Investment analysis:

TRADING OF SECURITIES

Contents:

Introduction to Securities Characteristics of securities Types of securities Types of markets for trading Issuance of securities Trading of securities Trading in exchanges Specialists and the execution of trades Other concepts

SECURITIES AND ITS TYPES

Security:
Securities can be defined as financial instruments that have some financial value, and they can be traded amongst investors, governments and private enterprises. A legal contract representing the right to receive future benefits under a stated set of conditions.

Characteristics of security:

Return on investment (ROI) Risk inherent in it Liquidity Volatility

Types of securities:

securities

Marketable

Non marketable

Marketable securities:

Stocks, bonds or any other types of securities which can be traded easily in organized financial markets or between two investors with the help of brokers are known as marketable securities. The chief feature of marketable securities is that it is easier to trade them and they can be converted into cash whenever required by the investor.

Types of marketable securities:

Marketable securities

Money market securities

Capital market securities

derivatives

Indirect investments

Money market securities:

one of the most reliable and highly liquid

assets, money market securities are shortterm bonds issued by governments or large financial corporations. Transactions are generally very large, to the tune of US$100,000 and the maturity period is one year or less.

Types of money market securities:

Treasury bills Commercial papers Euro dollars Negotiable certificates of deposits CDs Bankers acceptance Repurchase agreement (REPOS)

Characteristics:
types/ch aracteris tics description Issued by:
govt

Risk factor
Risk free

Face value
$1000-$1 mn
$100,ooo

Maturity Issued period at:

3,6 mths/ yearly
270 days or less Less than 6 mnths 30 -180 days , mostly 90. 14 days to 1 year Overnight to few days varies Discount rate

T.Bills
C .papers

Short term securities

Promissory notes Deposits in non uS banks Negotiable credit investments

Discount rate
Discount rate

banks/ corporatio ns Financial institution s Non financial firms Commercial bank Security dealers

safe

Euro dollars Bankers acceptan ce CDs REPOS

Not totally risk free Least risky

varies

$100,ooo

Certificates of deposit Agreement to repurchase security in future

Low risk

$100,000

Residual credit risk

varies

CAPITAL MARKET SECURITIES

Capital market securities:

Capital market securities include instruments

having maturities greater than one year and those having no designated maturity at all. In the latter category can be included common stock. The discussion of capital market securities divides them into
fixed income securities and 2. equities.
1.

Debt instruments:
These are investments that promise

guaranteed income on the amount invested, though at a lower rate of return. These are also known as fixed in come securities

Types of debt instruments:

Mutual funds

bonds

mortgages

Debt instruments

Bonds:
Definition:

They are a form of fixed-income securities, and payments are made as per the time and depending on the conditions mentioned in the deal. The investor can sell the purchased bond before maturity, depending on the market conditions and how that particular bond is rated.

Types of bonds:
Treasury notes and bonds
issued by the US government for longer maturity periods The terms of treasury notes are usually between 1 to 10 years while for the treasury bonds, it is between 10-30 years

Municipal bonds Corporate bonds

Federal agency securities

These are tax-exempted investments To raise funds for public work several counties, states and municipalities issue bonds.

are issued by corporate entities. the risk of default is higher.

federal agencies are permitted to issue debt in order to raise funds. The funds are then used to provide loans to assist specified sectors of the economy. The are two types of such agencies: federal agencies and federally-sponsored agencies.

Mortgages:
Mortgages are long term loans to individuals

or firms for the purchase of houses, lands and other real assets etc. the lands or houses purchased serve as securities of loans (collateral).

Mutual funds:
Mutual funds is a trust which pools the saving

of the people for investment in equity market.

Equity instruments:
Preferred stocks
Voting right Residual claim on dividend Variable dividend with no maturity Share of ownership No voting right

Can be callable
a fixed dividend and have maturity ownership rights are very limited.

Derivative instruments:
These classes of marketable securities

represent those investments values of which are dependent on the performance of several other securities. That means, their values are derived from the value of other investment instruments and hence, the name derivatives.

Types of derivatives:
derivatives

options

Future contracts

Rights and warrants

Call options

Put options

LEAPS

Types of derivatives:
options provides the holder the right, but not obligation to buy or sell securities at some fixed point of time in the future Future contracts . The futures market is extremely liquid, risky and very complex. Rights and warrants Rights are generally for short-term and expire within a week warrants may be traded for one to a few years.

