Topic 2:

Securities Markets and

Transactions
What will be covered in this
topic?
1. Types of securities
◦ Money market and capital market
◦ Primary market and secondary market (Broker vs Dealer
Market)
2. Basic types of Securities Transactions
◦ Long purchase
◦ Margin transaction
◦ Short selling
3. Basic types of Market Order
4. Market Indexes
1-2
2
1. Types of Securities Markets
In terms of maturities, Securities Markets can be
classified into:
Money Markets: the market where short-term securities are bought
and sold
Capital Market: the market where long-term securities such as stocks
and bonds are bought and sold

In terms of whether securities are being sold

initially to investors by the issuers or resold among
the investors:
Primary Market: the market in which new issues of securities are sold
to the public
Secondary Market: the market in which securities are traded after
they have been issued (trading of existing securities)

3
Money Market vs Capital
Market

4
Money Market:

1. A sub-sector of fixed-income market for short-term,

marketable, liquid, low-risk debt securities (cash
equivalents).

2. Many money market instruments are in large

denominations, so out of reach for individual investors.

3. Money market mutual funds make them accessible

to individuals by pooling resources from many investors.

4. Yields vary according to riskiness of securities

(risk premium) – who is the issuer, how long is the
maturities.

5
Money Market Instruments
• Treasury Bills
• discounted short term bonds
• maturities of 28, 91 or 182 days
• minimum denominations of $10,000
• income is exempt from taxes
• highly liquid
• the difference between the purchase price and face value of the T-
bills is the investor’s return
• The investor’s return is used in mathematical formulas to determine
the yield on T-bills
• bank discount yield method takes into account the return as percent
of the face value rather than purchase price – understate the yield
• an alternative formula, bond equivalent yield (investment yield/add
on yield), also can be used to calculate the yield. Unlike the discount
yield formula, the BEY relates the investor’s return to the purchase
price of the bill and uses 365 days.
6
Money Market Instruments
• Treasury Bills
-discounted short term bonds
- maturities of 28, 91 or 182 days
- minimum denominations of $10,000
- income is exempt from taxes
- highly liquid

• Certificates of Deposit
- time deposits with a bank
- treated as deposits by PIDM (insured up to RM250,000)
- negotiable if denomination > $100,000
- highly marketable if maturity < 3 months

7
• Commercial Paper
• unsecured debt by large, well-known companies (usually
backed by a line of credit, LOC, from a bank allowing the issuing
company access to cash that can be used (if needed) to pay off
the paper at maturity)
• maturities 270 days, usually 1-2 months
• denomination is usually multiple of $100,000

• Bankers Acceptances
• like post-dated checks (e.g. instruction by the importer to its
bank to make payment in 6-month to the exporter, importer’s
bank will inform the exporter’s bank, and once this instruction
is accepted by exporter’s bank, a B.A. is created and it can be
sold by the exporter in the secondary market), selling at
discount
• used in international trade (import-export business where the
exporter doesn’t need to know the importer’s
creditworthiness)
8
• Eurodollars Deposit
• USD-denominated deposits overseas
(because they are outside of US financial system, they escape
the regulation by the Federal Reserve Bank and therefore can
offer higher interest rate to the depositors).

•Repurchase Agreements (repos, RPs) and Reverse RPs

• used by dealers in government securities - dealer sells
government securities, usually overnight, and agrees to buy
them back at a slightly higher price (1-day loan with collateral
• term repos – repurchase after ≥30 days
• reverse repo – exactly the opposite of a repo – counter-party
of repo – ie, dealer finds an investor holding government
securities and buys them, agreeing to sell them back at a
specified higher price on future date
• safe, since backed by government securities

9
 Examples of Money Market Instruments in Malaysia
Early Upliftment Prior to Maturity
Instrument Risk Tenure
Date
Malaysian Treasury Bills
Risk free Not applicable 3-, 6- and 12-months
(MTB)
Bankers Acceptance Bank risk Not applicable 21 days to 365 days

Short-Term Money Bank risk No interest paid on early uplift 1 day to 364 days
Market Deposits
(STMMD)
Bank Negara Monetary BNM risk Not applicable 1 month to 3 years
Notes
Negotiable Certificates of Bank risk Not applicable 1 month to 5 years
Deposit (NCD) – a.k.a. NID

