FIN MKTSINSTINTL F
FIN MKTSINSTINTL F FIN 3244
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This 19 page Class Notes was uploaded by Jeanne Daugherty on Thursday September 17, 2015. The Class Notes belongs to FIN 3244 at Florida State University taught by Debra Peterson in Fall 2015. Since its upload, it has received 66 views. For similar materials see Financial Markets, Institutions, and International Finance Systems in Finance at Florida State University.
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Date Created: 09/17/15
Margin Trading 0 Margin is Equity Margin is NOT debt 0 When you quotbuy on margin 0 I Borrow based on the collateral Cash or Stocks you put up I Total Investment S Borrowed Equity Invested 0 Why would you buy on margin I Margin magnifies returns Gains amp Losses I Leverage The use of borrowed money to magnify returns Loan 0 Would magnifying returns or losses change the risk level 0 Debit Baance I YES there is a higher risk level with margin trading Borrowed 0 Equity Ownership Value 0 Dollar Amount I Investment s Market Value Debt Equity I Investment s Market Value Number of Shares x Current Price 39 Margin I The term margin is defined by law 0 How Margin Trading Works I You pay interest on the money you borrow I Two types 0 Initial Margin The minimum equity required to be in a margin account at the time of purchase 0 Set by the Fed currently at 50 If I have 1000 in an account I can borrow 500 0 Exchanges and Brokers can be more restrictive than the Fed Setting higher req is safer for them 0 Maintenance Margin The minimum equity required to be in a margin account after the purchase 0 Set by Exchanges and Brokers 0 Margin Trading Rules I Restricted Account 0 When equity is below initial margin but greater than or equal to maintenance margin 0 Additional purchases are not allowed at this time I Margin Call notice to bring account balance up to the minimum maintenance margin amount OR ELSE o Margin calls are issued when the account balance falls below the maintenance margin Requires investor to O 0 Deposit more equity securities or cash OR Sell some securities A margin call is usually given but it is not required Securiti es can be sold without notice The brokerage chooses which securities to sell and when 0 How Margin Magnifies Profits All Margin 75 Margin 50 Margin Initial Margin 100 75 50 Investors Equity 1000000 1000000 1000000 Initial Borrowing Limit 333333 1000000 Total Funds to Invest 1000000 1333333 2000000 Share Price Initial 5000 5000 5000 of Shares Bought 200 266 400 Total Market Value Initial 1000000 1330000 2000000 Share Price End 7000 7000 7000 of Shares 200 266 400 Total Market Value End 1400000 1862000 2800000 Years Held 050 050 050 Margin Interest Rate 006 006 006 Margin Interest Incurred 10000 30000 Gain 400000 518700 770000 Return on Investment 40 52 77 How to get these numbers 1st Column All Margin Margin Equity lnvestmen tls Mkt Value Equity Debt Equity Initial Margin 100 No Debt You have 10000 of equity to invest Purchase price 50 per share Selling price 70 per share How many shares can you buy 0 O O O Shares 1000050 200 shares Investment value when sold 200 x 70 14000 No interest costs no transaction costs 14000 710000 70 40 Return 10000 How to get these numbers 2quotd column 75 Margin Initial margin 75 10000 of investment equity 0 Purchase price 50 per share Selling price 70 per share 0 How much can you borrow M I Equity argm Equity Debt 10000 75 m 7500 75D 10000 75D 2500 D 333333 Total Investment 10000 333333 1333333 0 How many shares can you buy 0 Total Investment 1333333 1333333 0 Shares 266 shares 50 o What is your return 0 Market Value at Sale 266 x 70 18620 0 Interest 5yr x 06 x 3333 100 186207133007100 5220 10000 10000 I How to get these numbers 3rd column 50 Margin 0 Return 522 0 Initial margin 50 10000 of investment equity 0 Purchase price 50 per share Selling price 70 per share 0 How much can you borrow M I Equity argm Equity Debt 10000 50 m 5000 500 10000 500 5000 D 10000 Total Investment 10000 10000 20000 o How many shares can you buy 0 Total Investment 20000 0 Shares 2039000 400 shares 50 o What is