How Firms Issue Securities and IPO Mechanics
85 Questions
0 Views

Choose a study mode

Play Quiz
Study Flashcards
Spaced Repetition
Chat to lesson

Podcast

Play an AI-generated podcast conversation about this lesson

Questions and Answers

What is the primary objective of financial markets?

  • To increase the time required for trades.
  • To limit the liquidity of trading transactions.
  • To facilitate high-cost investments.
  • To connect buyers and sellers at low cost. (correct)

    • Which of the following best describes a brokered market?

  • A market where a third party assists in locating buyers or sellers. (correct)
  • A market that relies solely on electronic transactions.
  • A market where buyers and sellers must find each other independently.
  • A market that requires no intermediaries for transactions.

    • Which type of order ensures execution at the best available price immediately?

  • Market order. (correct)
  • Limit order.
  • Stop order.
  • Conditional order.

    • What distinguishes a dealer market from an auction market?

    <p>In dealer markets, a third party acts as an intermediate buyer/seller.</p> Signup and view all the answers

    Which type of order will NOT be executed until a specified price is reached?

    <p>Stop order.</p> Signup and view all the answers

    Which characteristic is typically associated with direct search markets?

    <p>Buyers and sellers locating each other independently.</p> Signup and view all the answers

    What is a key benefit of financial markets in terms of liquidity?

    <p>They ensure trades can be executed quickly.</p> Signup and view all the answers

    Which of the following is a disadvantage of using price-contingent orders?

    <p>They may not execute if price conditions are not met.</p> Signup and view all the answers

    Which main purpose does the Sarbanes-Oxley Act serve in relation to financial practices?

    <p>To create an independent board for overseeing public company audits</p> Signup and view all the answers

    What differentiates the primary market from the secondary market?

    <p>The primary market is where new issues of securities are sold.</p> Signup and view all the answers

    What does insider trading refer to?

    <p>Using nonpublic information for financial gain</p> Signup and view all the answers

    Which statement is true regarding privately held firms?

    <p>Shares are sold only to a limited number of investors.</p> Signup and view all the answers

    What requirement does the SEC impose on officers and major stockholders?

    <p>To disclose all stock transactions related to their firm</p> Signup and view all the answers

    What role do underwriters play during an initial public offering (IPO)?

    <p>They purchase securities from the issuing company and resell them at a higher price.</p> Signup and view all the answers

    What was one significant outcome of the enactment of the Public Company Accounting Oversight Board?

    <p>Ensuring the independence of audit committee financial experts</p> Signup and view all the answers

    What is the primary purpose of bookbuilding during an IPO's roadshow?

    <p>To finalize the price and allocate shares to investors.</p> Signup and view all the answers

    What potential consequence do businesses face regarding insider trading?

    <p>Severe legal penalties for failing to disclose transactions</p> Signup and view all the answers

    What is often a consequence of underpricing in an initial public offering?

    <p>Post-initial sale returns generally average around 10% or more.</p> Signup and view all the answers

    Which characteristic is associated with publicly traded companies?

    <p>They have the potential for unlimited shareholders.</p> Signup and view all the answers

    What is a common misconception about what occurs in the primary market?

    <p>Securities in the primary market are not traded among existing investors.</p> Signup and view all the answers

    Which of the following best describes the prospectus in an IPO context?

    <p>It is a document that describes the firm and the specific securities being issued.</p> Signup and view all the answers

    What is typically NOT a feature of secondary markets?

    <p>It involves the sale of new securities to initial investors.</p> Signup and view all the answers

    In the context of trading strategies, what is a key objective for investors during a successful IPO?

    <p>To capitalize on potential price increases due to underpricing.</p> Signup and view all the answers

    What is the equity when the stock price falls to $60 per share and the position value is calculated?

    <p>$25,000</p> Signup and view all the answers

    At what stock price does a margin call occur when 1,000 shares are held?

    <p>$58.33</p> Signup and view all the answers

    What margin percentage indicates a risk of a margin call when the market value is $58,333?

    <p>40</p> Signup and view all the answers

    In a short sale, what is the role of the broker when an investor borrows stock?

    <p>The broker sells stock and deposits the proceeds in a margin account.</p> Signup and view all the answers

    To restore the initial margin requirement after losing value, what is the required equity based on a market value of $58,333?

    <p>$29,167</p> Signup and view all the answers

    What is the implication of a stock price falling to $60 in terms of borrowed amount and position value?

    <p>The investor's equity decreases as the stock price falls.</p> Signup and view all the answers

    What is the initial position margin when 1,000 shares are bought at $60 each?

    <p>$60,000</p> Signup and view all the answers

    When covering or closing out a short sale position, what action does the investor take?

    <p>The investor buys stock to return to the broker.</p> Signup and view all the answers

    Which statement best describes the requirement of posting margin during a short sale?

