Trading Securities
Security Types and How
Securities are Traded
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New York Stock Exchange
• Lists about 2,800 firms
• Automatic electronic trading runs sideby-side with traditional
broker/specialist system
– SuperDot : electronic order-routing
system
– DirectPlus: fully automated execution for
small orders
– Specialists: Handle large orders and
maintain orderly trading
Some Initial Listing
Requirements for the NYSE
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NASDAQ
• Lists about 3,200 firms
• Originally, NASDAQ was primarily a dealer
market with a price quotation system
• Today, NASDAQ’s Market Center offers a
sophisticated electronic trading platform with
automatic trade execution.
• Large orders may still be negotiated through
brokers and dealers
Partial Requirements for Listing
on NASDAQ Markets
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Market Structure in Other
Countries
• London - predominately electronic
trading
• Euronext – market formed by
combination of the Paris, Amsterdam
and Brussels exchanges, then merged
with NYSE
• Tokyo Stock Exchange
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Globalization and Consolidation
of Stock Markets
• NYSE mergers and acquisitions:
– Archipelago (ECN)
– American Stock Exchange
– Euronext
• NASDAQ mergers and acquisitions:
– Instinet/INET (ECN)
– Boston Stock Exchange
• Chicago Mercantile Exchange acquired:
– Chicago Board of Trade
– New York Mercantile Exchange
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Market Capitalization of Major
World Stock Exchanges, 2007
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Major Full-Service, Premium Discount,
and Basic Discount Brokers
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Bid and Asked Prices
Bid Price
Ask Price
• Bids are offers to buy.
• In dealer markets, the
bid price is the price at
which the dealer is
willing to buy.
• Investors “sell to the
bid”.
• Bid-Asked spread is the
profit for making a
market in a security.
• Asked prices represent
offers to sell.
• In dealer markets, the
asked price is the price
at which the dealer is
willing to sell.
• Investors must pay the
asked price to buy the
security.
Secondary Market:
NYSE- Specialists
IBM
•
•
•
•
Bid
Ask
$160.25
$160.75
Specialist buys low, sells high
Specialists buys at $160.25, so you sell at $160.25.
Specialist sells at $160.75, so you buy at $160.75
$160.75 - $160.25 = $0.50 = “spread”
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Secondary Market: NASDAQ
• Suppose three dealers posts their best quotes for DELL
Computers.
Jennifer
Bid
8.00
Joe
Ask
8.50
Bid
7.75
Bob
Ask
8.25
NASDAQ reports:
Bid
8.00
Ask
8.25
Bid
7.50
Ask
8.50
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Types of Orders
• Market Order: Executed immediately
– Trader receives current market price
• Price-contingent Order:
– Traders specify buying or selling
price
– Limit orders and stop orders
Basic Types of Orders:
Two Most Common Orders
• Market Orders
– Orders to buy or sell stock at best price
available when order is placed for immediate
execution
– Fastest way to fill order
• Limit Orders
– Order to buy at or below a specified price or to
sell at or above a specified price
– If price limits are not met, order is not filled
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Price-Contingent Orders
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Trading on the Web
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Getting Started
(a) Open a brokerage
or trading account
(b) Deposit $10,000
into account
(d) Pay Commission,
Say $50
(c) Buy 100 Shares
of Disney
at $33 per share
(e) $6,650 Cash
in Account
$3,300 Stock
In Account
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Brokerage Accounts
• A Cash account is a brokerage account in
which securities are paid for in full.
• A Margin account is a brokerage account in
which, subject to limits, securities can be bought
and sold short on credit.
(more on selling short later)
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Margin Accounts, I
• Borrowing part of the total purchase price of a position using a loan
from a broker.
• Investor contributes the remaining portion.
• In a margin purchase, the portion of the value of an investment
that is not borrowed is called the margin. Margin refers to the
percentage or amount contributed by the investor.
Margin % = The portion in your money / Value of stock
• Of course, the portion that is borrowed incurs an interest charge.
– This interest is based on the broker’s call money rate plus
market-up.
– The call money rate is the rate brokers pay to borrow money to
lend to customers in their margin accounts.
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Margin Accounts, II
• In a margin purchase, the minimum margin that must be
supplied is called the initial margin.
– Initial margin is set by the Fed - Currently 50%
• The maintenance margin is the margin amount that must be
present at all times in a margin account.
• When the margin drops below the maintenance margin, the
broker can demand more funds. This is known as a margin
call.
• When the margin call is provoked, an investor must bring the
margin back to the initial margin.
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Margin Account Example
• Your margin account requires:
• an initial margin of 50%, and
• a maintenance margin of 30%
• A Share in Miller Moore Equine Enterprises (WHOA) is selling for $50.
• You have $20,000, and you want to buy as much WHOA as you can.
• You may buy up to $20,000 / 0.5 = $40,000 worth of WHOA.
Liabilities and
Account Equity
Assets
800 Shares of WHOA
@ $50/share
Total
$ 40,000
$ 40,000
Margin Loan
$ 20,000
Equity
$ 20,000
Total
$ 40,000
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Margin Account Example (cont’d)
•
After your purchase, shares of WHOA fall to $35. (Woe!)
