Salaar - FinanceINVESTMENTS BBA SPRING Semester 2012 Lahore School of Economics Salaar farooq –...

Salaar - Finance

INVESTMENTSINVESTMENTS

BBASPRING Semester 2012

Lahore School of Economics

Salaar farooq – Assistant Professor

Salaar - Finance

Securities

Markets

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Chapter 3Indirect Investing

Summary What is Indirect Investing?

Direct Investing

Indirect Investing

What is an Investment Company?

What are Types of Investment Companies?

What are Types of Mutual Funds?

What are the mechanics of Investing Indirectly?

What is Investment Company Performance?

What are Exchange Traded Funds?

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Chapter 4Securities Markets

Learning Objectives

Why are Financial Markets Important?

What are Primary Markets?

What are Secondary Markets?

What are Types Markets?

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What is the investment environment?

There are 2 main areas:

Financial Markets & the economy

a) Consumption Timing

b) Allocation of Risk

c) Separation of ownership

Clients of the Financial System

a) Household Sector (provide money by investing)

b) Business Sector (raise money to invest)

c) Government Sector (finance expenditures by borrowing)

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What is the investment environment? Financial Markets & the Economy

Consumption Timing (High Earning vs low earning)

Financial Markets allow this to happen

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What is the investment environment?

Financial Markets & the Economy

Consumption Timing (High Earning vs low earning)

If Individuals earn more than they spend as opposed to retirees, then what can be done with the excess money?

Q: How do you shift your purchasing power from high earnings period to low earnings period?

High Earning Period: a) You can store your wealth in financial assets

Low Earning Period: b) You can sell these assets to consume


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Allocation of Risk (High vs Low)


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Allocation of Risk (High vs Low)

Financial Markets allow the distribution of risk according to investor preferences.

High Risk: a) Is absorbed by high risk investors seeking high returns

Low Risk:b) Investors with little risk appetite are accommodated


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Separation of Ownership & Management


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Separation of Ownership & Management

Financial Markets allow funds to flow from suppliers to users with ease

Result: a) Larger scale of business & growth potential.

b) Investors can participate in ownership without management.

c) Mutually beneficial for both suppliers & users


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What are Financial Markets?

• Financial Market

• Purpose of Financial Markets

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What are Financial Markets?

• Financial Market– Mechanism to bring Buyers & Sellers together

dealing in Debt, Equity & other financial products.

• Purpose of Financial Markets– The purpose of financial markets is to

efficiently allocate flow of funds from savings to ultimate users.

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What are Financial Markets?Basic Types

– Primary Markets (underwriters)

– Secondary Markets (create liquidity)

– Dealer vs Auction markets

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What are Financial Markets?Basic Types

– Primary Markets (underwriters)•Original (initial) sale of securities – IPO’s –

raises capital– Secondary Markets (create liquidity)

•Buying & Selling of securities after initial sale has occurred – capital gains & dividends

– Dealer vs Auction markets•Dealers buy & sell for themselves•Brokers Auctions match buyers & sellers

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Flow of Funds in the Economy

INVESTMENT SECTOR

FIN

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CIA

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SAVINGS SECTOR

FINANCIAL BROKERS

SECONDARY MARKET

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FIN

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CIA

LIN

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SAVINGS SECTORSAVINGS SECTOR