your return 0 Market Value at Sale 400 x 70 28000 0 Interest 5yr x 06 x 10000 300 7700 0 Return 280007200007300 o How does margin magnify losses Initial Margin Investors Equity Initial Borrowing Limit Total Funds to Invest Share Price Initial ofShares Bought Total Market Value Initial Share Price End ofShares Total Market Value End Years Held Margin Interest Rate Margin Interest Incurred Gain RetumDn lUVESIUJE I I HOW to gut HIE iiuiiiur gt 0 Column 1 Return 0 Column 2 Return 0 Column 3 Return 0 When Margin Calls Get Issued Equity Equity Debt Inv Val Margin Call Margin Example 0 10000 10000 77 0 All Margin 75 Margin 50 Margin 100 75 50 1000000 1000000 1000000 333333 1000000 1000000 1333333 2000000 5000 5000 5000 200 266 400 1000000 1330000 2000000 3000 3000 3000 200 266 400 600000 798000 1200000 050 050 050 006 006 006 10000 30000 400000 542000 830000 40 54 83 4000 0 10000 40A 798071330071000 5419 0 10000 542A 122007200007300 8300 0 10000 10000 83A Investments Market Value iDebt Investments Market Value Debt 1 iMaintenance Margin 0 You buy 100 shares of XYZ corp at 45 with 60 margin 0 Your maintenance margin is 25 o What price does XYZ fall to before you get a margin call 0 45 x 100 4500 Inv Mkt Value 0 6 x 4500 2700 equity 0 You borrowed 4500 2700 1800 1800 1725 2400 0 2400 100 shares 24share 0 You get a margin call when the stock price is 24share 0 You get a margin call when 0 Potential Test questions about margin trading I What is the maximum dollar amount you can borrow I What is the minimum equity required to borrow X I What is your margin if you have X of equity and borrow X I What is your margin if your share price rises to X or falls to X I At what investment valuestock price will you get a margin call I What is your investment return I Chapter 2 practice problems 0 Page 83 84 P26 27 28 29 210 211 212 o Page 85 P219 220 o Margin Trading Mechanics I Must have Margin Account 0 Typical minimum 2000 5000 I Broker keeps securities as collateral o Margin Call Notice to bring account balance above maintenance margin 0 If not broker can sell assets in the account 0 Broker can set higher initial amp maintenance margins I Account size I Trader s experience 0 Specific brokerage house 0 Long and Short Stock Transactions 0 The quotLongquot Position I Buy securities hoping they ll increase in value I The Classic quotBuy lowSell highquot strategy Cash In Cash Out Costs Investment Return Dividends Interest Priceend Pricebegin TX Costs Returns Long Prlce begin I Example within a year s time 0 You buy 100 shares of XYZ Corp 0 Buy pay 30 per share amp brokerage fees of 15 0 XYZ Corp dividends total 1 per share annually 0 Sell 100 shares for 35 per share amp pay 15 for the trade DiV Interest Priceend Pricebegin TX Costs Returns Long Pricebegin RetumsLong 1 X 100 0 35 X 100 30 X 100 15 X 2 30 X 100 RetumSLon 100 0 3500 3000 30 5 3000 Returns 19 Long 0 Selling Short I Make money when stock prices DECLINE I The Idea Sell high and buy low In that order 0 You think a stock s price will decline 0 Borrow stock Typically the stock certificate is not held by the owner but by the brokerage firm 0 Sell immediately 0 Buy back when price declines and earn a return I Example 0 Apple sells for 45 per share today You think this is too high amp the price will drop You short 100 shares of the stock A month later the stock sells for 40 per share You cover your position Your Profit 10051ares x 45 40 500 I There is a MAXIMUM possible gain but an INFINITE possible loss I Short Sale Mechanics Shares borrowed from brokerage house 0 No charge for short selling o Brokerage earns profits from buy and sell commissions Requires a margin account 0 All margin account rules apply Sale proceeds remain with broker until position is closed Short seller pays any dividends earned on stock while short position is open As with margin trading 0 You can get margin calls 0 You can lose more money than your investment value Can artificially move the market 0 Down ifa lot of people are selling it puts downward pressure on stock price 0 Up short covering Short selling is very risky and is not something a part time investor