Securities Markets Reference: Chapter 3 BKM How Firms Issue Securities Primary Market: Market for new issues of securities Secondary Market: Market for already existing securities There are two types of primary market issues; Underwriting: Public offerings of both stocks and bonds typically are marketed by investment bankers who in this role are called underwriters IPO Seasoned Firm Commitment vs. Best Efforts Prospectus: A description of the firm and the security it is issuing How Firms Issue Securities (continued) Underwriting Syndicate Shelf Registration: Register securities and gradually sell them to the public for two years following the initial registration How Securities are Traded; Types of Markets Direct Search Markets: Least organized Direct seeking by buyers and sellers Commodity is low-priced, non-standard Brokered Markets: Active trading Brokers have specialized knowledge “Block Houses” How Securities are Traded; Types of Markets (continued) Dealer Markets: Markets in which traders specializing in particular assets buy and sell for their own accounts Dealer’s spread b/w bid and ask prices OTC is an example Auction Markets: A market where all traders meet at one place to buy or sell an asset Continuous vs. Periodic Types of Brokers Full service brokers are firms offering information (on different securities) and advice (for selling and/or buying) apart from usual services. Discount brokers are firms offering less (or no) research services and will charge less. Online brokers offer much similar services as full service brokers but trade interfaces are available to clients for online trading. Types of Brokers (at KSE) Dealing or execution only, i.e., your broker deals for you and executes your instructions. Advisory means the broker will offer you advice on buying, selling, or holding a specific scrip. Discretionary; Broker takes all the buying and selling decisions, informs you regularly regarding your portfolio. Types of Brokerage Accounts Cash account authorizes a customer for cash transactions only. Margin account authorizes a customer to transact for a value greater than the available cash, i.e., use a loan. Asset management account are unique, i.e., offering services such as investment of cash balances in funds and check writing facilities etc. Wrap accounts are special types of accounts accumulating all costs in one fee. How Securities are Traded; Types of Orders Bid price is the price at which a dealer or other trader is willing to purchase a security Ask price is the price at which a dealer or other trader will sell a security Bid-Ask spread is the difference between a dealer’s bid and asked price Costs Associated with Trading Commission charged by the broker depends upon; Price of a security; Market in which the security is traded, etc. CVT @ 0.02% of purchase price. WHT @ 0.005% of sale value (replaced with FED). Placing Orders for Trading An order may be classified on the basis of; Type of transaction (e.g., buy or sell) Price (e.g., market or limit) Duration/Time (e.g., day or good till cancelled) Orders may be placed through phone, in written, or online. Placing Orders for Trading Bid (buy) order is placed if an investor wants to buy securities. Offer (sell) order is placed if an investor wants to sell securities. Short sale is the sale of borrowed stocks with the hope of returning them at lower prices. Buy to cover is the sale executed to close out a short position. Placing Orders for Trading Both bid & offer orders are; Market or at Best orders, or Limit orders, and/or Stop orders Limit order specifies a limit for the purchase (in bid order) or sale (in offer order) price. An order is a market order if no price (purchase or sale) is specified by investor and is executed at available best market price. An order to buy or sell a security when its price crosses the specified level is called stop order. Placing Orders for Trading Orders may have Time in Force Restriction, i.e., Day (market orders are always day orders) Good Till Cancelled (GTC) (i.e. Open) Good to Date (Month-Day-Year) (GTD) Good for Week (GTW) Good for Month (GTM) Fill or Kill (FOK) (placed outside market hours, and executed in the immediate next trading session) Sorting Orders Limit orders are ranked on the basis of price first, i.e., highest price in buy orders and lowest price in sell orders are settled first, and then on first come & first serve basis, i.e., two orders with same price will be ranked on which order reached the exchange floor first. Limit orders will be executed only if the specified prices are available. Unsettled limit orders are queued for future execution (up to 90 days) and do not lose priority. Volume of the limit orders may not match for settlement. Sorting Orders Market orders are settled with the top limit order. If partially completed the market order is fulfilled from the next available limit order in the queue. Must be executed immediately. Sorting Orders Stop orders are of two main types; Stop Buy Order Stop Loss Order Stop buy order specifies a price which if breached triggers buying. Used by momentum traders who wish to take advantage when the stock price has moved upwards past a threshold level indicating upward momentum that is expected to continue. Sorting Orders Stop loss order is an order to sell stock if the price lowers than the specified price. Useful when investor wants to limit losses, especially during short selling. Sorting Orders Following terminologies are often encountered in trading; Tick Size; the minimum amount that a price of stock may change by. It is one paisa at KSE. Circuit Breakers/Locks; Level at which trades are stopped in a particular scrip. At KSE trading is restricted in upper & lower limits of 5% or Re. 1/-, whichever is higher/lower, from last closing price. Market Lot; Minimum tradable quantity of shares. Execution of Orders on Trade Screen A partial trade screen looks like; Symbol Bid Volume Bid Price Ask Volume Ask Price Hypothesize a company with a ticker/symbol XYZ. Symbol XYZ Bid Volume Bid Price Ask Volume Ask Price Execution of Orders on Trade Screen Investor A wants to buy 1000 shares of XYZ @ Rs. 10.00 (a limit order); S. No. Symbol Bid Volume Bid Price Ask Volume 1 XYZ 1000 Ask Price 10.00 Investor B wants to sell 500 shares of XYZ @ Rs. 10.80 (a limit order) S. No. Symbol Bid Volume Bid Price Ask Volume 1 XYZ 1000 10.00 500 Ask Price 10.80 Execution of Orders on Trade Screen A bid (buy) market order for 250 shares of XYZ reaches; S. No. Symbol Bid Volume Bid Price Ask Volume 1 XYZ 1000 10.00 250 Ask Price 10.80 A sell (ask) market order for 500 shares reaches; S. No. Symbol Bid Volume Bid Price Ask Volume 1 XYZ 500 10.00 250 Ask Price 10.80 Execution of Orders on Trade Screen A bid limit order reaches of 500 shares @ Rs. 10.01 per share; S. No. Symbol Bid Volume Bid Price Ask Volume 1 XYZ 500 10.01 2 XYZ 500 10.00 250 Ask Price 10.80 A sell (ask) limit order for 500 shares @ Rs. 10.75 per share reaches S. No. Symbol Bid Volume Bid Price Ask Volume Ask Price 1 XYZ 500 10.01 500 10.75 2 XYZ 500 10.00 250 10.80 Execution of Orders on Trade Screen Following orders reach the exchange; Bid limit order of 500 shares @ Rs. 10.50, and Ask limit order of 250 shares @ Rs. 10.50 S. No. Symbol Bid Volume Bid Price Ask Volume Ask Price 1 XYZ 500 10.50 250 10.50 2 XYZ 500 10.01 500 10.75 3 XYZ 500 10.00 250 10.80 Prices are matching but quantities are not. 250 shares @ Rs. 10.50 will be transferred to the bid trader.