1. Primary vs. Secondary Security Sales
New issue
Key factor: issuer receives the proceeds from the sale
Secondary
Existing owner sells to another party
Issuing firm doesn’t receive proceeds and is not directly involved

2. How Firms Issue Securities
Investment Banking
Shelf Registration
Private Placements
Initial Public Offerings (IPOs)

3. Investment Banking Arrangements
Underwritten vs. “Best Efforts”
Underwritten: firm commitment on proceeds to the issuing firm
Best Efforts: no firm commitment
Negotiated vs. Competitive Bid
Negotiated: issuing firm negotiates terms with investment banker
Competitive bid: issuer structures the offering and secures bids

4. Figure 3.1 Relationship Among a Firm Issuing Securities, the Underwriters and the Public

5. Initial Public Offerings
Process
Road shows:
1. generate interest among potential investors and provide information about the offering.
2. provide price information to the issuing firm and its underwriters.
Bookbuilding: process of polling potential investors
Underpricing
Post sale returns
Cost to the issuing firm

6. Figure 3.4 Long-term Relative Performance of Initial Public Offerings

7. Stock Market Order Types
Buy at best price available for immediate execution.
Sell at best price available for immediate execution.
Buy
Sell
Limit order
Buy at best price available, but not more than the preset limit price. Forgo purchase if limit is not met.
Sell at best price available, but not less than the preset limit price. Forgo sale if limit is not met.
Stop orders
convert to a market order to buy when the stock price crosses the stop price from below.
convert to a market order to sell when the stock price crosses the stop price from above

8. Limited Order and Stop order
Ex. Stock A selling $25:
a limit $23 [instruct the broker to buy when price falls below $23];
a limit [to sell when price goes above $27]
Stop-loss (sell) orders [ex. Stop
to sell if price falls a stipulated level
to sell to stop further losses from accumulating
Stop-buy orders [ex. Stop buy
to buy when price rises above a given limit
accompany short sales, to limit potential losses from the short position (problem 20, 21)

9. Order Specification and Trading Mechanisms
name of Company
buy or sell
size of order (odd lots = less than 100 shares; round lots = 100 shares)
how long is order to be outstanding (when expires)
types of order
Dealer markets
Electronic communication networks (ECNs)
Specialists markets

10. U.S. Security Markets Nasdaq Small stock OTC Organized Exchanges
Pink sheets
Organized Exchanges
New York Stock Exchange
American Stock Exchange
Regionals
Electronic Communication Networks (ECNs)
National Market System

11. OTC (Nasdaq) No central physical location
No membership requirements for trading: brokers register with the SEC as dealers in OTC
dealer market: quote bid & asked prices and execute,
over 400 market makers
note: bid (asked) price: at which a dealer is willing to purchase (sell)
about 35,000 issues are traded
NASD (National Association of Sec. Dealers) oversees trading of OTC securities
in 1971, the NASDAQ system began
The Nasdaq composite Index includes about 3,400 companies (about 5,000 companies in 2000) whose weight in the index is based on market capitalization
Nasdaq operates two market segments: Nasdaq National Market and Nasdaq SmallCap Market (listing requirements differ)

12. New York Stock Exchange
A facility (central physical location)
Only members may trade
The NYSE membership is limited to 1,366 members since 1953, who collectively own the NYSE. The NYSE represents approximately 80% of the value of all publicly owned companies in America.
Memberships (or seats) are valuable assets ($1 mil:1/6/2005, $1.7 mil: 4/3/00, $2 mil in 2003)
Member functions
Commission brokers
Floor brokers
Specialists

13. Margin Trading Using only a portion of the proceeds for an investment
Borrow remaining component
Margin arrangements differ for stocks and futures
Margin is the net worth of the investor’s account

14. Stock Margin Trading
Maximum margin is currently 50%; you can borrow up to 50% of the stock value
Set by the Fed
Maintenance margin: minimum amount equity in trading can be before additional funds must be put into the account
Margin call: notification from broker you must put up additional funds

15. Margin Trading - Initial Conditions
X Corp $70
50% Initial Margin
40% Maintenance Margin
Shares Purchased
Initial Position
Stock $70,000 Borrowed $35,000
Equity ,000

16. Margin Trading - Maintenance Margin
Stock price falls to $60 per share
New Position
Stock $60,000 Borrowed $35,000
Equity ,000
Margin% = Equity/Asset =$25,000/$60,000 = 41.67%

17. Margin Trading - Margin Call
How far can the stock price fall before a margin call?
(1000P - $35,000)* / 1000P = 40%
P = $58.33
* 1000P - Amt Borrowed = Equity

18. Short Sales
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. allowed only after an ‘uptick’ (P > 0)
Closing out the position: buy the stock and return to the party from which is was borrowed

19. Liabilities & Account Equity
Short Sales
Example: Short Sales
You want to short 100 Sears shares at $30 per share. Your broker has a 50% initial margin and a 40% maintenance margin on short sales.
Worth of stock borrowed = $30 × 100 = $3,000
Liabilities & Account Equity
Assets
Proceeds from sale $3,000 Short position $ 3,000
Initial margin deposit 1,500 Account equity 1,500
Total $4, Total $4,500

20. Liabilities & Account Equity
Short Sales
Example: Short Sales …continued
Scenario 1: The stock price falls to $20 per share.
Liabilities & Account Equity
Assets
Proceeds from sale $3,000 Short position $ 2,000
Initial margin deposit 1,500 Account equity 2,500
Total $4, Total $4,500
New margin = equity/short position =
$2,500 / $2,000 = 125%

21. Liabilities & Account Equity
Short Sales
Example: Short Sales …continued
Scenario 2: The stock price rises to $40 per share.
Liabilities & Account Equity
Assets
Proceeds from sale $3,000 Short position $ 4,000
Initial margin deposit 1,500 Account equity (A-L) 500
Total $4, Total $4,500
New margin = equity/short position=$500 / $4,000 = 12.5% < 40% Therefore, you are subject to a margin call.

22. Short Sale - Initial Conditions
Z Corp 100 Shares
50% Initial Margin
30% Maintenance Margin
$100 Initial Price
Sale Proceeds $10,000
Margin & Equity 5,000
Stock Owed 10,000

23. Short Sale - Maintenance Margin
Stock Price Rises to $110
Sale Proceeds $10,000
Initial Margin ,000
Stock Owed ,000
Net Equity ,000
Margin % (4000/11000) %

24. Short Sale - Margin Call
How much can the stock price rise before a margin call?
($15,000* - 100P) / (100P) = 30%
P = $115.38
* Initial margin plus sale proceeds

25. Example 23
Assume you purchased 200 shares of XYZ common stock on margin at $80 per share from your broker. If the initial margin is 60%, the amount you borrowed from the broker is __________.
A) $4000
B) $6400
C) $9600
D) $16,000
You short-sell 200 shares of Tuckerton Trading Co., now selling for $50 per share. What is your maximum possible gain ignoring transactions cost?
A) $50
B) $150
C) $10,000
D) unlimited