"Markets: An Overview" by Jimmy Gentry
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Transcript of "Markets: An Overview" by Jimmy Gentry
Markets: An Overview
Strictly Financials
Jan. 2, 2013
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Donald W. Reynolds National Center for Business Journalism
at Arizona State University
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n James K. Gentry, Ph.D. n Clyde M. Reed Teaching Professor n School of Journalism and Mass Communications n University of Kansas n [email protected]
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Risk-Return Relationship
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Basic Types of Risk
n Systematic or market n Unsystematic or nonmarket. Also called
“business risk.” Can be diversified away.
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Specific Types of Risk n Financial risk, credit risk, default risk n Market risk n Interest-rate risk n Purchasing power or inflation risk n Event risk n Exchange-rate or foreign-exchange risk n Liquidity risk n Political or sovereign risk n Tax risk
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Types of Businesses n Sole proprietorship n Partnership n Corporation
n Limited liability n Greater access to capital n Permanency n Flexibility n Double taxation
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Types of Structures
n Private corporations n Public corporations n Nonprofits
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Types of Investments
n Stocks n Bonds n Other
n Options, futures, commodities, real estate, collectibles, currencies
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Types of Markets
n Equity: Stocks n Credit: Bonds, debt or fixed income n Others
n Derivatives (such as options and futures), commodities, real estate, collectibles, currencies
n Historically, the amount of long-term debt financing issued in the U.S. greatly exceeds the volume of equity financing.
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Stock
n Stockholders want: n Stock price to increase n Dependable dividend stream n Increase in size of dividend
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Types of Stock
n Common stock n Preferred stock
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Common Stock
n Risk: Lose your money if company falters
n Reward: Owners share in success when company does well. n Appreciation n Dividends
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Dividends
n Represent a return on capital invested by shareholders.
n Board must declare dividend for it to be paid. n Dividend payment is not a business expense.
It is an after-tax expense. n Usually relationship between company’s age
and size, and the dividends it pays.
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Preferred Stock n Reduced risk, but reward may be limited n Dividend amount is stated and is paid before
dividends on common. n If company is liquidated, holders are
preferred over common holders. n Dividends don’t necessarily increase if
company prospers.
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Bond n Bond is debt a company owes n Individual or company “loans” money to the
company by buying a bond n Bond pays interest over a fixed period of time n Principal is repaid to the lender or holder of the
bond at end of the term n Interest rate is typically fixed when the bond is
sold (i.e., fixed-income security) n Interest rate is comparable to what other
bonds, with that rating, are paying Strictly Financials
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Bond Terminology n Interest rate: Fixed percentage of the bond’s
purchase price that is paid annually to the bond holder
n Yield: Return on investment if bond is held to maturity. Equals interest rate. If bond is traded before maturity date, yield could change, although interest rate stays the same.
n Par value: Dollar amount paid for bond at time of issue
n Maturity date: When bond comes due Strictly Financials
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Issuers Prefer Bonds n When companies need to raise funds, they
can issue stock or sell bonds. n They often prefer bonds, in part because
issuing more stock can dilute the value of shares investors already own.
n Bonds also may have income-tax advantages.
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A Quasi-Bond?
n Is preferred-stock debt (i.e., a bond) in disguise?
n Preferred holders have a “guaranteed” dividend. Is that like the fixed interest rate of a bond?
n Why do investors pick common, preferred or bonds?
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Risk and Reward
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Yield Curve Y
ield
Maturity
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Equity or Securities Markets
n Primary market n Go public n Private placement
n Secondary market
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Going Public
n Entrepreneurs have an idea. Company grows with an investment from the private-equity market (venture capital).
n Owners decide to “go public.” n Register with SEC to make an initial
public offering or IPO. n Investment bankers typically underwrite
the offering through a syndicate.
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Going Public (cont.)
n Company prepares a prospectus, which is a detailed analysis of the company’s financial history, its products and services, as well as management’s background and experience.
n Prospectus should identify and assess risk factors the company faces.