•
New margin = $8,000 / $28,000 = 28.6% < 30%
•
Therefore, you are subject to a margin call.
•
You must deposit $6,000 ( = 50% of $28,000 - $8,000)
Liabilities and
Account Equity
Assets
800 Shares of WHOA
@ $35/share
Total
$ 28,000
$ 28,000
Margin Loan
$ 20,000
Equity
$ 8,000
Total
$ 28,000
Example: The Effects of Margin,
I.
• You have $30,000 in a margin account, 60% initial margin
required.
• You can buy $50,000 of stock with this account (why?).
• Your borrowing rate from your broker is 6.00%.
• Suppose you buy 1,000 shares of Coca-Cola (KO), for
$50/share.
• Assume no dividends, and that your borrowing rate is still
6.00%, what is your return if:
– In one year, KO is selling for $60 per share?
– In one year, KO stock is selling for $60 per share, but you did
not borrow money from your broker? +20%
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Example: The Effects of Margin,
II.
• KO is selling for $60 per share.
• Your investment is worth $60,000.
• You owe 6% on the $20,000 you borrowed: $1,200.
• If you pay off the loan with interest, your account balance is:
$60,000 – $21,200 = $38,800.
• You started with $30,000.
• Therefore, your return is $8,800 / $30,000 = 29.33%.
• Suppose Coca-Cola stock was selling for $40 per share instead
of $60 per share? What is your return?
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Example: The Effects of Margin,
III.
• Coca-Cola stock is selling for $60 per share, but you did not
borrow from your broker.
• You started with $30,000, which means you were able to buy
$30,000 / $50 = 600 shares.
• Your investment is now worth $36,000.
• Therefore, your return is $6,000 / $30,000 = 20.00%.
• Suppose Coca-Cola is selling for $40 per share instead of $60
per share. What is your return in this case? -20%
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Short Sales
• An investor with a long position benefits from price
increases.
– You buy today at $34, and sell later at $57, you profit!
– Buy low, sell high
– “Go long” means you buy.
• An investor with a short position benefits from price
decreases.
– You sell today at $83, and buy later at $27, you profit.
– Sell high, buy low
– “Go short” means you sell.
– Purpose: to profit from a decline in the price of a
stock or security
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Short Sales
• Short Sale is a sale in which the seller does not actually
own the security that is sold.
Borrow
shares
from
someone
through
a dealer
Sell the
Shares
in the
market
Today
Buy
shares
From the
market
Return
the
shares
In the Future
Note that an investor who buys and owns shares of
stock is said to be “long the stock” or to have a
“long position.”
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Short Sales
• Short sale requirements
– There is an initial margin and a maintenance margin
– After you sell the borrowed stock, the proceeds from the sale are
credited to your account.
– But, you cannot use them until you “cover” the short position.
– If any dividends are paid on the stock while you have a short
– position, you must repay them.
– The owner of the shares need NOT know that the shares have
been lent to the short-seller.
– If the owner wishes to sell the shares, the brokerage firm will
simply borrow shares from another investor.
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Short Sales
• Four items on the account balance sheet
– Proceeds from sale
– Margin deposit
– Short position
– Account equity
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Example: Short Sales, I
• You short 100 shares of Texas Instruments (TXN) at $30
per share.
• Your broker has a 50% initial margin and a 40%
maintenance margin on short sales.
• The value of stock borrowed that will be sold short is:
$30 × $100 = $3,000
Liabilities and
Account Equity
Assets
Sale Proceeds
$ 3,000
Short Position
$ 3,000
Initial Margin Deposit
$ 1,500
Account Equity
$ 1,500
Total
$ 4,500
Total
$ 4,500
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Example: Short Sales, II
• Texas Instrument stock price falls to $20 per share.
• Sold at $30, value today is $20, so you are "ahead"
by $10 per share, or $1,000.
• Also, new margin: $2,500 / $2,000 = 125%
Liabilities and
Account Equity
Assets
Sale Proceeds
$ 3,000
Short Position
$ 2,000
Initial Margin Deposit
$ 1,500
Account Equity
$ 2,500
$ 4,500
Total
$ 4,500
Total
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Example: Short Sales, III
• Texas Instruments stock price rises to $40 per
share.
• You sold short at $30, stock price is now $40, you
are "behind" by $10 per share, or $1,000. (He who
sells what isn’t his, must buy it back.)
• Also: new margin = $500 / $4,000 = 12.5% < 40%
Therefore, you are subject to a margin call.
Assets
Liabilities and
Account Equity
Sale Proceeds
$ 3,000
Short Position
$ 4,000
Initial Margin Deposit
$ 1,500
Account Equity
$
Total
$ 4,500
Total
$ 4,500
500
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Example: Short Sales, IV
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More on Short Sales
• Short interest is the amount of common stock
held in short positions.
• In practice, short selling is quite common and a
substantial volume of stock sales are initiated by
short sellers.
• Note that with a short position, you may lose
more than your total investment, as there is no
theoretical limit to how high the stock price may
rise.
Biggest Short Positions
(from The Wall Street Journal)
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