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Chapter 6 The Stock Market.docx

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FIN 501
Edward Blinder

FIN501 investment analysis I CHAPTER 6 THE STOCK MARKET THE PRIMARY AND SECONDARY STOCK MARKETS  Primary market: the market in which new securities are originally sold to investors  Secondary market: the market in which previously issued securities trade among investors  Initial public offerings (IPOs): an initial public offering occurs when a company offers stock for sale to the public for the first time  Investment banking firm: a firm specializing in arranging financing for companies  Underwrite: to assume the risk of buying newly issued securities form a company and reselling them to investors o Underwriter spread is a basic part of the underwriter’s compensation which is the difference between the underwriter selling price and purchase price  Fixed commitment: underwriting arrangement in which the investment banker guarantees the firm a fixed amount for its securities  Best effort: arrangement in which the investment banker does not guarantee the firm a fixed amount for its securities  Some restrictions are imposed on you as part of the underwriting contract, such as not being able to sell personal stockholdings for six months after the underwriting  Ontario Securities Commission (OSC): he provincial regulatory agency charged with regulating Toronto Stock Exchange listed securities and the companies  Prospectus: document prepared as part of the security offering detailing a company’s financial position, its operations, and investment plans for the future  Red herring: a preliminary prospectus not yet approved by the Ontario Securities Commission EX. Assume you have a company initially set up a privately held corporation with 100,000 shares of stock, all sold for $1 per share. You bought 50,000 shares and sold the remaining 50,000 to friends and family. Company growth is now hampered by lack of capital; therefore you decide to take the company public. Talk to an investment banking firm and they will suggest issuing 4 million shares of common stock; 2 million will be distributed to original stockholders in exchange for their old shares. After much haggling, investment banker agrees to underwrite the stock issue by purchasing the other 2 million shares at $10 per share; thus raising $20 million. Investment banker will resell the stock in the primary market for $12 per share. When underwriting terms are decided, must obtain approved registration with OSC by preparing a prospectus. While waiting for approval, investment banker will circulate preliminary prospectus among investors to generate interest in stock offering. Once approved, investment banker can begin selling shares to investors.  Secondary market stock trading among investors is directed through three channels: 1. Directly with other investors 2. Indirectly through a broker who arranges transactions for others 3. Directly with a dealer who buys and sells securities from inventory  Dealer: a trader who buys and sells securities from inventory o An important function is maintaining an inventory to accommodate temporary buy and sell order imbalances o Bid price: the price a dealer is willing to pay o Ask price (offering price): the price at which a dealer is willing to sell o Spread: the difference between the bid and the ask price  Broker: an intermediary who arranges securities among investors THE NEW YORK STOCK EXCHANGE  The NYSE has minimum requirements for companies wishing to apply for listing on the Big Board 1. Company’s total number of shareholders must be at least 2,200 and stock trading in the previous six months must have been at least 100,000 shares a month on average 2. At least 1.1 million stock shares must be held in public hands 3. Publicly held shares must have at least $100 million in market value ($60 million for IPOs) 4. The company must have annual earnings of $10 million before taxes in the most recent year and $2 million pre-tax earnings in each of the preceding two years THE TORONTO STOCK EXCHANGE AND TSX VENTURE EXCHANGE  The TSX is a computerized exchange FIN501 investment analysis I  Vancouver and Alberta Exchanges merged to become the Canadian Venture Exchange (CDNX) but the TSX purchased the CNDX and called it the TSX Venture Exchange  Market order: a customer order to buy or sell securities marked for immediate execution at the current market price  Limit order: a customer order to buy or sell securities with a specified “limit” price o The order can be executed only at the limit price or better  Stop order: customer order to buy or sell securities when a preset “stop” price is reached and acts as a immediate conversion into market order o Stop-sell order: an order to sell shares if the stock price falls to a specified stop price below the current stock price  Generally called a stop-loss because it is intended to limit losses on a long position o Stop-buy order: an order to buy shares if the price rises to a specified stop price above the current stock
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