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IPO Terms
n Prospectus n Road show n Quiet period n Lockup period
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Shelf Registration
n Firm can file one registration statement for a relatively large block of stock and sell parts over a two-year period.
n This can reduce red tape and costs, and because stock can be sold directly to institutional investors, can eliminate the underwriting fee.
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Private Placement
n New issues can be sold in large lots to a small group of buyers. Lets start-up firms show appeal by raising capital on their own.
n Additional shares later can be offered through an underwriter.
n Many debt issues are placed privately, usually to large buyers such as insurance companies.
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Secondary Offering
n If company already is public, it can sell more stock through a secondary offering. n Causes dilution
n Major owners sell their shares. They get the funds, so no dilution.
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New York Stock Exchange
n In March 1792, Wall Street leaders met to establish an improved auction market.
n In May 1792, 24 men signed an agreement to trade securities only among themselves, maintain fixed commission rates and avoid other auctions.
n Considered the origination of NYSE Strictly Financials
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NYSE (cont.)
n Until March 2006, was owned by 1,366 seat-holding members
n Highest price ever paid for a seat was $4 million.
n Price was determined by auction.
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NYSE Members n Floor brokers
n House brokers n Independent brokers
n Specialists n Manage auction process n Execute orders for brokers n Serve as catalysts n Provide capital n Stabilize prices
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Making an Order
n Tell your broker or “registered representative” to buy or sell a stock at the current price, or market price. Called a market order.
n If you name the price to buy or sell, you’re making a limit order.
n Tell your broker to buy or sell once the price hits a specific price, you’re placing a stop order at a stop price.
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Trading on the NYSE Floor
n Trading occurs in the “Big Room.” n Numerous stations, each with a roughly
figure-eight shape, with counters and screens above. Called “trading posts.”
n Each counter is a “specialist’s” post.
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NYSE Floor (cont.)
n Order comes to the booth that is rented by a brokerage house.
n Floor broker takes order to appropriate specialist’s post.
n Specialist keeps a list of unfilled orders. Processes orders as prices move.
n Specialist’s job is to maintain an orderly market in the stock (match buyers/sellers).
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NYSE Floor (cont.)
n Stocks or groups of stocks are traded at trading posts near the specialists’ positions.
n Floor brokers can use a specialist or trade between themselves, called trading in the “crowd.”
n Terminals display the stock’s activity. n After every trade, a reporter records the stock
symbol, price and initiating broker. n Successful trades are confirmed.
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NYSE Floor (Then & Now)
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Round or Odd Lots
n Round lots: Buying or selling stock in multiples of 100 shares
n Odd lots: Buying or selling stock in other quantities
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Who Holds Your Stock?
n Virtually all investors leave shares in their brokerage account in what’s called the street name. Investor retains beneficial ownership, though.
n This offers safe storage. n You can get tangible certificates if you
want them. Typically, you must pay for them.
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SuperDOT System
n Super Designated Order Turnaround System n Allows orders to be sent electronically to
specialist rather than phoned to floor trader. n Can handle trades of 100,000 shares or less.
Priority to orders of 2,100 shares or less. n More than three-fourths of NYSE executed
orders involve SuperDOT system. n Originally for small trades. Increasingly big
role in portfolio or basket trading. Strictly Financials
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American Stock Exchange
n Non-members of NYSE couldn’t afford office space, so traded in the street
n 1842: New York Curb Exchange n By late 1870s ,known as “curbstone
brokers,” and their market was known as the Curb.
n Merged with NASDAQ in 1998 n Acquired by NYSE Euronext in 2009
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NASDAQ
n National Association of Securities Dealers Automated Quotations system
n NASDAQ is a computer network with no physical location for trading.
n Uses a multiple market-maker system, not the specialist system
n About 4,000-plus companies
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Trading on the NASDAQ
n Trading is through an open-market, multiple-dealer system, with many market makers and broker-dealers competing for transactions.
n Computer network checks for matches, which can be handled instantly.
n Market makers buy and sell, and maintain an inventory of shares.
n Broker-dealers are “independent” firms and business units of banks and investment firms.
