Securities Markets Chapter 12 4 topics in chapter 12 1. Securities markets 2. How securities are traded? 3. Dealing with investment dealers 4. Sources of investment information 1. Securities Markets • A securities market is where financial securities, such as common stocks and bonds, are traded. • The market may be a physical place such as a building on Bay Street in Toronto or an electronic connection between securities dealers from across the globe. • Securities markets consist of primary and secondary markets. Primary markets • A primary market is one in which new securities are traded. • There are two types of new offerings, initial public offerings and seasoned new issues. 1. An initial public offering (IPO) involves selling a company’s shares for the first time. IPO for Lululemon • In July of 2007 Lululemon’s IPO was priced at $18 US • The company offered 18.2 million shares • Share prices shot up to 29.72 on the TSX. • Lululemon used some of the cash from the IPO to open 25 stores in 2007 and up to 35 in 2008 in the US and Canada. • Current stock price for Lululemon (lll.to) 2. Seasoned new issues are stock offering by companies that already have common shares traded in the marketplace. The role of underwriters and investment dealers • Stocks and bonds are generally sold in primary markets through an investment dealer serving as an underwriter. • An underwriter is an investment dealer who purchases and then resells a new security issues. • The largest investment dealers in Canada are The BMO Nesbitt Burns Group, TD Securities, CIBC World Markets Inc., Scotia Capital Inc., and RBC Dominion Securities Ltd. Secondary markets • Securities that have been previously issued and bought are traded in the secondary markets. • The largest secondary market in Canada and the third largest in North America (NYSE, NASDAQ) is the Toronto Stock Exchange (TSX). • 95% of all equity trading in Canada occurs through the TSX. A firm must meet strict requirements to be listed on the TSX, which include: • Earnings before taxes (EBT) for the most recent year must be at least $200,000 • Pretax cash flow in the preceding year of the filing must be at least $500,00 • Net tangible assets must be at least $2 million • The market value of publicly held stock must be at least $4 million • There must be at least one million publicly held common shares • There must be at least 300 public shareholders • If a firm does not maintain the requirements, it is delisted. • The TSX and TSX Venture together represent approximately 3700 companies • They comprise about 9.7% of all listings worldwide. • An over-the-counter (OTC) market is a linkup of dealers, with no listing or membership requirements. • A bid price is the price an individual is willing to pay for a security • An ask price is the price at which an individual is willing to sell a security Secondary bond markets • The trading of bonds most often occurs through dealers in the OTC market rather than on the organized exchanges. International markets • The world bond market is valued at more than $25 trillion. • Dual listings are common. Regulation of securities markets • The objective of regulation is to protect the investor and to provide a level playing field for all investors. • There are two levels of regulation, provincial securities commissions and self-regulation by the exchanges. 2. How Securities are Traded • In discussing different trading mechanisms, we refer to securities as shares or stock, since they are the most frequently traded security. • When placing an order, you must be clear about the order size and the period for which the order will remain outstanding. • Order size: Common stocks are sold in either round lots or odd lots. • A round lot is a group or lot of 100 shares of common stock. • An odd lot is an order involving between 1 and 99 shares of common stock. There are alternative periods for which the order will remain outstanding: • day orders • open orders • fill-or-kill orders Types of Orders • There are several types of orders: market orders – An order to buy/sell a set number of shares immediately at the best price available – The order can be executed within minutes limit orders • An order that specifies a securities trade is to be made only at a certain price or better stop orders • An order to sell a security if the price drops below a specified level or to buy if the price rises above a specified level • Used to protect profits • Reduces risk of investing • Set the stop-loss order price so that you safeguard against only a major fluctuation Example • Suppose you purchased a stock at $50 and it rises to $100, you want to protect your profit of $50 per share because you never know when a stock price may drop. • You put in stop order to sell if it falls below $75, for instance. • Or choose another value..