Securities Trading: Primary vs. Secondary Markets and Underwriting Processes - Prof. Alexe, Study notes of Finance

Download Securities Trading: Primary vs. Secondary Markets and Underwriting Processes - Prof. Alexe and more Study notes Finance in PDF only on Docsity! Class 3 How Securities are Traded I Primary vs. Secondary Security Sales • Primary – New issue (marketed by Inv. Bankers) – Key factor: issuer receives the proceeds from the sale • Secondary – Existing owner sells to another party – Issuing firm doesn’t receive proceeds and is not directly involved Investment Banking Arrangements • Firm Commitment: – Underwriters purchase security from issuer – Resell to public – Underwriters assume the risk of selling shares • Best Efforts agreement: – Underwriter does not purchase the issue (does not bear the risk) – Is more common • Public offerings: registered with the SEC and sale is made to the investing public – Shelf registration (Rule 415, since 1982) • allows firms to sell securities for 2 yrs after initial registration • can be sold on short notice (are ‘on the shelf”) • Initial Public Offerings (IPOs) – Evidence of underpricing: price jumps (upward) • occur on the first trading day (public security markets) – IPOs are marketed to investors at attractive price – Long-term investment - not good (underperformance) Public Offerings IPOs: underpricing Underpricing of IPOs — shares sold at a discount (15% on average) + Netscape'’s initial offering price jumped from $14 a share to $28, and then to over $58 once issued. Netscape’s shares were underpriced by almost 108%! Possible Explanations sweetener to generate investor interest principle — agent conflict produce information about the firm (book building) . tax reasons (qualified vs. non-qualified) cascading ms one Long-run underperformance of IPOs — possible evidence of over-optimism, or cascading + debate ongoing in the financial literature IPO Issuance, 1980-2002 Total IPO Issuance Percentage of Year Number of [POs (Millions of Dollars} Total Market IPO 1980 147 1.315 O.077 1981 BAF 3,055 O.212 1982 121 0.080 ° ° e 1983 675 0.636 activity: 3 017 1985 3 0.276 1986 17,198 0.675 L987 13,012 o.510 1988 4.445 0.160 ee 1989 O.164 raising from == a3 1990 O45 1991 0.382 80s to 90s - oe ? 1993 0.576 ‘ 1994 0.339 especially om _ 1996 0.493 ] 999 2000 1997 32,413 0.295 - 1998 32,295 0.239 1999 54,272 o310 1990-99 275,010 0.364 2000 SL701 0.325 2001 a1 32,045 0.226 2002 86 1980-2002 9,095 0.320 Source: Thomson Financial Securities Data Corporation (SDC). IPOs: who goes public and why? Point: pre-issue underperformance of IPOs Private placement: sale to a limited number of sophisticated investors not requiring the protection of registration • Allowed under Rule 144A • Dominated by institutions • Very active market for debt securities • Not active for stock offerings Private Placements Organization of Secondary Markets • Organized exchanges • OTC market • Third market • Fourth market Organized Exchanges • Auction markets with centralized order flow - formally organized exchange • Dealership function: can be competitive or assigned by the exchange (Specialists) • Securities: stock, futures contracts, options, and to a lesser extent, bonds • Examples: NYSE, AMEX, Regionals, CBOE NYSE I (A) New York Stock Exchange (NYSE) e Largest U.S. market (and the world’s) — about 2,800 company stocks trading e Approximately 1.3 billion shares traded daily — dollar volume of about $40 billion / day e Listed companies worth $10 trillion e Strict listing criteria — e.g., market value of stock must be > $60m Other Exchanges (B) American Stock Exchange (AMEX) e National in scope as NYSE, but specializes in smaller, younger firms. (C) Regional exchanges e Midwest, Pacific, Philadelphia, Boston, etc. (D) International exchanges e Tokyo (Nikkei), London (F TSE), Frankfurt, Paris, Zurich, Toronto, Singapore, Hong Kong, emerging markets, etc. Exchanges: Market Capitalization Market Capitalization (trillions) Damestic Listed Companies (excluding closed- end funds - official FIBV figures) All xchanges of NYSE which: Nasdaq Tokyo London Euronext Germany NYSE Global Market Capitalization (trillions): Total Global Market Capitalization of all NYSE- Listed Companies of Domestic Cos. (excl. closed-end funds which: - official FIBV figure) Closed-End Funds Non-U.S. Companies (global market capitalization) 10/31/03 10/31/02 12/31/02 $28.6 310.8 $2.9 $2.3 $2.2 $1.9 $0.9 11/30/03 $16.1 $10.9 $0.1 $5.1 $22.0 $9.1 $2.0 $2.1 $1.8 $1.5 $0.7 11/30/02 $13.3 $9.4 $0.1 $3.8 $22.2 $9.0 $2.0 $2.1 $1.8 $1.5 $0.7 12/31/02 $13.4 $9.0 $0.1 $4.3 OTC Market • Dealer market without centralized order flow – informal network of dealers and brokers – NASDAQ: largest organized stock market for OTC trading; information system for individuals, brokers and dealers – National Market System – Nasdaq SmallCap Market • Lower volume securities – OTC Bulletin Board – Pink Sheets from NASD • Securities: stocks, bonds and some derivatives – Most secondary bonds transactions NASDAQ III e Most fixed-income securities are traded on OTC markets — 35,000 issues traded by hundreds of registered dealers linked by computer showing their bid and ask prices — most stocks have between 2 and 50 dealers offering quotes e brokers are also linked in and trade at the best price they see (supposedly. However, . . .) e Christie and Schultz (1994) found that NASDAQ dealers were avoiding odd eighth quotes => collusion among dealers to increase spread? (academics take credit; dealers unaware?) NASDAQ Scandal e NASDAQ scandal: 2 year investigation, ending Summer 1996 to see if NASDAQ dealers collude to fix bid/ask spreads — spread rarely 4 or #: more typically 4 or 4 e Immediately after the phenomenon was reported, spreads dropped quickly! (perhaps the most incriminating evidence) e Proposed settlement (July 1996) — no admission/denial of wrongdoing — no fines — dealers required to install costly monitoring equipment to prevent future collusion Third Market • Trading of listed securities away from the exchange (in OTC market) • Institutional market: to facilitate trades of larger blocks of securities – Before May 1, 1975 (May Day): • members of exchange were required to charge commissions for exchange-listed securities according to the fixed schedule • undercut by non-members (lower commissions) – After: commissions became negotiable