    <p>A margin must be posted regardless of stock price changes before the sale.</p> Signup and view all the answers

    How is the margin percentage calculated when the stock price is at $60 and the equity is $25,000?

    <p>41.67%</p> Signup and view all the answers

    What is the primary function of secondary markets like the NYSE?

    <p>To facilitate the buying and selling of previously issued securities</p> Signup and view all the answers

    Which of the following best describes high-frequency trading?

    <p>A trading strategy that executes numerous orders in a very short time for small profits</p> Signup and view all the answers

    What does the term 'spread' refer to in trading costs?

    <p>The difference between the ask price and the bid price of a security</p> Signup and view all the answers

    Which of the following describes algorithmic trading?

    <p>Employing computer algorithms to execute trading strategies</p> Signup and view all the answers

    Which statement is true about market consolidation in the context of global stock markets?

    <p>It results in fewer trading platforms and a more interconnected market environment.</p> Signup and view all the answers

    In the context of trading costs, what is a commission?

    <p>The fee paid to a broker for executing a transaction.</p> Signup and view all the answers

    What type of trading involves decisions made in milliseconds by algorithms?

    <p>High-frequency trading</p> Signup and view all the answers

    What is a distinguishing feature of the New York Stock Exchange (NYSE)?

    <p>It is the largest US stock exchange by volume of trading activity.</p> Signup and view all the answers

    Which of the following statements correctly describes bid and ask prices?

    <p>The bid price is what a dealer will pay for a security, while the ask price is what they will sell it for.</p> Signup and view all the answers

    What is the required initial margin for a short sale of stock priced at $60 per share for 100 shares?

    <p>50%</p> Signup and view all the answers

    At what market value does a margin call occur if the maintenance margin requirement is 30% for a short sale worth $6,000?

    <p>$6,923</p> Signup and view all the answers

    What primary requirement does the Sarbanes-Oxley Act impose on audit committees?

    <p>Including independent financial experts</p> Signup and view all the answers

    If the market value of short-sold shares increases to $6,923, what is the equity left in the margin account if the total margin was $9,000?

    <p>$2,077</p> Signup and view all the answers

    To restore the initial margin requirement after a drop in stock value, how much additional equity is needed if the market value is $6,923?

    <p>$1,384.50</p> Signup and view all the answers

    Which of the following best describes insider trading?

    <p>Utilizing nonpublic knowledge for trading decisions</p> Signup and view all the answers

    What does the SEC require from officers and major stockholders regarding their firm's stock?

    <p>To disclose all transactions</p> Signup and view all the answers

    What does a short seller become liable for beyond the initial margin pledged when short selling stocks?

    <p>Dividends paid on the stock</p> Signup and view all the answers

    Which of the following actions is specifically enforced by the Public Company Accounting Oversight Board?

    <p>Oversight of all audit firms</p> Signup and view all the answers

    Which aspect of the Sarbanes-Oxley Act is aimed at improving corporate governance?

    <p>Mandating increased public transparency</p> Signup and view all the answers

    What is a consequence of failing to comply with insider trading regulations?

    <p>Fines and possible imprisonment</p> Signup and view all the answers

    What primary function does the Public Company Accounting Oversight Board serve?

    <p>Providing oversight of the audit profession</p> Signup and view all the answers

    Which of the following groups is primarily affected by insider trading regulations?

    <p>Corporate officers and significant shareholders</p> Signup and view all the answers

    What occurs during the initial public offering (IPO) process?

    <p>The issuer and underwriter organize a 'road show' for bookbuilding and pricing.</p> Signup and view all the answers

    Which statement accurately characterizes publicly traded companies compared to privately held firms?

    <p>Publicly traded companies have unlimited shareholders and face stricter financial disclosure requirements.</p> Signup and view all the answers

    What is the primary purpose of underwriters in the IPO process?

    <p>To purchase securities from the issuing company and facilitate resale to investors.</p> Signup and view all the answers

    What is a consequence of underpricing in initial public offerings?

    <p>It typically results in average post-initial sale returns of 10% or more.</p> Signup and view all the answers

    What typically differentiates a primary market from a secondary market?

    <p>Primary markets facilitate the sale of new security issues, while secondary markets handle transactions of already-existing securities.</p> Signup and view all the answers

    Which of the following describes the role of the prospectus in the IPO process?

    <p>It provides a comprehensive description of the firm and the securities being offered.</p> Signup and view all the answers

    How do privately held firms typically issue their securities?

    <p>By selling directly to a small group of investors up to a capped number.</p> Signup and view all the answers

    Which aspect of the road show in the IPO process is most critical?

    <p>Bookbuilding and determining market pricing.</p> Signup and view all the answers

    What is the maximum number of shareholders allowed for privately held firms?

