Chapter 3 How Securities are traded? Bodie, Kane et all with Nepali context
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Transcript of Chapter 3 How Securities are traded? Bodie, Kane et all with Nepali context
Chapter 3:
How securities are
traded?Presented By:Group 4: PAISA WASUL
(This presentation is largely based on the text book on Investment Management by Bodie, Kane et all, Eight Edition)
What is Financial Market
• A market that brings buyers and sellers
together
• To trade in financial assets
• Most commonly used:
money markets and capital markets.
Capital Market and Money Market
• Capital market– Buyers and sellers engage in trade of financial securities– Participants - individuals and institutions.
• Money market – Securities and financial instruments with short-term
maturities are traded– Financial assets like treasury bills, certificates of deposits,
commercial paper and bankers' acceptance – Major function: to provide short term funds
How Firms Issue Securities
• Primary market
- Issue of new securities to public through underwriter
- Receive proceeds from sale
• Secondary market
- Trading of already- issued securities among investors
- Doesn't affect OS no. of securities
- Doesn't receive proceeds from sale
How Firms Issue Securities
• Primary market issuing common stock
-Seasoned Equity offering
Issue of additional securities from an established company
-IPO
Stocks issued by privately owned company that going public
How Firms Issue Securities
• Primary market issuing bonds-Public offeringIssue of bonds sold to general investing public that can then traded on secondary market-Private placementIssue that usually is sold to one or few institutional investors
Investment banking• Underwriter- Investment bankers who market the public offerings- Help securities issuers lessen their risk• Red herring - Preliminary prospectus • Prospectus- Final form of statement accepted by the SEC- Offered price of securities announced
Relationship Among a Firm Issuing Securities, the Underwriters, and the Public
Shelf Registration
–SEC Rule 415:
– Allows firms to register securities
–Gradually sell them for two years
–Can be sold in short notice
Private Placement
• Sells share directly to small group of institutional
• Far cheaper than public offering
• Less suitable for large offering
• Don’t trade in secondary market which reduce
their liquidity
Types of Markets
• Direct Search Markets
- Buyers and sellers seek each other
- For e.g. Sale of used refrigerator
• Brokered Markets
- Brokers search out buyers and sellers
- For e.g. Primary market (Investment bankers)
Types of Markets• Dealers Markets
- Dealers have inventories of assets from which they buy and sell
- Profit from Bid- ask spread
- For e.g. OTC securities market
• Auction Markets
- Traders converge at one place to trade
- For e.g. NYSE
Bid and Ask price• Bid price
- Maximum price that a buyers are willing to pay
• Ask price
- Minimum price that a sellers are willing to receive
• Spread – key indicator of the liquidity of the asset
• Smaller the spread, the better the liquidity.
Order size• Round lot- Orders must equal to 100 or multiple of 100• Odd lot- Orders must be less than 100 units• Block trade- Transaction of 10,000 shares- Order size >5% of the paid of shares (Nepal)
Time limit• Broker should attempt to fill the order• Day orders- Order filled only during day in which it entered• Week orders- Expires at the end of respective calendar week• Month orders- Expires at the end of respective calendar month
Time limit
• Open orders
- Remains in effect until they are filled/cancelled
• Discretionary orders
- Allow broker to set the specification for the order
- Complete : on all the order specification
- limited discretion: decides price and timing of the order
Type of Orders• Market Orders- Buy/sell orders –executed immediately at
current market price• Price Contingent order- Traders specify buying/selling price- Limit orders and stop orders
Types of ordersLimit orders1. Limit buy order:Specifies maximum price investors willing to pay2. Limit sell orderSpecifies the minimum price willing to sellStop orderstrade not to be executed unless stock hits a price limit1. Stop loss order2. Stop buy order
3-19
Price-Contingent Orders
Trading Mechanisms• There are 3 trading systems employed in the
United States. They are:– Over the counter dealer markets– Electronic Communications networks– Formal exchanges (Specialist Markets)
Trading Mechanism in Nepal• NEPSE
– established under the company act, operating under Securities Exchange Act, 1983
– 60 member brokers operate on the trading floor as per the Securities Exchange Act, 1983, rules and bye-laws
– NEPSE introduced fully automated screen based trading since 24th August, 2007
– It is called NEPSE Automated Trading System (NATS), which adopts the principle of an order driven market. Purchase & Sell of Physical Share certificates is done through NATS.
– It facilitates trading in shares, debentures, government bonds and mutual funds.
