INVESTMENT ANALYSIS

&
PORTFOLIO MANAGEMENT

Lecture # 2
Dr. Shahid A. Zia
 The Role of the Capital Markets

An exchange serves three principal functions:

• Economic Function
• Continuous Pricing Function
• Fair Pricing Function

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 Economic Function
Capital markets facilitate the flow of
capital from lenders to borrowers.

Capital

Lenders Borrowers

Capital Market

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 Economic Function: An Example
Mortgage

$ Bank

Banks offer home

mortgages so that home
Home Buyer buyers who are short of
cash can borrow money
$
Home to buy houses.
Ownership

Home Seller

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 Fair Pricing Function

Capital markets remove the fear that people have of

buying or selling at a rip-off price. This creates trust in
the system.
The greater the number of participants ( a lot of
potential sellers and buyers) and the more formal the
marketplace, the “fairer” the price. (Exchanges – very
formal).

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 Continuous Pricing Function
Capital markets enable market participants to
get accurate, up-to-date price information.

Compare against alternative of prices that are not up-to-date:

Antique clocks, Chinese porcelain, Pine timberland, Houses.

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• Borrowings ¾ or 75% from debt market
i.e. Bank.
• Borrowings ¼ or 25% from equity market
i.e. Stock Exchange

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In stock market this is relatively free place in
which you borrow easily.

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 Dividend

Dividend is the return whether in the form of

cash or shares (assets) on the amount invested
with you.

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 Advantage of Equity Market

But the advantage of going to the equity market

to raise capital is that you have to pay a dividend
only if you have made a profit.

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 Economic Function

The primary market is the “new

securities” market where securities
are sold to the public for the first
time.

The secondary market is the “used securities”

market, where previously issued securities are
traded among security holders.

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 Initial Public Offering IPO
Initial public offering means those shares that
are being offered first time.

Offer For Sale OFS

Offer for sale means offer those shares that are
already issued.

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 The Exchanges
United States

National Exchanges
New York Stock Exchange (NYSE)
American Stock Exchange (till 1999)
Regional Exchanges
e.g. Philadelphia Stock Exchange and others

International
Exchanges
e.g. London SE,
Euronext,
Tokyo SE,
Bolsa Mexicana
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de Valores
 The Exchanges
• National Exchanges
1. New York Stock Exchange (NYSE)
2. American Stock Exchange (AMEX)

• Regional Exchanges
1. Philadelphia Stock Exchange (Oldest US
exchange)

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 The Exchanges
• International Stock Exchanges
1. London Stock Exchange
2. Hong Kong Stock Exchange
3. Kuala Lumpur Stock Exchange

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 National and Regional Exchanges

• National Exchanges
1. New York Stock Exchange (NYSE)
 Also known as the Big Board
 In 2004, on an average day, 1.46 billion
shares, valued at $46.1 billion, traded on the
NYSE
2. American Stock Exchange (AMEX)
• Merged with NASDAQ in 1999

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 Regional Exchanges

Philadelphia Stock Exchange (oldest US

exchange).
Others (Boston, Cincinnati, Chicago,
Pacific).
Some securities are dual listed.
Traded on both national and regional
exchanges.
Some traded on international exchanges.

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 Trading Systems - NYSE
• Specialists are charged with making a fair and
orderly market in one or more assigned securities at
posts on the exchange floor.
– Distinct feature of NYSE and AMEX.
– A post is a location where a particular stock trades.
– Human runners physically take wired orders from brokers to the
specialist.
– Specialists post screen shows bid/ask/last price.
• Bid price – highest price at which anyone is willing to buy.
• Offer (Ask) price – lowest price at which anyone is willing to sell.
• Difference between the two prices is the spread.
– Specialists ensure buyers will find sellers and sellers will find buyers
(important in crisis situations like October 27, 1997- the Asian flu –
DJ Industrials dropped 554 points) 18
 Trading Systems - NYSE

• SuperDot is an electronic system enabling NYSE firms to send

market orders (up to 30,000 shares before open and up to 2,100
shares after open) and limit orders directly - without human runner - to
the specialists’ posts (up to 100,000 shares). Trades are confirmed by
specialists, so there is the potential for price improvement (“Split the
spread”).
– Covers about 85% of orders that reach the specialist
• NYSE Direct is a system offering automatic execution of limit
orders up to 1,099 shares (small orders). No possibility of price
improvement. Execution price will be the bid or ask price. No
exchange fees charged on such transactions.

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 Pakistan Trading System
• LOTS:
Lahore Online Trading System.
• KATS:
Karachi Automated Trading System.
• ISECTS:
Islamabad Stock Exchange Computerized
Trading System.

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 Trading Systems - CBOE

• Market makers are groups of competing

individuals – “the crowd” - (rather than a
single person) who maintain a fair and
orderly market through open outcry trading
in pits on the exchange floor.
– Used in Options trading like Chicago Board
Options Exchange (CBOE – world’s largest
options exchange)

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 Participants of Stock Market
Member:
A very important participant is member. Member
would mean a member of stock exchange. If
missed a member of stock exchange, you
cannot do business for people. You are
authorized to do business by the exchange if
you are a member.

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 Participants of Stock Market
Brokers:
Brokers are those which participate in the
brokerage industry. They may be a member or a
part of corporate entity.
Agents:
Agents are the authorized representatives of
members licensed by regulatory body as well as
exchanges.

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 Participants of Stock Market
Traders:
Trader is somebody who is directly in touch with
the investors. Traders helps execute your trade.

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 Capital Market
Money market and capital market are
types of Financial markets. Stock market
is a type of capital market.

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 Corporate Culture
Corporate Culture is not mature culture till
yet because when we develop our
organization from scrap, we have some
emotional attachment with organization.

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If you have no dividend in your company,
then you are not bound to pay dividend.
This is basic difference between borrowing
from debt market and equity market.

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 Forms of Organization
• Proprietorship
• Partnership
• Private Limited Companies
• Public Limited companies
Public Unlisted Company
Public Listed Company

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 Types of Stock Exchanges
• Physical Stock Exchange
• Electronic Stock Exchange

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 Physical Stock Exchange
The trading in Physical Stock Exchange is
on:
• Actual Physical Tradition.
• Auction Market.

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Overview of Lecture