02-issuing and trading securities_2014

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Issuing and TradingSecurities

Marriott School of Management

Fin 410

Fall 2014

Rob Schonlau

Last updated Sept 6, 2014

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onsider yourself an asset manager

Recently 100 of your closest friends heard you were taking thisclass and spontaneously entrusted to you a sum total of $2 millionfor you to invest. They asked that you invest it in the best possiblemanner over a 5 year period.

On Wednesday we discussed the types of securities you couldinvest in.

In todays lecture we will discuss how those securities are

issued and traded.

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Lecture 2 outline

How are securities issued?

Where and how are securities traded? What are thecommon order types?

Discuss trading costs, margins, and short sales.

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IPOs and SEOs common stock)

New issues of common stock are classified as either initialpublic offerings (IPOs) or seasoned equity offerings (SEOs).

IPOs represent the first sale of public shares from a previously

private company. SEOs (or SPOs) represent subsequent issues of stock from

firms that already have existing shares trading in the market.

WSJ calendar of upcoming IPOs and SEOs(http://online.wsj.com/mdc/public/page/2_3022-newoffer.html?mod=topnav_2_3000)

NASDAQ calendar of upcoming IPOs(http://www.nasdaq.com/markets/ipos/)

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http://online.wsj.com/mdc/public/page/2_3022-newoffer.html?mod=topnav_2_3000http://online.wsj.com/mdc/public/page/2_3022-newoffer.html?mod=topnav_2_3000http://www.nasdaq.com/markets/ipos/http://www.nasdaq.com/markets/ipos/http://online.wsj.com/mdc/public/page/2_3022-newoffer.html?mod=topnav_2_3000http://online.wsj.com/mdc/public/page/2_3022-newoffer.html?mod=topnav_2_3000http://online.wsj.com/mdc/public/page/2_3022-newoffer.html?mod=topnav_2_3000http://online.wsj.com/mdc/public/page/2_3022-newoffer.html?mod=topnav_2_3000


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Public offerings and private

placements bonds)

New issues of bonds sold to the public are considered publicofferings.

New issues of bonds sold to one or just of few institutionalinvestors are considered a private placement.

Debt issues are offered by corporations as well as by the federal,state, and local governments. Each of these issues have differenttax and risk characteristics. Depending on the bond they offerdifferent maturities and different payoff schedules.

Calendar of bond offeringshttp://online.wsj.com/mdc/public/page/2_3022-bondoffer.html?mod=topnav_2_3022

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http://online.wsj.com/mdc/public/page/2_3022-bondoffer.html?mod=topnav_2_3022http://online.wsj.com/mdc/public/page/2_3022-bondoffer.html?mod=topnav_2_3022


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Investment banks

New stock and bond issues are generally facilitatedby investment bankers acting as underwriters.

Example list of a few of the larger investment banks:

Bank of AmericaBarclaysBNP ParibasCitigroupCredit Suisse

Deutsche BankGoldman SachsHSBCJPMorgan ChaseMorgan Stanley

Royal Bank ofScotlandSociete GeneraleUBSWells Fargo

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Role of investment banks in primary

markets

Investment banks advise the firm regarding the terms on which itshould attempt to sell the securities

Investment banks help the firm create and file SEC registrationstatements

red herring prospectus

If the deal was set up as a firm commitment, banks buy securitiesfrom the issuing company at public offering price less a spreadand then resell to public.


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Road shows/book building/fees

Investment bankers escort firm executives around tomeet big institutional investors to generate interest inthe offering.

Shares are allocated according to interest. If an investorwishes to get shares, he/she must indicate optimism. Why would investors be willing to indicate interest?

Recent famous IPOs Upcoming IPOs Groupon http://www.nasdaq.com/markets/ipos/ Facebook

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http://www.nasdaq.com/markets/ipos/http://www.nasdaq.com/markets/ipos/http://www.nasdaq.com/markets/ipos/


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Two IPO puzzles

IPO stocks experience large returns on average on the firstday of trading.

Very strong result

IPO stocks under-perform over the next five years.

Mixed results


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Average IPO first-day returns

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100

200

300

400

500

600

700

800

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

1990199119921993 1994 1995 1996199719981999 2000200120022003 20042005200620072008 2009

Average First Day Returns (blue line)# of IPOS (red bars)

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Based on SDC data


12/3212These charts are from www.renaissancecapital.comas of Aug 14, 2014
http://www.renaissancecapital.com/http://www.renaissancecapital.com/


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Money left on the table

Money left on table = (Closing PriceOpening Price)*(Shares Issued)

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100

200

300

400

500

600

700

800

$0.00

$10.00

$20.00

$30.00

$40.00

$50.00

$60.00

$70.00

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

$Billions Left on Table (blue line)# of IPOS (red bars)

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IPO first day returns

Firms depend on the road show to get information frombig investors about how the market might receive theissue (price discovery).

Firms often adjust the opening price according to thelevel of interest expressed during road show.

To entice big investors to truthfully reveal information

Allocate more shares to those who express strongerinterest

Offer the shares at a discount


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Concept questions

What purpose does the book building step have in the IPOprocess?

Why would investors reveal their interest in an upcoming IPO ifit affects prices?

Why are IPOs underpriced?

If you as an investor had the opportunity to buy IPO shares,would you? Why or why not?

How was Googles IPO different than most IPOs?

