Federal Reserve System
although an individual brokerage firm can set it higher.
This requirement has varied considerably over time and has been as high as 100%, which precludes any borrowing for new purchases.
Margin is one of the tools utilized by the Federal Reserve to influence the economy.
For accounts that already include borrowing, the amount of cash an investor needs for an additional purchase depends on the price movements of the securities owned and the amount of prior borrowing.

20. 3.2.2 Initial Margin Long Purchase (2/2)
Thus initial margin regulates the amount that can be borrowed at the time securities are purchased.
The amount that can be borrowed can vary from zero to more than 100%.
It could be more than 100% if the securities in the account had declined significantly in value,
because at the time of any new purchase, initial margin requirements must hold for the whole account.
The securities serve as collateral for the investor’s loan and for the broker’s loan.
To guarantee that the loans can be paid, there is a lower limit to which the margin can fall without the investor having to put up additional security.

21. 3.2.3 Maintenance Margin Long Purchase (1/2)
The minimum amount to which the margin can decline without an investor having to take action is called the maintenance margin.
The maintenance margin is set by the exchanges, although an individual brokerage firm can set it higher.
If the stockholder’s margin drops below the maintenance margin, then the brokerage firm issues a margin call.
The shareholder must bring the margin above the maintenance margin by either adding additional cash or securities to the account or selling securities.
If the investor fails to respond to the margin call or the investor is unable to be reached by the brokerage firm, the brokerage firm sells off sufficient securities to bring the margin above the maintenance margin.
Usually initial margin requirements are substantially higher than maintenance margin requirements.
Thus there could be a substantial decline in price without a margin call.

22. Maintenance Margin Long Purchase (2/2)
The amount of decline in price before a margin call is easy to calculate.
Let P be the price that will result in a margin call. We will calculate this price for our original example where 100 shares of AT&T were purchased at $50 a share using $3,000 in cash and $2,000 in borrowed funds.
If the maintenance margin requirement is 25%, then

23. 3.2.4 Effect of Margin on Return (1/3)
Margin is the purchase of securities utilizing leverage.
As such, all gains and losses are accentuated.
The amount of the accentuation depends on the percentage of the purchase the investor paid for in cash.
Assume the share was purchased at $50. A $5 increase in price over six months would result in a six-month return for the security of

24. Effect of Margin on Return (2/3)
Now assume the share was purchased with 50% margin and that the annual interest rate on the borrowing was 6% or 3% semiannually.
With 50% margin the investor would put up $25 in cash, and the interest paid over the six months would be 0.03 (25) =$0.75. A $5 increase in share price results in a return on the cash investment (rc) of
put up 支付

25. Effect of Margin on Return (3/3)
the return on the cash invested is
卖空交易者的出售所得减手续费以现金方式存放于账号。

26. 3.2.5 Margin Required for Short Sales (1/2)
卖空交易的保证金比率视为卖空市值的某个百分比。

27. Margin Required for Short Sales (2/2)
The amount of money that must be added to the account for additional short sales depends on what happened to share price subsequent to the short sales.
If the stock price falls, then an account will be above the initial margin requirement, and additional shares can be sold short without putting up as much additional money, or perhaps no money at all.
If the margin is below the initial margin, then the investor must bring the account up to the initial margin for additional short selling; therefore additional short sales involve more than a normal cash contribution.
Short sales, like long purchases, require a minimum margin to be exceeded at all times; this is called a maintenance margin.
Many accounts have both short sales and long purchases.
These accounts would need to meet margin requirements for both types of trades.

28. 03 Financial Markets
3.1 Trading Mechanics 3.2 Margin 3.3 Markets 3.4 Trade Types and Costs

29. 3.3 Markets 3.3.1 Characteristics of Markets 3.3.2 Major Markets
discuss the markets in which trades take place.
The section is divided into two parts.
In the first part we discuss the general characteristics of markets.
In the second part we discuss some of the principal U.S. markets.

30. 3.3.1 Characteristics of Markets
There are a number of ways to classify markets. 1) Primary markets and secondary markets 2) Call or continuous markets 3) Dealer or broker markets 4) Whether the trading is executed by humans or done electronically

31. 1) Primary markets and secondary markets
Primary markets are security markets where new issues of securities are initially sold.
The Federal Reserve auctions off on a weekly basis new government bills and on a less frequent basis government bonds.
This auction market is considered a primary market.
A secondary market is a market where securities are resold.
The New York Stock Exchange (NYSE) is a secondary market.