Repurchase Agreement Bank risk Early upliftment fee - negotiable 1 day to 1 year
(REPO)
Commercial Paper (CP) Corporatio Not applicable 1-month to 1 year
ns
Fixed Deposit Bank risk Based on Assoc of Banks in 1 month to 5 years
Malaysia (ABM) rules placement <
3 months - no interest paid
Placement tenor > 3 months -
50% of contracted rate
10
Question: What are the Advantages and Disadvantages of
Money Market Investments which are short term in nature?
Advantages
High liquidity
Low risks of default (issuers are government, banks or highly
established companies)

Disadvantages
Low levels of return
Loss of potential purchasing power from inflation
(Money market instruments are a.k.a. marketable securities)
Capital Market (Stock and Bond Market) will be discussed in
the later topics.

11
Primary Market vs
Secondary Market

12
 Primary Markets
The market in which new issues of securities (equity or debt) are sold to
investors.
The most significant transaction in the primary market is the initial public
offering (IPO) - first public sale of a company’s stock and results in the
company’s taking on a public status.
The primary markets also provide a forum for the sale of additional stock, called
seasoned equity issues (SEO), by already public companies.
Requires SEC approval
Three choices to market securities in the primary market:
◦ Public offering: securities offered for sale to public investors.
◦ Rights offering: shares are offered to existing shareholders on a pro rata
basis
◦ Private placement: securities sold directly to select groups of private
investors. Investors involved in private placements are usually large banks,
mutual funds, insurance companies and pension funds)

13
Table 2.1 U.S. Annual IPO Data, 1999-2014

1-14
Small underpricing of Eco World International’s IPO
IPO price =RM1.20, First day closing Price (3 April 2017)= RM1.28

15
Going Public: The IPO Process
One of the earliest step to go public is to appoint an investment
bank as the underwriter.
Prospectus: registration statement describing the issue and the
issuer
Red Herring: preliminary prospectus available to prospective
investors during the waiting period
Quiet Period: time period after prospectus is filed with SC when
company must restrict on what can be said about the company
(usually about one month) – purpose is that all prospective
investors have same info from the preliminary prospectus.
Road Show: series of presentations to potential investors prior to
the actual IPO date.

16
Figure 2.1 Cover of a Preliminary Prospectus for a Stock Issue

17
The Investment Banker’s Role
Underwriting the Issue: purchases the security at agreed-on
price and bears the risk of reselling it to the public
Underwriting Syndicate: group formed by investment bankers
to share the financial risk of underwriting (lead underwriter +
co-underwriters)
Selling Group: other brokerage firms that help the
underwriting syndicate sell issue to the public
Tombstone advertisement: public announcement of issue
and the underwriting groups involved in the IPO
Investment Banker Compensation: typically in the form of a
discount on the purchase price from the issuing firm known as
Underwriting Spread

18
Figure 2.2 The Selling Process for a Large Security Issue

19
Secondary Markets

Secondary Market (aftermarket): the market in which

securities are traded after they have been issued.
Role of Secondary Markets
◦ Provides liquidity to security purchasers
◦ Provides continuous pricing mechanism (with active
participants of buyers and sellers, prices should reflect the true value
of the securities based on all publicly available information at any
point of time – ‘continuous’)

20
Secondary Markets can be divided into two segments on the
basis of how securities are executed: Broker Market and
Dealer Market

Secondary
Market

Broker Dealer
Market Market

National Regional
Nasdaq OTC
Exchanges Exchanges

21
Broker markets consists of national and regional
securities exchanges, which is an important feature
of secondary market.
Securities Exchanges: centralized place where buyers
and sellers of securities or their orders are brought
together to execute trades – the seller sells his
securities directly to the buyer. With the help of a
broker, securities effectively change hands on the
floor of the exchange.
NYSE has more than 4000 companies listed, Bursa
Malaysia has close to 1000 companies listed.