should engage in In the absence ofa short selling mechanism security prices tend to be biased in favor of more optimistic investors causing the market to depart from the standards of a perfect market Practice problems in the book 0 Pg 85 P219 P220 0 Basic Stock Positions Summary I Long Position Enter into 0 Buy stock shares I Own them 0 Exit I Sell Shares I Short Position 0 Enter into 0 Borrow stock shares 0 Exit 0 Buy shares 0 Return them to owner I Online Information and Investing o Stockbrokers I The Role of Stockbrokers 0 Licensed by 1 SEC 2 Exchanges I Process Investor Places order 0 Stockbroker transmits order to o Brokerage transmits order to 0 Exchange OTC Market OffExchange Market 0 Confirmation is sent back up to brokerage stockbroker investor I Facilitate trades amp provide services 0 Execute trades o Retain securities in Street Name allows for quicker transactions 0 Research 0 Advice 0 Account statements 0 Money market investment of idle cash I Beware of Churning an illegal process in which broker makes trades simply to generate commission Very hard to prove I Types of Brokerage firms 0 Full Service Goldman amp Sachs 0 Premium Discount 0 Online ETrade Scottrade These usually have the lowest commissions o The differences between these are somewhat blurred I Brokers amp Advisors When they make a suggestion always think about what is in THEIR best interest 0 Some on line brokers are listed in the book on P 112 Table 35 0 Investing Tips I Not everything online is true I Double check tickers and transactions for accuracy 0 AAPL and APL are very different 0 AAPL Apple Computers 0 APL Atlas Piping Partners LLC Studies show the more frequently you trade less likely you ll beat the market This is because 0 Too slow to realize losses too slow to sell a stock in decline Too quick to realize gains People trade on emotions Difficulty Interpreting data Higher transaction costs IT IS VERY DIFFICULT TO TIME THE MARKET There might be questions on these articles in the course library Black Swan Nassim Taleb Why Investors Need to See the Light and Slow Down How News and Statistics Fool Investors Tips for Protecting Yourself Against Financial Fraud Top 6 Recession Investing Myths I Order Types 0 The 3 order types are I Market Order I Limit Order buy or sell I Stop Order AKA Stop loss order I Trade off 0 Price Certainty vs Execution Certainty 0 Market Order I Least complicated most commonly used 0 Tells broker to immediately buy or sell I Whatever the bidask price place order now 0 Advantage 0 Certain order execution 0 Speed Fastest order execution o Disadvantage o Uncertain price usually close to price when ordered 0 Risk In very fast markets I Price can vary significantly from expected 0 Limit Order to buy or sell I Limit order to buy you set max purchase price 0 Tells broker to 0 Buy only if price is equal to or below the limit price 0 Enters a long position I Limit order to sell you set minimum sell price 0 Tells broker to 0 Sell only if price is equal to or higher than limit price 0 Exits long position I Limit order process 0 Order is entered into specialistdealer s book 0 Executed I At limit price or better I After all orders with precedence o Precedence I All market orders I Limit orders with higher buy prices I Limit orders with lower sell prices I Earlier orders at the same price chronologically executed o Advantage 0 Price certainty o Disadvantages 0 Can miss the market 0 No execution certainty 0 Stop order aka stoploss order I Suspended order 0 Activated if specified price is reached 0 Then becomes a market order I Stop Order to Sell 0 Exits long position if activated I Advantage Execution certainty if activated I Disadvantage uncertain price I Primary Use 0 To limit amount of loss if market moves against you I Trade off 0 Price Certainty vs Execution Certainty 0 Miscellaneous Order Types Information I Order time limits 0 Market Orders Not Applicable 0 Limit or Stop Orders 0 Fill or Kill cancelled if not immediately executed 0 Day Order If not executed is automatically canceled at the end ofthe day 0 Good til canceled generally remains in effect for 6 months unless