• Market timings: The market timings of the equities are:-
Market Open: - 12:00 HoursMarket Close: - 15:00 Hours
Odd Lot Trading is done on Fridays. For Odd Lot Trading Market Timings areMarket Open: - 12:00 HoursMarket Close: - 13:00 Hours
Trading Costs
1. Brokerage Commission: fee paid to broker for making the transaction– Explicit cost of trading– Full Service vs. Discount brokerage
2. Spread: Difference between the bid and asked prices– Implicit cost of trading
Charges on Buying & Selling Securities (NEPAL)
• A. Charges on Buying Securities – Brokerage Commission (ranges from 0.7% to 1% of
transaction amount)– Fee to SEBON (fixed 0.015% of transaction
amount)
Contd…• B. Brokerage Commission for Government Bond – Brokerage Commission (ranges from 0.7% to 1% of
transaction amount)– Fee to SEBON (fixed 0.015% of transaction amount)– Capital Gain Tax (fixed 5% on Net Profit)– Net Profit = Selling Price - Buying Price - Commissions
to brokers - Charges of SEBON
Brokerage Commission• Brokerage Commission for Equity
• Brokerage Commission for Government Bond
S.No. Trading Amount Brokerage %A Up to 50,000 1B > 50,000 & < 500,000 0.9C > 5,00,000 & < 10,00,000 0.8D > 10,00,000 0.7
S.No. Trading Amount Brokerage %A Up to 5,00,000 0.20B > 5,00,000 & < 50,00,000 0.10C > 50,00,000 0.05
• Brokerage commission for all stocks that are not listed in 1 and 2
The brokerage commission is not the net revenue of the broker. It is distributed as follows:
– 60% of the brokerage is retained by concerned Broker.– 25% of the brokerage is paid to NEPSE.– 15% of the brokerage is deducted as TDS (Tax Deducted at Source).– The rate of commission is charged on the transaction amount.
S.No. Trading Amount Brokerage %A Up to 50,000 0.75B > 50,000 & < 50,00,000 0.60C > 50,00,000 0.40
Index• A figure based on the current market price of a certain group of shares
on a stock exchange, a such as NASDAQ composite, S&P 500, Dow Jones industrial average, NEPSE index.
• NEPSE index is calculated by considering all the stocks listed in NEPSE
Group wise index
NEPSE Sub-Indices
Current 6-4-2014
Banking 720.56 Hotels 1523.69 Dev. Bank 502.27 HydroPower 2243.03 Finance 396.55 Insurance 2903.99 Others 769.52
Circuit Breaker• Refers to any of the measures used by stock exchanges
during large sell-offs to avert panic selling• After an index has fallen a certain percentage, the
exchange might activate trading halts or restrictions on program trading
• For eg, if the Dow Jones Industrial Average falls by 10%, the NYSE might halt market trading for one hour.
Circuit breaker in Nepal• 3% movement either way =market halt for 15 minutes if the
movement takes place during first hour of trading i.e. 13:00 hours.
• In case this movement takes after 13:00 hours there will be no trading halt at this level and market shall continue trading.
• In case of 4% movement either way =market halt for half an hour if the movement takes place before 14:00 hours
• In case this movement takes after 14:00 hours there will be no trading halt at this level and market shall continue trading.
• In case of 5% movement in either way, trading shall be halted for the remainder of the day.
NEPSE• NEPSE witnessed 3 circuit breakers recently in Dec 18,2013• Market operations was suspended for 15 mins from 12:24 PM
after hitting 3% circuit breaker• Then again, the market came to halt for 30 minutes from
12:49 PM after inclining by 4 percent• Following the 17 minutes after market resumption, market
came to witness 5 percent incline after which the secondary market came to halt.
• Coming to an end, the stock index added 35.62 points to close at 806.82 levels.
3-32
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
3-33
Partial Requirements for Listing on NASDAQ Markets
New York Stock Exchange
• Lists about 2,800 firms• Automatic electronic trading runs side-by-
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
3-35
Some Initial Listing Requirements for the NYSE
3-36
Electronic Communication Networks
• ECNs: Private computer networks that directly link buyers with sellers for automated order execution
• Major ECNs include NASDAQ’s Market Center, ArcaEx, Direct Edge, BATS, and LavaFlow.
• “Flash Trading”: Computer programs look for even the smallest mispricing opportunity and execute trades in tiny fractions of a second.
