Chapter 2 Markets and Transactions PDF

Chapter 2 Markets and Transactions Copyright © 2008 Pearson Addison-Wesley. All rights reserved. Markets and Transactions Learning Goals 1. Identify the basic types of securities markets and describe the IPO process. 2. Explain the characteristics of broker markets....

Chapter 2 Markets and Transactions Copyright © 2008 Pearson Addison-Wesley. All rights reserved. Markets and Transactions Learning Goals 1. Identify the basic types of securities markets and describe the IPO process. 2. Explain the characteristics of broker markets. 3. Understand dealer markets, alternative trading systems, and the general conditions of securities markets. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-2 Markets and Transactions Learning Goals (cont’d) 4. Review the key aspects of global securities markets, including the risks associated with foreign investments. 5. Discuss trading hours and regulation of securities markets. 6. Explain long purchases, margin transactions and short sales. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-3 Types of Markets Money Markets: the market where short-term securities are bought and sold Capital Market: the market where long-term securities such as stocks and bonds are bought and sold Primary Market: the market in which new issues of securities are sold to the public Secondary Market: the market in which securities are traded after they have been issued Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-4 Primary Markets Initial Public Offering (IPO) – First public sale of a company’s stock – Requires SEC approval Three Choices to Market Securities in Primary Market – Public offering – Rights offering – Private Placement Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-5 Secondary Markets Secondary Market: the market in which securities are traded after they have been issued Role of Secondary Markets – Provides liquidity to security purchasers – Provides continuous pricing mechanism Securities Exchanges: forums where buyers and sellers of securities are brought together to execute trades Nasdaq Market: employs an all-electronic trading platform to execute trades Over-the-counter (OTC) Market: involves trading in smaller, unlisted securities Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-6 Dealer Markets Bid Price: the highest price offered by market maker to purchase a given security Ask Price: the lowest price at which a market maker is willing to sell a given security Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-7 Dealer Markets Nasdaq – Largest dealer market – Lists large companies (Microsoft, Intel, Dell, eBay) and smaller companies Over-the-counter (OTC) Bulletin Board – Lists smaller companies that cannot or don’t wish to be listed on Nasdaq – Companies are regulated by SEC Over-the-counter (OTC) Pink Sheets – Lists smaller companies that are not regulated by SEC – Liquidity is minimal or almost non-existent – Very risky; many nearly worthless stocks Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-8 Alternative Trading Systems Third Market – Large institutional investors go through market makers that are not members of a securities exchange – Institutional investors (mutual funds, life insurance companies, pension funds) receive reduced trading costs due to large size of transactions Fourth Market – Large institutional investors deal directly with each other to bypass market makers – Electronic Communications Networks (ECNs) allow direct trading – ECNs most effective for high-volume, actively traded securities Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-9 General Market Conditions Bull Market – Favorable markets – Rising prices – Investor/consumer optimism – Economic growth and recovery – Government stimulus Bear Market – Unfavorable markets – Falling prices – Investor/consumer pessimism – Economic slowdown – Government restraint Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-10 Globalization of Securities Markets Diversification: the inclusion of a number of different investment vehicles in a portfolio to increase returns or reduce risks Use of International Securities Improves Diversification – More industries and securities available – Securities denominated in different currencies – Opportunities in rapidly expanding economies International Investment Performance – Opportunities for high returns – Foreign securities markets do not necessarily move with the U.S. securities market – Foreign securities markets tend to be more risky than U.S. markets Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-11 Globalization of Securities Markets (cont’d) Indirect Ways to Invest in Foreign Securities – Purchase shares of U.S.-based multinational with substantial foreign operations Direct Ways to Invest in Foreign Securities – Purchase securities on foreign stock exchanges – Buy securities of foreign companies that trade on U.S. stock exchanges – Buy American Depositary Receipts (ADRs): dollar denominated receipts for stocks of foreign companies held in vaults of banks Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-12 Risks of International Investing Usual Investment Risks Still Apply Government Policies Risks – Unstable foreign governments – Different laws in trade, labor or taxation – Different economic and political conditions – Less stringent regulation of foreign securities markets Currency Exchange Rate Risks – Value of foreign currency fluctuates compared to U.S. dollar – Value of foreign investments can go up and down with exchange rate fluctuations Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-13 Trading Hours of Securities Markets Regular Trading Session for Philippine Stock Exchange –9:30 A.M. to 12:00 P.M. –1:00 P.M. to 1:00 P.M. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-14 Regulation of Securities Markets Insider Trading – Use of nonpublic information about a company to make profitable securities transactions Blue Sky Laws – Laws imposed by individual states to regulate sellers of securities – Intended to prevent investors from being sold nothing but “blue sky” Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-15 Basic Types of Securities Transactions Long Purchase – Investor buys and holds securities – “Buy low and sell high” – Make money when prices go up Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-16 Basic Types of Securities Transactions (cont’d) Margin Trading – Uses borrowed funds to purchase securities – Currently owned securities used as collateral for margin loan from broker – Can be used for common stocks, preferred stocks, bonds, mutual funds, options, warrants and futures Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-17 Margin Trading Advantages – Allows use of financial leverage – Magnifies profits Disadvantages – Magnifies losses – Interest expense on margin loan – Margin calls Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-18 Basic Types of Securities Transactions Short Selling – Investor sells securities they don’t own – Investor borrows securities from broker – Broker lends securities owned by other investors that are held in “street name” – “Sell high and buy low” – Investors make money when stock prices go down Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-19 Short Selling Advantages – Chance to profit when stock price declines Disadvantages – Limited return opportunities: stock price cannot go below $0.00 – Unlimited risks: stock price can go up an unlimited amount – If stock price goes up, short seller still needs to buy shares to pay back the “borrowed” shares to the broker – Short sellers may not earn dividends Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-20 Table 2.5 The Mechanics of a Short Sale Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-21 Chapter 2 Review Learning Goals 1. Identify the basic types of securities markets and describe the IPO process. 2. Explain the characteristics of broker markets. 3. Understand the dealer markets, alternative trading systems, and the general conditions of securities markets. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-22 Chapter 2 Review (cont’d) Learning Goals (cont’d) 4. Review the key aspects of global securities markets, including risks associated with foreign investments. 5. Discuss trading hours and regulation of securities markets. 6. Explain long purchases, margin transactions and short sales. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-23 Chapter 2 Additional Chapter Art Copyright © 2008 Pearson Addison-Wesley. All rights reserved. Figure 2.1 Cover of a Preliminary Prospectus for a Stock Issue Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-25 Table 2.1 Annual IPO Data, 1996– 2005 Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-26 Table 2.2 Important Federal Securities Laws Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-27 Table 2.6 Margin Positions on Short Sales Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 2-28