Chapter 1- An Introduction to the Markets Flashcards Preview

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Flashcards in Chapter 1- An Introduction to the Markets Deck (63):


Investor hopes for reasonable rate of return in a matter of time, should strive to be an investor rather than speculator



More short sighted, wants an attractive return by tomorrow.  Not a wise approach if it is the only approach


How does the market evolve?

it changes along with the attitude of its investors


History of Stocks: Early 1900's

-bonds were the primary form of investment

-stocks still speculative

-easy to manipulate prices


History of Stocks: 1920's

- brought changes in attitudes

- still speculative

- heavy margin trading

- margin calls force the 1929 market collapse

- forced federal government to regulate the securities markets


Margin Trading: What Happens when the stock falls?

stock brokers issue a margin call- Investors owe the amount that the stock dropped

Example: stock was 10 then drops to 6: owes broker 4 dollars

- forces people to sell their stock


What were some results of the margin calls during the depression?

Affected housing and mortgages: forced people to sell thier homes to stop all the constant payments

- no one makes money in this type of overheated market


Securities Act of 1933

- required full disclosure of all information from companies- gave investors security and comfort in their investments


Securities Act of 1934

- Established SEC as government regulatory body


Investment Company Act of 1940

- creation and regulation of mutual funds


Investment Advisors Act of 1940

- companies must disclose their background and investment history

- must register with the SEC

- investors msut confess background to their clients


Securities Act Amendments of 1975

- beginning of the marketwe know today

-abolished fixed commissions and established an electronic communication network to make stock pricing more competitive

-cheaper to make trades


Insider Trading and Fraud Act of 1988

-- prohibits indiser trading on non public information


Insider Trading

making trades on info that is not availible to the public; if info is transferred to another person and other person invests in the stock then they are liable as well


Sarbanes-Oxley Act of 2002

- tightened accounting and audit to reduce corporate fraud

-holds anyone responsible off on illegal activity, knowingly or not

-CEO is expected to be aware of what is going on in a company


Financial Industry Regulatory Authority of 2007

FINRA: a self regulatory organization established to oversee securities firms and brokers

- involved in testing, licensing, arbitration; to ensure the integrity of the markets and promote public trust




- conveniant way to save and dissave money; loss of money is less likely

- reduce risk through diversification and hedging

- lottery



- value the firm and price new issue

- raise new capital

-find out the worth of something

- provides managerial incentives


Money Markets

market where short term securities are bought and sold


Capital Market

-Market where long term securities are bought and sold


Primary Market

- the market in which new issues of securites are sold to the public- Used for intial Public Offering (IPO)


Public Offering

-first public sale of companies stock, requires SEC approval

- information required to go public


Rights Offering

- sale to exsiting shareholders


Private Placement

- information that never goes public


Secondary Market

- the market in which securities are traded after they have been issued


Underwriting the offering

-promoting the stock and facilitating the sale of a company's shares



- registration statement describing the issue and the issuer


Red Herring

-preliminary prospectus availible during the waiting period


Quiet Period

- time period after prospectus is filed when company must restrict what is said about the company


Road Show

- series of presentations to potential investors


Underwriting Syndicate


A temporary group of investment banks  and broker-dealers who come together to sell new offerings of equity or debt securities to investors. The underwriter syndicate is formed and led by the lead underwriter for a security issue. An underwriter syndicate is usually formed when an issue is too large for a single firm to handle. The syndicate is compensated by the underwriting spread, which is the difference between the price paid to the issuer and the price received from investors and other broker-dealers.


