INVESTMENT AND PORTFOLIO MANAGEMENT-3.ppt

PORTFOLIO MANAGEMENT

MARKETS FOR SECURITIES


Definition:A security market is a place or medium where buying and selling of securities takes place.Most of the countries in the world have developed such markets to facilitate security trading as it is considered to play a significant role in the economy.Security markets can be broadly classified in:

Primary markets, and Secondary markets.Another classification is:

Money markets, and Capital marketsMarket mechanisms make possible the transfer of funds from surplus to deficit sectors, efficiently and at low cost.


MARKETS FOR SECURITIESSecurity Market

Equity Market

Debt Market

Derivatives Market

Government Securities Market

Corporate Debt Market Money Market

Options Market Future Markets

Primary Market Secondary market

The top ten stock markets of the world• 1- New York Stock Exchange• 2- Tokyo Stock Exchange• 3- NASDAQ• 4- London Stock Exchange• 5- Euronext• 6- Toronto Stock Exchange• 7- Frankfurt Stock Exchange (Deutsche Börse)• 8- Madrid Stock Exchange (BME Spanish

Exchanges)• 9- Hong Kong Stock Exchange• 10- SWX Swiss Exchange




GCC Stock Markets • TASI (Saudi Stock Market)• DFM (Dubai Financial Market)• ADX (Abudhabi Securities Exchange)• KSE (Kuwait Stock Exchange)• BSE (Bahrain Stock Exchange)• MSM (Muscat Securities Market) • QE (Qatar Exchange) • ASE (Amman Stock Exchange)


Pakistan Stock MarketsIslamabad Stock Exchange (ISE)Lahore Stock Exchange (LSE)Karachi Stock Exchange (KSE):• A stock market was established in 1947.• Started with 5 companies with a paid-up capital of

Rs.37 million.• Currently Karachi Stock exchange is now owned

by 200 members.• 1850 terminals exist at broker end.• 651 companies are listed with KSE.• Trading through an electronic trading system• Market capitalization, as of June 30, 2009, US$

26.48 billion.


Characteristics of Good Stock Markets• To determine the appropriate price, participants must have timely

and accurate information on the volume and prices of past transactions and on all currently outstanding bids and offers. Therefore, one attribute of a good market is timely and accurate information.

• Another prime requirement is liquidity, the ability to buy or sell an asset quickly and at a known price—that is, a price not substantially different from the prices for prior transactions, assuming no new information is available.

• A component of liquidity is price continuity, which means that prices do not change much from one transaction to the next unless substantial new information becomes available.

• A market with price continuity requires depth, which means that numerous potential buyers and sellers must be willing to trade at prices above and below the current market price.

• Another factor contributing to a good market is the transaction cost.

• Prices to adjust quickly to new information regarding supply or demand, which means that prices reflect all available information about the asset. This attribute is referred to as external efficiency or informational efficiency.


Key Terminologies:Stock Exchanges: It is an institution where securities that have already

been issued are bought and sold. Presently there are three stock exchanges in Pakistan. The oldest and most important one is Karachi Stock Exchange.

Listed Securities: Securities that are listed on various stock exchanges and hence eligible for being traded.

Depositories: A depository is an institution which dematerializes physical certificates and effects transfer of ownership by electronic book entries.

Brokers: Brokers are registered members of the stock exchanges through whom investors transact.

Under-writers: An under-writer agrees to subscribe to a given number of shares (or any other security) in the even the public subscription is inadequate. The under-writer, in a essence, stands guarantee for public subscription.

Bankers to an issue: The Bankers to an issue collect money on behalf of the company from the applicants.

Venture Capital Funds: A Venture Capital Fund is a pool of capital which is essentially invested in equity shares or equity-linked instruments of unlisted companies.


Broker/Brokerage House/Representative• A stock broker or stockbroker is a regulated professional broker who

buys and sells shares and other securities through market.• A registered representative is an individual from brokerage house, with

whom the investor has most contact. Based on the type of investor the brokerage houses can be divided into the following:

– Dealing with investor of modest size primarily interested in odd-lots– Addressing the wealthier investors.– Focusing on institutional business.

• Analytical reports for different interest groups are published or issued by these brokers.

