How Securities Are Traded Brokerage Firms Types: Full Service Discount Income Only 15% come from commission paid by investors Brokers Income Less than 50% customer commissions Selling mutual funds owned by their firm Load funds-commission Principal transactions Public buy recommendation Or Being compensated to sell this security Sale of new issues of securities Administrative fees on Inactive accounts Transfers Maintenance fees Types of Brokerage Accounts 1. Cash Account Pays cash no later than settlement + 2 business days Reg T Extension Granted by exchange on which the security trades and gives the customer another 3 business days Failure to pay on time ---brokerage firm obligated to sell out the position 2. Margin Account Buy sec or sell short as long as Reg T initial margin is met If Reg T doesn't apply then meet the exchange's maintenance margin (Exempted securities: US Govt, Agencies, Muni, & Commercial Paper) Initial Margins set by Fed. Res. Reg T Long Positions Short Positions Stock=50% Convertible Sec.=50% Stock =50% Convertible Sec.=50% U.S. Govt = na Muni=na Corp bond = na U.S. Govt = na Muni=na Corp bond = na Stock Options= 100% of Premium Broad Based Index Option = 100% of Premium Int. Rate/Foreign Currency Option=100% of Premium Minimum Margins: Exchanges require a min. margin be maintained after the Reg T requirement has been met Usually less than the initial Maintenance Calls Must bring up to the min maintenance margin within 3 bus. days NYSE margins $2000 for both long/short positions long-$2000 equity or price of security if less than $2000 short---$2000 equity at any time NYSE Min. Maintenance Long Stock=25% Convert. Sec.=25% Short Stock=30% Convert. Sec.=30% Corp Debt = Greater of 20% of market value Or 7% of face value Same Muni = Greater of 15% of market value Or 7% of face value Same All Options=100% of Premiums Example: Investor's Equity ---Long Position Buy 200 shares @ $100 Long MV - 20000 - Debit(Loan) = Equity (Reg. T) 10000 = 10,000 Margin 50% market value drops to $90 18000 - 10000 = 8000 8000/18000=44% Actual Margin=(MV of Sec - Amt borrowed)/MV of Sec Market value drops to $65 13,000 - 10,000 = 3000 3000/13000 =23% Maintenance call to bring account up to 25% (set by NYSE) 25% (13000)=3250 ----- call for $250 MV at Maintenance Call: MV-Loan =.25 MV Loan/.75= MV Ie. 10000/.75 = 13,333 Per Share value at maintenance Call: Loan / (number of shares (1-maintenance percentage)) Example: Investor's Equity-----Short Margin Sell short 200 sahres @ $50 Sell Short 10,000---Sale Price 5,000---Reg T--initial margin 15,000 Investor's brokerage accont Initial Short Sell @ $50 Credit - Short MV = Equity 15,000 10,000 = 5,000 Margin 50% market value increase to $60 Credit - Short MV = Equity 15000 - 12000 = 3000 Margin 3000/12000=25% Maintenance Call (margin 30%) 30% (12000) =3600---have 3000, call for 600 MV at Maintenance Call Credit Acct- Short MV = .3 Short MV Credit Account/ 1.3 = Short MV Restricted Accounts: Account's equity is less than 50% of Market value 50% of proceeds from sale of any security in account must be retained to increase the equity Margin On Options: Long---100% of option price Puts or Naked Calls o Initial Margin = 20% of the underlying security's market o Minimum Margin = 10% of the underlying security's market value 3. Asset Management Accounts Requires min. balance to open Pymt of annual fee Bank cards & checks Loans 4. Wrap Account All accounts are wrapped in one fee Broker matches clients with independent money managers Typical fee 3% of assets managed Commissions NYSE required its members to charge a fixed (and minimum) commission Securities Act Amendment 1975 Eliminated all fixed fees Fees--negotiated Large variation Internet trading effect Fidelity Investments Schwab E-Trade DRIPS Dividends are reinvested into company shares Typically no brokerage or administrative fees are involved Advantage: dollar cost averaging Outgrowth- no load stock purchases programs (DSP) offered to first time-investors Treasury Direct Program www.publicdebt.treas.gov Directory of Dividend Reinvestment Plans by S&P www.dripcentral.com www.netstockdirect.com Trading Specialists Expected to maintain a fair and orderly market in those stocks assigned to them Act as both dealers and brokers o Brokers--limit book o Dealers--buy/sell shares of their assigned stock(s) to maintain an orderly market Buy from commission brokers who have orders to sell Sell to Commission brokers with orders to buy Min. required amount of capital Automation of NYSE Electronic system Super Dot Super Dot's Opening Automated Report Service (OARs) Postopening market order system (2,099 shares) Specialist's Electronic Book Large trades can avoid the floor trading by the "clean-cross" rule OTC Market