Salaar - Finance
INVESTMENTS
BBA
SPRING Semester 2012
Lahore School of Economics
Salaar farooq – Assistant Professor
Salaar - Finance
Securities
Markets
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Chapter 3
Indirect Investing
Summary
 What is Indirect Investing?
 Direct Investing
 Indirect Investing
 What is an Investment Company?
 What are Types of Investment Companies?
 What are Types of Mutual Funds?
 What are the mechanics of Investing Indirectly?
 What is Investment Company Performance?
 What are Exchange Traded Funds?
Salaar - Finance
Chapter 4
Securities Markets
Learning Objectives
 Why are Financial Markets Important?
 What are Primary Markets?
 What are Secondary Markets?
 What are Types Markets?
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What is the investment environment?
There are 2 main areas:
 Financial Markets & the economy
a) Consumption Timing
b) Allocation of Risk
c) Separation of ownership
 Clients of the Financial System
a) Household Sector (provide money by investing)
b) Business Sector (raise money to invest)
c) Government Sector (finance expenditures by borrowing)
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What is the investment environment?
Financial Markets & the Economy
 Consumption Timing (High Earning vs low earning)
Financial Markets allow this to happen
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What is the investment environment?
Financial Markets & the Economy
 Consumption Timing (High Earning vs low earning)
If Individuals earn more than they spend as opposed to retirees, then what
can be done with the excess money?
Q: How do you shift your purchasing power from high earnings period to low
earnings period?
High Earning Period: a) You can store your wealth in financial assets
Low Earning Period: b) You can sell these assets to consume
Financial Markets allow this to happen
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What is the investment environment?
Financial Markets & the Economy
 Allocation of Risk (High vs Low)
Financial Markets allow this to happen
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What is the investment environment?
Financial Markets & the Economy
 Allocation of Risk (High vs Low)
Financial Markets allow the distribution of risk according to investor
preferences.
High Risk: a) Is absorbed by high risk investors seeking high returns
Low Risk: b) Investors with little risk appetite are accommodated
Financial Markets allow this to happen
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What is the investment environment?
Financial Markets & the Economy
 Separation of Ownership & Management
Financial Markets allow this to happen
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What is the investment environment?
Financial Markets & the Economy
 Separation of Ownership & Management
Financial Markets allow funds to flow from suppliers to users with ease
Result:
a) Larger scale of business & growth potential.
b) Investors can participate in ownership without management.
c) Mutually beneficial for both suppliers & users
Financial Markets allow this to happen
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What are Financial Markets?
• Financial Market
• Purpose of Financial Markets
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What are Financial Markets?
• Financial Market
– Mechanism to bring Buyers & Sellers together dealing in
Debt, Equity & other financial products.
• Purpose of Financial Markets
– The purpose of financial markets is to efficiently allocate
flow of funds from savings to ultimate users.
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What are Financial Markets?
Basic Types
– Primary Markets (underwriters)
– Secondary Markets (create liquidity)
– Dealer vs Auction markets
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What are Financial Markets?
Basic Types
– Primary Markets (underwriters)
• Original (initial) sale of securities – IPO’s – raises
capital
– Secondary Markets (create liquidity)
• Buying & Selling of securities after initial sale has
occurred – capital gains & dividends
– Dealer vs Auction markets
• Dealers buy & sell for themselves
• Brokers Auctions match buyers & sellers
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Flow of Funds in the Economy
FINANCIAL BROKERS
SECONDARY MARKET
SAVINGS SECTOR
FINANCIAL
INTERMEDIARIES
INVESTMENT SECTOR
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Flow of Funds in the Economy
FINANCIAL BROKERS
SECONDARY MARKET
FINANCIAL
INTERMEDIARIES
INVESTMENT SECTOR
SAVINGS
SECTOR
Households
Businesses
Government
SAVINGS SECTOR
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Flow of Funds in the Economy
FINANCIAL BROKERS
SECONDARY MARKET
SAVINGS SECTOR
FINANCIAL
INTERMEDIARIES
INVESTMENT SECTOR
SECONDARY
MARKET
Security
Exchanges
OTC
Market
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Flow of Funds in the Economy
FINANCIAL BROKERS
SECONDARY MARKET
FINANCIAL
INTERMEDIARIES
INVESTMENT SECTOR
INVESTMENT
SECTOR
Businesses
Government
Households
SAVINGS SECTOR
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Flow of Funds in the Economy
FINANCIAL BROKERS
SECONDARY MARKET
SAVINGS SECTOR
FINANCIAL
INTERMEDIARIES
INVESTMENT SECTOR
FINANCIAL
INTERMEDIARIES
Commercial Banks
Savings Institutions
Insurance Cos.