FINANCIAL BROKERS

SECONDARY MARKET

SAVINGSSAVINGSSECTORSECTOR

Households

Businesses

Government

INVESTMENT SECTOR

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FIN

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CIA

LIN

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SAVINGS SECTOR

FINANCIAL BROKERS

SECONDARY MARKETSECONDARY MARKET

SECONDARYSECONDARYMARKETMARKET

SecurityExchanges

OTCMarket

INVESTMENT SECTOR

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FIN

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CIA

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SAVINGS SECTOR

FINANCIAL BROKERS

SECONDARY MARKET

INVESTMENTINVESTMENTSECTORSECTOR

Businesses

Government

Households

INVESTMENT SECTORINVESTMENT SECTOR

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FIN

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CIA

LF

INA

NC

IAL

INT

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ME

DIA

RIE

SIN

TE

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SAVINGS SECTOR

FINANCIAL BROKERS

SECONDARY MARKET

FINANCIALFINANCIALINTERMEDIARIESINTERMEDIARIES

Commercial BanksSavings Institutions

Insurance Cos.Pension Funds

Finance CompaniesMutual Funds

INVESTMENT SECTOR

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FIN

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SAVINGS SECTOR

FINANCIAL BROKERSFINANCIAL BROKERS

SECONDARY MARKET

FINANCIALFINANCIALBROKERSBROKERS

Investment Bankers

Mortgage Bankers

INVESTMENT SECTOR

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Financial Markets?Primary Markets

Primary Market

Initial Public Offering (IPO)

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Financial Markets?Primary Markets

Primary Market

Market for new issues of securities (investment bankers)

Issuers receive funds (raise capital)

Buyers receive financial claims

Initial Public Offering (IPO)Process of initial sale of new securities

After initial sale, securities trade in the secondary markets

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INVESTMENT BANKERS

• Specialize in design & sale of securities

• Work with issuers to bring a new issue to market—legal, accounting, pricing, and so forth

• Involved in other matters, such as advising firms on mergers and acquisitions, or reorganizations

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INVESTMENT BANKING

• Investment bankers form a syndicate to sell the new securities--multiple investment bankers

• Investment bankers underwrite an issue, purchasing the securities from the issuer and assuming the risk of reselling them to investors profitably

• Investment bankers profit from spread between price they pay and the price they sell the issue for

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Financial Markets?Investment Banking

Performed by 2 groups:

Securities Firms

Firm specializing in the distribution of new securities to the public & also in secondary mkts as brokers & dealers

Commercial BanksAlso underwrite securities.

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Investment Banking

How they make money?

1. Commissions

2. Fees

3. Spread Income

Also from:

Money management

Mergers & Acquisitions

Trading of securities etc.

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Financial Markets?Under-writing Process

3 Main Areas:

1. Advising the issuer on terms & timing of offering

2. Buying Securities from issuer

3. Distributing the securities to public

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Financial Markets?Under-writing Process

Buying securities:

Firm Commitment:

Investment Bank agrees to buy from issuer at fixed price

Best efforts under-writing

When the IB does not buy the securities but provides expertise

Gross Spread – Discount (4-7%)

Difference b/w price paid to issuer & price received from public

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issuer

Originating investment banker

Underwriting Syndicate (group of invest bankers)

Selling group (syndicate + selected retail brokers)

INVESTORS BUYING IN PRIMARY MKT

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Financial Markets?Investment Banker

Investment Banker

Firm specializing in the sale of new securities to the public

UnderwritingProcess by which investment bankers purchase an issue of securities from a firm

and resell it to the public

PROSPECTUS: Provides info about the IPO to the customers

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Privatization?

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Privatization?

Offering securities of Govt owned companies to public…

Thereby liquidating Govt ownership

Also performed by Investment Banks

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Arbitrage?Another activity of Investment Banks

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Arbitrage?Another activity of Investment Banks

Trading discrepancies in same security at different locations…

Example…

JNJ at 51.83-.90 in NY

JNJ at 51.95-99 in LDN

Locking a profit with no risk

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Financial Markets?Global Investment Banking &

Private Placements

Global Investment Banker

Private Placements

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Financial Markets?Global Investment Banking &

Private Placements

Global Investment Banker

Firm specializing in the sale of new international securities to the public

Private PlacementsDebt securities are issued directly to financial institutions bypassing the open

market.

No SEC filing required

Investment banking fees is saved

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Financial Markets?Secondary Markets

Markets where existing securities are traded

For investments to be attractive, they must have liquidity & secondary markets provide that.

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Financial Markets? US Securities Markets for Equities

Where are these exchanges?