Underwriting the Issue

- purchases the security at agreed price and bears the risk of reselling it to the public


Selling Group

- help the underwriting syndicate sell issue to the public



- investment banker key particpant in the public market


Securities Exchanges

centralized institutions in which transactions are made in already outstanding securities


Over the Counter Market

- widely scattered telecommunications network in which transactions are made in both initial public offerings and already outstanding securitiies


Bull Market

- feel stock prices will rise


Bear Market

-stock prices will decline, tend to be more speculative


New York Stock Exchange

(NYSE)- an auction market - largest stock exchange in world- over 2700 companies - specialists make transactions in key stocks - strict listing policies - 1366 seats selling up to 4 million


NYSE Euronext

formed in 2007- NYSE Euronext manages a variety of exchanges, located in six countries. The company operates the world's most liquid exchange group, with nearly 4,000 listed companies, which represents a total market capitalization of approximately $30.5 trillion.


Type of NYSE seat holders

- comission or house brokers - independent brokers or floor traders - some are two dollar brokers- paid two dollars to make stock exchange


Designated Market Makers

- specialists who make up 200+ seats, specialzie in certain companies whose job is to maintain an orderly market and facilitate price discovery, make sure that price fluctuations are relatively small, lets public know what exact stock price is.


Regional Stock Exchanges

- typically lists between 100-500 companies - listed on NYSE or NASDAQ - Best known: Chicago, Pacific, Philadelphia, Boston and Cincinnati


Options Exchanges

- allows trading of options on NYSE


Futures Exchanges

Traditionally, a term referring to a central marketplace where futures contracts and options on futures contracts are traded



- a "dealer" market - electronic network connects dealers with buyers and sellers - shares are offered not auctioned


Bid Price

- the highest price offered by market maker to purchase a given security


Ask Price

- the lowest price at which a market maker is willing to sell a given security



- the differnce between the bid price and ask price, this is how dealers make money


Third Market

- large institutional investors go through market makers on the OTC market to trade NYSE listed Stocks - institutional investors (mutual funds, life insurance companies, pension funds) revive reduced tradeing costs due to large size of transactions


Fourth Market

- Large institutional investors deal directly with each other to bypass OTC market makers - Electronic Communications Networks allow direct trading, (Instinet) is an example - ECNs account for about a third of all NASDAQ transactions


Margin Trading

- uses borrowing funds to purchase securities - currently owned securities used as collateral for margin loan from banker - margin requirments set by Federal Reserve Board - determines the minimum amount of equity required - should do a margin trade when you know your stock is going up


Advantages of Margin Trading

- allows use of financial leverage - magnifies profits, make money in a short amount of time


Disdavantages of Margin Trading

- magnifies losses - interest expense on margin loan


Example of Good Margin Trade

- buy 1000 shares at 10 dollars a share- 10000 - stock rises to 15 and I make 5000 or 50% - buy 1000 shares and I put 5000 and I borrow 5000 - stock goes to 15 and I sell - I make $5000 less interest on my 5000 100% return put up 5000 dollars and made 5000 dollars


Example of Bad Margin Trade

- buy 1000 shares at 10 per share - 10000 - stock falls to $5 and I lose $5000 and I borrow 5000 - stock goes to $5 and I sell - I lose $5000 less interest - all of my investment is gone


Short Selling

- investor sells securities they don't own - investor borros securities form the broker - broker lends securities owned by other investors that are held in "street name" - "sell high buy low" - investors make money when stock prices go down - opposite of standard marke procedure (buy low sell high) - investors make money when stock prices go down


Advantages of Short Selling

- chance to profit when stock price declines


Disadvantages of Short Selling

- limits return oppurtunities: stock price cannot go below $0.00 - unlimited risks: stock price can go up an unlimited amount - If the stock price goes up, short seller still needs to buy shares to pay back the "borrowed" amount - Short selling may not earn dividends, stock doesnt decline you dont make money


example of a good Short Sell

- expect Walmart to fall from its current price of $55 a share - sell short 200 shares- I get 11,000 - stock drops to $50 - I replace the stock I borrowed- $10,000 cost - I make $1000 on stock I never owned!


Example of A Bad Short Sell

- expect Walmart to fall from its current price of $55 a share - sell short 200 shares- I get $11,000 - stock rises $60 - I replace the stock I borrowed- $12,000 cost - I lose $1000!