22
Dealer Market
• No centralized trading floor; comprised of market makers
linked via a mass electronic network.
• Consists of both the Nasdaq market and the OTC market
• Dealers facilitate trading by buying or selling from their
own inventory. Dealers are known as the market makers.
• In NYSE, some brokers also act as dealers, they are also
known as the Specialists who are able to play the dual
roles.
• Income for dealers is generated from the bid-ask spread
when they trade with the investors. Income for broker is
generated from the commissions.
• Dealers are known as market makers because they post
their bid and ask prices to trade.

23
Dealer market – Nasdaq vs OTC Markets
• Nasdaq Market in the US: employs an all-electronic trading
platform to execute trades. More than 3800 companies
listed on NASDAQ.
• Over-the-counter (OTC) Market: involves trading in smaller,
unlisted securities of companies who cannot or do not want
to meet the listing requirements of exchanges. Companies
traded on the OTC Markets Group are not required to file
with the SEC.
• NASDAQ used to be considered as an OTC market but from
2006 onward, NASDAQ was formally recognized by the SEC
as an exchange.
• The main feature of the OTC is the informal network of
dealers via electronic system to post their bid and ask
prices.

24
 Matching Order
◦ In broker markets, trades are executed when a buyer
and a seller are brought together by a broker and the
trade takes place directly between the buyer and
seller
◦ Nowadays, many exchanges are using the automated
computerized matching system to execute the orders
placed by investors via their broker (remisier)
◦ Matching means that the highest bid price among all
the bid prices placed by investors will be matched
with the lowest ask price among all the ask prices
placed by investors.
1-25
25
Matching of buy and sell order in broker market
BUY SELL
Order Qty Price Price Qty Order
A 4,500 3.10 2.98 6,600 K
B 25,000 3.08 2.98 5,000 L
C 3,200 3.08 2.99 3,600 M
D 1,900 3.04 3.00 17,500 N
E 49,700 3.00 3.06 1,900 O
F 8,000 2.99 3.08 16,900 P
G 16,400 2.98 3.10 8,500 Q
H 5,400 2.97 3.12 21,650 R
I 900 2.96 3.14 11,420 S
J 4,575 2.95 3.16 290 T

26
Example: Assume you are considering the purchase of 100 shares
of Intel. When you contact your broker, he or she will consult the
Nasdaq electronic quotation machine to determine the current
dealer quotations for INTC, the trading symbol for Intel. The
quote machine will show that about 35 dealers are making a
market in INTC. An example of differing quotations might be as
follows: Which dealer will be selected?

Dealer BID ASK

1 30.60 30.75
2 30.55 30.65
3 30.50 30.65
4 30.55 30.70

If you had been interested in selling 100 shares of Intel

instead of buying, which dealer will be contacted?

27
Alternative Trading Systems

◦ Third market: consists of over-the-counter transactions made in

securities listed on the exchange.
◦ Large institutional investors go through market makers that are
not members of a securities exchange.
◦ Institutional investors (mutual funds, life insurance companies,
pension funds) receive reduced trading costs due to large size
of transactions

◦ Fourth Market: consists of transactions made through a computer

network, rather than on an exchange, directly between large
institutional buyers and sellers of securities.
◦ Unlike third market transactions, fourth market transactions bypass
the market maker.
◦ Electronic communications networks (ECNs) allow direct trading.
◦ Most effective for high-volume, actively traded securities and
play a key role in after-hours trading.
◦ Can save money because they only charge a transaction fee, per
share or based on order size.
General Market Conditions
Bull Market
◦ Favorable markets
◦ Rising prices
◦ Investor/consumer optimism
◦ Economic growth and recovery
◦ Government stimulus (to stimulate the economy)
Bear Market
◦ Unfavorable markets
◦ Falling prices
◦ Investor/consumer pessimism
◦ Economic slowdown
◦ Government restraint (to slowdown an overheated market)

29
2. Basic Types of Securities
Transactions
An investor can make a number of basic types of
securities transactions. Each type is available to
those who meet the requirements established by
government agencies as well as by brokerage firms.
Long Purchase
Margin Trading
Short Selling

1-30
 Basic Types of Securities
Transactions
Long purchase
◦ Long purchase: transaction in which investors buy
securities, usually in the hope they will increase in value
and can be sold at a later date for profit.
◦ Object is to “buy low and sell high”
◦ Most common type of transaction
◦ Return comes from any dividends or interest received
during the ownership period, plus the difference (capital
gain or loss) between the purchase and selling prices.
◦ Reduced by transaction costs