Equity

NYSE

AMEX

NASDAQ

ECN’S

BONDSNYSE & AMEX Bond markets

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Financial Markets? US Securities Markets for Equities

Equity

NYSE (New York Stock Exchange)

AMEX (American Stock Exchange)

NASDAQ (National Association of Securities Dealers)

ECN’S (Electronic Communications Network)


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Financial Markets?US Securities Markets for Equities

Equity

NYSE – 1366 seats (1.5mil$)-2800 co’s valued 13 trillion-Dvol 1.5Bil

AMEX – 807 seats – 760 companies – 2% of ttl value – 200mil vol

NASDAQ- 3843 co’s – 1bil vol – computerized mkt network

ECN’S (Electronic Communications Network)-linked to all

OTC – Not listed but registered, 3000 co’s – dealer network linked


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Bid price

Offer Price

Block trades

Program trading

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Bid price

Px some one will buy for

Offer PricePx someone will sell for

Block tradesTrades of 10,000 or more

Program tradingComputer generated buy & sell signals for $1 mil or more

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OTC (Over the counter mkts)

ECN’s

After Hours Trading

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OTC (Over the counter mkts)

Stocks not listed on an exchange but traded on closed computer networks

ECN’sComputerized trading network for large traders & brokers – computer matched orders

After Hours TradingNormal hrs: 9.30 – 1600

AHT hrs: 1600-2000

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Dow Jones Industrial Average

Standard & Poor’s (S&P 500)

Nasdaq

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Dow Jones Industrial Average30 Blue chip stocks – stock price weighted average

Standard & Poor’s (S&P 500)500 stock composite

Nasdaq100 Large cap companies

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• The Dow Jones Industrial Average consists of the following 30 companies:

• 3M Co. (NYSE: MMM) • ALCOA Inc. (NYSE: AA) (aluminium) • Altria Group, Inc. (NYSE: MO)

(tobacco) • AIG(NYSE: AIG) • American Express Co. (NYSE: AXP)

(credit services) • AT&T Inc. (NYSE: T) (telecoms) • Boeing Co., The (NYSE: BA)

(aerospace/defense) • Caterpillar, Inc. (NYSE: CAT) (farm &

construction equipment) • Citigroup, Inc. (NYSE: C) (money

center banks) • Coca-Cola Co. (NYSE: KO) (beverages) • E.I. du Pont de Nemours & Co. (NYSE:

DD) (chemicals) • Exxon Mobil Corp. (NYSE: XOM) (major

integrated oil & gas) • General Electric Co. (NYSE: GE)

(conglomerates, media) • General Motors Corporation (NYSE:

GM) (auto manufacturers) • Hewlett-Packard Co. (NYSE: HPQ)

(diversified computer systems) • Home Depot, Inc. (NYSE: HD) (home

improvement stores)

• Honeywell International, Inc. (NYSE: HON) (conglomerates)

• Intel Corp. (NYSE: INTC) (semiconductors)

• International Business Machines Corp. (NYSE: IBM) (diversified computer systems)

• JPMorgan Chase and Co. (NYSE: JPM) (money center banks)

• Johnson & Johnson Inc. (NYSE: JNJ) (consumer and health care products conglomerate)

• McDonald's Corp. (NYSE: MCD) (restaurant franchise)

• Merck & Co., Inc. (NYSE: MRK) (drug manufacturers)

• Microsoft Corp. (NYSE: MSFT) (software)

• Pfizer, Inc. (NYSE: PFE) (drug manufacturers)

• Procter & Gamble Co. (NYSE: PG) (consumer goods)

• United Technologies Corp. (NYSE: UTX) (conglomerates)

• Verizon Communications (NYSE: VZ) (telecoms)

• Wal-Mart Stores, Inc. (NYSE: WMT) (discount, variety stores)

• Walt Disney Co., The (NYSE: DIS) (entertainment)

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Chapter 4Securities Markets

Learning Summary

Why are Financial Markets Important?

What are Primary Markets?

What are Secondary Markets?

What are Types Markets?

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END

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