1. Chapter 11 Securities Markets © 2000 John Wiley & Sons, Inc.

2. 2 Chapter Outcomes Describe the processes and institutions used by businesses to distribute new securities to the investing public. n Outline the recent difficulties and changes in structure of the investment banking industry. n Describe how securities are traded among investors. n Identify the regulatory mechanisms by which the securities exchanges and the over-the-counter markets are controlled. Explain influences that affect broker commissions.

3. 3 Primary Security Markets n Primary versus secondary securities markets n Initial Public Offerings (IPOs) n Investment Banks

4. 4 Functions of Investments Banks n Three Main Functions: –Origination –Underwriting –Selling n Origination –Public Offering –Private Placement –Prospectus

5. 5 Investment Bank Functions, continued n Underwriting –“Carrying the risk” –Best efforts –Shelf registration –Private placement –Rights offerings –Competitive bids

6. 6 Investment Bank Functions, continued n Selling –Syndicate –Tombstone Ad –Aftermarket

7. 7 The Costs of Raising Capital n The costs of issuing stocks and bonds are called “flotation costs.” –Out-of-pocket costs –Spread –Underpricing n The sum of these costs can total 20- 30%..or more...of the funds raised n Hot/cold IPO markets

8. 8 What else do Investment Banks do? n Commercial paper n Mergers and acquisitions n Manage investment funds (e.g., company pension funds)

9. 9 Secondary Securities Markets n Organized Exchange versus Over- the-Counter (OTC) n Organized Exchange: NYSE

10. 10 Trading on the NYSE floor n Members own “seats” n Commission brokers n Floor brokers n Registered traders n Specialists n Companies need to meet listing requirements, pay fees

11. 11 Ways to Trade Stock n Market order n Limit order n Stop order n Short sale –Uptick rule –67 15/16 67 15/16 68 68 68 –68 1/8 68 1/8 68 68 68

12. 12 Buying on Margin n “Buying on margin” means to use some of your money (equity) and some borrowed funds to purchase a security n Margin: investor’s equity position n Margin requirements: minimum percentage of the purchase price that the investor must pay from his/her funds

13. 13 Margin’s effect on trading profits Assume: 60% margin Initially buy securities worth $50,000 Initial position t=1 t=2 Mkt value $50,000 $55,000 $45,000 Less: borrowed funds 20,000 20,000 20,000 Equity $30,000 $35,000 $25,000

14. 14 More investing terms n Margin call n Maintenance margin n Round lot n Odd lot n Program trading

15. 15 Over-The-Counter Market (OTC) n NASDAQ n Not just for small firms –Intel, Apple, Microsoft n Centralized versus non-centralized location n Specialists versus dealers

16. 16 Other Secondary Markets n Third Market –Large blocks (10,000 shares) traded OTC n Fourth Market –Electronic trading

17. 17 Commissions Commission affected by: n Type of broker –Full service brokers –Discount brokers –On-line brokers n Size of trade, security price n Liquidity of securities traded

18. 18 How’s the Market Doing? n Security Market Indexes are used to track overall market and sector performance n Well-known stock market indexes: –Dow Jones Industrial Average Based on price –Standard & Poor’s (S&P) 500 Based on market value

19. 19 Wandering from Home: Investing Overseas n Diversification benefits n Harder to do trades –Liquidity –Currency differences –Regulations, tax laws n Solutions: –American Depository Receipts –Global Depository Receipts –Mutual funds--professional investing

20. 20 Insider Trading n An insider: someone with access to important non-public information n can be a corporate officer, investment banker, major shareholder n blue-collar workers, too (e.g., printing press operators)

21. 21 What will the future hold? n Electronic and on-line trading n Continued globalization n Security prices in tenths n Can the NYSE survive?

22. 22 Learning Extension 11A Introduction to Futures and Options n What is a derivative security? n Why do they exist? n Future Contracts n Options

23. 23 What is a derivative security? A derivative security has its value determined by, or derived from, the value of another investment vehicle. They represent a contract on an underlying security or asset

24. 24 Why do derivatives exist? n Shift risk from those who don’t want to carry risk to those who are willing to do so. n Bring additional information into the market from hedgers, speculators, market expectations. n Lower commissions and margin requirements than in spot market

25. 25 Futures contracts n A futures contract obligates the owner to purchase the underlying asset at a specified price (the exercise or strike price) on a specified date

26. 26 Types of futures contracts n Corn, wheat, soybeans… n Stock indexes, interest rates, foreign currency values… n Gold, copper, silver, oil… n Coffee, sugar, cocoa...

27. 27 Options An options contract gives the owner the choice of trading the underlying asset at a specified price (the exercise or strike price) on or before a specified date or expiration date.

28. 28 Two basic types of options n Call option: an option to buy the underlying asset at the strike price n Put option: an option to sell the underlying asset at the strike price

29. 29 Call Options n Suppose you buy an option to buy 100 shares of Exxon stock at $75 a share. How much is the option worth if on the expiration date the price of Exxon is: n a) $60 a share? n b) $75 a share? n c) $80 a share?

30. 30 Put Options n Suppose you buy an option to sell 100 shares of Exxon stock at $75 a share. How much is the option worth if on the expiration date the price of Exxon is: n a) $60 a share? n b) $75 a share? n c) $80 a share?