executed cancelled or renewed I Securities Investor Protection Corporation SIPC o nsures accounts against brokerage firm failures I Practice Problems on P 137 138 0 P36 37 39 310 0 Common Stocks 0 Why are Stock Returns hard to predict I Stock prices move on 0 New information News 0 BP makes a big oil find stockjumped up 37 overnight 0 Fact or Rumor 0 Does everyone get info at the same time 0 Does everyone interpret it the same way I Psychology Behavioral Finance 0 Fear 0 Greed 0 Common Stock characteristics I Represents Equity ownership I Owners are entitled to 0 Residual earnings 0 Retained earnings Capital gains benefit investors 0 Distributed earnings Dividends benefit investors 0 Limited Voting privileges I Do stocks have maturity dates 0 No I There are different classes of common stock 0 These can differ in 0 Voting rights 0 Dividend payments 0 Example Ford Motor Company 0 Ford has two classes of stock Same dividend payments Class A has one vote per share Class B has 40 votes per share The Ford family fortune is held in Class B stock They 000 control 40 of shareholder votes The family fortune has suffered significant losses due to decrease in the value of their stock this has prompted some family members to want to sell their shares 0 How and why Firms change of Shares Outstanding I Public offerings I Rights offerings I Spin Offs 3ComPalm 0 Company decides to spin off a segment oftheir business The value ofthe stock will drop by the value ofthe spin off I Stock Splits Apple 0 Stock splits are Cosmetic o Shareholders each get more shares 0 Each share is worth proportionally less 0 No change in shareholder wealth so why split 0 Trading range theory investors like stocks trading in a certain price range 0 No guarantee of increased earnings 0 Studies show approx 10 abnormal returns over next year I Stock Dividends o Management s goal is to be able to continue paying dividends in at least the same amount once they begin paying dividends o Dividend Decision Directors evaluate the firm s operating results and financial condition to determine whether dividends should be paid and if so in what amount 0 Factors impacting dividend decision 0 Earnings EPS Earnings per share 0 Growth amp investment opportunities 0 Current Cash position 0 Contractual constraints that limit dividends o Dividend Dates In Chronological Order 0 Declaration Date I Dividend is announced 0 Ex Dividend date I Determines if one is a registered shareholder on the date of record 0 Date of Record I Determines if shareholder is entitled to dividends 0 Payment Date I Dividend checks are mailed 0 Types of Dividends 0 Cash Dividends I Most common type I Impact on stock prices 0 Compare 0 The closing price on the day before the ex dividend day 0 With the opening price on the ex dividend day 0 Examples XOM GM 0 Cash dividends are currently taxed at 0 Long term capital gains rate 0 Beneficial to investors in high tax brackets most 0 Stock dividends I Paid as additional stock shares I Taxes differed 0 Not paid until gains or losses are realized I Impact on stock prices Decrease 0 Stock Prices 0 Based on Supply and Demand 0 Fixed Supply 0 Demand changes I Expectations of future earnings I Investor Psychology intrinsic value 0 Overpriced think that market expectations are too high 0 Underpriced think that market expectations are too low 0 Price to Earnings ratio PE I Prices move on 0 NEW INFORMATION 0 Market Value ofa Firm 0 Intrinsic investment value I Price you believe a share of stock to be worth I Sets the upper price limit you re willing to pay per share I Price to Earnings ratio PE 0 Market value usually given lper share Market Value 0 Price of common Shares Outstanding per share 0 Common Types of Stock 0 Income O O O O O O I stocks with long and sustained records of paying higher than average dividends Growth I Stocks that experience high rates of growth in operations and earnings Blue Chip I Financially strong high quality stocks with long and stable records of earnings and dividends Technology I Stocks that represent the technology sector of the market Speculative I Stocks that offer the potential for