Pension Funds
Finance Companies
Mutual Funds
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Flow of Funds in the Economy
FINANCIAL BROKERS
SECONDARY MARKET
SAVINGS SECTOR
FINANCIAL
INTERMEDIARIES
INVESTMENT SECTOR
FINANCIAL
BROKERS
Investment
Bankers
Mortgage Bankers
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Financial Markets?
Primary Markets
Primary Market
Initial Public Offering (IPO)
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Financial Markets?
Primary Markets
Primary Market
Market for new issues of securities (investment bankers)
Issuers receive funds (raise capital)
Buyers receive financial claims
Initial Public Offering (IPO)
Process of initial sale of new securities
After initial sale, securities trade in the secondary markets
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INVESTMENT BANKERS
• Specialize in design & sale of securities
• Work with issuers to bring a new issue to market—
legal, accounting, pricing, and so forth
• Involved in other matters, such as advising firms on
mergers and acquisitions, or reorganizations
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INVESTMENT BANKING
• Investment bankers form a syndicate to sell the new
securities--multiple investment bankers
• Investment bankers underwrite an issue,
purchasing the securities from the issuer and
assuming the risk of reselling them to investors
profitably
• Investment bankers profit from spread between price
they pay and the price they sell the issue for
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Financial Markets?
Investment Banking
Performed by 2 groups:
Securities Firms
Firm specializing in the distribution of new securities to the public &
also in secondary mkts as brokers & dealers
Commercial Banks
Also underwrite securities.
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Investment Banking
How they make money?
1.
Commissions
2.
Fees
3.
Spread Income
Also from:
Money management
Mergers & Acquisitions
Trading of securities etc.
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Financial Markets?
Under-writing Process
3 Main Areas:
1.
Advising the issuer on terms & timing of offering
2.
Buying Securities from issuer
3.
Distributing the securities to public
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Financial Markets?
Under-writing Process
Buying securities:
Firm Commitment:
Investment Bank agrees to buy from issuer at fixed price
Best efforts under-writing
When the IB does not buy the securities but provides expertise
Gross Spread – Discount (4-7%)
Difference b/w price paid to issuer & price received from public
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issuer
Originating investment banker
Underwriting Syndicate (group of invest bankers)
Selling group (syndicate + selected retail brokers)
INVESTORS BUYING IN PRIMARY MKT
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Financial Markets?
Investment Banker
Investment Banker
Firm specializing in the sale of new securities to the public
Underwriting
Process by which investment bankers purchase an issue of securities from a firm
and resell it to the public
PROSPECTUS: Provides info about the IPO to the customers
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Privatization?
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Privatization?
 Offering securities of Govt owned companies to public…
 Thereby liquidating Govt ownership
 Also performed by Investment Banks
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Arbitrage?
Another activity of Investment Banks
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Arbitrage?
Another activity of Investment Banks
Trading discrepancies in same security at different locations…
Example…
JNJ at 51.83-.90 in NY
JNJ at 51.95-99 in LDN
Locking a profit with no risk
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Financial Markets?
Global Investment Banking &
Private Placements
Global Investment Banker
Private Placements
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Financial Markets?
Global Investment Banking &
Private Placements
Global Investment Banker
Firm specializing in the sale of new international securities to the public
Private Placements
Debt securities are issued directly to financial institutions bypassing the open
market.

No SEC filing required

Investment banking fees is saved
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Financial Markets?
Secondary Markets
Markets where existing securities are traded
For investments to be attractive, they must have liquidity & secondary
markets provide that.
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Financial Markets?
US Securities Markets for Equities
Where are these exchanges?
Equity
NYSE
AMEX
NASDAQ
ECN’S
BONDS
NYSE & AMEX Bond markets
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Financial Markets?
