Finance 301 1st Edition Lecture 14 Outline of Last Lecture I Stock exchanges II Monitoring publicly traded companies III Market for Corporate Control IV Globalization of Stock Markets Outline of Current Lecture V Stock Market Transactions VI Margin Trading Stock Price Increases VII Margin Trading Stock Price Decreases VIII Cash Purchases IX Stock Market Transactions Current Lecture I Stock Market Transactions a Short Selling i What does this mean You can short sell a stock you sell someone elses stock Place an order with your broker you are betting that the price is going to fall They use one of their other customers stock or their own stock or another brokers customers stocks Sell it for 20 you want to buy it back at 15 Do not do for long periods of time 3 months or less you are betting against a company 10 percent of the market is short sell Barnes and Noble and GameStop They would do this because the value of company goes down since you can buy things through technology Electronic Books Online Games ii What is the risk 1 Having to pay other persons dividend Stock price not falling Price can increase iii Restrictions on Short Selling 1 Concerns about Short Selling When the credit crisis intensified in 2008 hedge funds and other investors took large short positions on many stocks What would happen here The price would go down because people are dumping the stock makes the price continue to drop 2 In October 2008 the SEC required that short sellers borrow and deliver the shares to the buyers within three days This rule is important because there were many cases in which brokerage firms were allowing speculators to engage in naked shorting 3 In 2009 the SEC also reinstated the uptick rule previously eliminated in 2007 which prohibits speculators from taking a short position except after the stock price increases iv II Margin Trading Stock Price Increases a Return SP INV Loan D INV b Assume the following i PP 40 ii D 1 iii M 50 iv Interest 10 v SP 60 vi Return 60 40 2 22 loan plus interest 1 20 19 20 95 return Good leverage c III Margin Trading Stock Price Decreases a Return SP INV Loan D INV b Assume the following i PP 40 ii D 1 iii M 50 iv Interest 10 v SP 30 c Bad leverage 30 20 22 1 20 11 20 55 55 return d IV Cash Purchases a Assume that we are investing with cash and not on margin What are the returns b Increasing Prices i Return 60 40 1 40 21 40 52 5 No debt c Declining Prices i Return 30 40 1 40 9 40 22 5 return d Borrow half shares so you can buy half shares of another stock V Stock Market Transactions a Placing an Order To place an order to buy or sell a specific stock an investor contacts a brokerage firm i The investor communicates the order to the broker by specifying 1 the name of the stock 2 whether to buy or sell that stock 3 the number of shares to be bought or sold and 4 whether the order is a market or a limit order ii What is a bid quote Someone trying to buy the stock iii What is an ask quote this is how they set the prices Someone is trying to sell the stock iv What is a market order paying market price v What is a limit order sets min or max price you are going to pay usually last for that day vi As 95 Bid 94 asking for 95 but I am not selling I am bidding 94 but I am not buying On limit order the ask is the seller the bid is the buyer On the market order The bid is the seller the ask is the buyer vii The Federal Reserve imposes initial margin requirements which means we must have a certain of cash What is this percentage 50 percent viii Margin account buying with borrowed money you generally have to have 50 percent of the money and then you can borrow 50 percent You have to set up a margin account ix Maintenance margin x Margin Call if stock is half of what it was they will call it xi Stop Loss Order to protect gains or to limit losses 1 Investor specifies a selling price that is lower than the current market price of the stock xii Stop Buy Order 1 Investor specifies a purchase price that is Higher the current market price xiii Why use this 1 Bought stock at 20 dollars do not wanna loose more than 10 percent on any stock place a stop loss order which would be 18 It protects your loses it is like setting a floor