$85, $70? Short selling • Involves borrowing shares from your dealer and selling them with an obligation to replace the shares later along with any lost dividends. • A way to profit from falling stock prices • You sell the borrowed stock, then buy when the price falls, repay dealer his/her stocks and profit from different in price. • Goal is to sell high and buy low • Margin requirement is a condition; the percentage that an investor must have on deposit with a dealer when selling short • Extremely risky!!! Example Expect price of lululemon to fall • Borrow 100 shares from a broker when price is $15/share • Sell shares immediately (+$1500) • Share prices fall to $12/share • Buy back 100 shares (-$1200) and return shares to dealer • Profit= $1500 – 1200 = $300 less commission 3. Dealing with Investment Dealers • Many financial planners are investment dealers. • An investment dealer is someone who is licensed to buy or sell shares for others. Types of investment dealers: • Full-service investment dealer – Paid by commission based on sales volume – Provides advice and direction – Executes trades – CIBC World Markets Inc., RBC Dominion Securities Ltd., Scotia Capital Inc. Discount investment dealer • Executes trades without providing advice • Lower commissions • TD Waterhouse, Bank of Montreal Investor Line, Royal Bank Action Direct Inc. Online Discount Dealers • Typically discount dealers • Allows you to execute trades over the Internet • Lower costs • Investing information is made available, i.e. analyst’s recommendations and earnings reports Cash versus margin accounts: • Cash accounts are “securities trading accounts in which the traders pay in full for their security purchases” • Margin accounts are “securities trading accounts in which the traders borrow a portion of the purchase price from their dealer”. – Pay interest & service fee • The margin is the limit set on the percentage of the security purchase that must be paid by the investor. • It is set by the Investment Dealers Association. • It is advantageous to purchase on margin when the return on the stocks is greater than the cost of borrowing. • A maintenance margin is put in place to protect the investment dealer. • It specifies a minimum percentage margin of collateral that you must maintain, often the initial margin. • Margin accounts are only suitable for experienced investors. Example: • Assume a margin rate of 50% • You purchases 300 shares of Abitibi Inc. at $56 /share • Total cost= $16800 (300 x $56) • Less amount borrowed = $8400 • Your contribution = $8400 • What would happen to your investment if the price of Abitibi rose to $58 /share • Total value= $17400 • Less loan = $8400 • Profit = $9000 • What would happen to your investment if the price of Abitibi dropped to $6/share • Total value= $1800 • Less loan = $8400 • Loss = $6600 Joint accounts • When buying securities with a spouse, the joint account can be set up in different ways: – Joint tenancy with the right of survivorship: surviving owner receives full ownership of assets in the account when the joint owner dies. – Tenancy in common: the deceased’s portion of the account goes to the heirs. Relationship with the investment dealer • Keep in mind that an investment dealer’s income is proportional to the number of trades they do. • It is advised that you take the advice given by the investment dealer and investigate it. The costs of trading securities • Costs can vary dramatically from dealer to dealer. • Example: the purchase of 500 shares of a stock can range from $500 with a full service dealer to $19 with a discount dealer. • There is a lot of variability among full service dealers and among discount dealers, shop around. • When purchasing fixed income securities such as treasury bills, the cost difference may be little to none. Day trading • A day trader is one who trades with a very short time horizon (less than a day), usually over the Internet. • Risky! 4. Sources of Investment Information • Corporate sources Annual reports are a free, easily available and good source. Look for facts and trends in sales, profits and dividends. Lululemon investor information Investment dealer reports • Provided by full service and some discount investment dealers • Cover the direction of the economy • Information on individual companies, analyzing their prospects. Press • Globe & Mail, Financial Post in Canada; Wall Street Journal in U.S. • Financial magazines: Forbes, Fortune, etc. • Personal finance magazines: Money, Smart Money, etc. • The Economist • Public library is a good source • Information on the market and individual stocks: Moody’s Investors Service, Standard & Poor’s, and Value Line. Internet Sources • Corporate information • Many sites, yahoo finance • Beware about source of site, no one controls who can post information.