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Class Note for FINA 4320 with Professor Boulatov at UH 2


Class Note for FINA 4320 with Professor Boulatov at UH 2

Marketplace > University of Houston > Class Note for FINA 4320 with Professor Boulatov at UH 2

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This 32 page Class Notes was uploaded by an elite notetaker on Friday February 6, 2015. The Class Notes belongs to a course at University of Houston taught by a professor in Fall. Since its upload, it has received 37 views.

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Date Created: 02/06/15
Class 4 HOW Securities are Traded II Fourth Market Investors trading directly with other investors without brokers Originally developed for institutional trading Trading now on ECNS Electronic Communication Networks ECNs alternative to both Exchanges NYSE and Dealer markets NASDAQ Mechanism crossing matching n0 bidask spread Both sides of the trade bene t anonymity ECN 30 TV in NASDAQ stocks pressure on NYSE Electronic Computer Networks ECNs Maj or ECNs Island ECN Instinet REDIBook Archipeligo Competing with Nasdaq and NYSE for volume Lead to some fragmentation of markets Electronic Computer Networks May lead to some fragmentation of markets Lack of info exchange between ECNs eg price quotes on different ECNs Intermarket Trading System ITS only stock exchanges can participate ECNs are excluded afterhour trading larger markets are closed Resolution could be electronic center limitorder book ECNs a technological revolution McAndrews and Stefanadis 2004 The equity lll l39licl an in llllJ mills 1 will Ll li l lll39lLillllEl mil Ij39LJ iIL I lLilllLilli lllE l l wuld ifmlul inn lllL39fll39 alrutlui c and iiiiicraliihii In recent fi C39dl39E i clucii39aiunius L i llll lill lli ll ll licm39i39ii39lia I lil39Hrsi llll lL39Ti39l hl39lll L S39lix39wlzti39mling SFEIUJTLS llml l39IJlfn39 on tmnpulcr SUll i39iTll39C lo mulch buy and Still ugui39L39lcra hamc ilci cluifml i39Elquot1lLllquot and captured a Simhlc Slllll39ii 1 I39 this th39 llall39 l l llLlIITIlIJ mlquot curtain ll ElLlIJE 39l39lin aimi39zilni39s llic nul 3939iquotsmi39l3 claim that lIL Ns s ll39l ifi iipti ll ii iT1 ll39iilL39llll llill Im39ii licl i lilflIJl39 by lii39ii s ii39liiig l aslm39 male CECEIII 1m limur li a iiisaaint lion CITISli and I IquotIi391l lfL L Illlplcl Him ll39llli39ll 139llfll Costs of Trading Commission fee paid to broker for making the transaction Spread cost of trading with dealer Bid price dealer will buy from you Ask price dealer will sell to you pread ask bid Combination on some trades both are paid OTC Market Trading Cost Tra ding Tests I Broker s 1zrzjn 1missien about 2 fer full service a Specielrsts er dealer s bid ask spread Meving the rrlerket when large blocks are tmught and sold price carr react decreasing profit m the firm More Expensiw in Trade mm mrs39 mmmznrj mallImm mum Imam mm Types of Orders Instructions to the brokers on how to complete the order Market Limit Stop loss Market Order Market buy sell given quantity current market price Complications price may depend on quantity liquidity discounts Trading inside the spread two brokers exchange asset inside the quoted bidask spread Timing market prices may change during the trade nite order execution time Limit Order Limit specify the prices which the certain amounts are traded demand schedule limit order book Examples sellbuy a speci ed number of shares when the price is within certain spread Stoploss Order Similar to Limit Are only executed if the price is in the certain range Stoploss sell When the price is below certain value stop further losses Stopbuy buy when the price is above certain value limit potential losses from short position Specialist and Trading Makes the Market in several stocks combines functions of dealer and broker As a Broker income commission executes the orders of other brokers maintains limit order book unexecuted limit orders As a Dealer income spreads Trades from hisher own account if there is no broker to take the other side of the trade maintains an orderly Auction market best orders Win Finite BidAsk spread Competition and price continuity requirement Trading on OTC market