    <p>499 shareholders.</p> Signup and view all the answers

    What term describes the phenomenon where there are higher initial returns due to underpricing in IPOs?

    <p>Winner's curse.</p> Signup and view all the answers

    What is the calculation for the market value at which a margin call occurs when 1,000 shares are held?

    <p>$58.33</p> Signup and view all the answers

    What must the equity amount be to restore the initial margin requirement after a price drop to $58,333?

    <p>$29,167</p> Signup and view all the answers

    How is the margin percentage calculated when the stock price drops to $60 and equity is $25,000?

    <p>41.67%</p> Signup and view all the answers

    What is the borrowed amount when the stock price is at $60, with a total position value of $60,000?

    <p>$35,000</p> Signup and view all the answers

    What is the new equity amount when the market price decreases to $58,333 and the borrowed amount remains unchanged?

    <p>$23,333</p> Signup and view all the answers

    In a short sale transaction, what is the first step an investor must take with borrowed shares?

    <p>Post margin with the broker.</p> Signup and view all the answers

    What action does an investor take to close out a short sale position?

    <p>Buy back the stock and return it.</p> Signup and view all the answers

    What is the overall effect of a stock price dropping below the margin call level on an investor's position?

    <p>Potential liquidation of shares by the broker.</p> Signup and view all the answers

    Which of the following describes the role of a broker in a short sale?

    <p>Facilitate borrowing of shares for the investor.</p> Signup and view all the answers

    What does 'covering' a short sale entail?

    <p>Buying back the stock to return it to the lender.</p> Signup and view all the answers

    What is the primary characteristic of high-frequency trading?

    <p>It utilizes computer algorithms to execute trades at high speeds.</p> Signup and view all the answers

    Which statement correctly describes a commission in trading costs?

    <p>It is a fee charged by a broker for executing a transaction.</p> Signup and view all the answers

    What does the term 'spread' refer to in trading costs?

    <p>The difference between the highest bid price and the lowest ask price.</p> Signup and view all the answers

    Which of the following best describes automated electronic trading?

    <p>The use of computer systems to facilitate trading in financial markets.</p> Signup and view all the answers

    What impact does globalization have on stock markets according to current trends?

    <p>It extends trading hours, moving towards 24-hour operations.</p> Signup and view all the answers

    What defines algorithmic trading distinctly from other trading strategies?

    <p>It uses pre-programmed instructions to execute trades automatically.</p> Signup and view all the answers

    What is the role of market consolidation in a global financial context?

    <p>It refers to the merging of smaller exchanges into larger ones.</p> Signup and view all the answers

    What feature distinguishes the New York Stock Exchange (NYSE) from other exchanges?

    <p>It is the largest stock exchange in the United States by market capitalization.</p> Signup and view all the answers

    How is the spread calculated in trading?

    <p>Spread = Price Ask − Price Bid.</p> Signup and view all the answers

    Which of the following statements about trading costs is true?

    <p>Spreads can vary based on market activity and liquidity.</p> Signup and view all the answers

    Study Notes

    How Firms Issue Securities

    • Primary Market: New securities are issued.
    • Secondary Market: Existing securities are traded.
    • Privately Held Firms: Shares are sold to a maximum of 499 shareholders directly.
    • Publicly Traded Companies: Securities are sold to the general public.
    • Initial Public Offering (IPO): The first public sale of stock by a formerly private company.
    • Underwriters: Purchase securities from the issuing company and resell them to the public.
    • Prospectus: Describes the firm and the security being issued.

    IPO Mechanics

    • Issuer and underwriter conduct a "road show" to market the IPO.
    • Bookbuilding and Pricing: The process of collecting orders from investors and determining the final offering price.
    • Underpricing: The practice of setting the IPO price below the market value.
    • Winner's Curse: The tendency for investors to underestimate the true value of an IPO, resulting in higher post-IPO returns.

    How Securities Are Traded: Financial Markets

    • Provide a platform for buying and selling securities at a low cost.
    • Bring together buyers and sellers efficiently.
    • Offer liquidity by minimizing trading time.
    • Promote price continuity by establishing and updating prices.
    • Reduce information costs associated with investing.

    How Securities Are Traded: Market Types

    • Direct Search Markets: Buyers and sellers locate each other directly.
    • Brokered Markets: A third party assists in finding a buyer or seller.
    • Dealer Markets: A third party acts as an intermediary buyer or seller.
    • Auction Markets: Brokers and dealers trade in one location, and trades often occur continuously.

    Order Types

    • Market Order: Executes immediately at the best available price.
    • Price-Contingent Order: Specifies a specific price at which the investor will buy or sell.
      • Limit Buy/Sell Order: Executes only at a specified price or better.
      • Stop Order: Executes only after a specific price point is reached.