After an IPO, does trading of the firms stock in the secondarymarket affect the number of shares outstanding?

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Lecture 2 outline




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Where and how are stock traded?

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Types of orders

Market order: Buy or sell order to be executed immediately.

Price-contingent order: Order which specifies a price at which theyare willing to buy or sell. If the price occurs then the order isexecuted.

Limit buy order: buy shares if stock trades below a specific price Limit sell order: sell shares if stock trades above a specific price Stop-loss order: sell stock if it trades below a specific price Stop-buy orders: buy stock if it trades above a specific price

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Price contingent order intuition Market buy: buy at best going price

Market sell: sell at best going price

When theprice does

this:

Pricedecreasesbelow limit

Priceincreasesabove limit

Sell Stop-loss

(Stop-sell)

Limit sell

Buy Limit Buy Stop Buy


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Concept checkWhat type of trading order would you use in these

situations?

1. You want to buy IBM stock to diversify your portfolio. Youthink it is fairly priced.

2. You plan to sell your IBM stock next month to pay for tuition.You think IBM will rise over the period but cant afford to have

the value of your IBM stock decrease.3. You want to buy IBM stock but think the current price of $100

is overvalued by $5.

4. You shorted 1000 shares of IBM stock. You expect IBMs

stock to decrease in value but are concerned about how much

you might lose if it rises.5. You think that IBM stock will ultimately end up lower by 10-

20% over the next year but that over the next few weeks itmight spike 1 or 2 percent given its recent positive earningsreport.

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Bid-ask prices

The ask price is the price at which someone standswilling to sell. I.e., they are asking for that amount to

sell the security to you.

The bid price is the price at which someone standswilling to buy. I.e., they are bidding that amount to buy

the security from you.

Ask>Bid


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Example: Bid-ask prices for OTC

markets

Ask price of $45.60 Bid price: $45.50

Market buy orderbuy at $45.60 (we buy at ask price)

Market sell ordersell at $45.50 (we sell at bid price)


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Concept check

Assume an ask price of $45.60 and a bid price of$45.50

1. Would a limit buy order at $45.55 be executed?

2. Would a stop sell (stop loss) order at $45.55 beexecuted?

3. Would a stop buy order at $45.55 be executed?

4. Would a limit sell order at $45.55 be executed?

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Lecture 2 outline




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Examples of trading costs

Brokers require commissions

Bid-Ask spread

Price concessions for trading in large quantities.

ECNs can charge additional fees Block houses have fees to connect block sellers with buyers.

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Buying on margin

Investors can buy securities on margin by using loans from theirbrokers to make the purchase.

The initial margin is the portion of the purchase pricecontributed by the investor (not the broker). After buying the

asset on margin the asset value can increase or decrease andthe new margin is the net worth of the investors account

relative to value of asset.

Brokers charge interest/fees on the money lent and can requireadditional money from the investor via a margin call if the

margin goes below a certain level (maintenance margin).

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Calculating margin

Assume you purchase $7,000 of stock at $100/share using$5,000 of your own funds and borrowing $2,000 from the broker.(70 total shares)

Initial margin: 5,000/7,000=71.4%

Regardless of what the share price does in the near futureyou will owe the broker $2,000 (plus interest).

Now assume the share price decreases to $45/share.

New margin: (70*45-2,000)/(70*45) = 36.5%

New market value of sharesminus value owed to broker

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Short sales

A short sale of stock allows an investor to sell a stock withoutfirst owning it.

To short sell a stock the investor borrows the stock from thebroker and sells it. Later, to cover the short position and pay-back the broker, the investor then buys a share of the samestock in the market and gives it to the broker.

The short seller only makes money if the share price declines.

http://www.nasdaq.com/quotes/short-interest.aspx

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http://www.nasdaq.com/quotes/short-interest.aspxhttp://www.nasdaq.com/quotes/short-interest.aspxhttp://www.nasdaq.com/quotes/short-interest.aspxhttp://www.nasdaq.com/quotes/short-interest.aspxhttp://www.nasdaq.com/quotes/short-interest.aspx


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Do short sellers anticipate financial

misconduct?Short Sellers and Financial Misconduct, Journal of Finance 2010, by

Karpoff and Lou,

Financial Misconduct Revealed

Level of short interest

Months relative to disclosure of financial misconduct

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Concept check

Why would an investor want to buy on margin? Isthis wise?

When would you want to short sell a stock? What

does this suggest about firms with high shortinterest?

If a firm has a high days-to-cover ratio and releasesunexpected good news about expected future cash

flows, what effect could the shorts have on the pricemovement?

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Practice problem 1

You think that Google is going to do really well over the nextyear. You spend $6000 of your own money and borrow $3000from your broker to buy 15 total shares. Your broker charges8% for the loan.

What will your rate of return be if Googles share priceincreases 5%?

How far does the price of Google have to immediately fallbefore you get a margin call? Assume a maintenancemargin of 30%.

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Practice problem 2

You think that IBM is going to decrease in value this year soyou decide to sell short 100 shares at the current price of $100per share. Assume there are no fees associated with the shortposition as long as you satisfy the margin requirements.

How much cash or securities do you have to have in yourbrokerage account if your brokers initial margin requirement

is 50%?

At what price would you get a margin call? Assume thebroker requires a 30% maintenance margin.

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02-issuing and trading securities_2014

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