Chapter 2 - Securities Market PDF

**[CHAPTER 2]** 1. What is the difference between the primary market and the secondary market? What are three choices to market securities in the primary market? The **primary market** is where firms and governments sell new issues of securities directly to investors, allowing the issuer...

**[CHAPTER 2]** 1. What is the difference between the primary market and the secondary market? What are three choices to market securities in the primary market? The **primary market** is where firms and governments sell new issues of securities directly to investors, allowing the issuer to receive the proceeds from these sales. In contrast, the **secondary market** is where securities trade after they have been issued, and transactions do not involve the issuer. In the secondary market, money flows between investors rather than from investors to the issuer. Three choices for marketing securities in the primary market include: - **Public offering**: Offering securities to the general public. - **Rights offering**: Offering shares to existing stockholders on a pro-rata basis. - **Private placement**: Selling securities directly to select private investors without SEC registration 12. 2. What are underwriting, prospectus, quiet period, red herring, and road show in the IPO process? **Underwriting** involves an investment bank purchasing securities from the issuer and reselling them to the public, assuming the risk of the sale. A **prospectus** is a disclosure document that outlines key aspects of the securities and the issuer\'s financial position. The **quiet period** is a time during which the issuer cannot communicate with investors while waiting for SEC approval. A **red herring** is a preliminary prospectus that indicates the offer\'s tentative nature. A **road show** is a series of presentations made by the issuer to potential investors to gauge interest and explain the business 34. 3. What are benefits and disadvantages of direct listing? The benefits of a **direct listing** include saving on investment banking fees and allowing pre-IPO investors to liquidate holdings. However, disadvantages include the lack of a road show to promote the company and uncertainty regarding the initial trading price. Additionally, direct listings do not raise new capital, making them less suitable for companies needing funds 56. 4. What is difference between a broker and a dealer? What do market makers do in dealer markets? What is bid/ask spread? A **broker** facilitates transactions between buyers and sellers, while a **dealer** buys and sells securities for their own account. Market makers in dealer markets provide liquidity by offering to buy and sell securities at stated prices. The **bid/ask spread** is the difference between the bid price (the price a buyer is willing to pay) and the ask price (the price a seller is willing to accept), representing a trading cost for investors 78. 5. What is over the counter (OTC) market? What is the characteristic of companies traded on the OTC markets? The **over-the-counter (OTC) market** consists of securities that trade outside of formal exchanges, primarily involving smaller companies that do not meet listing requirements. Companies traded on OTC markets often provide little information about their operations, and the market is divided into tiers based on the level of disclosure and regulation 910. 6. What are conditions in security markets normally associated with the bull market? What are conditions in security markets normally associated with the bear market? Conditions in **bull markets** are characterized by rising prices, investor optimism, and economic recovery, often supported by government stimulus. Conversely, **bear markets** are associated with falling prices, investor pessimism, and economic slowdown, typically marked by a decline of at least 20% in stock prices 11. 7. What is diversification? What is international investment? Why international investment relates to diversification? **Diversification** involves including a variety of different securities in a portfolio to increase returns and reduce risk. **International investment** refers to investing in foreign markets, which enhances diversification by spreading risk across different economies and currencies. However, investing internationally carries specific risks, such as changes in trade policies, labor laws, and political instability in foreign countries 1213. **Diversification** is the strategy of including a variety of different securities in a portfolio to increase returns and reduce risk. This can be achieved by holding a wider range of industries and securities, securities traded in various markets, and securities denominated in different currencies. The potential for diversification is even greater when combining domestic and foreign securities, especially for investors from less diversified home markets 12. **International investment** refers to investing in foreign markets, which allows investors to seek opportunities beyond their home countries. This can be done either directly, by purchasing foreign securities, or indirectly, by investing in multinational corporations that operate globally. Many U.S.-based firms, such as Google and Coca-Cola, derive a significant portion of their revenues from overseas, providing a way for investors to achieve international diversification 14. **International investment** relates to diversification because it enables investors to spread their risk across different economies and currencies. By investing in a mix of domestic and foreign securities, investors can potentially enhance their portfolio\'s performance and reduce exposure to any single market\'s volatility 12. 8. What specific risks may involve when investing in foreign markets? Investing in foreign markets comes with specific risks, including: 1. **Currency exchange risk**: Fluctuations in currency values can significantly impact returns on foreign investments. For example, changes in the currency exchange rate can affect the value of profits or losses when converting back to the investor\'s home currency 15. 2. **Political and economic instability**: Changes in trade policies, labor laws, and taxation can affect the operating conditions for firms in foreign countries. Additionally, the stability of the government in those countries can pose risks 13. 3. **Regulatory differences**: Investors may encounter different securities exchange rules, transaction procedures, and accounting standards in foreign markets, which can complicate investment decisions 16. 9. What is margin in margin trading? What is margin requirement? What is initial margin? What is maintenance margin? What is a margin call? Margin trading involves borrowing funds from a broker to purchase securities, allowing investors to leverage their investments. The **margin** in margin trading refers to the amount of equity an investor must maintain in their margin account, which acts as collateral for the borrowed funds 14. The **margin requirement** is the minimum amount of equity that must be maintained in a margin account. This requirement is set by the Federal Reserve Board and can vary by brokerage firms, which may impose stricter requirements 15. **Initial margin** is the minimum amount of equity that an investor must provide at the time of purchase when executing a margin transaction. This requirement serves as a limit on how much risk an investor can take through margin trading 15. **Maintenance margin** is the absolute minimum amount of equity that must be maintained in the margin account at all times. If the equity falls below this level, the investor will receive a **margin call**, which is a demand from the broker to deposit additional funds or sell securities to bring the account back up to the required level 16. 10. What is the difference between a long purchase (long position) and a short selling (short position)? The difference between a **long purchase (long position)** and **short selling (short position)** lies in the investor\'s expectations about the price movement of the security: - In a **long position**, an investor buys securities expecting their prices to rise, allowing them to sell at a profit later. - In a **short position**, an investor borrows securities to sell them at the current market price, anticipating that the price will fall so they can buy them back at a lower price, returning the borrowed shares and pocketing the difference.