salaar - finance capital markets winter semester 2009 lahore school of economics salaar farooq –...
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Salaar - FinanceSalaar - Finance
Capital MarketsCapital Markets
Winter Semester 2009Winter Semester 2009
Lahore School of EconomicsLahore School of Economics
Salaar Farooq – Assistant Professor
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LectureLecture
Securities FirmsSecurities Firms&&
Investment banksInvestment banks
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Salaar - FinanceSalaar - Finance
Securities Firms & Investment Banks
Learning Objectives
Underwriting?
Broker-dealer-IPO’s
Investment Banking?
Secondary markets?
Mechanics of Markets?
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Primary MarketsLearning Objectives
What are Primary Markets & IPO’s?
What is an Investment Banker?
How securities are issued: Process?
What is Arbitrage?
What are private placements?
What are some SEC regulations?
World Capital Mkts considerations
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Salaar - FinanceSalaar - Finance
Financial Markets?Primary Markets
Primary Market
Initial Public Offering (IPO)
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Salaar - FinanceSalaar - Finance
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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Salaar - FinanceSalaar - Finance
Financial Markets?Investment Banker
Investment Banker
Firm specializing in the sale of new securities to the public
Key Role of Investment BanksAssist in obtaining funds for Corporations, Govts, & Foreign Entities.
And for Investors, act as brokers or dealers in buying & selling securities.
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INVESTMENT BANKERS
• Specialize in design & sale of securities in the primary market
• Work with issuers to bring a new issue of securities 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 new securities--multiple investment bankers working together
• Investment bankers underwrite an issue, purchasing securities from issuer & assuming risk of reselling
• Investment bankers profit from the spread between price they pay & price they sell the issue
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Salaar - FinanceSalaar - Finance
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?
Commissions
Fees
Spread Income
Also from:
Money management
Mergers & Acquisitions
Trading of securities etc.
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Salaar - FinanceSalaar - Finance
Financial Markets?Investment Banker
Investment Banker
Firm specializing in the sale of new securities to the public
Underwriting – Buying of securities from issuerProcess 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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Salaar - FinanceSalaar - Finance
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
MARKETING MUSCLE CRITICAL
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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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Salaar - FinanceSalaar - Finance
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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Salaar - FinanceSalaar - Finance
Financial Markets?Global Investment Banking &
Private Placements
Global Investment Banker
Private Placements
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Salaar - FinanceSalaar - Finance
Financial Markets?Global Investment Banking &
Private Placements
Global Investment Banker
Firm specializing in the sale of new international securities to the public
Private PlacementsSecurities are issued directly to financial institutions bypassing the open market. - typically insurance, pension funds and investment companies
No SEC filing required
Investment banking fees is saved
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OTHER PRIMARY MARKET ISSUES
• Investment banking is a global operation now,
…as firms raise capital around the world in order to reduce costs
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Financial Markets?Regulation of Issuance of Securities
Underwriting is regulated by the SEC
Some rules:
Registration statement of intent to issue
Part I: Prospectus
Part II: Supplemental Info
Responsibility of Due Diligence is with underwriter
Shelf Registration rule : can sell in the market (not allowed before)
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Continued…Regulation of Issuance of Securities
Underwriting is regulated by the SEC
Some rules:
Continued Reporting
Rule 144A:
Privately placed securities CAN be sold immediately
(not allowed before)
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Raising Capital outside domestic market
4 main reasons:
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Raising Capital outside domestic market
4 main reasons:
1. Local market may not be large enough
2. Reduced cost of funding
3. To diversify source of funding
4. To manage foreign exchange risks
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Salaar - FinanceSalaar - Finance
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?
Secondary Markets
Function of Secondary Markets?
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Financial Markets?
Secondary Markets
Function of Secondary Markets
Provides info on Value of Security
Indicates Consensus price
Shows how well the Firm is using funds
Gives an idea of how NEW issues would be received
Provides Liquidity to the markets
Allows for investments to change ownership easily
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Salaar - FinanceSalaar - Finance
Financial Markets? US Securities Markets for Equities
Where are these exchanges?
Equity
NYSE
AMEX
NASDAQ
ECN’S
KSE
BONDSNYSE & AMEX Bond markets
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Salaar - FinanceSalaar - Finance
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)
KSE (Karachi!)
BONDSNYSE & AMEX Bond markets
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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
KSE: 200 seats, 163 active, 658 co’s, 35B MCap, 350m! vol, 100 co’s =90% Mcap
BONDSNYSE & AMEX Bond markets
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Perfect Markets?Conditions Required?