1-31
Basic Types of Securities Transactions -
Terminologies
Margin Trading
◦ Making Margin Transactions
◦ Margin account: established to execute a margin transaction, an
investor must contribute a minimum of equity or 100% of the purchase
price, whichever is less, in the form of cash or securities.
◦ Initial margin: minimum amount of equity that must be provided by the
investor
◦ Restricted account: account with equity less than the initial margin
requirement
◦ Maintenance margin: absolute minimum amount of margin (equity)
that an investor must maintain in the margin account at all times
◦ Margin call: Investor receives this when an insufficient amount of maintenance
margin exists and then has a short period of time (few hour to few days) to
bring equity up above the maintenance margin.
◦ Debit balance: amount of money being borrowed in the margin loan

1-32
 Basic Types of Securities Transactions (cont’d)
Margin Trading
◦ Investors use funds borrowed from brokerage firms to make securities
purchases.
◦ Currently owned securities used as collateral for margin loan from broker.
◦ Margin requirement: the minimum amount of equity that must be in the
margin investor’s own funds.
◦ Margin requirements in Malaysia is set by either BNM (for Commercial Banks)
or Securities Commission (for Investment Banks and securities firms) – margin
is in the range of 50-60%.
◦ Determines the minimum amount of equity required
◦ On $4,445 purchase with 50% margin requirement, investor puts up
$2,222.50 and broker will lend remaining $2,222.50
◦ Can be used for common stocks, preferred stocks, bonds, mutual funds,
options, warrants and futures.
◦ Essentials of Margin trading
◦ The idea of margin trading is to employ financial leverage.
◦ Financial leverage: the use of debt financing to magnify investment returns

33
Table 2.3 The Effect of Margin Trading on Security Returns

34
 Basic Margin Formula
Value of securities  Debit balance
Margin 
Value of securities
V D

V
Debit balance refers to your borrowed amount. Example: to buy 100 shares
at $40/share with initial margin of 70%, what will be the margin level if
your stock price moves to $65?

V D $6,500  $1,200
Margin    0.815  81.5%
V $6,500

1-35
35
Margin Formulas (cont’d)
Return on Invested Capital

Total Total Market Market

current interest value of value of
  
Return on income paid on securities securities
invested capital received margin loan at sale at purchase

from a margin Amount of equity at purchase
transaction

36
 Margin Formulas (cont’d)
Example: You buy 100 shares at $50/share with 50%
margin for 6 months. The share pays $1 per share
dividends during the period. You will pay 10% interest
p.a. on the margin loan. So the borrowed amount is
$2500 and interest amount for 6-month is $125 (10%x
$2500x0.5 =125). If share price moves up to $75/share,
what is the return?
Return on
invested capital $100  $125  $7,500  $5,000 $2,475
   0.99  99%
from a margin $2,500 $2,500
transaction

37
Margin Formulas (cont’d)
Maintenance margin – when the amount in margin account drops
because of decline in the stock price, it will eventually reach a pre-
determined level known as the maintenance margin level where the
investor will receive a margin call from the broker to ask him to bring
equity up above the maintenance margin.
Example: To buy 100 shares at $40/share with initial margin of 70%, if
the maintenance margin is 30%, at what stock price will you receive
margin call? (maintenance margin of 30% means that you need to own
at least 30% equity from the total value of your securities investment)
Margin call price = Po [(1-initial margin)/(1- maintenance margin)]
= 40 (0.3/0.7)
= 17.14

38
Margin Trading
Advantages
1. Allows use of financial leverage
2. Magnifies profits or returns
3. Same investment amount of money can achieve greater
diversification
4. Pyramiding in margin refers to a tactic whereby any excess
margin generated in the margin account (amount above the
initial margin requirement) can be used to purchase
additional securities. Pyramiding is used to magnify returns
to its limit.
Excess margin: more equity in the account than required

39
Margin Trading
Pyramiding Example: If a margin account holds $60,000 worth of
stocks and has the debit balance of $20,000, it is at a margin
level of 66.67% ((60,000-20,000)/60,000. If initial margin
requirement is 50%, the excess margin is 16.67% of $60,000
(which is $10,000) and it can be used to purchase additional
stocks.