32. 2) Call or continuous markets
In a call markets, trading takes place at specified time intervals.
Prices at which investors wish to buy or sell are entered into the computer, and a preliminary price is displayed.
Investors can change their orders or enter new orders until a specified execution time when the price that best matches buys and sells is determined.
If there is no price that completely matches buys and sells, an allocation method is needed.
Continuous markets are markets where trading takes place on a continuous basis.
For example, a market order placed in a continuous market will be executed quickly at the best available price.
preliminary price 初步价格

33. 3) Dealer or broker markets
In a broker market, a broker acts as an agent for an investor and buys or sells shares on the investor’s behalf. In a broker market, shareholders are trading with other shareholders, albeit utilizing an agent.
In a dealer market, the dealer purchases or sells shares for the investor utilizing the dealer’s own inventory. In a dealer market, investors’ trades are not made directly with other investors but rather with the dealer, who serves as an intermediary between buyers and sellers.
dealer 交易商
broker 经纪商

34. 4) Whether the trading is executed by humans or done electronically
Execution on the NYSE involves people.
Executions are done electronically on the Paris, Australia, and Toronto stock exchanges and for some stocks on the Tokyo stock exchange.
One advantage of an electronic market is that the power of the computer allows complex conditional trades to be handled.
For example, electronic trading would allow an order to be executed conditional on the value of a market index.

35. However we classify a market, there are a number of characteristics that are desirable for it to have.
1) investors buy and sell assets based on information.
Useful market information includes past prices, volume, current bids and offers, and the amount of short sales outstanding.
Thus it is desirable that this market information be promptly and accurately available to investors.
2) markets differ according to trading costs. The lower the costs of trading shares in the market, the better the market.
3) the markets should be liquid. Liquidity refers to the ability to transact a large number of shares at prices that don’t vary substantially from past prices unless new information enters the market.
Liquidity is often subdivided into continuity and depth.
4) markets differ in the speed with which new information is incorporated into share prices.
Investors would hope that the share price reflected all available information about the share. This is referred to as informational efficiency
ceteris paribus n.<拉>（如）其他条件[情况]均同，别无其他情形；

36. Liquidity is often subdivided into continuity and depth
Price continuity means that an investor can expect to transact some shares at prices close to those at which the security recently traded absent any new information in the marketplace.
A deep market is one that has a large number of buyers and sellers willing to trade at close to the current transaction price, so that a large number of shares can be transacted without a substantial change in price.
价格连续性是指，如果市场不出现新信息，投资者可以预期以接近近期交易的价格买卖股票。
有深度的市场是指，大量买卖者愿意已接近即期价格的水平交易，因而大量股票交易不会导致价格发生重大变化。

37. 3.3.2 Major Markets Stock Markets Bond Markets Primary Markets
Government Bonds
Corporate Issues
Clearing Procedures
In this section we discuss some of the important markets in the United States, including both primary and secondary markets. First we discuss markets that are principally secondary markets.

38. Stock Markets (1/5)
Most stock trading in the United States takes place on exchanges.
The most familiar are the NYSE (formally “NYSE Equities”) and NASDAQ, but there are a number of others.
An exchange provides two services: listing and trading.
A listing is primarily a kind of sponsorship.
The fact that IBM is listed on the NYSE implies that it meets certain standards of size, financial reporting, and governance.
For this certification, IBM pays listing fees to the NYSE.
Most U.S. firms list on one exchange: the NYSE, NASDAQ, NYSE MKT (formerly the American Stock Exchange), or NYSE ARCA.
The listing exchange does not have a monopoly over trading. IBM can, and does, trade on many exchanges.
listing 挂牌

39. Stock Markets (2/5)
The trading services an exchange provides generally take the form of a computer platform governed by rules and procedures.
The most widely used trading mechanism in equity markets is the limit order book, sometimes simply called a book or orderdriven market.
In a book market, customer limit orders that cannot be immediately executed (because the buy limit price is too low or the sell limit price is too high) are collected in a book.
In the book, orders are ranked by price and time.
That is, on the bid (buy) side of the book, a high-priced limit order has priority over a lower-priced order. On the offer (ask) side of the book, a low-priced limit order has priority.
If two orders have the same price, the one that arrived at the exchange earlier has priority over the later arrival.

43. Stock Markets (3/5)
The trade-off between price and execution certainty is fundamental to trading strategies and is difficult to assess.
It is only one of the decisions confronting a trader.
Another problem concerns the rate of trade.
The calculations and analysis necessary to achieve optimal order splitting and pricing are sufficiently complex
that the resulting strategies are implemented with automated processes and are described as algorithmic.

44. Stock Markets (4/5)
From a regulatory viewpoint, the diverse U.S. exchanges are considered to compose a “National Market System.”
The Securities and Exchange Commission’s “Regulation National Market System” guides the permissible interactions across exchanges.
All trades are reported to a consolidated system and are quickly made public.
Regulation NMS certainly simplifies the decisions faced by traders, but it does not solve all problems.
There is no time priority, for example, across exchanges.
The practice of placing the trading algorithms on computers in the same room as the Exchange's computers is commonly known as collocation.
It is one technique for minimizing latency (delay).

