Practice investment management pim3 ch06

CHAPTER SIX

MARKET MECHANICS

Practical Investment Management
Robert A. Strong


Outline


Placing Orders
Order Information Flow
 Types of Orders
 Settlement Procedures




The Specialist and the Book
The Specialist and the Spread
 Adjusting Limit and Stop Prices for Dividends


The

Ticker Tape

Format
 Accuracy
 Other Ticker Tape Information



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Outline


Types of Accounts
Cash Account
 Margin Account
 Other Types of Accounts




Selling Short
Rationale
 Criticisms
 Mechanics of a Short Sale
 Selling Short Against the Box


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Outline



Trading Fees
The Costs of Trading
 The Commission Structure
 Full-Service Brokers
 Discount Brokers
 Electronic Brokers
 Current Events


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Placing Orders: Order Information Flow
3. Confirms trade
Stock Exchange

3. Confirms
trade

2. Submits
order

4. Confirms
trade

1. Places
order

Broker

Brokerage Firm
Accounting Operations

5. Mails
confirmation
statement

Individual Investor
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Placing Orders: Types of Orders


Market orders are to be executed as soon as
possible after reaching the exchange floor.



Limit orders must specify a price and a time
limit, e.g. “Buy 500 at $90, good till canceled.”



A stop order differs from a limit order in that
the order is only executed if the specified
price, called the stop price, is touched.
Stop orders become market orders when the
stop price is reached.

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Placing Orders: Types of Orders

Insert Figure 6-2 here.

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Placing Orders: Types of Orders

BID

VOL

ASK

VOL

90.25

25

90.50

50

Last Trade 90.50

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Placing Orders: Types of Orders


The most important use of a stop order is to
protect a profit.
Moving a stop up behind a rising stock is
called using a crawling stop order.



Other orders:
- once cancels the other
- all or none
- fill or kill

- stop limit

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Placing Orders: Types of Orders

Insert Figure 6-3 here.

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Placing Orders: Settlement Procedures


The activities surrounding the transfer of
ownership are called settlement procedures.



In the United States, stock and bond
transactions settle three business days after
the trade date.



A number of market speculators engage in a
practice known as a day trade, which involves
buying and selling securities on the same day.

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The Specialist and the Book


Specialists help maintain a fair and orderly
market.



To tighten the spread in the market,
specialists may actively participate in the
market.

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The Specialist and the Book

Insert Figure 6-4 here.

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The Specialist and the Book

Insert Figure 6-5 here.

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The Specialist and the Book

Insert Figure 6-6 here.

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The Specialist and the Book



Unless a customer indicates a contrary
wish, limit and stop orders are
automatically adjusted

downward for the payment of
a cash dividend.

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The Ticker Tape
DE
HRD
PEP
ASN C DIS
90 1/4 6s25 3/4 10,000s37 2s55 8 6s55.2s 1/8



Today, the tape is electronic , passing by on a
screen.



To accommodate the human eye, an upper
speed limit is set for the tape. So, on heavy
trading days, trade data can get backlogged.



Notices like data corrections, omissions,
and news may also appear on the tape.

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The Ticker Tape

Insert Figure 6-8 here.

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Types of Accounts
In a cash account, an investor must come
up with cash equal to the full value of the
securities purchased.
Cash Account
Assets
Cash
$23,089.76
500 DE
45,000.00
300 INTC
24,000.00
100 RBD
3,000.00
500 OCR

17,437.50
$112,527.26

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Liabilities

Equity

$112,527.26
$112,527.26

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Types of Accounts
A margin account permits an investor to
borrow part of the cost of investments from
a brokerage firm.
Margin Account
500
300
100
500

Assets
DE
$45,000.00
INTC
24,000.00

RBD
3,000.00
OCR
17,437.50

Liabilities
Margin
$33,792.10

Equity
$89,437.50

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$55,645.40
$89,437.50

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Margin Accounts: The Nature of the Debt


An investor must pay interest on a
margin loan, until the debt is
repaid from the eventual sale of
the securities.



The base rate for these loans is called the
broker’s call money rate.



The smaller the loan, the higher the interest
rate.

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Margin Accounts: Fed Regulation T


Margin trading is governed by Regulation T of
the Federal Reserve Board.



The initial margin requirement is the
percentage an investor must pay toward new
purchases.

The

maintenance margin requirement
determines how badly a position can
deteriorate before the investor must deposit

more money into the account portfolio.

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Margin Accounts: Buying Power
 Buying power is a measure of how much
more can be spent for securities without
having to put up any additional cash.




buying 
1

 1  equity 
power
initial margin


 requiremen t



debit
balance

Buying power can be used to withdraw cash,
but the reduction in buying power will be
greater than the amount of cash
withdrawn.

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Margin Accounts: Buying Power
Margin Account
Assets
500 DE
$45,000.00
300 INTC
24,000.00
100 RBD
3,000.00
500 OCR
17,437.50
3000 BAD
18,000.00
$107,437.50

Liabilities
Margin
$51,792.10

Equity

$55,645.40
$107,437.50

Buying Power: $55,645.50 - $51, 792.10 = $3,853.30
Figure 6-11
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Margin Accounts: Withdrawing Cash
Margin Account
Assets
500 DE
$45,000.00
300 INTC
24,000.00
100 RBD
3,000.00
500 OCR
17,437.50
3000 BAD
18,000.00
$107,437.50

Liabilities
Margin
$53,718.75

Equity

$53,718.75
$107,437.50

Buying Power: $53,718.75 - $53,718.75 =$0
Figure 6-12
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