US Securities Markets for Equities
Equity
NYSE (New York Stock Exchange)
AMEX (American Stock Exchange)
NASDAQ (National Association of Securities Dealers)
ECN’S (Electronic Communications Network)
BONDS
NYSE & AMEX Bond markets
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Financial Markets?
US Securities Markets for Equities
Equity
NYSE – 1366 seats (1.5mil$)-2800 co’s valued 13 trillion-Dvol 1.5Bil
AMEX – 807 seats – 760 companies – 2% of ttl value – 200mil vol
NASDAQ- 3843 co’s – 1bil vol – computerized mkt network
ECN’S (Electronic Communications Network)-linked to all
OTC – Not listed but registered, 3000 co’s – dealer network linked
BONDS
NYSE & AMEX Bond markets
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Financial Markets?
US Securities Markets for Equities
Bid price
Offer Price
Block trades
Program trading
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Financial Markets?
US Securities Markets for Equities
Bid price
Px some one will buy for
Offer Price
Px someone will sell for
Block trades
Trades of 10,000 or more
Program trading
Computer generated buy & sell signals for $1 mil or more
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Financial Markets?
US Securities Markets for Equities
OTC (Over the counter mkts)
ECN’s
After Hours Trading
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Financial Markets?
US Securities Markets for Equities
OTC (Over the counter mkts)
Stocks not listed on an exchange but traded on closed computer networks
ECN’s
Computerized trading network for large traders & brokers – computer matched orders
After Hours Trading
Normal hrs: 9.30 – 1600
AHT hrs: 1600-2000
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Financial Markets?
US Securities Markets for Equities
Dow Jones Industrial Average
Standard & Poor’s (S&P 500)
Nasdaq
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Financial Markets?
US Securities Markets for Equities
Dow Jones Industrial Average
30 Blue chip stocks – stock price weighted average
Standard & Poor’s (S&P 500)
500 stock composite
Nasdaq
100 Large cap companies
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The Dow Jones Industrial Average consists of
the following 30 companies:
3M Co. (NYSE: MMM)
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ALCOA Inc. (NYSE: AA) (aluminium)
Altria Group, Inc. (NYSE: MO) (tobacco)
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AIG(NYSE: AIG)
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American Express Co. (NYSE: AXP) (credit
services)
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AT&T Inc. (NYSE: T) (telecoms)
Boeing Co., The (NYSE: BA)
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(aerospace/defense)
Caterpillar, Inc. (NYSE: CAT) (farm &
construction equipment)
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Citigroup, Inc. (NYSE: C) (money center
banks)
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Coca-Cola Co. (NYSE: KO) (beverages)
E.I. du Pont de Nemours & Co. (NYSE: DD) •
(chemicals)
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Exxon Mobil Corp. (NYSE: XOM) (major
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integrated oil & gas)
General Electric Co. (NYSE: GE)
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(conglomerates, media)
General Motors Corporation (NYSE: GM) (auto•
manufacturers)
Hewlett-Packard Co. (NYSE: HPQ)
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(diversified computer systems)
Home Depot, Inc. (NYSE: HD) (home
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improvement stores)
Honeywell International, Inc. (NYSE: HON)
(conglomerates)
Intel Corp. (NYSE: INTC) (semiconductors)
International Business Machines Corp. (NYSE
IBM) (diversified computer systems)
JPMorgan Chase and Co. (NYSE: JPM) (mone
center banks)
Johnson & Johnson Inc. (NYSE: JNJ)
(consumer and health care products
conglomerate)
McDonald's Corp. (NYSE: MCD) (restaurant
franchise)
Merck & Co., Inc. (NYSE: MRK) (drug
manufacturers)
Microsoft Corp. (NYSE: MSFT) (software)
Pfizer, Inc. (NYSE: PFE) (drug manufacturers
Procter & Gamble Co. (NYSE: PG) (consumer
goods)
United Technologies Corp. (NYSE: UTX)
(conglomerates)
Verizon Communications (NYSE: VZ)
(telecoms)
Wal-Mart Stores, Inc. (NYSE: WMT) (discount
variety stores)
Walt Disney Co., The (NYSE: DIS)
(entertainment)
Salaar - Finance
Chapter 4
Securities Markets
Learning Summary
 Why are Financial Markets Important?
 What are Primary Markets?
 What are Secondary Markets?
 What are Types Markets?
Salaar - Finance
END