• While selecting a brokerage an investor should see the following attributes:

– Equipped with a research department– Have qualified staff that can provide first hand market analysis– Provide assistance to companies for raising funds or new securities.– Equipped with a research library

• Following attributes should be considered while selecting a representative– Educational qualifications, experience, investment philosophies and goals– Availability and level of burden– Not always trying to sell something to the investor– Have a good knowledge of scripts owned by the investor.– Able to keep investor update and give adequate advices.


Primary Markets:• Securities available for the first time are

offered through the Primary Markets. These are primarily arranges additional funds for the coffers of the issuer. Whereas in the secondary markets just change in hands takes place.

• After going through the primary markets the securities can be traded in the secondary markets.


Primary Markets:Investment Banker (IB):• The traditional middleman in the Primary markets is

called Investment Banker.• IB’s primary responsibility is to bring buyers and

sellers.As an Underwriter:• IB normally buys the new issue from the issuer at the

agreed upon price and hope to resell it to the investing public at a higher price.

• In this capacity, IB are said to underwrite, or guarantee, an issue.

• Usually IBs joined hand (make a syndicate) to underwrite an issue. In such case the commission of the IB will be according to its purchase.


Primary Markets:


Primary Markets:As a best-efforts /agency arrangement• In this case IB does not underwrite the issue but only

facilitate to sell the scripts through its best efforts. Any unsold script is returned back to the issuer. It happens in two situations:

– When a company is small or the issuer is new to the market.– The issuer is confident with the script and hope a higher prices

can be obtained from the market.Private Placement:• At times issuers make direct sales to the investor

groups or institutions. This is called Private Placement.• In cases the IB acts as a facilitator to locate investor

for direct sales, and charge a commission for it.


Secondary Markets:• The stock once sold to the investor can be

traded in the Secondary Markets.• Organized Exchanges are physical market-

places where the agents of buyers and sellers operate through the auction process.

• The transactions in the Secondary Markets can be divided into:– Organized Exchange– Over-the-counter (OTC)

• The primary middleman is categorized as:– Broker: It acts as an agent– Dealer: It acts as principal dealer in transaction.


Secondary Markets:• The over-the-counter (OTC) market includes

trading in all stocks not listed on one of the exchanges.

• The OTC market is not a formal organization with membership requirements or a specific list of stocks deemed eligible for trading.

• In theory, any security can be traded on the OTC market as long as a registered dealer is willing to make a market in the security (willing to buy and sell shares of the stock).


Secondary Markets:• Every market lists certain stocks for trading. KSE

has a list of 651 companies. • These companies have to follow certain rules

and regulations and pay annual fees for maintaining their name in the registered list.

• The initial listing requirements are:– Number of shareholders– Minimum demonstrated earnings– Asset size– Number of shares outstanding


Secondary Markets:A person is eligible for registration as a broker, in the Karachi Stock Exchange if s/he:

• is a member of the stock exchange;• is not less than twenty one years of age;• is a citizen of Pakistan;• has at least passed graduation or equivalent

examination from an institution recognized by the Government;

• Provided that the SECP may relax the educational qualification in suitable cases on merit having regard to the applicant’s experience;

• has not been adjudicated as insolvent or has suspended payment or has compounded with his creditors;

• has experience of not less than five years in the business of buying selling or dealing in securities



Secondary Markets:Members of the stock exchange performs various functions in the market. These are:Commission Brokers: Get commission on selling and buying on behalf of the investorsOdd-lot dealers: Deals in lower denominations of shares generally for small investorsRegistered Traders: Involved in direct selling and purchasing and do not require to pay any commissionSpecialist: Generally assigned to ensure marketability of a specified share and enter into transaction that are not routine.Bond Broker: deals in bond trading

MARKETS FOR SECURITIESSecondary Markets:Listed Stock Tables:• All the stock listed and traded in the stock market, in a

particular day is provided in the trade screen.• The trade screen changes with the interval of time or when

and where a transaction takes place.• The stock tables varies from one stock exchange to another.

It may include following information: Symbol: A symbol is allotted to every listed company Trades: Number of trades High: The highest price at which a transaction has taken place Low: The lowest price at which a transaction has taken place Close: The price at which the last transaction occurred Volume: The total number of shares traded in the market Value: The value of the shares transacted in the market. Change: The net increase or decrease in closing Price from yesterday

MARKETS FOR SECURITIESSecondary Markets:Types of Orders/Transactions• Buy Order: This given by an investor in anticipation of rise in price of a

stock. The investor can qualify its order according to its preferences.• Sell Order: On contrary when an investor anticipates a fall in script value

which s/he is holding, s/he places a sell order. Sell-Long Order is given to broker when the investor foresees continuous decline in the share value. Sell-Short Order is placed when an investor would like to take advantage of bearish trend of a script.

