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How Securities are Traded
Investment
In economy, an investment is the purchase of
goods that are not consumed today but are
used in the future to create wealth.

In finance, an investment is a monetary asset

purchased with the idea that the asset will
provide income in the future or will be sold at a
higher price for a profit.

Investment in financial instruments are

securities
▪ It brings buyers and sellers TOGETHER to aid in
the transfer of goods and services
▪ It DOES NOT need to have a physical location
▪ The market does not necessarily have to own the
goods and services
▪ It can deal in any VARIETY of goods and services
▪ Both buyers and sellers benefit from the market
Capital markets are markets for buying and
selling equity and debt instruments.

Capital markets channel savings and investment between

suppliers of capital such as retail
investors and institutional investors, and users of capital
like businesses, government and individuals.
▪ Availability of past transaction information - must be
timely and accurate

▪ Liquidity
▪ Marketability
▪ Price continuity
▪ Depth

▪ Low transaction costs: Internal efficiency

▪ Rapid adjustment of prices to new information: External

efficiency
▪ Primary markets
▪ Market where new securities are sold and
funds go to issuing unit (IPOs)

Shares Shares
Investment
Corporation Investors
$$$ Bank $$$
Corporate Bond and Stock Issues

• Corporate bond issues are almost always sold

through a negotiated arrangement with an
investment banking firm that maintains a
relationship with the issuing firm.

New Stock Issues

• Initial public offerings (IPOs): A firm selling its
common stock to the public for the first time
• Seasoned new issues: New shares offered by firms
that already have stock outstanding
• These new issues are typically underwritten by
investment bankers
▪ The investment banker purchases the entire
issue from the issuer and resells the security to
the investing public.
▪ The firm charges a commission for providing
this service.
▪ For municipal bonds, the underwriting function
is performed by both investment banking firms
and commercial banks.

ISSUER UNDERWRITER PUBLIC

Secondary capital markets
▪ Market where outstanding securities
are bought and sold by investors. The
issuing unit does not receive any funds
in a secondary market transaction

Buyer Brokers Seller

Why Secondary Capital Markets Are
Important?
▪ Provides LIQUIDITY to investors who
acquire securities in the primary market
▪ Results in LOWER required RETURNS than
if issuers had to compensate for lower
liquidity
▪ Helps determine MARKET PRICING for
new issues
▪ Market Orders
▪ Buy or sell at the best current price
▪ Provides immediate liquidity

▪ Limit Orders
▪ Order specifies the buy or sell price
▪ Time specifications for order may vary:
Instantaneous “fill or kill”, part of a day, a full day,
several days, a week, a month, or good until
canceled (GTC)
Special Orders
▪ Stop Loss Order
▪ A conditional market order to sell stock if it
drops to a given price
▪ Does not guarantee price you will get upon
sale
▪ Market disruptions can cancel such orders

▪ Stop Buy Order

▪ A conditional market order to buy stock if it
increases to a specified price
▪ Investor who short sell may want to limit
loss if stock increases in price
▪ On any type order, instead of paying 100% cash,
investors can borrow a portion of the transaction
and use the stock as collateral
▪ Interest rate on the money borrowed is normally
1.50% above the bank rate, referred to as the call
money rate.
▪ Changes in stock price change the total market
value of the stock bought and affect the investor’s
equity position in the stock
▪ Margin Requirement
▪ The initial margin requirement is set by the Federal
Reserve at 50%, although individual investment firms
can require higher percentages
▪ Is the margin that investor must pay/bare

▪ Maintenance Margin
▪ Required proportion of equity to stock after
purchase
▪ Protects broker if stock price declines
▪ Minimum requirement is 25%
▪ Margin call on under-margined account to meet
margin requirement
▪ If margin call is not met, the stock will be sold to
pay off the loan
▪ You have $40,000 to invest in Sophie Shoes, selling at $80 per
share. Initial margin requirement = 60%. Show the detail of impact
to your rate of return if the stocks rises to $100 per share and if it
declines to $40 per share; assuming :
(i) you pay cash for the stock
▪ # of shares = $40,000/$80 = 500 shares.
rate of return = (sales proceeds – purchase)/purchase

(sales price per share x number of shares) - (purchase price per share x number of shares)
purchase price per share x number of shares

to $100 $50,000 − $40,000

= = 25.00%
$40,000

$20,000 − $40,000
= = −50.00%
$40,000
to $40
 (ii) you buy it using maximum leverage
▪ Letting X = total investment, Your cash will represent 60 percent of purchase.
▪ Thus 0.60X = $40,000 ; and X = $66,667 (total investment).
▪ Initial investment $40,000; Borrowing $26,667.
▪ At $80 per share, he can purchase ($66,667/$80) = 833 shares.

Total Profit = Total Return – Borrowing – Initial investment

(1) If stock rises to $100/share:
Total profit = ($100 x 833 shares) - $26,667 – 40,000
= $83,300 - $26,667 - $40,000 = $16,633 (profit).
Rate of return = $16,633/$40,000 = 41.58%

(2) If stock falls to $40/share:

Total profit = ($40 x 833 shares) - $26,667 - $40,000
= $33,320 - $26,667 – $40,000
= -$33,347 (loss).
Rate of return = -$33,347/$40,000 = -83.37%
Total liability / Total shareholder equity = leverage ratio

Margin of requirement % = Total investment(100%) / leverage

ratios
▪ Total cost of the purchase = number of share x share

price
▪ Equity invested = margin of requirement × total cost of

purchase
▪ Amount borrowed = ( 100% – margin )x total cost of

purchase / total cost of purchase – equity invested

▪ Interest paid at month end = interest rate x amount

borrowed
▪ Dividend received at month end = div % / div $ x number of

share

▪ Sales /Proceeds on stock sale = number of share x share price

▪ Total commissions paid = % of commission on purchase and

sales

▪ Net gain/loss = −sales – purchase – commission – interest

▪ Initial investment = total cost of purchase (with commission)

▪ Return = net gain /loss / initial investment

▪ Sell overpriced stock that you don’t own and
purchase it back later (hopefully at a lower
price)
▪ Borrow the stock from another investor (through
your broker)
▪ Must pay any dividends to lender
▪ Margin requirements apply (cash or stocks)

Sell high
price
In anticipation of i.e:RM5
price decline
Buy back lower
price
i.e:RM4.50