INDIRECT INVESTMENTS & NON MARKETABLE SECURITIES.

Indirect investments:
Investments in securities that are made by

purchasing shares of an investment company are known as indirect investments. Just like any other company, even an investment company tries to diversify its portfolio and generate funds for its business purposes.

Types of indirect investments:

Indirect investments

Investment trusts

Unit trusts

Hedge funds

Indirect investments:
Investment funds Unit trusts Hedge funds
A unit trust functions under a trust deed . Also known as open-ended investments. The value of a unit trust depends on the number of units issued and the price of each unit.

functions under a trust deed. Also known as open-ended investments, the value of a unit trust depends on the number of units issued and the price of each unit.

limited to a few accredited investors, they are not ideal for average investors. The private capital pooled in hedge funds is generally, very large and is invested by few sophisticated investors.

Non marketable securities:

Securities that are difficult to trade in a

normal financial market are generally called non-marketable securities. These securities are traded between investors and large financial institutions like commercial banks, so it is a risk-free and safe investment.

Types of non marketable securities:

Non marketable securities

Saving accounts

Govt . Saving bonds

Non negotiable CDs

Money market deposit accounts (MMDA)

Characteristics:
Saving account earn an interest over a period Withdrawing money is possible at any point of time investor needs to maintain some minimum balance Govt. saving bonds can't be traded in the open market traded amongst investors and (banks) indirectly earn interest only when they are redeemed. Non negotiable CDs CDs are promissory notes that are issued by commercial banks. CDs are insured maturity period of one month to five years. (TDs) MMDAs very high interest rates along with some restrictions an investor is allowed a limited number of transactions every month maintain a minimum balance

Purpose of investment in securities:

When firms need to raise capital, they may

issue securities to the public by investment Bankers.

Types of markets:
Primary markets market for new securities. e.g. Initial public offering

Secondary markets
a market for already-existing securities e.g. stock exchanges

ISSUANCE OF SECURITIES

Issuance of securities:

Primary market issuance of common stock 1. Initial Public Offerings (IPOs). 2. Seasoned New Issues:

Primary market issuance of bonds 1. Public Offering 2. Private Placement

Mechanisms of issuance of securities:

Investment banking Shelf registration

Private placement Initial public offering

Investment banking:
Two concerns in Investment Banking: 1.Underwriting: Public offerings of both stocks and bonds typically are marketed by investment bankers who in this role are called underwriters. A preliminary registration statement must be filed with the Securities and Exchange Commission (SEC), describing the issue and the prospects of the company. This preliminary prospectus is known as a red herring. When the statement is in final form, and approved by the SEC, it is called the Prospectus. A firm commitment: In a typical underwriting arrangement, the investment bankers purchase the securities from the issuing company and then resell them to the public. The issuing firm sells the securities to the underwriting syndicate for the public offering price less a spread that serves as compensation to the underwriters. This procedure is called a firm commitment. 2. Best Efforts Agreement: This is an alternative to the firm commitment. Here, the investment banker does not actually purchase the securities but agrees to help the firm sell the issue to the public. They simply act as intermediary.

Investment banking (contd.)

SHELF REGISTRATION
Here are the securities on the shelf which are ready to be issued introduced in 1982 when the SEC approved Rule 415. This rule allows firms to register securities and gradually sell them to the public for two years following the initial registration. Because the securities are already registered, they can be sold on short notice, with little additional paperwork. Moreover, they can be sold in small amounts

without incurring substantial floatation costs.

Private placement:
Primary offerings also can be sold in a private placement rather

than a public offering. In this case, the firm (using an investment banker) sells shares directly to a small group of institutional or wealthy investors. Private placements can be far cheaper than public offerings. This is because Rule 144A of the SEC allows corporations to make these placements without preparing the extensive and costly registration statements required of a public offering. Private placements do not trade in secondary markets like foreign exchanges. This greatly reduces their liquidity and presumably reduces the prices that investors will pay for the issue.

Initial public offerings:

Investment bankers manage the issuance of new securities to the public. Once the SEC has commented on the registration statement and a preliminary prospectus has been distributed to interested investors, the investment bankers organize road shows in which they travel around the country to publicize the imminent offering. These road shows serve two purposes: o First, they generate interest among potential investors and provide information about the offering. o Second, they provide information to the issuing firm and its underwriters about the price at which they will be able to market the securities. Large investors communicate their interest in purchasing shares of the IPO to the underwriters; these indications of interest are called a book and the process of polling potential investors is called book building.

