II: Equities I
6: Primary Equity Markets
7: Secondary Equity Markets
Introduction
 Introduction to Stock Market Investment
 designed for people who suspect that the
New York Stock Exchange is in New York
 www.business.illinois.edu/finance_dev/
Chapter 6: Primary Equity Markets
© Oltheten & Waspi 2012
Begin With A Business
 Discovery Café
 Use the Surveying Building as a Cyber Café
 Dean’s permission
 I need $$
or Partner with $$
Chapter 6: Primary Equity Markets
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Partnership
 Two equal Partners
Par
Value
 Joe W. Partner ($10,000)
 Elisabeth Entrepreneur ($10,000)
 Two equal shares
Chapter 6: Primary Equity Markets
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Potential Buyer
 Price?
 Par Value
 Book Value
Assets – Liabilities = Shareholders Equity
 Earnings
 Earnings per Share (EPS)
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Price – Note 1
 I am using information from the past to make
educated guesses about what will happen in
the future. You can't just graph all the past
data and draw a straight line though it. A lot
will depend on how I evaluate the company's
ability to grow and change over an uncertain
future.
Chapter 6: Primary Equity Markets
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Price – Note 2
 Price really is irrelevant unless someone wants
to buy or sell.
Chapter 6: Primary Equity Markets
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Share Prices
 Decreasing Prices
 Dean gets food poisoning
Chapter 6: Primary Equity Markets
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Share Prices
 Increasing Prices
 Dean schedules the Faculty meetings in the
Discovery Café
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Expansion
 Opportunity to expand to three new sites
on campus.
 We need $$$
or another partner with $$$
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Private Equity
 Accredited Investors: investors
sophisticated enough to analyze the risks of
a new business and who control enough
money to be able to take these risks.
 Angel: one venture capitalist as opposed to
a group or consortium
 Finance 423:
Financing Emerging Businesses
Chapter 6: Primary Equity Markets
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Venture Capitalist
 Negotiates 40% partnership for the
$50,000 we need to expand to three new
sites.
Chapter 6: Primary Equity Markets
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Pricing
 What is my share worth?
 What is the company worth?
(Market Capitalization)
Chapter 6: Primary Equity Markets
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Success at Last
 Opportunity to expand to other campuses
 We need $$$$$
or more partners with $$$$$
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Public Equity Market
 Individual Investors: smaller investors who
would normally not have the opportunity to
invest in businesses
 IPO: Initial Public Offering
Chapter 6: Primary Equity Markets
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Investment Banking
 Underwriter: financial advisers, lawyers,
and marketers all rolled into one. The
Underwriter takes us through the
procedure of carving out a piece of the
company to sell and making sure we do so
legally and advantageously.
Chapter 6: Primary Equity Markets
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Going Public
 We decide to issue 300,000 shares.
 The original investors retain 180,000 shares.
 The other 120,000 shares will be offered to the
public.
Chapter 6: Primary Equity Markets
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SEC
 Securities Exchange Commission
 to ensure that all investors have equal access
to the information they need to make
informed investment decisions,
 and
 to administer the federal securities laws and
regulate firms that provide investor services
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EDGAR





Electronic
Data
Gathering
And
Retrieval
Annual and Quarterly Filings
made available to the investing
public.
sec.gov/edgar/searchedgar/webusers.htm
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SEC

Registration Statement


Prospectus
Red Herring
Chapter 6: Primary Equity Markets
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SEC
 Registration Statement
 Prospectus
 Red Herring
 Road Show
 Registration becomes “Effective”
Chapter 6: Primary Equity Markets
© Oltheten & Waspi 2012
Setting the Price
 Too High (?%$^#*&)
 Investors may not buy all the shares we offer.
Then the underwriter will be stuck with shares
it can not sell,- or at least not at a profit.
 Too Low (?%$^#*&)
 We will not generate as much money as we
might have done to finance our expansion.
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Setting the Price
 $50/share
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IPO: Hot
 By 9:30 all 120,000 shares are sold.
 Secondary market
 Prices rise.
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Hot IPO: Netscape (NSCP)
 Netscape Communications
(NSCP) was the classic hot
issue. It went public August 9,
1995 at an offer price of $28.
On the same day it hit a high
of $74¾ and closed at $58¼.
Netscape hit an all time high
of $174 in December 1995
and split 2:1 February 7,
1996.
 A year later NSCP was trading
at $30
 Merged with AOL in March
1999
Chapter 6: Primary Equity Markets
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Cold IPO:
 Cyberian Outpost (COOL)
was the classic cold issue. It
went public July 31, 1998 at
an offer price of $26. It
closed the same day at $20
1/4. This represents a drop
of 20% in one day. In
September it hit a low of $5
5/16 before closing at $10
7/16 at the end of the
month.
 Acquired by Fry’s Electronics
in November 2001 for 25c
per share
Chapter 6: Primary Equity Markets
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Ice Cold IPO
 Underwriter cannot sell all the shares
offered
 Underwriter can not sell enough shares to
make the issue worth while and the offering
may be pulled.
Chapter 6: Primary Equity Markets
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Discovery Café
 Price hovers right around the offer price of
$50
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Discovery Café
 What is my share worth?
 What is the Market Capitalization?
 How much money did we raise?
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Pricing
 IPO at $50
$15,000,000
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Secondary Markets
Chapter 7: Secondary Equity Markets
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Stock Exchanges
 Exists to bring buyer and seller together in a
two sided auction.
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Auction
 Buyers Bid










