Investment and Risk Analysis
Chapter Two
Securities Market
Slides Prepared
By
Mohd. Mohsin,
Assistant Professor of Finance, IIUC
Three interrelated reasons for
constructing global investment portfolios
When investors compare the absolute and relative
sizes of domestic and foreign markets for stocks
and bonds, they see that ignoring foreign markets
reduces their choices to less than 50 percent of
available investment opportunities.
2. The rates of return available on global securities
often have substantially exceeded those for
domestic securities.
1.
3. One of the major tenets of investment theory is that
investors should diversify their portfolios.
WHAT IS A MARKET?
 A market is the means through which buyers and
sellers are brought together to aid in the transfer of
goods and/or services.
 Several Aspects of Market Definition
1) A market need not have a physical location. It is only necessary
that the buyers and seller can communicate
1) The market does not necessarily own the goods and services
involved; the important criterion is the smooth ,cheap transfer of
goods and services.
1) A market can deal any variety of goods and services
Characteristics of Good Market
1. Timely and accurate information is available on the price and
volume of past transactions and the prevailing bid and ask prices.
2. It is liquid, meaning an asset can be bought or sold quickly at a
price close to the prices for previous transactions (has price
continuity), assuming no new information has been received. In
turn, price continuity requires depth.
3. Transactions entail low costs, including the cost of reaching the
market, the actual brokerage costs, and the cost of transferring the
asset.
4. Prices rapidly adjust to new information; thus, the prevailing
price is fair because it reflects all available information regarding
the asset.
Organization of Securities Market
PRIMARY CAPITAL MARKETS
 The primary market is where new issues of bonds, preferred
stock, or common stock are sold by government units,
municipalities, or companies to acquire new capital.
Three Methods of Stock/ Bond Issues
1.
Competitive bid sales typically involve sealed bids. The bond issue
is sold to the bidding syndicate of underwriters that submits the bid with
the lowest interest cost
2.
Negotiated sales involve contractual arrangements between
underwriters and issuers wherein the underwriter helps the issuer prepare
the bond issue and set the price and has the exclusive right to sell the issue.
3.
Private placements involve the sale of a bond issue by the issuer directly
to an investor or a small group of investors usually institutions). The firm
enjoys lower issuing costs because it does not need to prepare the extensive
registration statement required for a public offering. return. In fact, the
institution should require a higher return because of the absence of any
secondary market for these securities,
Best Effort :Investment banker acts as broker
4.
Underwriting Function
The underwriting function can involve three services:
origination, risk bearing, and distribution.
1. Origination involves the design of the bond issue and initial
planning.
2. The risk bearing function involves the underwriter
acquires the total issue at a price dictated by the competitive bid
or through negotiation and accepts the responsibility and risk of
reselling it for more than the purchase price.
3. Distribution means selling it to investors, typically with the
help of a selling syndicate that includes other investment
banking firms and or commercial banks.
Underwriting Continued-------
Corporate Stock Issues
 For corporations, new stock issues are typically divided into
two groups:
(1) seasoned equity issues : Seasoned equity issues are new
shares offered by firms that already have stock outstanding.
(2) Initial public offerings (IPOs) : Initial public offerings
(IPOs) involve a firm selling its common stock to the public
for the first time.
SECONDARY FINANCIAL MARKETS
 Secondary markets permit trading in outstanding issues; that
is, stocks or bonds already sold to the public are traded
between current and potential owners.
 The proceeds from a sale in the secondary market do not go
to the issuing unit (the government, municipality, or
company) but, rather, to the current owner of the security.
Three major segments Of Secondary
Equity Markets:
 (1) the major national stock exchanges, including the
New York, the Tokyo, and the London stock exchanges;
(2) regional stock exchanges in such cities as Chicago, San
Francisco, Boston, Osaka and Nagoya in Japan, and Dublin in
Ireland; and
(3) the over-the-counter (OTC) market, which
involves trading in stocks not listed on an organized exchange.
Third Market & Fourth Market
 Third market describes OTC trading of shares listed on
an exchange. Although most transactions in listed stocks take
place on an exchange, an investment firm that is not a
member of an exchange can make a market in a listed stock.
 Fourth market describes direct trading of securities
between two parties with no broker intermediary. In almost
all cases, both parties involved are institutions.
Listing Requirements in DSE
Application for listing as per Form I;
(ii) Memorandum & Articles of Association;
(iii) Copy of the Certificate of incorporation;
(iv) Copy of the Certificate of Commencement of Business;
(v) Copy of the Feasibility Report, in case of a new project;
(vi) Copy of the certificate of registration of the industrial Units issued by the
Council of Investment or any other competent authority;
(vii) Copies of all material contracts and agreements entered into or exchanged
with foreign participants, machinery suppliers and any other financial institutions;
(viii) Copies of Letter (s) of Credit established in favour of Machinery
Suppliers, if linked with the public issue;
(ix) Copy of Consent order issued by the Commission;
(x) Names of Directors along with directorship of other companies listed on
the Exchange;
i.
