Chapter: Security Markets

by Leo Vashkor Dewri

Chapter Outline:
• Definition of Security Markets
• primary markets and secondary markets,
• the changing securities markets,
• IPO,
• Trading with Margin,
• Price-weighted Index,
• Market value weighted Index,
• Trading on DSE.

1-2
 Definition of Security Markets
A security is a fungible, negotiable financial instrument that holds
some type of monetary value. It represents an ownership position
in a publicly-traded corporation (via stock), creditor relationship
with a governmental body or a corporation (represented by owning
that entity's bond), or rights to ownership as represented by an
option.
Security Markets are places where traders gather to trade
securities(eg. DSE or LSE). Trading is a search process, where
buyers or sellers try to find a counter-party. Price, quantity and
time to the trade are key factors. Dealers or brokers help people
trade. Dealers are willing to take the other side of a trade on
demand. They quote a bid (buy) price and a offer (ask) price and
profit from the spread. Dealers acquire their clients’ positions and
then try to trade for them at a profit. Brokers are agents who help
traders search for counter parties; they profit through commissions.
Security markets are designed to reduce counterparty search cost.
 There Are Three Types of Securities

1. Equity securities
2. Debt securities
3. Derivative securities

1-4
• 1. Equity securities are shares of a corporation. You can
buy stock of a company through a broker. You can also buy
shares of a mutual fund that selects and purchases stocks for you.
The secondary market for equity derivatives is the stock market.
It includes the Dhaka and Chittagong Stock
Exchange, the NASDAQ, and London Stock Exchange.
• An Initial Public Offering is when companies sell the stock for
the first time. Investment banks, like Lankabangla
Securities or IDLC, sell these directly to qualified buyers. That's
because it is an expensive investment option. These shares are
sold in bulk quantities. Once they hit the stock market, their price
typically goes up. But you can't cash in until a certain amount of
time has passed. By then, the stock price might have fallen below
the initial price.
1-5
2. Debt securities are loans, called bonds, made to a company or
a country. You can buy bonds from a broker. You can also buy
mutual funds of selected bonds.
Rating companies evaluate how likely it is the bond will be repaid.
These companies include S&P, Moody’s, and Fitches. To ensure a
successful bond sale, borrowers must pay a higher interest rate if their
rating is below AAA.

If the ratings are very low, they are known as junk bonds. Despite
their risk, investors buy junk bonds because they offer the highest
interest rates.
Corporate bonds are loans to a company. If the bonds are to a country,
they are known as sovereign bonds. The government issues Treasury
bonds. Because these are the safest bonds, Treasury yields are the
benchmark for all other interest rates. Debenture, issued by higher
rating companies.

1-6
3. Derivative securities are based on the value of underlying
stocks, bonds, or other assets. They allow traders to get a higher
return than buying the asset itself.

Stock options allow you to trade in stocks without buying them

upfront. For a small fee, you can purchase a call option to buy the
stock at a certain date at a certain price. If the stock price goes
up,
you exercise your option and purchase the stock at your lower
negotiated price. You can either hold onto it or immediately
resell it for the higher actual price.

1-7
 Primary Market, Secondary Markets and OTC Market

• Primary Market
– New issues through IPO
– Key factor: issuer receives the proceeds from the sale
• Secondary Market
– Existing owner sells to another party
– Issuing firm doesn’t receive proceeds and is not directly involved
• OTC Market
- Over-the-Counter (OTC) means the facilities provided by an exchange
for the purpose of buying or selling of unlisted or delisted securities
from the stock exchanges. The OTC Market provides an alternative to
stock exchange listing for securities of issuers that either choose not to
be listed on Dhaka Stock Exchange or not to meet the relevant listing
requirements.

1-8
 How Securities Are Issued

• Shelf Registration
• Private Placements
• Initial Public Offerings (IPOs)
 Shelf Registrations

Shelf registration is a method for publicly traded companies

to register new stock offerings without having to issue them
immediately. Instead, the securities can be issued at any
time within a two-year period, allowing a company to adjust
the timing of the sales to take advantage of more favorable
market conditions should they arise.
 Private Placements
Private placement is an issue of stock either to an individual
person or corporate entity, or to a small group of investors.
Investors typically involved in private placement issues are
either institutional investors, such as banks and pension funds,
or high-net-worth individuals.