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In Which Market?
n In general, but with exceptions: n NYSE: Oldest, largest, best known n AMEX: Smaller, younger n NASDAQ: Youngest, least experienced n Some of NYSE’s most actively traded
stocks are also quoted on the NASDAQ.
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ECNs
n Electronic Communications Networks n Are basically websites that allow
investors to trade directly with one another
n Eliminates trading through an exchange n Archipelago and Instinet best known n BATS Trading
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NYSE - Archipelago Marriage
n Merged in March 2006 to create NYSE Group Inc., a publicly held company.
n Largest merger ever between securities exchanges.
n Combined leading equities market with most successful electronic exchange.
n Archipelago: low fees, user-friendly technology
NYSE Euronext
n Merged April 2007 n Operates world’s largest, most liquid
exchange with diverse products and services
n Six equities exchanges in five countries and six derivatives exchanges
Deutsche Borse Purchase Of NYSE Euronext Blocked
n Worked on a deal since early 2011. n Would have created world’s largest
trading entity. n EU blocked the merger on Feb. 1, 2012,
fearing the new company would be a near monopoly.
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NYSE ‘Hybrid Market’
n Floor trading and automated trading n Specialists or Archipelago strengths n Why? Customers’ desire for faster
access to liquidity and greater anonymity
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NASDAQ Response
n NASDAQ acquired Instinet Group Inc., another ECN
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Exchanges v. OTC Market
n Stocks in almost 10,000 companies aren’t listed on any exchanges.
n They are traded “over the counter” (OTC)
n Typically handled by phone or computer n Generally, comparatively inexpensive
and infrequently, or “thinly,” traded
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BATS Global Markets
n Newer exchange, founded in 2005 n Located in Kansas City n Competes on technology and cost n Developed its own software platform n Also offers an options-trading platform n An ECN
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U.S Equities Market Share 2012 2011
n NYSE 23% 27.5% n Arca 12% 14% n Floor 11% 13.5%
n NASDAQ 19% 21.5% n BATS 13% 12%
n Direct Edge 9% 8%
October 2012
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Direct Edge n Another ECN n Has exchange status
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Dark Pools n Also “Dark Liquidity” or “Dark Pool Liquidity” n Lightly regulated trading not open to the public. n Mostly involves block trades by institutions away from
public exchanges so trades are anonymous. n Main advantage to institutional investors: Can buy or
sell in large blocks without other investors knowing since neither size of trade or trader’s identity are revealed. Prices are reported after trades completed.
n Also means some market participants are disadvantaged since they can’t see trades executed and prices paid, so this market is not transparent.
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High-Frequency Trading
n Also known as “high-speed trading.” n Electronic-trading strategies driven by
statistics and algorithms. n WSJ reported in 2011 that by some
measures, such firms make up 5 of every 10 stock trades in the U.S. each day.
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High-Frequency Trading
n Research has shown that algorithmic trading broadly makes prices less volatile and reduces the overall cost of trading.
n These firms’ ability to buy and sell large blocks of securities in fractions of a second has raised fears that ordinary investors are being left behind. Much criticism.
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Second Markets
n Markets where illiquid assets are traded. n Employees or investors can sell private
company stock or options, bankruptcy claims, restricted stock, structured products, loans.
n Examples: Facebook, Zynga, Groupon. n Buyers: Hedge funds, private equity funds,
individuals. n Largest are Second Market, SharesPost
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Stock Ownership
n In 2011, 54% of Americans said they had money in the stock market, either in an individual stock, a mutual fund or self-directed 401(k) or IRA
n This was down from 56% in ‘10 and 57% in ‘09. High in the 21st Century was 67% in ‘02 and 65% in ‘07.
n Gallup, April 2011
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Stock Ownership
n 87% of upper-income Americans ($75,000 or more annually) own stocks.
n 83% of postgraduates and 73% of college graduates own stocks.
n 64% of Republicans hold stocks, compared with half of Democrats and independents.
n Ages 50 to 64 are most likely to say they have money in the stock market.
n Gallup, April 2011
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Institutional Investors
n Organizations that invest their own assets or pool those they hold in trust for others.
n Examples: Investment companies (including mutual funds), pension systems, insurance companies, universities and banks.
n Trade regularly and in tremendous volume. n Must buy or sell at least 10,000 shares for a
transaction to be an “institutional trade.”
