Chapter 5. Page 1. How Securities Are Traded. Learning Objectives. INVESTMENTS: Analysis and Management Second Canadian Edition

Transcription

1 INVESTMENTS: Analysis and Management Second Canadian Edition W. Sean Cleary Charles P. Jones Chapter 5 How Securities Are Traded Learning Objectives Explain the role of brokerage firms and stockbrokers. Describe how brokerage firms operate. Outline how orders to buy and sell securities are executed. Discuss the regulation of the Canadian securities industry. Explain the importance of margin trading and short selling to investors. Page 1

2 Brokerage Operations Brokerage firms earn commissions on executed trades, sales loads on mutual funds, profits from securities sold from inventory, underwriting fees and administrative account fees Full-service brokers offer order execution, information on markets and firms, and investment advice Discount brokers offer order execution Brokerage Account Types Cash account: Investor pays 100% of purchase price for securities Margin account: Investor borrows part of the purchase price from the broker Wrap account: Brokers match investors with outside money managers; all costs are wrapped in one fee Fees and Costs Brokerage commissions differ by security, broker, and investor Institutional investors have greatest negotiating power On-line trading offers significantly lower commission rates to individual investors In 1992 E*TRADE became the first brokerage service to offer on-line trading Dividend reinvestment plans (DRIPs) permit reinvestment of dividends in additional stock Page 2

3 Orders on Organized Exchanges The TSX introduced the world s first computerassisted trading system (CATS) in 1977 The NYSE continues to make use of the specialist system Specialists maintain the limit order book Specialists keep a fair and orderly market by providing liquidity Orders in OTC Markets Dealers are ready to either buy or sell Bid price is the highest offer price to buy Ask price is the lowest price willing to sell Ask price - Bid price >0 (dealer spread) Dealer makes a market in the security More than one dealer for each security in overthe-counter markets Types of Orders Market order: Authorizes immediate transaction at best available price Limit order: Specifies a particular market price before a transaction is authorized Stop order: Specifies a particular market price at which a market order is authorized Page 3

4 Clearing Procedures Settlement dates for stocks are three business days after the trade date Legal ownership transferred and financial arrangements settled with brokerage firm Transfer of securities and funds between exchange members facilitated by a clearinghouse: The Canadian Depository for Securities (CDS) Canadian Regulatory Environment Self-Regulatory Organizations (SROs) regulate their own activities Canadian Investor Protection Fund (CIPF) was established to protect investors Investment Dealers Association of Canada (IDA) is the national trade association for the investment industry Canadian Securities Institute (CSI) is the national education body of the Canadian securities industry Margin Accounts Exchanges set minimum required deposits of cash or securities Investor pays part of investment cost, borrows remainder from broker Margin is the percent of total value that cannot be borrowed from broker Margin call occurs when the actual margin declines below the margin requirement Page 4

5 Short Sales Investor borrows stock from a third party Borrowed security sold in open market, to be repurchased later at an expected price lower than sale price Investor liable for declared dividends Short sale proceeds held by broker Investor responsible for borrowed shares Copyright Copyright 2005 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein. Page 5