CHAPTER 3 How Securities are Traded Investments, 8th edition Bodie, Kane and Marcus Slides by Susan Hine McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. Securities Markets • Primary market: New issue • Secondary market: Existing owner sells to another party • Initial Public Offerings – Evidence of “underpricing” – Subsequent underperformance 3-2 Types of Orders • Market order (MO): buy or sell at the best price now available • Limit order (LO): buy or sell at the stated price or better. Normally, a LO: – To buy is below the market price – To sell is above the market price 3-3 Example of Limit Order • You own a stock that is trading at $50. You are willing to buy more at a price of $40 and you are willing to sell at a price of $60. • Enter a LO to buy @ $40. • Enter a LO to sell @ $60. • If the mkt price drops to $40, you will buy, if it increases to $60, you will sell. 3-4 Types of Orders: Stop Order • Stop (or stop loss) order: – To sell is normally to close a long position and price is below market. – To buy is normally to cover a short position, and price is above market. 3-5 Example of Stop Order • You buy a stock when the price is $50. You are not willing to lose more than $10 per share. • Enter a stop loss order to sell @ $40. If the mkt price drops to $40, it becomes a market order and will be sold. 3-6 Order Size • • • • Block trade: 10,000 share minimum Round lot: 100 shares Odd lot: less than 100 shares Block trades account for about 20% of shares traded; odd lot trades are less than 5%. 3-7 Trading Mechanisms • Dealer markets (NASDAQ) • Electronic communication networks (ECNs) • Specialists markets (NYSE) 3-8 Trading Costs • Commission: fee paid to broker for making the transaction • Spread: cost of trading with dealer – Bid: price dealer will buy from you – Ask: price dealer will sell to you – Spread: ask - bid • Combination: on some trades both are paid 3-9 Buying on Margin • Investing on margin is purchasing securities with borrowed funds. • In margin transactions, margin refers to the investor’s equity in the position. 3-10 Stock Margin Trading • Margin is currently 50%; you can borrow up to 50% of the stock value – Set by the FRS • Maintenance margin: minimum amount equity in trading can be before additional funds must be put into the account • Margin call: notification from broker that you must put up additional funds 3-11 Short Sales Purpose: to profit from a decline in the price of a stock or security Mechanics • Borrow stock through a dealer • Sell it and deposit proceeds and margin in an account • Closing out the position: buy the stock and return to the party from which it was borrowed 3-12