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