substantial price appreciation usually because of some special situation such as new management or the introduction of a promising new product Cyclical I Stocks whose earnings and overall market performance are closely linked to the general state of the economy Defensive I Stocks that tend to hold their own and even do well when the economy starts to falter Small Mid Large Cap Stocks I A stocks size is based on it s market value This is calculated as the market price of the stock times the number of shares outstanding I Small Cap less than 1 Billion usually has the highest growth potential but the highest risk I Mid Cap 1 billion to 4 or 5 billion I Large Cap 5 billion Investment Strategies Buy and Hold Strategy use quality stocks I Long term wealth accumulation o For Capital Gains Stock price change 0 Long term 0 Results typically follow the market direction 0 Avoids market timing errors 0 Minimizes transaction costs amp taxes 0 For current income dividends I But you still need an exit strategy sell if 0 Aggressive strategy I High stock turnover O 0 High transaction costs I Market Timing I Primary return source capital gains I Risky Speculative Strategy I Profit from market psychology amp irrationality I Very rapid position switching I Extremely risky 0 Comparative Stock Returns 0 Expecations I Smaller firm s stocks more risky I Smaller firm s stocks more volatile I Smaller firm s stocks higher average return over long term 0 DJIA performance 1975 2006 0000000000 0 0 High return 38 1975 Low return 17 1977 23 Positive years 9 Negative years Simple Average of yearly returns 1083 Does this mean you ll earn a 1083 yearly return on the DJIA NO Some years you ll earn that or more Other years you ll lose money It s not as simple as taking an average simple arithmetic mean This illustrates the importance of minimizing negative returns I DIVERSIFICATION 0 Different stocks 0 Different asset classes vehicles instruments Recall the future isn t guaranteed to be the same as the past Historical data is just a tool for predicting future returns 0 Globalization 0 US Equity market is less than 50 ofthe world equity market I Indirectly invest globally through 0 International mutual funds 0 Ex Morgan Stanley Country Index 0 American Depository Receipts o Allows for trading in foreign firms listed on US market exchanges o Priced in US dollars I Directly invest globally by investing in the individual foreign markets 0 The Financial Community is now GLOBAL 0 Retail vs Institutional Investors 0 Retail Us the little guys 0 Institutional Investors the big guys 0 Information I Speed of receipt I Speed of response I Quality 0 Whisper numbers the numbers quotpeople in the know expect to see from a company 0 Access to CEOsCompany insiders I Experience I Emotions I Transaction Costs always reduce returns 0 Best accepted Investing practices 0 Buy low sell high 0 Let compound interest work earn interest on interest 0 Don t try to time the market get in at bottom out at top 0 Diversify 0 Monitor I General economy I Industry trends I Your chosen investment financial footnotes 0 Index 0 Stock index a number that measures I The current price of some stock grouping relative to an earlier time period 0 Indexes let investors quickly I Gauge general market conditions I Compare individual stock returns to those of a large diversified portfolio I Often used as benchmarks I Help to forecast market behavior cycles amp trends 0 Indexes I Dow Jones Industrial Average ADJI 30 securities 0 Chosen for o oftotal market value 0 Broad public ownership 0 High quality large cap stocks NASDAQ 100 ANDX SampP 500 AGSPC Broader than DJIA Wilshire 5000 ADWC All NYSE AMEX amp actively traded OTC stocks Small Cap Indexes Medium Cap Indexes International Indexes 0 Different indexes reference different time periods This makes comparing index numbers meaningless except for 0 General Directional Moves 0 Performance Benchmarks Compare your return to that of an 0 Appropriate index over the same time period It s not just the size of returns but Did you beat the appropriate indexl
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