Disadvantages
◦ 1. Magnifies losses (refer back to example in Table 2.3)
◦ 2. Interest expense on margin loan
◦ 3. Margin calls – forced sell by the broker

40
Basic Types of Securities Transactions
Short Selling
◦ Investor sells securities they don’t own
◦ Investor borrows securities from broker
◦ Broker lends securities owned by other investors
◦ Try to make money by “Sell high and buy low”
◦ Investors make money when stock prices
go down
◦ Short seller also needs to fulfill the margin requirement.
◦ Ex: If initial margin is 60%, it means that the short seller must deposit in
60% of the short selling proceeds to the margin account. In addition, the
broker retains the proceeds from the short sale. The deposit plus the
proceeds from sale of the borrowed shares assure the broker that
sufficient funds are available to buy back the shorted securities at a later
date, even if their price increases.

41
Table 2.5 The Mechanics of a Short Sale

42
Table 2.6 Margin Positions on Short Sales
When share price changes, the margin level will also change and can be calculated by:
(Your total deposit with broker - Current cost to buy back stock) / Current cost to buy
back stock ) or (Account equity/Current cost to buy back stock)

43
Short Selling
Advantages
◦ Chance to profit when stock price declines
Disadvantages
◦ Limited or capped return opportunities: stock price
cannot go below $0.00
◦ Unlimited risks: stock price can go up an
unlimited amount
◦ If stock price goes up, short seller still needs to buy shares
to pay back the “borrowed” shares to the broker
◦ Short sellers may not earn dividends (and actually may
need to pay dividends)

44
3. Basic Types of Market Orders
Terminologies
Odd-lot Orders
◦ Orders for less than 100 shares of stock
Round-lot Orders
◦ Orders for a 100-share unit or multiples thereof

45
Basic Types of Market Orders
Investors use different types of orders to make
security transactions – depends on the investor’s
goals and expectations.
The three basic types of orders:
1. Market order
2. Limit order
3. Stop-loss order

1-46
46
Basic Types of Orders (cont’d)

1. Market Order:
◦ Orders to buy or sell stock at the best price
available at the time the order is placed
◦ Quickest way to fill order

47
 Basic Types of Orders (cont’d)
2. Limit Order
◦ Order to buy when the price falls to or below a specified price (a limit buy order)
or order to sell when the price up to or above a specified price (a limit sell order).
◦ Ex: if current price is selling at 30.50 and you place a limit buy order at $30. Limit
order is normally used during high stock fluctuation period.
◦ If price limits are not met, order is not filled. So, if the stock price up to $42 later,
you will miss the opportunity to make $11.50 profit (with limit buy order at $30).
If under market order, you already made $11.50 profit.
◦Investors can place a limit order in one of the following forms:
◦Fill-or-Kill Orders (FOK) - Limit orders which is canceled if the entire order is
not filled immediately
◦(Normally used by a trader who sees a short-lived opportunity to buy or sell a
certain specific number of shares that suit a strategy or fit his portfolio.)
◦Day Orders - Limit orders that expires at end of the day if not filled
◦Good-’til-Canceled (GTC) Orders - Limit orders that remains in effect for six
months unless filled, canceled, or renewed

48
Scenario 1: At 10:00 AM Tuesday, you want to place an order to 1000 shares of
XYZ stock. You want the entire order to fill right away, otherwise you don't want it.
Your limit order to buy and the market price of XYZ are the same, $13.50, when
you transmit the order. If there are sufficient number of sell order (1000 shares) at
$13.50, your entire order is immediately filled, if not, your order will be canceled.

In Scenario 2, the market price of XYZ rises to 13.51, away from your limit price of
13.50. Your entire order cannot be immediately filled so it is canceled.