• Allowed under Rule: Private Placement of Debt Securities

2012
• Dominated by institutions
• Very active market for debt securities
• Not active for stock offerings
 Process of Going Public
Two ways a company goes to public

1. Initial issue (initial public offering (IPO))

• Fixed Price, when offered at par value
• Book building, when offered above par value
2. Direct listing
Company can go for direct listing if company paid-up
capital is BDT 300 core or more i.e. United Power
Company Ltd.
Relationship Among a Firm Issuing Securities, the
Underwriters and the Public
Indexing

1-14
 Price-weighted Index
• A price-weighted index is a stock index in which
each stock influences the index in proportion to its
price per share. The value of the index is generated
by adding the prices of each of the stocks in the index
and dividing them by the total number of stocks.
Stocks with a higher price will be given more weight
and, therefore, will have a greater influence over the
performance of the index.

1-15
 Market value-weighted index

An index of a group of securities computed by calculating a

weighted average of the returns on each security in the index,
where the weights are proportional to outstanding market value.

To find the value of a cap-weighted index, an analyst should

multiply each constituent's market price by its total outstanding
shares to arrive at the total market value of the index. Then, the
proportion of this value to the overall total market value of all
the index components gives the weight of the company in the
index. For example, consider the following five companies:

1-16
Price-weighted & Market value-weighted

ABC 200 10 80 16000

BCD 120 10 51 6120
XYZ 80 10 160 12800
SDFS 215 10 26 5590
FSDF 142 10 56 7952
VFD 251 10 53 13303
1008 61765

Price weightedIndex 61.274802

Market weightedIndex 10294.167

Copyright © 2009 Pearson Prentice

1-17
Hall. All rights reserved.
Capital Market Structure in Bangladesh
Organization's Responsibilities
Ministry of Finance Policy making organization.
Bangladesh Securities and Regulator of the capital market and
Exchange Commission (BSEC) IPO issuing authorities. Creating
level playing field for investors.
Bangladesh Bank Regulating authority of financial
institutions in the country and
controller of investment policy by
financial institution in the capital
market
Central Depository Bangladesh Ltd. Ownership record keeping
authorities of equities, mutual funds,
debentures, bond etc. Keep up-to-
date equities ownership in every
single day in the end of trading
days.
1-18
Capital Market Structure in Bangladesh continue….

Dhaka and Chittagong Stock Equities trading platform for all

Exchange investors.
Brokerage houses or merchant Members of both stock exchanges
banks and equities trading intermediaries
of investors and stock exchanges.
Investors (institutions, foreigners Investing through brokerage houses
and individuals)

1-19
Stock Market & Trading Mechanism in Stock
Exchange
Participants in the Stock Market:
Buyers and sellers are the essential constituent of any type of market,
but the Stock Market is a bit different. Of-course buyers and sellers
exist here as well, but there are various other entities involved here too.
Let us discuss about all the participants of the stock market in detail.
Bangladesh Securities and Exchange Commission (BSEC): BSEC
is the main regulatory body which keeps an eye on the functioning of
the stock markets in Bangladesh. It is a government body and is
responsible for laying down all the necessary framework and
regulations required for the smooth and fair functioning of the markets.
All the other bodies in the market have to comply with BSEC and
abide all the regulations to protect the investor’s interest.

1-20
Continue…
•Stock Exchanges: All the trading in the stock market is facilitated by the stock
exchanges. It is the main intermediary body which connects buyers and sellers.
The two most prominent stock exchanges in Bangladesh are the Dhaka Stock
Exchange (DSE) and Chittagong Stock Exchange (CSE). However, you cannot
directly approach a stock exchange for trading.
•Broking Houses: These are the bodies which help investors trade on the
exchanges. To trade on any of the nationalized stock exchange you need to take
the help of a stockbroker. A broker needs to be registered with BSEC in order to
trade on the exchange. The broker charges brokerage fees from you for every
trade that you place on the exchange.
•Traders and Investors These are the most important constituents of the stock
market. These are the individuals who invest in the stocks or other assets with the
aim of extracting profits. You can trade or invest on any of the stock exchange by
opening a BO account.

