1. Finance 300 Financial Markets Lecture 5 Fall, 2001© Professor J. Petry http://www.cba.uiuc.edu/broker/fin300/fin300pp.htm

2. 2 Housekeeping Please turn in extra credit assignments Project 1—Equity analysis. 9% of grade, due 9/26, 9/27 depending on day we meet Teams should be formed and you should have your stock The assignment has the following parts: Executive Summary (<1 page, 5/35 of point total) Introduction (2 pages, 5/35 of point total) Beta Calculation (2 pages, 10/35 of point total) Diversification (1 page, 10/35 points) Conclusion (1 page, 5/35 points) You should be done with Introduction by next class Bridge demonstration next class will allow you to do data portion.

3. 3 Chapter III-Equity & Equity Markets Primary Markets Initial Public Offerings The first time a firm sells shares to the public Seasoned Offering An issue of new shares to the public by a firm that is already publicly owned Underwriter Brokerage firm or investment bank that assists in development of a new issue (sets the price, markets the issue). Registration Statement Information provided by a firm to the SEC and public as a part of its IPO. Contains information about the firm, management, markets and the security, as well as certified financial statements.

4. 4 Chapter III-Equity & Equity Markets Primary Markets Red Herring A preliminary prospectus, which can be circulated while the Registration Statement is being approved, is not an offer to sell, nor does it have a price yet established. Hot Issue When an IPO immediately begins trading at a higher price in the secondary market than the public offer price. Demand exceeds supply for the issue.

5. 5 Chapter III-Equity & Equity Markets Primary Markets Private Placements When the entire issue is offered to accredited investors (generally institutional investors) rather than to the general public. No SEC registration is required. Corporate and financial information is circulated through a Private Placement Memorandum instead of a prospectus. Accredited Investors Defined by the SEC as those who are able to analyze the risk and return characteristics of an offering and have the financial resources to bear those risks.

6. 6 Chapter III-Equity & Equity Markets Primary Markets Rights Subscription right is a distribution to existing shareholders of a negotiable right to buy newly issued shares of the company at a subscription price. The subscription price is often below the offer price at which the stock is offered to the general public. A right usually has a life of a few weeks, and during this time, trades on the secondary market. Standby Commitment The rights offering itself is usually handled by an Investment Bank under a standby commitment. This commitment obliges the Investment Bank to buy any shares not subscribed for under the rights offering.

7. 7 Chapter III-Equity & Equity Markets Primary Markets Things to Do III-2 Ferengi Exports Inc (QRK) issues new stock with a subscription price of $28. Under the terms of the offering four rights are required to subscribe to one new share. If existing shares of QRK are trading at $32, where should QRK rt trade?

8. 8 Chapter III-Equity & Equity Markets Primary Markets American Depository Receipts (ADRs) and Shares (ADSs) Means to facilitate the holding of foreign stocks by Americans American Depository Shares (ADSs) or Sponsored ADRs A negotiable receipt representing common stock of a foreign company held in trust by a foreign bank. ADS holders are registered with the issuing firm as shareholders and have equal rights with other shareholders. Firm must provide quarterly and annual reports in English and distribute dividends in dollars. American Depository Receipts (ADRs) (Unsponsored ADR) A negotiable reciept representing common stock of a foreign firm held in trust in a US bank. ADR holders are entitled to dividends and capital gains. The issuing firm is not involved in the issuance of the ADR. The US bank is the registered owner of the shares, and is responsible for translating earnings statements, etc

9. 9 Chapter III-Equity & Equity Markets Secondary Markets Stock Exchange An organized market where member brokers buy and sell securities for themselves and their clients. Seat To trade securities on an exchange you must be a member or sit on the exchange. The number of seats are fixed, and can be bought and sold for a market determined price. Listing Requirements Only issued listed with the exchange may be traded. Each exchange has specific listing requirements. An issue may be listed on more than one exchange. Board Lot (Round Lot) Refers to the trading unit defined by the exchange. Odd or Broken lots carry a higher sales commission or trade at less advantageous prices than Board Lots.

10. 10 Chapter III-Equity & Equity Markets Market Concepts & Terminology Continuous Market Market prices are determined continuously through the hours the market is open. Call Market Orders are collected for the next auction, which take place at regular intervals during the day. Each auction determines the market clearing price or fix. Transparency The absence of closed door deals. All market participants are fully and rapidly informed, keep profit-making from private information to a minimum. Execution Cost The difference between the execution price of a security and the price that would have existed in the absence of that trade.

11. 11 Chapter III-Equity & Equity Markets Market Concepts & Terminology Information Based Trade A trade made because an informed trader believes she has information not yet reflected in the absence of that trade. Informationless Trade A trade made by a liquidity trader to reallocate her portfolio, not based on a real or perceived informational advantage.

12. 12 Chapter III-Equity & Equity Markets Brokers & Dealers Broker An agent of an investing client; the broker takes no position in the securities she trades. Dealer A dealer maintains her own positions in the securities traded, thereby supplying immediacy. Immediacy is the ability to trade as soon as the order hits the floor rather than wait for the coincidence of buyers and sellers. Market Maker A dealer who guarantees that she will always stand ready to buy and to sell shares in the stock in which she makes a market. This insures there is always a market for the issue. Market makers always have a bid (at which she will buy) and an ask (at which she will sell), providing a continuous auction market.

13. 13 Chapter III-Equity & Equity Markets Brokers & Dealers Specialist The dealer designated by the exchange as the only market maker on the floor of the exchange for specifically assigned stocks. The specialist executes orders for other brokers, and is required to maintain fair and orderly markets. The specialist also opens the market by examining the orders which have accumulated overnight, and setting the opening price such that the market will clear at the opening bell. Thus the market is continuous from during the course of trading hours, but opens with a call market in which the opening price is fixed.