.
.
.
.
Bid Ask Spread =10₵
.
10
@ $50.40
1
@ $50.35
10
@ $50.30
90
@ $50.25
120 @ $50.20
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 Sellers Ask










60
@ $50.65
10
@ $50.60
95
@ $50.55
50
@ $50.50
.
.
.
.
. Tick =5 ₵
.
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Discovery Café
 Over The Counter
 NASDAQ
 NYSE
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OTC: Over The Counter
 Stocks not listed on an exchange trade overthe-counter.
 OTC stocks are generally smaller companies
that trade infrequently
Chapter 7: Secondary Equity Markets
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OTC
 John Q. Investor goes to his broker to buy
1000 shares of
Discovery Café.
Chapter 7: Secondary Equity Markets
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OTC: Pink Sheets
Chapter 7: Secondary Equity Markets
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OTC
 The Pink Sheets brings buyers and sellers
together by providing a contact of the
dealers in the stock.
http://www.OTCmarkets.com/home
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NASD
 National Association of Securities Dealers
 self regulating organization
 oversees the OTC market
 administers rules of fair practice and governs
the rules of how securities are traded,
delivered, and settled.
Chapter 7: Secondary Equity Markets
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NASDAQ
 National Association of Securities Dealers
Automated Quotation
 Began as a computerized network to link
traders of OTC issues that traded more
frequently.
 Filed for status as an exchange under the
name NASDAQ
Chapter 7: Secondary Equity Markets
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NASDAQ
 Has no trading floor
 network of computer and telephone lines
that link the members of the NASD
 Works through a system of competing
Market Makers
Chapter 7: Secondary Equity Markets
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Brokers, Dealers, Market Makers
 Suppose that Bill Gates writes a book
entitled "The Secrets of My Success - The
Microsoft Story".
 Bill is a good friend* and I can get copies of
this book autographed by the author.
 *Actually, Bill doesn’t know me from Eve
Chapter 7: Secondary Equity Markets
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Broker
 Agent
 When you want to buy a book I can buy it for
you. I charge you what I paid for the book (plus
commission).
 When you want to sell a book I can sell it for
you. I give you what I get for the book (minus
commission).
Chapter 7: Secondary Equity Markets
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Dealer
 Manages an Inventory
 When you want to buy a book I sell it to you
from my inventory of books. I charge you my
quoted ask price plus a small markup for
handling.
 When you want to sell a book I buy it from you
for my inventory of books. I pay you my quoted
bid price less a small markup for handling.
Chapter 7: Secondary Equity Markets
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Market Maker
 Must always stand ready to buy/sell
 When you want to buy a book, whenever you
want to buy a book, I must sell you one from
my inventory of books.
 When you want to sell a book, whenever you
want to sell a book, I must buy it from you.
Chapter 7: Secondary Equity Markets
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Market Maker
 Bid $50
 If you want to sell a
book, I will buy it
from you for $50
Chapter 7: Secondary Equity Markets
 Ask $53
 If you want to buy a
book, I will sell it to
you for $53
© Oltheten & Waspi 2012
Market Maker
 Bid $40
 Discourage book
sellers by lowering
the price to $40
Chapter 7: Secondary Equity Markets
 Ask $42
 Encourage book
buying by lowering
the price at which I
sell to $42
© Oltheten & Waspi 2012
NASDAQ: Example
 Discovery Café applies for listing in NASDAQ
 Assigned the ticker symbol CAFE (all
NASDAQ stocks have 4 character symbols –
or they used to anyway.)
Chapter 7: Secondary Equity Markets
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NASDAQ
 John Q. Investor goes to his broker to buy
1000 shares of
Discovery Café
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NASDAQ: Example
Chapter 7: Secondary Equity Markets
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NASDAQ
 NASDAQ does not bring buyers and sellers
together; it uses a system of wholesellers
to ensure that you can always buy and sell
Chapter 7: Secondary Equity Markets
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New York Stock Exchange
Chapter 7: Secondary Equity Markets
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NYSE
 Has a trading floor
 Uses a specialist system
 Specialist: one and only market maker for a
particular stock.
 The specialist is situated at one of the
seventeen specialist posts on the floor of the
exchange. There are 482 Specialists employed
by 21 firms.
Chapter 7: Secondary Equity Markets
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NYSE: Example
 Discovery Café decides to list its shares on
the NYSE
 Our ticker symbol must change
 DVC
Chapter 7: Secondary Equity Markets
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NYSE
 John Q. Investor goes to his broker to buy
1000 shares of
Discovery Café
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NYSE: Example
 Specialist Bid $50
Broker Joe gets $1
per share more for
his shares
Chapter 7: Secondary Equity Markets
 Specialist Ask $52

John’s broker can buy
directly from the
specialist at $52ohn
pays $1 per share less
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NYSE:
 The specialist system brings buyers and
sellers together by bringing everyone to the
same place on the floor of the exchange
 If there is an insufficiency of buyers then
there is a market maker at hand
 Specialist keeps the limit order book
Gosh, I can hardly wait to find
out what a limit order is….
maybe I’ll read chapter 8
Chapter 7: Secondary Equity Markets
© Oltheten & Waspi 2012
II: Equity Markets I