45. Stock Markets (5/5)
High-frequency trading is generally characterized by automation, collocation, and various other practices that aggressively accelerate the reaction time to market developments.
It is a controversial practice.
Its practitioners claim that the technology helps tie markets together and lowers trading costs for other users.
Detractors claim that highfrequency traders profit at the expense of other users and that the technology aggravates market instability.

46. Bond Markets
Almost all bond trading in the secondary market occurs in the over- the-counter (OTC) market. While there is limited listing of bonds on the NYSE and AMEX, almost all the volume is OTC.
The trading volume in government bonds is very large, and they are highly liquid.
The secondary markets for corporate bonds, or Ginnie Maes, are fairly illiquid.
Only recent issues or some large issues have an active secondary market.

47. Primary Markets
Primary markets are markets that involve new issues of securities and hence, unlike secondary markets, provide a direct flow of cash to the issuing entity.
In this section we discuss some of the principal primary markets.
Government Bonds
Corporate Issue

48. Government Bonds
Treasury securities are issued by auction on a regular basis, where the frequency of issuance depends on the maturity of the security.
For example, 91-day and 182-day Treasury bills are offered every Monday; 7-, 10-, and 30-year Treasury bonds are issued quarterly.

49. Corporate Issues (1/2)
Corporate bonds and common stocks are usually sold using the services of an investment banker.
The corporation normally has an ongoing relationship with an investment banker; when it has a need for funds , the corporation negotiates the instruments and price with the investment banker.
A need for funds 融资

50. Corporate Issues (2/2)
The investment banking firm either can purchase the shares directly from the firm at an agreed-upon price and then resell them to the general public (called firm commitment 包销) or can simply help the firm in selling to the general public (called best efforts代销).
Underwriters承销人 have a conflict of interest. As an adviser to the issuing firm, they have an obligation to obtain the best price possible. However, the lower the price, the easier it is to market the securities to the public.
The empirical evidence indicates that IPOs earn abnormally large returns on the day of issuance but underperform similar-risk securities in subsequent months.

51. Clearing Procedures 清算程序
Most transactions require that settlement be made in five business days.
A brokerage firm will engage in trades involving customers from a number of other brokerage firms in the same security.
Some will be sales, and some will be purchases.
It would be very costly to have to settle each and every trade rather than the net of the purchases and sales.
To facilitate settlement, clearing corporations have been established.
brokerage firm
英 [ˈbrəʊkərɪdʒ fə:m]  美 [ˈbrokərɪdʒ fɚm] 
释义经纪人事务所，经纪公司；
逐笔清算远比按买卖轧差后的净值清算成本高。

52. 03 Financial Markets
3.1 Trading Mechanics 3.2 Margin 3.3 Markets 3.4 Trade Types and Costs

53. 3.4 Trade Types and Costs Types of Trades Trading Costs
In this section we discuss motivations for trading and what factors influence the costs of a trade.

54. 3.4.1 Types of Trades
There are generally considered to be two reasons for investors to trade.
The first reason investors trade securities is that traders believe that the price is incorrect, and they buy or sell based on a perceived mispricing. These traders are referred to as information traders.
The second reason for buying or selling securities is because of a surplus of or need for money.
An investor needing the down payment for a house or the money to purchase a car or boat might liquidate part of his or her portfolio to obtain the necessary funds.
Similarly, an investor receiving an inflow of funds might purchase shares because stocks in general are a good investment rather than because of information indicating that the particular stock being purchased is mispriced. These investors are referred to as liquidity traders.
down payment
英 [daun ˈpeimənt]  美 [daʊn ˈpemənt] 
na.预付定金； 分期付款的首次交款；
liquidate
英 [ˈlɪkwɪdeɪt]  美 [ˈlɪkwɪˌdet] 
vt.清算； 清偿； 结束； 换现款

55. 3.4.2 Trading Costs
The size of the trading costs affects how large the perceived mispricing must be before an investor can profitably swap one share for another.
Substantial trading costs mean that investors will hold nonoptional portfolios because the transaction costs of adjusting them are too high.
There are three major sources of trading costs.
First are the direct costs: commission to the brokers plus a tax on the trade.
The second cost is the bid–ask spread. An investor buying and then subsequently selling the stock will purchase at the ask and sell at the bid.
Third is the potential price impact of a large sale or purchase.
Small purchases and sales can be executed at the bid and ask, but large purchases or sales may cause an adverse change in the bid and ask.

56. Conclusion
In this chapter we have described the markets in which securities are traded.
This chapter and Chapter 2 have supplied the reader with the background necessary for the discussion of investment analysis.
We start with a more detailed analysis of risk and portfolio management.
This will allow us to return to an examination of many of the securities discussed to this point
to see how they are priced and how they fit into a portfolio.