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1 Chapter 12 Market Microstructure and Strategies Financial Markets and Institutions, 7e, Jeff Madura Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved. 2 Chapter Outline Stock market transactions How trades are executed Regulation of stock trading How barriers to international stock trading have decreased 3 Stock Market Transactions Placing an order Brokerage firms: Serve as financial intermediaries between buyers an sellers of stock Receive orders from customers and pass the orders on to the exchange through a telecommunications network Full-service brokers offer advice to customers on stocks to buy or sell Charge about 4 percent of the transaction amount Discount brokers only execute the transactions Charge about 1 percent of the transaction amount The larger the transaction amount the lower the percentage charged by many brokers 4 Stock Market Transactions (cont’d) Placing an order (cont’d) Investors communicate their order to brokers by specifying: The name of the stock Whether to buy or sell that stock The number of shares to be bought or sold Whether the order is a market order or a limit order A market order to buy or sell a stock means to execute the transaction at the best possible price A limit order differs from a market order in that a limit is placed on the price at which a stock should be purchased or sold 5 Stock Market Transactions (cont’d) Placing an order (cont’d) Stop-loss orders: Are orders where the investor specifies a selling price that is below the current market price of the stock Are typically placed by investors to either protect gains or limit losses Stop-buy orders are orders where the investor specifies a purchase price that is above the current market price 6 Stock Market Transactions (cont’d) Placing an order (cont’d) Placing an order online Many brokers accept orders online, provide real-time quotes, and provide access to information Individual investors maintain more than 5 million online brokerage accounts About one of every seven stock transactions is initiated online Traditional brokers have started to offer some online services Some of the more popular online brokers include Ameritrade, Charles Schwab, Datek, E*Trade, and National Discount Brokers Average execution speed is about 8 seconds 7 Stock Market Transactions (cont’d) Margin trading A margin trade involves cash along with funds borrowed from the broker The Federal Reserve imposes margin requirements which limit the amount of credit brokers can extend to their customers Currently, at least 50 percent of an investor’s invested funds must be paid in cash Margin requirements are intended to ensure that investors can cover their position if the value of their investment declines over time 8 Stock Market Transactions (cont’d) Margin trading (cont’d) Investors: Must establish a margin account with their broker Are required to satisfy a maintenance margin Initially satisfy the maintenance margin with the initial margin Impact on returns The return on stocks purchased on margin is: INV DLOANINVSP R +−− = 9 Computing the Return on A Margin Purchase Billy purchases a stock on margin, borrowing 50% of the funds necessary to complete the purchase. The stock is currently priced at $50 per share, and the stock pays an annual dividend of $.50 per share. The brokerage firm charges an annualized interest rate of 8%. After one year, the stock is sold at a price of $55 per share. What is the return on the margin transaction? %14 25$ 50$.27$25$55$ = +−− = +−− = INV DLOANINVSP R 10 Computing the Return on A Margin Purchase (cont’d) Reconsider the previous example, but assume that the stock declined from $50 to $47 per share over the one year period. What would the return on the margin transaction have been in this case? %18 25$ 50$.27$25$47$ −= +−− = +−− = INV DLOANINVSP R [...]... the previous two examples if Billy had paid the entire price of the stock, without borrowing on margin :Stock Rises to $55 R= $55 − $50 + $.50 = 11% $50 :Stock Falls to $47 $47 − $50 + $.50 R= = −5% $50 12 Stock Market Transactions (cont’d) Margin trading (cont’d) Margin calls If the investor’s equity no longer represents the minimum percentage of the stock’s value required by the broker, the . 1 Chapter 12 Market Microstructure and Strategies Financial Markets and Institutions,. ©2006 by South-Western, a division of Thomson Learning. All rights reserved. 2 Chapter Outline Stock market transactions How trades are executed Regulation
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