Transcript Investments: Analysis and Management, Second Canadian Editiion

INVESTMENTS:
Analysis and Management
Second Canadian Edition
W. Sean Cleary
Charles P. Jones
Chapter 5
How Securities Are Traded
Learning Objectives
• Explain the role of brokerage firms and
stockbrokers.
• Describe how brokerage firms operate.
• Outline how orders to buy and sell securities are
executed.
• Discuss the regulation of the Canadian securities
industry.
• Explain the importance of margin trading and
short selling to investors.
Brokerage Operations
• Brokerage firms earn commissions on executed
trades, sales loads on mutual funds, profits from
securities sold from inventory, underwriting fees
and administrative account fees
• Full-service brokers offer order execution,
information on markets and firms, and investment
advice
• Discount brokers offer order execution
Brokerage Account Types
• Cash account: Investor pays 100% of
purchase price for securities
• Margin account: Investor borrows part of the
purchase price from the broker
• Wrap account: Brokers match investors with
outside money managers; all costs are
wrapped in one fee
Fees and Costs
• Brokerage commissions differ by security,
broker, and investor


Institutional investors have greatest negotiating
power
On-line trading offers significantly lower
commission rates to individual investors
•
In 1992 E*TRADE became the first brokerage
service to offer on-line trading
• Dividend reinvestment plans (DRIPs) permit
reinvestment of dividends in additional stock
Orders on Organized Exchanges
• The TSX introduced the world’s first computerassisted trading system (CATS) in 1977
• The NYSE continues to make use of the
specialist system


Specialists maintain the limit order book
Specialists keep a fair and orderly market by
providing liquidity
Orders in OTC Markets
• Dealers are ready to either buy or sell


Bid price is the highest offer price to buy
Ask price is the lowest price willing to sell
•


Ask price - Bid price >0 (dealer spread)
Dealer “makes a market” in the security
More than one dealer for each security in overthe-counter markets
Types of Orders
• Market order: Authorizes immediate
transaction at best available price
• Limit order: Specifies a particular market price
before a transaction is authorized
• Stop order: Specifies a particular market price
at which a market order is authorized
Clearing Procedures
• Settlement dates for stocks are three
business days after the trade date

Legal ownership transferred and financial
arrangements settled with brokerage firm
• Transfer of securities and funds between
exchange members facilitated by a
clearinghouse: The Canadian Depository for
Securities (CDS)
Canadian Regulatory Environment
• Self-Regulatory Organizations (SROs) regulate
their own activities
• Canadian Investor Protection Fund (CIPF) was
established to protect investors
• Investment Dealers Association of Canada (IDA)
is the national trade association for the
investment industry
• Canadian Securities Institute (CSI) is the national
education body of the Canadian securities
industry
Margin Accounts
• Exchanges set minimum required deposits of
cash or securities
• Investor pays part of investment cost,
borrows remainder from broker

Margin is the percent of total value that cannot
be borrowed from broker
• Margin call occurs when the actual margin
declines below the margin requirement
Short Sales
• Investor borrows stock from a third party
• Borrowed security sold in open market, to be
repurchased later at an expected price lower
than sale price



Investor liable for declared dividends
Short sale proceeds held by broker
Investor responsible for borrowed shares
Copyright
Copyright © 2005 John Wiley & Sons Canada, Ltd. All rights
reserved. Reproduction or translation of this work beyond that
permitted by Access Copyright (The Canadian Copyright
Licensing Agency) is unlawful. Requests for further information
should be addressed to the Permissions Department, John Wiley
& Sons Canada, Ltd. The purchaser may make back-up copies
for his or her own use only and not for distribution or resale. The
author and the publisher assume no responsibility for errors,
omissions, or damages caused by the use of these programs or
from the use of the information contained herein.