Post on 09-Feb-2016
description
Security Markets
ObjectivesPrimary market
Secondary MarketSummary
Investments 4 2
Objectives U.S. Treasury Bonds Stock Issue in the Primary Market
Why do companies issue stock? How are stocks placed? Where are the opportunities?
Stock Trading in the Secondary Market Where are stocks traded? How are stocks traded?
Investments 4 3
U.S. Treasury Bonds Initially sold in an auction by the NY Fed
Auction participants: Primary dealers
Competitive vs. Non-competitive bids On-the-run vs. off-the-run treasuries
On-the-run - most recently issued bonds or notes of a particular maturity
Off-the-run – treasuries issued before on-the-run treasuries
On-the-run treasuries are more liquid and expensive compared to off-the-run treasuries
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Primary Market Why do Companies Issue Stock?
To finance business expansion A new factory costs $100MM
To retire existing debt Payoff $10MM high interest loan from the bank
To buy-out venture capital Venture capitalist exits in 1-3 years after IPO
Benefit CostLower financing cost Underwriter fee*Broader investor base Loss of control
*usually 7% of the issue
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Primary Market How are Stocks Placed?
IPO (initial public offering) market for new issues SEO (seasoned equity offering) for secondary Private placement (not traded in secondary markets)
Underwriting Process
Issuing Firms
Lead Underwriter
Investment Banker A
Investment Banker B
Investment Banker C
Investors
Underwriting Syndicate
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Primary Market IPO Process
Choosing investment bankers
Filing a preliminary registration with the SEC (red herring)
Approval of the final statementby the SEC (prospectus)
The issuing firm
Underwriters
Investors
Firm CommitmentFirm Commitment
The issuing firm
Investors
Underwriters
Best-Efforts AgreementBest-Efforts Agreement
Underwriters
Potential Investors
Potential Investors
Underwriters
Potential Investors
Potential Investors
Road Shows
Book Building
Issue
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IPO Performance – Short-Term Opportunities
First day underpricing >10% appreciation from IPO price to first day closing
E.g. $10 IPO closes at more than $11 on the first day of trading
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IPO Performance – Long-Term Subsequent underperformance
* Data for 1970-2006 IPOs
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Primary Market Money on the Table
Q: FBN, Inc sold 100,000 shares at offer price of $50/share in an IPO, underwriter charges a fee of $70,000 and the share price jumps immediately to $53 after trading
What is the cost of equity issue to FBN? What is the profit for the underwriter?
A: The stock is under priced at $50. The company could have got $53, so …
Total cost to the company Money on the table = 100,000×3 = 300,000, Fee = 70,000, Total cost = 370,000
Underwriter’s profit Fee = 70,000
Where did the $300,000 go?
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Primary Market Exploiting the Opportunities
Buy at IPO price and flip after IPO date Benefit:
18.8% return on average for one day Concern:
Smaller chance of getting into good IPOs Greater chance of getting into bad IPOs
Sell short IPO stocks on the first day of trading Benefit:
Profit from the long-run underperformance Problem:
Cost of shorting IPO shares
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Secondary Market Definition
Markets for investors to buy and sell stocks How are stocks traded?
Q: How do I buy 100 shares of Microsoft? A: Depending on the type of order
Market order: buy immediately at current market price Quick execution with unknown price E.g., last transaction for MSFT is $26.12, so you will be
able to buy at a price around $26.12 immediately. Limit order: buy with a price specified
Slow execution with known price E.g., you submit an order to buy MSFT at $26 (limit price),
and wait until the price drops to $26.
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Secondary Market How are stocks traded?
Sell order Market (23.723?) Limit (above 23.74?) Stop-loss (below 23.723?)
Buy order Market (23.74?) Limit (below 23.723?) Stop-buy (above 23.74?)
Limit Order Limit the gain
Stop Order Stop the loss
Where is the price going?
Price 23.733 Orders 47,892
Time 13:34.3 Volume 5,766,868
SHARES PRICE SHARES PRICE
1,720 23.723 100 23.742,000 23.722 3,000 23.74
536 23.721 97 23.749200 23.721 1,000 23.749
1,310 23.72 20,000 23.751,900 23.72 300 23.75
500 23.72 1,000 23.755100 23.71 100 23.76100 23.71 1,720 23.768500 23.71 5,000 23.77
1,000 23.71 1,000 23.77600 23.71 2,000 23.78
1,000 23.71 800 23.787200 23.701 2,400 23.79500 23.7 700 23.799
MSFT (source: Island, 2/25/2003)
LAST MATCH TODAY'S ACTIVITY
BUY ORDERS
(546 more)
SELL ORDERS
(464 more)
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Secondary Market Market Buy of 4,100
shares 100 at 23.74 3,000 at 23.74 1,000 at 23.749
Market Sell of 2,000 shares
1,720 at 23.723 280 at 23.722
Limit Buy 100 share at 23.715
100 share appears on the book between 23.71 and 23.72
Price 23.733 Orders 47,892
Time 13:34.3 Volume 5,766,868
SHARES PRICE SHARES PRICE
1,720 23.723 100 23.742,000 23.722 3,000 23.74
536 23.721 1000 23.749200 23.721 1,000 23.749
1,310 23.72 20,000 23.751,900 23.72 300 23.75
500 23.72 1,000 23.755100 23.71 100 23.76100 23.71 1,720 23.768500 23.71 5,000 23.77
1,000 23.71 1,000 23.77600 23.71 2,000 23.78
1,000 23.71 800 23.787200 23.701 2,400 23.79500 23.7 700 23.799
MSFT (source: Island, 2/25/2003)
LAST MATCH TODAY'S ACTIVITY
BUY ORDERS
(546 more)
SELL ORDERS
(464 more)
1,720
100 23.715
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Secondary Market Where are stocks traded?
Exchanges NYSE, AMEX, … Specialist (Designated Market Maker) system
Buyers SellersBrokerage
FirmBrokerage
Firm
Commission Broker
Floor Broker
Commission Broker
Floor Broker
Specialist
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Secondary Market Where are stocks traded?
Over-the-Counter Market NASDAQ Multiple dealer system
Buyers SellersBrokerage
FirmBrokerage
Firm
Dealer
Dealer
Dealer
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Secondary Market Where are stocks traded?
Electronic Communication Network (ECN) The fourth market Island, ArcaEx, Instinet, … Direct trading among investors on a electronic
limit order book
Buyers SellersBrokerage
FirmBrokerage
Firm
ElectronicLimit Order
Book
Investments 4 17
To Think About… NYSE, Amex, NASDAQ, ECNs – are
they all linked together? Price Discovery
What is it? Where does it take place?