TRADING OF SECURITIES

Trading of securities:
The Secondary Markets: WHERE SECURITIES ARE TRADED
Stock exchanges The over-theare secondary counter market is markets where an informal already issued network of brokers securities are and dealers who bought and sold by negotiate sale of securities. members.

Direct trading between two parties

Price of security:
Bid price: the price at which a dealer is willing to purchase a security.
Ask price : the price at which a dealer is

willing to sell a security. Spread: Ask Bid (profit of a dealer)

Structural feature of secondary market:

Once securities are issued to the public, investors may trade them among themselves in what is known as the secondary market. The challenge in this market is matching up buyers with sellers because few investors in the secondary market trade large enough amounts to make it worth their while to hire investment bankers so there is a need to find a cost effective transaction execution system.

Transaction execution system

TES
Oder-driven system Hybrid system Quote-or Dealer-driver system

Types of TES
Order-driven system
buyers quote the highest price sellers quote the lowest price .available to sell. The bids and asks are matched on a publicly accessible order book.

Quote driven system

Quote-driven or dealerdriven systems involve dealers holding inventories of securities, and quoting their bid and asking rates for specific securities. . Dealer systems are also known as decentralized systems, given that the exchange of securities is not limited to a centralized market place. Dealers usually use electronic means to broadcast their bid and ask prices as over-thecounter, or OTC, systems.

Hybrid system
combination of the orderand dealer - driven systems e.g.NYSE. Market specialists are given an exclusive license to provide buy and sell quotes for designated securities . Specialists profit by exploiting the spread.

Third and fourth markets:

The third market refers to trading of

Exchange listed securities on the OTC market. The fourth market refers to direct trading between investors in Exchange listed securities without the benefit of a broker. The direct trading among investors has exploded in recent years due to the advent of electronic communication Networks, ECNs.

Trading on exchanges:
The investor places an order with a broker

The brokerage firm for which the broker works, contacts its commission broker, who is on the floor of the Exchange, to execute the order

. If commission broker is too busy with the other orders, then they will use the services of floor brokers

At the specialists post is a monitor called the Display Book that presents all the current offers.

TYPES OF ORDERS & TYPES OF TRADING.

Types of orders:

orders

Market orders

Limit orders

Stop loss orders

Stop buy orders

Orders:
Market orders
simply buy or sell orders that are to be executed immediately at current market prices.

Limit orders
Stop buy orders Stop loss orders

investors specify prices at which they are willing to buy or sell a security.

a stock should be bought when its price rises above a limit

the trade is not to be executed unless the stock hits a price limit. the stock is to be sold if its price falls below a stipulated level

Graphical representation:

Specialists and the execution of trades:

A specialist is a trader who makes a market in the shares of one or more firms and who maintains a fair and orderly market by dealing personally in the market. Therefore, a specialist may also act as a broker or dealer in the market.

Block sales:
Block transactions are large transactions in

which at least 10,000 shares of stocks are bought or sold. The larger block transactions are often too large for specialists to handle, as they do not wish to hold such large blocks of stock in their inventory. Therefore, Block houses have evolved to aid in the placement of larger block trades.

Major security markets:

In USA: NASDAQ NY STOCK EXCHANGE AMERICAN STOCK EXCHANGE

Trading costs:
A. Part of the cost of trading a security is

obvious and explicit: Your broker must be paid a commission. Individuals may choose from two kinds of brokers: Full service brokers. Discount brokers. B. In addition to the explicit part of trading costs-the broker`s commission-there is an implicit part the dealer`s bid-ask spread.

Margin trading:
Margin is the net worth of the investor`s

account and describes securities purchased with money borrowed in part from a broker. When purchasing securities, investors have easy access to a source of debt financing called broker`s call loans . Thus, this process is called buying on margin.

Formula for margin account:

M= V-L/V x 100
M= margin V= value of the security L= brokers loan

Short sales:
This is especially used to profit from a decline

in a security`s price. An investor borrows a share of stock from a broker and sells it. Later, the short seller must purchase a share of the same stock in the market in order to replace the share that was borrowed. This is called Covering the Short Position.

GRATITUDE..!