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Chapter 3

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Ryerson University
FIN 501
Edward Blinder

Chapter 3: Buying and Selling Securities 3.1 Getting Started: Brokerage or trading accounts: open an account with a securities broker, such as Scotia McLeod or TD Waterhouse if you have some money that you want to invest Opening a trading account: - You will be asked to supply some basic information about yourself and sign an agreement (often called a customers agreement) that spells out your rights and obligations and those of your broker - You then give your broker a cheque and instructions on how you want the money invested - Ex: You open an account and instruct your broker to purchase shares of a companys stock and to retain any remaining funds in your account. Your broker will locate a seller and purchase the stock on you behalf. - In addition, for providing this service, your broker will charge you a commission - Your broker will hold your stock for you or deliver the shares to you, whichever you wish. At a later date, you can sell your stock by instructing your broker to do so - You would receive the proceeds from the sale, less another commission charge - You always add money to your account and purchase additional securities, and you can withdraw money from your account or even close it altogether Choosing a Broker: - The first step in opening an account is choosing a broker - Brokers are traditionally divided in 3 groups: 1. Full service brokers o Provide investment advice regarding the types of securities and investment strategies that might be appropriate for you to consider (or avoid) o The larger brokerage firms do extensive research on individual companies and securities and maintain lists of recommended (and not recommended) securities o They maintain offices throughout the country, so, depending on where you live, you can actually stop in and speak to the person assigned to your account o They will even manage your account for you if you wish 2. Discount Brokers o Fall somewhere between the 2 cases offering more investment counseling than the deep-discounters and lower commissions than the full-service brokers 3. Deep-discount brokers o The only services provided are account maintenance and order execution- that is, buying and selling o You generally deal with a deep-discount broker over the telephone, or increasingly, using a Web browser - What distinguishes the three groups is the level of service they provide and the resulting commission they charge - Which type of broker should you choose? Depends on how much advice and service you need or want - If you are the do-it-yourself type, then you may seek out the lower commissions and if you are not, then a full-service broker might be more suitable - Often investors begin with a full-service broker, and then, as they gain experience and confidence, move on to a discount broker - Full-service brokers frequently discount commissions to attract new customers (particularly those with large accounts) - Discount brokers have begun to offer securities research and extensive account management services Online Brokers: - The most important recent change in the brokerage industry is the rapid growth of online brokers, also known as e-brokers or cyber- brokers - With an online broker, you place buy and sell orders over the Internet using a Web browser (ex: Stock- Trak) - Before 1995, online accounts did not exist but millions of investors were buying and selling securities online by 2000 (rapid growth) - Online investing has fundamentally changed the discount and deep-discount brokerage industry by slashing costs dramatically - In a typical online trade, no human intervention is needed by the broker as the entire process is handled electronically, so operating costs are held to a minimum - As cost have fallen, so have commissions - Even for relatively large trades, only brokers typically charge less than $10 per share - Some take a no-frills approach, offering only basic services and very low commission rates - Others, particularly the larger ones, charge a little more but offer a variety of services, including research and various banking services such as cheque-writing privileges, credit cards, debit cards, and even mortgages - As technology continues to improve and investors become more confortable using it, online brokerages will almost surely become the dominant form because of their convenience- and the low commission rates - Table 3.1 page 73: List of Full-Service and Discount Brokerages Canadian Investor Protection Fund: Insurance fund covering investors brokerage accounts with member firms - When you deposit money into the bank, your account is protected (up to $100,000) by the Canadian Deposit Insurance Corporation (CDIC) which is federal Crown corporation - Brokerage firms, even though they are often called investment banks, cannot offer CDIC coverage - Most brokerage firms do belong to the Canadian Investor Protection Fund (CIPF) which was created in the 1969 o It insures your account for up to $1,000,000 for losses of securities, commodity and future contracts, segregated insurance funds and cash o Unlike the CDIC, the CIPF is not a government agency; it is a private insurance fund supported by the securities industry o Almost all brokerage firms are members of the CIPF - There is a very important difference between CIPF coverage and CDIC coverage: o Up to the maximum coverage, the value of whatever you deposit in a bank is fully guaranteed by the CDIC; you will not lose a cent under any circumstances o However, the CIPF insures only that you will receive whatever cash and securities were held for you by your broker in the event of fraud or other failure. The value of any securities, however, is not guaranteed. You can lose everything in CIPF-covered account if the value of your securities falls to zero. Broker-Customer Relations: - Any advice you receive from a broker is not guaranteed (rely on them at your own risk). Your broker does have a duty to exercise reasonable care in formulating recommendations and not recommend anything grossly unsuitable, but that is essentially the extend of it - Your broker works as your agent and has a legal duty to act in your best interest; however, brokerage firms are in the business of generating brokerage commissions (there is a potential for conflict of interest). o On rare occasions, a broker is accused of churning an account, which refers to extensive trading for the sole purpose of generating commissions o You are responsible for checking your account statements- In the unlikely event of a significant problem, your account agreement will probably specify very clearly that you must waive your right to sue and/or seek a jury trial. Instead, you agree that any disputes will be settled by arbitration and that arbitration is final and binding. o Arbitration is not a legal proceeding- a panel will be composed of a small number of individuals who are knowledgeable about the securities industry, but a majority of them will not be associated with the industry o The panel makes a finding and the findings cannot be appealed o The panel does not have to disclose factual findings or legal reasoning 3.2 Brokerage Accounts: The account agreement that you sign has a number of important provisions an details specifying the types of trades that can be made and who can make them Important concern is whether the broker will extend credit and the terms under which credit will be extended Cash Accounts: a brokerage account in which all transactions are made on a strictly cash basis - Simplest arrangement - Securities can be purchased to the extent that sufficient cash is available in the account - If additional purchases are desired, then the needed funds must be promptly supplied Margin Accounts: a brokerage account in which, subject to limits, securities can be bought and sold on credit - Margin Purchase: You can purchase securities on credit using money loaned to you by your broker (subject to limits) - Call Money Rate: the interest rate brokers pay to borrow bank funds for lending to customer margin accounts (the interest rate you pay on the money you borrow which is the rate the broker pays to borrow the money)
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