1. CHAPTER FIVE How Securities Are Traded Cleary / Jones Investments: Analysis and Management

2. Learning Objectives n To explain the role of brokerage firms and stockbrokers n To describe how brokerage firms operate n To outline how orders to buy and sell securities are executed n To discuss the regulation of the Canadian securities industry n To explain the importance of margin trading and short selling to investors

3. Brokerage Operations n Brokerage firms earn commissions on executed trades, sales loads on mutual funds, profits from securities sold from inventory, underwriting fees and administrative account fees n Full-service brokers offer order execution, information on markets and firms, and investment advice n Discount brokers offer order execution

4. Account Types n Cash account: Investor pays 100% of purchase price for securities n Margin account: Investor borrows part of the purchase price from the broker n Wrap account: Brokers match investors with outside money managers; all costs are wrapped in one fee

5. Fees and Costs n Brokerage commissions differ by security, broker, and investor –Institutional investors have greatest negotiating power –On-line trading offers significantly lower commission rates to individual investors n Dividend reinvestment plans (DRIPs) permit reinvestment of dividends in additional stock

6. Orders on Organized Exchanges n The TSE introduced the world’s first computer-assisted trading system (CATS) in 1977 n The NYSE continues to make use of the specialist system –Specialists maintain the limit order book –Specialists keep a fair and orderly market by providing liquidity

7. Orders in OTC Markets n Dealers are ready to either buy or sell –Bid price is highest offer price to buy –Ask price is lowest price willing to sell n Ask price - Bid price >0 (dealer spread) –Dealer “makes a market” in the security –More than one dealer for each security in over-the-counter markets

8. Types of Orders n Market order: Authorizes immediate transaction at best available price n Limit order: Specifies a particular market price before a transaction is authorized n Stop order: Specifies a particular market price at which a market order is authorized

9. Clearing Procedures n Settlement dates for stocks are three business days after the trade date –Legal ownership transferred and financial arrangements settled with brokerage firm n Transfer of securities and funds between exchange members facilitated by a clearinghouse: The Canadian Depository for Securities (CDS)

10. Canadian Regulatory Environment n Self-Regulatory Organizations (SROs) regulate their own activities n Canadian Investor Protection Fund (CIPF) established to protect investors n Investment Dealers Association of Canada (IDA) is the national trade association for the investment industry

11. Margin Accounts n Exchanges set minimum required deposits of cash or securities n Investor pays part of investment cost, borrows remainder from broker –Margin is percent of total value that cannot be borrowed from broker n Margin call occurs when the actual margin declines below the margin requirement

12. Short Selling n Investor borrows stock from a third party n Borrowed security sold in open market, to be repurchased later at an expected price lower than sale price –Investor liable for declared dividends –Short sale proceeds held by broker –Investor responsible for borrowed shares