• Market Order: Under a market order the broker is required to sell or purchase a particular stock immediately no matter what the prevailing price is. This is the quickest and least expensive way in which you can complete your order. Volatile markets may deprive you of the possibility of getting a price close to the one that is listed last. Additionally, you are not guaranteed that you will get the last price listed if you are following the market order.

• Limit Order: Under a limit order the broker is required to sell or buy a particular stock at a pre-specified price. Once the desired price is reached, the order is completed. Otherwise, the order is not filled. The investor must also indicate how long the limit order will be outstanding.Limit orders are helpful since they provide investors with an entry and exit point through the setting of the price.

MARKETS FOR SECURITIESSecondary Markets:Types of Orders with respect to Time:• Round Lots: The order is in a number of a Unit considered

as whole lot in a specified Stock Market.• Odd-Lots: An order less than a unit of trading is considered

as odd-lot Types of Orders with respect to Time:• Day Order: It remains active only for the trading day.

Unless and until advised by the investor, the broker continues to execute the order during the day. However, it is suspended with the close of market for that.

• Week Orders: In general the order expires at the end of the calendar week.

• Open Orders: It remains effective until it is cancelled by the investor. These are also called GTC (good-till-cancelled) orders. These are generally issued in conjunction with limit orders. However, these orders are susceptible to higher risk.

MARKETS FOR SECURITIESMargin Trading:• Borrowing money from bank or a broker to execute a

securities transaction is referred to as using margin.• The amount of money an investor can borrow depends

upon specific regulations of the market/regulating agency of the country. The margin (%) varies from type of security an individual is borrowing. For a broker this amount of money is sometimes considered as collateral against the borrowing.

• The regulatory authority of a country specifies the limit of borrowing or Margin in term of percentage for different types of securities.

• If a customer buys shares of Rs.10,000 and puts up Rs.7,000 in cash, his margin is Rs.7,000 or 70% of the value of the shares acquired.

MARKETS FOR SECURITIESMargin Trading – Example

If Zaid enter into transaction for 1,000 shares each at a price of Rs.20, an amount of Rs.20,000 is required.Zaid has decided to provide 50% (as per the regulations) of the cash with the broker. The margin account of Zaid with the broker reflects following details:Stock Rs.20,000 Debt: Rs.10,000

Equity: Rs.10,000Margin = 10,000 / 20,000 = 0.5 = 50%If the stock falls gradually and the value of the share reaches Rs.17.00The value of the stock will reach Rs.17,000The Margin Account of Zaid will reflect as follows: Stock Rs.17,000 Debt: Rs.10,000

Equity: Rs.7,000New Margin = 7,000 / 20,000 = 0.412 = 41.20%It is Important to note that:– The shock of the falling price needs to be absorbed by the customer– The lenders (broker’s) risk is rising as the borrowed funds are more than

the equity.

MARKETS FOR SECURITIESMargin Trading – Example (Continued)

If the stock continues to fall, it will further increases the broker’s risk. However, the broker will stop at a point, perhaps as per the regulations, and will ask the customer to raise his/her equity. The point at which the broker will ask to raise his equity can be worked out as follows: LoanMarket value of securities = -------------------- 1-Cut off MarginLet us consider that the cut-off margin is 30%, the broker will ask the customer to deposit additional equity when: Loan 10,000Market value of securities = -------------- = ------- = Rs.14,2861-Cut off Margin (1-0.3)

If the maintenance margin falls below 30%, the broker will send a margin call to the customer asking to to additional deposit of funds within a certain time frame


Margin Trading – Example (Continued)Consider If the stock continues to fall further and the share value reached at Rs.13, the new Margin can be worked out as follows: Stock Rs.13,000Debt: Rs.10,000

Equity: Rs.3,000 3,000

Margin = ------- = 23%13,000

To lift the margin to 30% maintenance level requires equity of 30% of Rs.13,000 which is equal to Rs3,900. This will lead to a further deposit of Rs.900 by the customer.