    Trading Strategies

    • Algorithmic Trading: Computer programs are used to make trading decisions rapidly.
    • High-Frequency Trading: A subset of algorithmic trading using programs to make very rapid decisions, often resulting in small profits.

    Globalization of Stock Markets

    • Moving towards automated electronic trading.
    • Market consolidation resulting in 24-hour global trading.

    U.S. Securities Markets

    • NYSE: Largest U.S. stock exchange.
    • NASDAQ: A major electronic stock exchange.

    Trading Costs

    • Commission: A fee paid to the broker for facilitating a transaction.
    • Spread: The cost of trading with a dealer.
      • Bid: Price at which the dealer will buy.
      • Ask: Price at which the dealer will sell.

    Buying on Margin

    • Buying securities with borrowed funds.
    • Margin %: The percentage of equity in the position.
    • Margin Call: A demand from the broker to deposit additional funds to restore the minimum margin requirement.

    Short Sales

    • Selling borrowed shares with the expectation of buying them back later at a lower price.
    • Mechanics: Borrow shares, sell them, buy them back (covering), and return the borrowed shares.

    Regulation of Securities Markets

    • Self-Regulation: Industry organizations establish and enforce rules.
    • Sarbanes-Oxley Act (2002): Legislation aimed at improving corporate governance and financial reporting.
      • Created the Public Company Accounting Oversight Board.
      • Requires independent financial experts on audit committees.
    • Insider Trading: Using nonpublic information about a corporation for personal gain.
      • The SEC requires officers, directors, and major stockholders to report transactions in their firm's stock.

    Publicly Traded Companies

    • Securities sold to the general public, meaning investors are able to trade shares on stock exchanges
    • Companies are obligated to release financial statements to the public
    • Securities are typically sold to the public through an underwriter

    Initial Public Offering (IPO)

    • First public sale of stock for a formerly private company
    • Underwriters purchase securities from issuing company and resell them to the public
    • Prospectus describes the company and security being offered to the public

    Importance of the Prospectus

    • Contains detailed information about the company's business, financial condition, and management team
    • Allows investors to make informed decisions about whether to invest in the company
    • Key information for investors to assess risks and potential returns

    Nasdaq

    • Stock exchange that lists approximately 3,000 companies

    NYSE

    • Largest stock exchange in the U.S
    • Secondary Market - where already-issued securities are bought and sold

    Algorithmic Trading

    • Computer programs make rapid trading decisions

    High-frequency trading

    • A subset of algorithmic trading
    • Computer programs make very rapid trading decisions for very small profits

    Globalization of Stock Markets

    • Trend toward 24-hour global markets
    • Move towards market consolidation

    Trading Costs

    • Commission: Fee paid to a broker for making a transaction
    • Spread: Difference between the bid price and the ask price
    • Bid: Price at which a dealer will buy from you
    • Ask: Price at which a dealer will sell to you

    Buying on Margin

    • Borrowing money from a broker to buy securities
    • Initial Margin Requirement: Proportion of total purchase price that must be paid by the investor
    • Margin Call: Occurs when the value of the security falls below a certain threshold, requiring the investor to deposit additional funds to maintain the initial margin requirement

    Short Selling

    • Sale of securities that the investor does not own
    • Mechanics
      • Investor borrows shares from the broker and must post margin
      • Broker sells the borrowed shares, deposits cash proceeds into the margin account
      • Position covering or closing out: Investor buys shares to return them to the lender, closing out the short position
    • Covering or closing out position: Investor buys stock; broker returns title to original party

    Short Selling: Example

    • Investor sells 100 shares of stock short at $60 per share, so they deposit $6,000 in margin account (50% of total value)
    • This means the margin account holds $9,000
    • Short sale equity = total margin account - market value
    • Maintenance Margin Requirement (MMR): Minimum equity percentage that must be maintained in the account
    • Margin Call: An investor needs to deposit additional funds when the equity in the short sale account falls below the MMR percentage

    Margin Call: Example

    • If the MMR is 30% of market value, then a margin call occurs when equity is equal to or less than 30% of the market value.
    • To calculate the price at which a margin call will occur:
    • Market value = Total margin account / (1 + MMR)
    • To restore the initial margin requirement, the investor needs to deposit additional funds to ensure the equity is equal to or greater than half the market value.

    Studying That Suits You

    Use AI to generate personalized quizzes and flashcards to suit your learning preferences.

    Quiz Team

    Related Documents

    Bodie, Kane, And Marcus Essentials Of Investments 12e Chapter 03 PDF

    Description

    This quiz covers the primary and secondary markets for securities, explaining the role of privately held and publicly traded companies. It delves into the processes of issuing securities, including Initial Public Offerings (IPOs), bookbuilding, pricing strategies, and the implications of underpricing and the winner's curse.

    More Like This

    Use Quizgecko on...
    Browser
    Open
    Browser
    Browser