Trades are done through Dealers Trade from their own accounts maintain inventory Payoffs BidAsk spread NASDAQ Small Order Execution System SOES Market Makers are required to trade at quoted BA spreads control Disadvantage of OTC trading through trading at quoted spreads While better spreads are available SEC Regulations 1996 public display of L0 Margin Trading Taking advantage of Broker s Call Loans Investor borrows part of stock price from broker Margin in the account portion paid by investor Brokers borrow from banks Call money Rate charge that loan service charge Stock Margin Trading Maximum margin is currently 50 you can borrow up to 50 of the stock value Set by the Fed Maintenance margin minimum amount equity in trading can be before additional funds must be put into the account Margin call noti cation from broker you must put up additional funds Percentage Margin De nition of Margin Ratio of the equity amount of the account to market value of securities Example I Initial Conditions A Corp 1 00 50 Initial Margin 30 Maintenance Margin 100 Shares Purchased Initial Position Stock 10000 Borrowed 4000 Equity 6000 Example I Maintenance Margin Stock price falls to 70 per share New Position Stock 7000 Borrowed 4000 Equity 3000 Margin 30007000 43 Example I Margin Call How far can the stock price fall before a margin call IOOP 4000 IOOP 30 P 5714 IOOP Amt Borrowed Equity Example II Initial Conditions X Corp 70 50 Initial Margin 40 Maintenance Margin 1000 Shares Purchased Initial Position Stock 70000 Borrowed 35000 Equity 35000 Example 11 Maintenance Margin Stock price falls to 60 per share New Position Stock 60000 Borrowed 35000 Equity 25000 Margin 2500060000 4167 Example 11 Margin Call How far can the stock price fall before a margin call IOOOP 35000 IOOOP 40 P 5833 IOOOP Amt Borrowed Equity Buying on Margin Why Why do the investors buy on margin Invest the amount greater than their own money allows Tradeoff Higher upside potential VS higher risk Buying on Margin Example Tradeoff Higher upside potential VS higher risk Suppose period 1 invest W1 by paying W and borrowing Wb at interest rate rb Therefore W1WWb period 2 W2W11r r is an uncertain return Effective return reffW2Wb 1 rb W W This yields reff r rrbWbW note WbW 1010 1 in this case see below Suppose r 30 rb 9 then reff 51 What if r 30 Then reff 69 Risky Q Suppose we borrow 9 Borrow 5000 Investment 5000 10000 15000 Suppose the price goes up r 30 What is the rate of return reff What ifr 30 r 0 Answer reff r r rbWbVV Ifr30 reff 405 ifr 30 reff 495 ifr 0 reff 92 45 Short Sales Purpose to pro t from a decline in the price of a stock or security Mechanics Borrow stock through a dealer Sell it and deposit proceeds and margin in an account Closing out the position buy the stock and return to the party from which is was borrowed Payoffs Short Sell amp Purchase Buy stock Ending Price Dividend Initial Price Short Sell Initial Price Ending Price Dividend Short Sale Basic Rules Last recorded price change should be positive to avoid speculation waves Proceeds are kept in broker s account short seller can not invest them immediately Short sellers are required to maintain margin with the broker cover losses if the price goes up Short Sale Initial Conditions Z Corp 100 Shares Short sell 50 Initial Margin set by broker This means that we maintain at least 5000 in the acct 30 Maintenance Margin Equity in acct must be at least 30 of short position value 100 Initial Price Sale Proceeds 10000 Margin amp Equity 5000 Stock Owed 10000 Short Sale Maintenance Margin Stock Price Rises to 110 Sale Proceeds 10000 Initial Margin 5000 Stock Owed 11000 Net Equity 4000 Margin 400011000 36 gt 30 n0 margin call Short Sale Margin Call How much can the stock price rise before a margin call 15000 100p 100p 30 P 11538 Initial margin plus sale proceeds Regulation and Trends in Markets ECNs present new challenges in regulation Current Issues with Agency problems associated with investment banking and research Insider trading violations SEC regulations Evidence of insider trading CEOs as insiders recent scandals Information leakage before the events e g announcements Insiders returns


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