• Margin Trading – Example (Continued).Now suppose the price of the share rises from Rs20 to Rs.25. the new position of the customer account will be as follows: Stock Rs.25,000 Debt: Rs.10,000

Equity: Rs.15,000

15,000Margin = ------- = 60%

25,000

• The investor can now buy additional stock of Rs.5,000 without investing a single Rupee. This will decrease its margin to 50% which is the initial requirement under the regulation.


Security Market Indicators:• If an investor owns more than a few stocks or

bonds, it is cumbersome to follow each stock or bond individually to determine the composite performance of the portfolio.

• Also, there is an intuitive notion that most individual stocks or bonds move with the aggregate market. Therefore, if the overall market rose, an individual’s portfolio probably also increased in value.

• To supply investors with a composite report on market performance, some financial publications or investment firms have developed stock market and bond market indexes.

MARKETS FOR SECURITIESSecurity Market Indicators: Uses• As benchmarks to evaluate the performance

of professional money managers• To create and monitor an index fund• To measure market rates of return in

economic studies• For predicting future market movements by

technicians• As a proxy for the market portfolio of risky

assets when calculating the systematic risk of an asset.


Security Market Indicators:• We hear a lot about what happens to the Dow

Jones Industrial Average (DJIA) each day. • In addition, you might also hear about other

stock indexes, such as the S&P 500 index, the Nasdaq composite, or even the Nikkei Average. These indexes change by differing amounts.

• The indexes are organized by the weighting of the sample of stocks based on:– the price-weighted series - some of the most popular

indexes are in this category. – The next group is the market-value-weighted series,

which is the technique currently used for most indexes.

MARKETS FOR SECURITIES Security Market Indicators:A price-weighted series is an arithmetic average of current prices, which means that index movements are influenced by the differential prices of the components.


Security Market Indicators:• A market-value-weighted series is generated by deriving the

initial total market value of all stocks used in the series (Market Value = Number of Shares Outstanding X Current Market Price).

• This initial figure is typically established as the base and assigned an index value (the most popular beginning index value is 100, but it can vary—say, 10, 50).

• Subsequently, a new market value is computed for all securities in the index, and the current market value is compared to the initial “base” value to determine the percentage of change, which in turn is applied to the beginning index value.

MARKETS FOR SECURITIESSecurity Market Indicators:


Security Market Indicators:DEMONSTRATION OF THE IMPACT OF DIFFERENT VALUES ON A MARKET-VALUE-WEIGHTED STOCK INDEX

MARKETS FOR SECURITIESSecurity Market Indicators: A Global Overview


The expected return from an investment is defined as:Expected Return = A respective sum of (Probability of

Returns) X (Possible Returns)• Let us begin our analysis of the effect of risk with an example of

perfect certainty wherein the investor is absolutely certain of a return of 5 percent.

• Perfect certainty allows only one possible return, and the probability of receiving that return is 1.0. Few investments provide certain returns.

• In the case of perfect certainty, there is only one value for PiRi:• E(Ri) = (1.0)(0.05) = 0.05

MARKETS FOR SECURITIESIn an alternative scenario, suppose an investor believed an

investment could provide several different rates of return depending on different possible economic conditions. As an example, in

• a strong economic environment with high corporate profits and little or no inflation, the investor might expect the rate of return on common stocks during the next year to reach as high as 20 percent.

• In contrast, if there is an economic decline with a higher-than-average rate of inflation, the investor might expect the rate of return on common stocks during the next year to be –20 percent.

• Finally, with no major change in the economic environment, the rate of return during the next year would probably approach the long-run average of 10 percent.

• The investor might estimate probabilities for each of these economic scenarios based on past experience and the current outlook.

INTRODUCTION TO THE SECURITY ANALYSIS

• The measures of risk for an investment are:– Variance of rates of return– Standard deviation of rates of return– Coefficient of variation of rates of return (standard

deviation/means)– Covariance of returns with the market portfolio (beta)

• The sources of risk are:– Business risk– Financial risk– Liquidity risk– Exchange rate risk– Country risk

INTRODUCTION TO THE SECURITY ANALYSIS INVESTMENT – RECALLING SOME BASIC CONCEPTS

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INVESTMENT AND PORTFOLIO MANAGEMENT-3.ppt

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