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Perfect Markets?Conditions Required
1. Large no. of buyers & sellers & no one is significant. (LIQUIDITY)
2. Everyone is a price taker
3. Price is determined by pure Supply-Demand
4. No frictions exist (COSTS)
Frictions
Costs & barriers to affecting Buyers/sellers payoffs
Eg.Commisions
Bid-ask spreads
Taxes etc
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Financial Markets?Securities Markets for Equities
Bid price
Offer Price
Block trades
Program trading
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Financial Markets?Securities Markets for Equities
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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Salaar - FinanceSalaar - Finance
Financial Markets?
Securities Markets for Equities
OTC (Over the counter mkts)
ECN’s
After Hours Trading
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Salaar - FinanceSalaar - Finance
Financial Markets?Securities Markets for Equities
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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Financial Markets?Securities Markets for Equities
Dow Jones Industrial Average
Standard & Poor’s (S&P 500)
Nasdaq
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Financial Markets?
Securities Markets for Equities
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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KSE 30
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Salaar - FinanceSalaar - Finance
Brokerags vs Dealers?
Brokers = middle-men
Dealers = shopkeepers (MARKET MAKERS)
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Brokerage Firms
Full Service Brokers
Discount Brokers
Online Discount Brokers
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Brokerage Firms
Full Service BrokersOffer Full Range of services including info and advice.
Discount Brokers
offers execution services
Online Discount Brokers
offers platforms on the net
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Types of Brokerage Accounts
Cash Account
Margin Account
Asset Management Account
Wrap Account
Commissions
Drip (Dividend Reinvestment Plan)
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Types of Brokerage Accounts
Cash AccountOnly cash transactions
Margin AccountAllows cash and debt transactions
Asset Management AccountOffers investment of cash balances and Cheque writing
Wrap Accountall fees are wrapped into one
Commissions Drip (Dividend Reinvestment Plan)
free reinvestment by companies
DOLLAR COST AVERAGING - illustrate
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How Orders Work
Organize Exchanges (NYSE, NASDAQ)
Super Dot (NYSE)
NASDAQ System of dealers
Decimalization of stock prices
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How Orders Work
Organize Exchanges (NYSE, NASDAQ)
Super Dot (NYSE)Electronic system for NYSE
NASDAQ System of dealersThrough computer market making firms
Decimalization of stock pricesJan 2001 stocks were decimalized, average spread five cents (NOW 1c)
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Salaar - FinanceSalaar - Finance
Types of Orders
Market Order
Limit Order
Stock Order
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Types of Orders
Market OrderBest price on the floor – ENSURES EXECUTION NOT PX
Limit Order (new position)specified or better price – ENSURES PX – NOT EXECUTION
Stop Order (existing position)Automatic execution at specified price
BUY STOP – PROTECTS PROFITS
SELL STOPS – PROTECT LOSSES
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Investor Protection
Government Regulation
SEC
Self Regulation
NASD
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Investor Protection
Government Regulation SEC
1934
Self Regulationstock exchanges monitor and regulate
NASDAlso monitor
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Margin
Margin
Initial Margin
Maintenance Margin
Margin Call
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Margin (Leveraged Positions)
Marginpart of transaction value which is customers equity
Initial Marginthe part the customer must pay to initiate a transaction – 50%
Maintenance Margin%age of securities value which must be on hand as equity – 25%
Margin Calldemand from broker for cash if actual M < maintenance M
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Salaar - FinanceSalaar - Finance
Margin
Marginpart of transaction value which is customers equity
Initial Marginamount investor puts up / value of transaction
Maintenance Margin%age of securities value which must be on hand as equity
Margin Call
MARKED TO MARKET EVERYDAY
Actual margin =
(current value of stock – amount borrowed) / current value
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Salaar - FinanceSalaar - Finance
Short Sales
Being Long
Being Short
Short Sale
Short Interest Ratio
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Salaar - FinanceSalaar - Finance
Short Sales
Being Longnormal position of buying stock
Being Shorthaving sold stock not owned
Short Saleselling stock not owned but borrowed
Short Interest Ratioshares short to average daily volume
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Salaar - FinanceSalaar - Finance
Market Efficiency
Markets absorb & reflect all new information
into security prices
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Salaar - FinanceSalaar - Finance
Securities Firms & Investment Banks
Learning Objectives
Underwriting?
Broker-dealer-IPO’s
Investment Banking?
Secondary markets?
Mechanics of Markets?