chapter 3...–investment bank purchases securities from the issuing company and then resells them...
TRANSCRIPT
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Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
CHAPTER 3
How Securities are Traded
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How Firms Issue Securities
• Primary Market
– Firms issue new securities through
underwriter to public
– Investors get new securities; firm gets
funding
• Secondary Market
– Investors trade previously issued securities
among themselves
– Ownership is transferred, no new securities
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How Firms Issue Securities (Ctd.)
• Stocks
– IPO
– Seasoned offering
• Bonds
– Public offering
– Private placement
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Investment Banking
• Underwriting: investment bank helps the
firm to issue and market new securities
• Prospectus: Describes the issue and the
prospects of the company.
– Pre-file with SEC - Red herring
– Once registration is final and accepted by
SEC - Red Herring turns into Prospectus
– Registration does not mean approval
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Figure 3.1 Relationship Among a Firm Issuing
Securities, the Underwriters, and the Public
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Investment Banking
• Firm commitment
– investment bank purchases securities
from the issuing company and then
resells them to the public
– investment bank carries price risk
• Shelf Registration
– SEC Rule 415 (1982): Allows firms to
register securities, and then gradually sell
them to the public for two years
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Investment Banking (Ctd.)
• Private placements
– Firm uses underwriter to sell securities
to a small group of institutional or
wealthy investors.
– Cheaper than public offerings
– Suitability concerns
– Not traded in secondary markets
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Initial Public Offerings (IPOs)
• Process
– Road shows to publicize new offering
– Bookbuilding to determine demand for the new issue
– Degree of investor interest in the new offering provides valuable pricing information
– IPO Shares allocated based on interest
• Caveats: high ethics are required during IPO process
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Figure 3.3 Long-term Relative Performance of Initial Public Offerings
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How Securities are Traded
Types of Markets:
• Direct search
– Buyers and sellers seek each other
• Brokered markets
– Brokers search out buyers and sellers
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How Securities are Traded
Types of Markets:
• Dealer markets – Dealers buy for their own account
– Dealers have inventories of assets from which they buy and sell
– Example: Corporate bonds
• Auction markets
– traders converge at one place to trade
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Bid and Asked Prices
Bid 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-Ask spread is the
profit for making a
market in a security
Ask Price • 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
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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
• A large order may be filled at multiple
prices
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Limit and Stop orders
• Limit order – Order to buy/sell X shares at price P or better
– “Sell X shares of Facebook at 25 (or better)”
– “Buy X shares of Apple at 600 (or better)
– Guarantees price but not execution
• Stop order – Order to sell X shares once a stock hits a price trigger
– “Sell X shares of FB at stop price of 15”
– “Buy X shares of Apple at stop price of 700”
– Once price trigger is hit, it guarantees execution, as it
turns into market order, but does not guarantee price
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Figure 3.5 Price-Contingent Orders
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Price-Contingent Orders: Sell-Stop
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Price-Contingent Orders: Sell-Stop
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Price-Contingent Orders: Buy-Stop
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Price-Contingent Orders: Buy-Stop
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Price-Contingent Combined Orders:
Sell-Stop-Limit
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Price-Contingent Combined Orders:
Sell-Stop-Limit