Continued-------------------------(xi) Draft prospectus/Offer for sale;
(xii) Auditors Certificate for the amount subscribed by the
promoters/directors/subsidiaries/associates;
(xiii) Copies of the agreements relation to issue to securities for consideration other than
cash, if any;
(xiv) Copy of underwriting agreement (if any);
(xv) Statement of audited accounts for the last 5 years or for a shorter number of years if
the company is in operation only for such shorter period;
(xvi) Statement showing the cost of project and means of finance;
(xvii) Copies of the approval of tax-holiday application under Ordinance, 1984;
(xviii) Copies of the consent Letters from Bankers or Financial Institution to the Issues;
(xix) Application for submission of Under of Undertaking and payment of fees as per Form
II;
(xx) Copy of approval of prospectus/offer for sale from Commission; and
(xxi) Any other documents/material contract and such other particulars as may be required
by the Exchange or by the Council and/or by the Commission;
Exchange Membership
Securities exchanges typically offer four major categories of
membership:
(1) Specialist,
(2) Commission broker : are employees of a member firm
who buy or sell for the customers of the firm.
(3) Floor broker : Floor brokers are independent members of
an exchange who act as brokers for other members.
(4) Registered traders are allowed to use their memberships
to buy and sell for their own accounts.
Types of Orders
 Market Orders : The most frequent type of order is a
market order, an order to buy or sell a stock at the best
current price. Market orders provide immediate liquidity for
someone willing to accept the prevailing market price.
Example of Market Order
 Assume you are interested in General Electric (GE) and you call
your broker to find out the current “market” on the stock. The
quotation machine indicates that the prevailing market is 45 bid—
45.25 ask. This means that the highest current bid on the books of
the specialist is 45; that is, $45 is the most that anyone has offered
to pay for GE.
 The lowest offer is 45.25, that is, the lowest price anyone is
willing to accept to sell the stock.
 If you placed a market buy order for 100 shares, you would buy
100 shares at $45.25 a share (the lowest ask price) for a total cost
of $4,525 plus commission.
 If you submitted a market sell order for 100 shares, you would sell
the shares at $45 each and receive $4,500 less commission.
Limit Order------------------ Limit order specifies the buy or sell price.You might
submit a bid to purchase 100 shares of Coca-Cola stock at
$50 a share when the current market is 60 bid–60.25 ask,
with the expectation that the stock will decline to $50 in the
near future.
 A limit order can be instantaneous (“fill or kill,” meaning fill
the order instantly or cancel it).
Stop loss order
 A stop loss order is a conditional market order whereby the investor
directs the sale of a stock if it drops to a given price.
Example:
 Assume you buy a stock at 50 and expect it to go up. If you
are wrong, you want to limit your losses. To protect yourself,
you could put in a stop loss order at 45.
 In this case, if the stock dropped to 45, your stop loss order
would become a market sell order, and the stock would be
sold at the prevailing market price.
Short Sales
 A short sale is the sale of stock that you do not own with
the intent of purchasing it back later at a lower price.
Specifically, you would borrow the stock from another
investor through your broker, sell it in the market, and
subsequently replace it at (you hope) a price lower than the
price at which you sold it.
Margin Transactions
 Margin transaction means leveraging the transaction.
 means the investor pays for the stock with some cash and
borrows the rest through the broker, putting up the stock for
collateral.
Initial Margin: That part of transaction's value that a
customer must pay to initiate the transaction
Examples of Margin Transaction
 Assume you acquired 200 shares of a $50 stock for a total
cost of $10,000. A 50 percent initial margin requirement
allowed you to borrow $5,000, making your initial equity
$5,000. If the stock price increases / decreases by 20
percent to $60 / $40 a share
Required:
i.
Find the return on your investment if the share price
increases / decreases by 20 %.
ii. What would be the answer of requirement 1 if you have to
pay 6% interest on your borrowed fund and $1000
commission on your transaction?
Solution--------------------------
Continued-------------
Maintenance margin,
 It is the required proportion of your equity to the total value
of the stock; the maintenance margin protects the broker if
the stock price declines.
Margin call
Call for more equity funds or additional cash from
the broker as a result of the actual margin declining
below the maintenance margin
Examples of Margin Call
SECURITY MARKET (Indicator
Series)INDEXES
 It gives the answer to the question “What happened to the
market today?” to investors
 Supply investors with a composite report on market
performance
USES OF SECURITY MARKET INDEXES
Security market indexes are used:
 As benchmarks to evaluate the performance of professional
money managers
 . To create and monitor an index fund
 . To measure market rates of return in economic studies
 . For predicting future market movements by technicians
 . As a proxy for the market portfolio of risky assets when
calculating the systematic risk of an asset
STOCK MARKET INDICATOR SERIES
Three principal weighting series are used:
(1) a price-weighted series,
(2) a market-value-weighted series, and
(3) an un weighted series, or what would be described as an
equally weighted series.
Price-Weighted Series
A price-weighted series is an arithmetic average of
current prices, which means that index movements are
influenced by the differential prices of the components.
 Dow Jones Industrial Average(DJIA) is a price-weighted
average of 30 large, well-known industrial stocks of US
 The DJIA is computed by totaling the current prices of the
30 stocks and dividing the sum by a divisor that has been
adjusted to take account of stock splits and changes in the
sample over time.
Example of Price Weighted Series
Market –Value-Weighted Series
 A market-value-weighted series is generated by
deriving the initial total market value of all stocks
used in the series (Market Value = Number of Shares
Outstanding × Current Market Price).
 This initial figure is typically established as the base and
assigned an index value (the most popular beginning index
value is 100, but it can vary—say, 10, 50).
 Subsequently, a new market value is computed for all
securities in the index, and the current market value is
compared to the initial “base” value to determine the
percentage of change, which in turn is applied to the
beginning index value.
Continued-------
where:
Index t = index value on day t
Pt = ending prices for stocks on day t
Qt = number of outstanding shares on day t
Pb = ending price for stocks on base day
Qb = number of outstanding shares on base day
Continued---------------------------
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