CHAPTER

TWO

BUYING AND SELLING SECURITIES

1

THE SECURITIES MARKET
• BROKERS
– DEFINITION: act as agents for investors and compensated by commissions.

2

THE SECURITIES MARKET
• Types of Brokerage Firms:
– Retail – Regional – Discount

• Commission

3

Stock Order
• Order Specification - Stock name - Order – buy or sell - Order size - Maximum time order to be left outstanding - Order type to be used
4

ORDERING
• Order Size
– Round lots – Odd lots

5

ORDERING
• Time Limits to Orders
– the investor must specify a time limit when ordering from a broker

6

ORDERING
• Time Limits to Orders
– some typical time limits:
• • • • Day order good-till-canceled (GTC) fill-or-kill (FOK) discretionary

7

ORDERING
• Types of Orders:
– Market order – the broker is instructed to buy or sell a stated number of shares immediately

8

ORDERING
• Types of Orders:
– Limit order – a limit price is specified by the investor when the order is placed

9

ORDERING
• Types of Orders:
– Stop order (Stop-loss) - a trading order that specifies a stop price

10

ORDERING
• Types of Orders:
– Stop limit – trading order specifies both a stop price and a limit price

11

MARGIN ACCOUNTS
• THE PURPOSE OF MARGIN ACCOUNTS:
– these accounts act as a line of credit for more money than is in the investor’s cash account.

12

MARGIN ACCOUNTS
• SOME FEATURES OF MARGIN ACCOUNTS:
– a hypothecation agreement:
• allows pledging and lending

13

MARGIN ACCOUNTS
• SOME FEATURES OF MARGIN ACCOUNTS:
– a street name:
• facilitates pledging/lending

14

MARGIN ACCOUNTS
• MARGIN PURCHASES:
- Purchase of securities financed by borrowing a portion of the purchase price from a brokerage – Initial Margin Requirement – minimum % of a margin purchase price that must come from the investor’s own fund – Actual Margin:
= Market Value – Loan Market Value
15

Question
• Kimone Mesquita purchases on margin 200 shares of Dwayne Blidgen’s Enterprise stock at $75 per share. The initial margin requirement is 55%. Prepare Kimone Mesquita’s balance sheet for this investment at the time of pruchase.

16

Answer
• Assets Securities $75/shr  200 shrs = $15,000 Liabilities & Net Worth Liabilties Margin Loan (1-.55)  $75/shr  200 shrs = $6,750 Net Worth $15,000 - $6,750 = $8,250

17

Questions
• Nordia Richards opened a margin account at Capital & Credit Securities Limited. Richards’ initial investment was to purchase 200 shares of Melanine Facey Corporation on margin at $40 per share. Richards borrowed $3,000.00 from a broker to complete the purchase. • A) At the time of the purchase, what was the collateral in Richards’ account? • B) If Facey stock subsequently rises in price to $60 per share, what is the collateral in Richards’ account? • C) If Facey stock subsequently falls in price to $35 per share, what is the collateral in Richards’ account?
18

Answer
• An investor’s actual collateral is simply the market value of the investor’s assets in the margin account. Thus for Richards: • a. 200 shrs  $40/shr = $8,000 • b. 200 shrs  $60/shr = $12,000 • c. 200 shrs  $35/shr = $7,000

19

MARGIN ACCOUNTS
• MAINTENANCE MARGINS:
– Purpose:
• to prevent default by the investor • to be maintained at the level or above • to restore when undermargined

20

MARGIN ACCOUNTS
• UNDERMARGINED
– the investor’s account value has fallen below the maintenance level

21

MARGIN ACCOUNTS
• Formula for determining the minimal amount of collateral that the investor must keep in his or her account is calculated as follows:
__________Loan_______________ 1 – Maintenance margin requirement The above formula is used to determined if the account is undermargined

22

MARGIN ACCOUNTS
• UNDERMARGINED
– results in a margin call by broker to investor who may
• deposit cash or securities into the account • pay off part of the loan • sell some securities

23

MARGIN ACCOUNTS
• OVERMARGINED:
– if the price of the securities rises above the maintenance margin The following formula is used to determine if the account is over restricted: Loan/1- Initial margin requirement.

24

MARGIN ACCOUNTS
• OVERMARGINED:
– investor may withdraw some funds

25

SHORT SALES
• WHAT IS A SHORT SALE?
– a sale which involves the investor borrowing stock from his/her broker to sell at a higher price and repurchase at a later time at a lower price
26

SHORT SALES
• RULES FOR SHORT SALES:
– The Up-tick Rule – Delivery – Term of the Loan

27

SHORT SALES
• SHORT-SALE MARGINS
– Initial margin

28

SHORT SALES
• SHORT-SALE MARGINS
Actual margin
= (Short Sales Proceeds + Initial Margin) - Loan Loan

29

SHORT SALES
• SHORT-SALE MARGINS
– Maintenance margin
• equal to the current dollar value of the loan.

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