makers Dealers in the over-the-counter market make markets in stocks, buying from investors and selling to them from their inventory. Thus, they have a vested interest in each transaction and in the spread between the bid and asked price. Bid prices Asked prices On NASDAQ-- stocks traded average about 11 market makers per sec. TYPES OF ORDERS 1. Market Orders Order to be filled immediately at the prevailing market price No price specified on the order Market Order--Not Held Market Order 2. Limit Order Specify a price at which to buy or sell Ie. Buy 100 GM @ 42--the price is the limit A limit order is to be filled at that price or better (lower) Alimit order to sell is to be filled at that price or better (higher) Entered as: Day orders Day orders are cancelled at the end of the day if order is not filled Good-til Cancelled Order sits with exchange until it is cancelled by customer (Max. 6 mon) All or None (AOL) Either the entire order is filled or the order is not executed Fill or Kill (FOK) Either the entire order is filled on the first try or the order is cancelled Immediate or Cancel (IOC) Either part or all of the order is filled on the first try and the balance is cancelled 3. Stop Orders Used to buy and sell after a stock reaches a certain price level A Stop on the order tells the trader that this order cannot be executed until the market reaches the specified price Sell Stop Order Once the specified price is reached (or lower), the order is triggered and turns into a market order Order is then filled on the next trade Used to limit losses on long stock positions in falling markets Buy Stop Order Once the specified price is reached (or higher), this order is triggered and turns into a market order Order filled on the next trade Used to limit losses on short stock positions in rising markets Stop-Limit Order If a stop order is triggered, it becomes a market order to be filled on the next trade If a stop-limit order, when the stop price is hit, the order is triggered as a limit order and is filled at the limit price or better Example: Sell 100 ABC @ 30 stop Limit 28 When price falls to 30, the order is triggered. It turns into a limit order to sell for 28 or higher. Clearing Procedures Regular Way Occurs 3 business days after the trade date SUN MON TU WED TH FRI SAT 10* 11 13 14 12 15** *Trade date ** Settlement date--customer becomes the legal owner of any securities bought or gives the security up if sold Street Name Brokerage firm safeguards clients securities--hold in street name Clearinghouses Net out all transactions made by its members during a day Depository Trust Co. (DTC) Investor Protection Regulation 1. Federal Level Great Depression SEC (1934) Independent quasi-judicial agency of the US govt 5 members appointed by Pres for 5 year terms enforces the Securities Act 1933 and the 1934 extension Maloney Act 1936 Extend the SEC control to the OTC market Self-regulation of the OTC dealers Investment Co Act 1940/ Investment Advisor Act 1940 Investment co's and investment advisors must register with the Sec and disclose certain information Securities Investor Protection Act 1970 Insurance co protecting investors from brokerage firms that fail Securities Act Amendment 1975 Called for SEC to move toward establishment of a nat'l markt 2. Self-Regulation Stock exchanges regulate and monitor trading for the benefit of investors and the protection of the financial system NYSE Rules are self-imposed and approved by SEC Circuit Breakers Sidecar Rule 80A Index arbitrage orders in stocks comprising the S&P 500 Index subject to tick test if DJIA moves 50 points or more from the previous day's close in down (up) market sells (buy) orders can be executed only on a plus or zero-plus (minus or zero-minus) tick Prices: 10 Start 11 plus 11 zero-plus 10 minus 10 minus-zero NASD Trade assoc established to enhance the self-regulation of the security industries Virtually all brokerage firms are members Regulates brokers and dealers All brokers must register with NASD to trade Keep records of disciplinary actions Insured Brokerage Accounts SIPC Arbitration Binding arbitration before the NASD Short Sales Sale of a stock not owned in order to take advantage of an expected decline in the price of the stock Seller borrows the stock from the broker by borrowing from those held in street-name margin accounts and lending it to the short-seller Sell borrowed security on the open market Dividend declared on any stock must be covered by the short seller Must have a margin account to sell short 50% initial margin 50% maintenance margin Net proceeds from a short sale plus the required margin are held by the broker Account is marked to market Short sales are permitted only on rising prices Uptick or zero-plus