FOK: Situation 1 FOK: Situation 2

Action BUY Action BUY

Qty 1000 Qty 1000

Order Type LMT Order Type LMT

Market Price 13.50 Market Price 13.51

Limit Price 13.50 Limit Price 13.50

Time in Force FOK Time in Force FOK

49
 Basic Types of Orders (cont’d)
3. Stop-Loss Order or Stop Order
◦ Typically used to protect investors from stock price declines
◦ “Suspended” order is placed to sell a stock if price reaches
or falls below a specified level
◦ Orders can be ‘day orders’ or ‘GTC orders’
◦ Once activated, becomes a market order
◦ Ex: Assume you own 100 shares of Firm A which is traded
now at $35/share. You are worried it may fall and decide to
place a stop-loss order to sell at $30. if the price later falls to
$30, your stop order will be activated and allow the broker
to sell at the best price available. If the best price available
by the time your stop order comes up is $28, your share will
be sold at 28.

50
Basic Types of Orders (cont’d)
Stop-Limit Orders
◦ Combine stop order with limit order
◦ Orders to sell stock at a given or better price once
a stipulated stop price has been met
◦ Prevents sales at undesirable price
◦ From the previous example, if you were to place a
‘stop-limit order to sell’ at $30, the broker will not
sell your stock at $28 since it is below the selling
limit at $30. This prevents the selling at
undesirable price. If the price later moves up
again from 28 to $31, your broker will be able to
sell it at $31.
51
 4. Understanding Market Averages
and Indexes
Studying the performance of market averages and
indexes allow you to conveniently
1. Gauge general economics & market conditions – index
represents the entire stock market movement
2. Compare your portfolio performance to large, diversified
portfolio (performance measurement)
3. Study market cycles, trends and behaviors to forecast
future market behavior (technical analysis) – Ex: Is there
such pattern as stock prices are higher in January
(January Effect)?

1-52
Understanding Market Indexes
Stock market averages and indexes measure the general
behavior of stock prices over time.

Stock Market Averages and Indexes

◦ Averages: reflect the arithmetic average price behavior of a
representative group of stocks at a given point in time.
◦ Indexes: measure the current price behavior of a
representative group of stocks in relation to a base value set
at an earlier point in time.

There are generally three different weighting methods used to

construct indexes:
1. Price-weighted
2. Market-capitalization weighted
3. Equally-weighted indexes

53
 Understanding Market Indexes (cont’d)

1. Price-weighted Index:
A price-weighted index adds the market prices of each
stock in the index and divides this total by the number of
stocks in the index. The divisor, however, must be
adjusted for stock splits and other corporate events that
will affect the stock prices so that the index (after the
adjustment) should not be affected by these corporate
events.
Example: Dow Jones Industrial Average (DJIA)

54
Understanding Market Indexes (cont’d)
Dow Jones Industrial Average (DJIA)
◦ Is the most popular price-weighted index in the world
◦ Comprised of 30 high quality, diversified stocks of various
industries in the US
◦ Tracks overall market activity
◦ The DJIA is computed by adding up the prices of 30 blue chip
stocks and divided by a divisor. Over hundred over years of
history since the beginning of DJIA, thousands of corporate
events had occurred and the adjustment made to the divisor
has caused it to become a very small value today, about 0.14

55
Formula for
Price-weighted
Index:

Example:

56
Drawbacks of price-weighted index is that a given percentage
change in the price of a higher price stock has a greater impact on
the index than does an equal percentage change in the price of a
lower priced stock

57
Understanding Market Averages and Indexes (cont’d)
2. Market-Capitalization Weighted Index:
Standard & Poor’s 500 Composite Indexes (S&P 500 Index)
◦ Comprised of 500 large (but not necessarily the largest) stocks from
major industry sectors
◦ More broad-based and representative of overall market than DJIA
◦ They are widely used, frequently as a basis for estimating “market
return”
◦ Standard & Poor’s provide seven other indexes for tracking specific
industry sectors (US)

The most popular index for Malaysia is the ‘FTSE Bursa Malaysia KLCI’
index which is also a market- capitalization index based on 30 blue chip
stocks.

58
Example:

59
Comparing Price-weighted and Market-Weighted Index:

60
61
62
3. Equally-Weighted Index:

What will be the equally-weighted index from the

previous example assuming an initial index value of 100?
Answer:
{[(200/100) -1] + 0 + 0}/3 = 0.33 = 33%
New index value = 100 (1+0.33) = 133

63