3-37
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
Long Versus Short Position
• Long Position– Purchase of security– Suitable when price is expected to rise (bullish)– Buy – Hold – Sell – Buying on Margin
• Short Position– Sale of security– Suitable when price is expected to decline (bearish)– Sell – Hold – Buy– Short Selling
Margin Trading• Buying on Margin
– Borrowing part of the total purchase price of a stock from the broker - Broker’s call Loan
• Purchase Price = Borrowed Loan + Margin
– Margin = the portion of the purchase price contributed by the investor
• What’s in it for:– Investors? = Allows you to invest more than what you have
– Brokers?= Gets additional trading business
• Advantage = Earn when prices rise (upside potential)
• Disadvantage= Greater risk when prices fall (downside risk)
Margin Account• Two types of account with the brokerage firm:
• Cash Account – A regular brokerage account in which the customer is required to pay
for securities by cash when a purchase is made.• Margin Account
– An account that needs to be maintained to purchase security in margin from the broker
Account
Cash Account Margin Account
Margin Account• The securities purchased from the loan provided by the broker serves
at the Collateral (daily settled)• Protects margin purchases• Initial Margin and Maintenance Margin• Initial Margin (IM)
– Minimum amount of purchase price that must be contributed and deposited by the investor for a purchase (daily settled)
– Percentage of net worth or equity value (IM=Equity/Value of stock)– Currently 50% for stocks, set by Federal Reserve– What does IM=50% Mean???– You can borrow up to 50% (1-IM%) of the purchase price– What if IM=60? How much can you borrow then? – You can borrow up to 40% (1-0.40) of the purchase price
Margin Account• One problem with Initial Margin
– Fall in the price of the stock• Maintenance Margin (MM)
– Minimum amount/margin that must be maintained margin all the time– Currently 25% – It the actual margin falls below MM Margin Call – Request to maintain MM by either adding cash or adding other
securities– If failed to address Call, brokers may sell the collateral securities to
maintain the MM
Margin Call• Margin Call Price/Trigger Price
– The price below or above which there will be a Margin call– Depends on long and short position
• For Long Position– Margin call is made if price falls below a Margin Call
Price/Trigger Price• How far the price will have to fall for a Margin call?
– The broker issues margin call at that price when IM=MM– Lets see an example
Margin Call: Example
Initial Margin (IM) = 40%Maintenance Margin (MM)=30%Purchase Price per share = Rs.1000Number of Shares = 100Margin Call Price (P) = ? Rs. 100000 (Value of Stock)
Rs. 40000 (Equity) Rs. 60000 (Borrowed Loan)
Margin Call: ExampleCondition:
Meaning? If the price of the stock falls below Rs.857.14s margin call will be made
Margin Call
Short cut formula:
Why do investors buy on margin?
• To earn upside potential
Example: Tata Motors (bullish)
• Beginning Investment Value=$10000 (100 shares @ $100 each)
• Investors invest price increase by 30%
• Borrowed Loan =$10000 @ 9% p.a.
• Total Investment Value =$20000 (200 shares)
• Ending Investment Value =$26000 (1.3*$20000)
• Interest on loan = $900(9% of $10000)
• Total Payment = $10900
• Ending Investment Value after paying loan =$26000-$10900 =$15100
• What is the rate of return earned by the investor?
Why do investors buy on margin?
Example: Tata Motors (bullish)
So, the investor turned a 30% return into 51% by buying on margin.What will happen to the return IF PRICE FALLS?
Why do investors buy on margin?
Example: Tata Motors (bullish)
SO, Buying on Margin magnifies Downside risk
Short Sales• Sale of shares not owned by investor but
borrowed through broker and later purchased to replace loan
• Profit can be made when price declines • Basic Philosophy
“Borrow high return it low”• Covering short position
Short Selling Process
2. Short sell
Broker
Investor
Market
1. Lends shares
3. Buy shares
4. Return shares
•If the price has fallen then the investor earns profit, which is the difference between Selling and Buying Price•But if the price has risen then the broker earns profit.
Short Sell• Margin Account (sales proceeds)• Margin Call For Short Position– Margin call is made if price rises above a certain
price/trigger price/margin call price• How far the price will have to rise a Margin call?– The broker issues margin call at that price when
IM=MM– Lets see an example
Margin Call: Example
Initial Margin (IM) = 40%Maintenance Margin (MM)=30%Selling Price per share = Rs.1000Number of Shares = 100Margin Call Price (P) = ?
Rs. 100000 (Value of Stock owed)
Rs. 40000 (Equity)
Rs.100P (Value of stock owed)
Margin Call: ExampleCondition:
Meaning? If the price of the stock falls below Rs.85.71 margin call will be made
Margin CallShort cut formula:
Insider Trading in Nepal • Securities Act 2063 (2007) Chapter 19, Section 92
– “If any person deals in securities or causes any other person to deal in securities on the basis of any insider information or notice that are unpublished or communicates any information or notice known to such a person in the course of the discharge of his or her duties in manner likely to affect the price of securities such a person shall be deemed to have been committed an insider trading in securities”
– Affecting the price of the security– Persons likely to be involved
• Directors, employees, shareholder• Professional service provider to a firm• Other persons who can obtain information (direct or indirect)
Insider Trading in Nepal • Punishment (Section 101)– Fine equal to the amount of offense of
controversy or– Imprisonment for a term not exceeding one year
or – Both
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