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Changing Attitudes
n Institutional investors who own large blocks of stock are increasingly demanding a say in corporate management.
n Socially or environmentally conscious individual shareholders also are becoming more involved.
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Stock Market Averages n Dow Jones Industrial Average: Best known
and most widely reported market indicator n Made up of 30 industrial companies n Dow Jones Transportation Average: 20
airlines, railroads and trucking companies n Dow Jones Utility Average: 15 gas, electric
and power companies n Dow Jones 65 Composite Average: all 65
companies in the other three averages
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Stock Market Indexes n NYSE Composite Index: All stocks traded on
the NYSE. n Standard & Poor’s 500 Index: Broad base of
500 stocks. Considered benchmark for large-stock investors.
n NASDAQ Stock Market Composite Index: Stocks traded through its electronic system. Often more volatile because of types of companies it covers.
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Market Indexes (cont.) n AMEX Composite: Companies on the AMEX. n Russell 2000: Follows smallest two-thirds of
the 3,000 largest U.S. companies. Includes many IPOs of past few years. Benchmark for small-company stocks.
n Value-Line: 1,700 common stocks. n Wilshire 5000: Broadest index, including
nearly all stocks traded in U.S. markets.
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Reg FD, Disclosure and Guidance
n Regulation Fair Disclosure, October 2000
n Bars public issuers from selectively revealing material nonpublic information to securities analysts, broker-dealers, investment advisers, and institutional investors, before disclosing it to the public.
n Tension: Guidance vs. disclosure Strictly Financials
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Stock Split
n If stock price increases significantly, a company might do a split to lower the price, which it expects to stimulate trading.
n In a split, more shares are available, but total market value is still the same.
n Price may move up after split, therefore increasing the value of your stock.
n Reverse split: Exchange more shares for fewer, say 10 for five. To boost share price.
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Credit or Debt Markets
n Historically, the amount of long-term debt financing issued in the U.S. greatly exceeds the volume of equity financing.
n Short-term or “money market” n Bond market
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Money Market
n Commercial paper n Bankers’ acceptance n Repurchase agreements n Certificates of deposit n Municipal notes n Treasury bills n Money-market mutual funds
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Who Issues Bonds
n Issued by U.S. companies n Issued by the U.S. Treasury n Issued by federal, state and local
government agencies n Issued by overseas companies and
governments. When sold in dollars, are sometimes called Yankee Bonds.
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Issuers Prefer Bonds
n When companies need to raise money, they can issue stock or sell bonds
n They often prefer bonds, in part because issuing more stock tends to dilute the value of shares investors already own.
n Bonds also may have income-tax advantages
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Treasury Issues
n Life, or term, is fixed at time of issue n Treasury bill: One year or less n Treasury note: One to 10 years n Treasury bond: 10 years or more n Generally, the longer the term, the
higher the interest rate
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How Bonds Are Traded
n Most already issued bonds are traded over the counter.
n Bonds also can be purchased from the inventory of a brokerage firm that might make a market in the bonds.
n Commissions and markups
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Rating Bonds
n Standard & Poor’s, Moody’s Investors Services and Fitch are best known.
n Corporate, international and municipal bonds are rated.
n Credit ratings influence interest rates. n If a company’s rating is downgraded,
investors demand a higher yield.
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Bond Rating Code
n Aaa/AAA: Best quality n Aa/AA: High quality
n A/A: High-medium quality
n Baa/BBB: Medium quality n Ba/BB: Some speculative element n B/B: Future default risk
n Caa/CCC: Poor quality, default danger n Ca/CC: Highly speculative n C/C: Lowest rated, poor prospects
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