INVESTMENTS:
Analysis and Management
Third Canadian Edition
W. Sean Cleary
Charles P. Jones
Prepared by
Khalil Torabzadeh
University of Lethbridge
Chapter 5
How Securities Are Traded
Learning Objectives
• Explain the role of brokerage firms and
stockbrokers.
• Describe how brokerage firms operate.
• Outline how orders to buy and sell securities are
executed.
• Discuss the regulation of the Canadian securities
industry.
• Explain the importance of margin trading and
short selling to investors.
Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 5
Brokerage Transactions
• Brokerage firms earn commissions on executed
trades, sales loads on mutual funds, profits from
securities sold from inventory, underwriting fees
and administrative account fees
• Full-service brokers offer order execution,
information on markets and firms, and investment
advice
• Discount brokers offer order execution
Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 5
Types of Brokerage Accounts
• Cash account: Investor pays 100% of
purchase price for securities
• Margin account: Investor borrows part of the
purchase price from the broker
• Wrap account: Brokers match investors with
outside money managers; all costs are
wrapped in one fee
Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 5
Fees and Costs
• 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
•
In 1992 E*TRADE became the first brokerage
service to offer on-line trading
• Dividend reinvestment plans (DRIPs) permit
reinvestment of dividends in additional stock
Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 5
Orders on Organized Exchanges
• The TSX introduced the world’s first computerassisted trading system (CATS) in 1977
• 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
Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 5
Orders in OTC Markets
• Dealers are ready to either buy or sell


Bid price is the highest offer price to buy
Ask price is the lowest price willing to sell
•


Ask price - Bid price >0 (dealer spread)
Dealer “makes a market” in the security
More than one dealer for each security in overthe-counter markets
Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 5
Types of Orders
• Market order: Authorizes immediate
transaction at best available price
• Limit order: Specifies a particular market price
before a transaction is authorized
• Stop order: Specifies a particular market price
at which a market order is authorized
Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 5
Clearing Procedures
• Settlement dates for stocks are three
business days after the trade date

Legal ownership transferred and financial
arrangements settled with brokerage firm
• Transfer of securities and funds between
exchange members facilitated by a
clearinghouse: The Canadian Depository for
Securities (CDS)
Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 5
Canadian Regulatory Environment
• Self-Regulatory Organizations (SROs) regulate
their own activities
• Canadian Investor Protection Fund (CIPF) was
established to protect investors
• Investment Dealers Association of Canada (IDA)
is the national trade association for the
investment industry
• Canadian Securities Institute (CSI) is the national
education body of the Canadian securities
industry
Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 5
Margin Accounts
• Exchanges set minimum required deposits of
cash or securities
• Investor pays part of investment cost,
borrows remainder from broker

Margin is the part of the total value of
securities that must be deposited with the
broker to initiate the transaction with the other
part being borrowed from the broker
• Margin call occurs when the actual margin
declines below the margin requirement
Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 5
Short Sales
• Investor borrows stock from a third party
• 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
Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 5
Appendix 5A: Trading on the NYSE
• Centralized continuous
auction market
• Exchange participants:

single specialist
 commission brokers
 independent floor
brokers
 registered traders
• SuperDot
• Major roles of NYSE
specialist

Dealer
 Agent
 Catalyst
 Auctioneer
• Commissions

deregulated in 1975
Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 5
Appendix 5B: U.S. Securities Regulation
• The Securities and Exchange Commission (SEC)
was created by the U.S. Congress in 1934

An independent and quasi-judicial agency of the US
government
• SEC is required to investigate complaints of
violations in securities transactions
• Investment advisor and companies must register
with the SEC and disclose certain information
• Financial Industry Regulatory Authority (FINRA),
formed in 2007, is the largest non-governmental
regulator for securities firms in the U.S.
Cleary Jones/Investments: Analysis and Management, 3rd Canadian Edition, Chapter 5
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