1-21
 Trading Mechanism in Stock Exchange
Companies list their shares in the Primary Market through an Initial
Public Offering Or IPO. After the IPO the stocks of the company are
listed on an exchange and are available for trading in the secondary
market.
Stocks of companies are traded in order to make profits or cut down
losses. This trading of stocks is carried out through a stockbroker or
brokerage firm. These brokers act as an intermediary body between you
and the stock exchange.

1-22
Continue…

Whenever you want to buy and trade a stock, you place the order with
your broker at a fixed price. The broker passes on the order to the stock
exchange. The exchange then searches for availability of buyer or seller
to execute the order at the instructed price. If the order is completed the
exchange communicated with the broker that the order has been
executed.
The CDBL keep record of all the details of buyers and sellers trading
on the exchange through the brokers to avoid any chance of default.
The stocks are then transferred from the BO account of the seller to the
BO account of the buyer electronically. The settlement process earlier
used to take weeks, but the electronic settlement and introduction of
BO has made it possible to carry out all settlements in T+2 days.

1-23
 Stock Market Transactions
• Placing an Order.
• Margin Trading.
• Short Selling.
• Investing in Stock Indexes
PLACING AN ORDER

To place an order to buy or sell a specific stock, an investor contacts a brokerage

firm. Brokerage firms serve as financial intermediaries between buyers and sellers
of stock in the secondary market. They receive orders from customers and pass
the orders on to the exchange through a telecommunications network. The orders
are frequently executed a few seconds later.

The investor communicates the order to the broker by specifying

(1) the name of the stock (ticker), (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

1-25
 Types of limit order
• Stop-Loss Order: A stop-loss order is a particular type of limit
order. The investor specifies a selling price that is below the current
market price of the stock. When the stock price drops to the
specified level, the stop-loss order becomes a market order. If the
stock price does not reach the specified minimum, the stop-loss
order will not be executed. Investors generally place stop-loss orders
to either protect gains or limit losses.

• Stop-Buy Order: A stop-buy order is another type of limit order. In

this case, the investor specifies a purchase price that is above the
current market price. When the stock price rises to the specified
level, the stop-buy order becomes a market order. If the stock price
does not reach the specified maximum, the stop-buy order will not
be executed.
 Trading with Margin
• Margin Requirements.
• Maintenance Margin.
• Margin Calls.
• Impact on Losses and Returns.
 MARGIN ORDER
Margin requirements: When investors place an order, they may consider
purchasing the stock on margin; in that case, they use cash along with funds
borrowed from their broker to make the purchase. The BSEC imposes margin
requirements, which represent the minimum proportion of funds that must be
covered with cash.

Currently, at least 50 percent of an investor’s invested funds must be paid in

cash. Margin requirements are intended to ensure that investors can cover their
position if the value of their investment declines over time. Thus, with margin
requirements, a major decline in stock prices is less likely to cause defaults on
loans from brokers and therefore will be less damaging to the financial system.

To purchase stock on margin, investors must establish an account (called

a margin account) with their broker. Their initial deposit of cash is
referred to as the initial margin.
Margin continue….
- Maintenance margin: Investors are subject to a maintenance
margin, which is the minimum proportion of equity that an investor
must maintain in the account as a proportion of the market value of
the stock. The investor’s equity position represents what the stock is
worth to the investor after paying off the loan from the broker.

- Margin call: If the investor’s equity position falls below the

maintenance margin, the investor will receive a margin call from the
brokerage firm and will have to deposit cash to the account in order
to boost the equity.
Impact of return: The return on a stock is affected by the proportion of the
investment that is from borrowed funds. Over short-term periods, the return on
stocks (R) purchased on margin can be estimated as follows:

Consider a stock priced at BDT40 that pays an annual dividend of BDT1 per
share. An investor purchases the stock on margin, paying BDT20 per
share and borrowing the remainder from the brokerage firm at 10 percent
annual interest. If, after one year, the stock is sold at a price of BDT60 per
share, the return on the stock is
60 - 20 - 22  1
R
20
19

20
95%
 Short Selling
• What is a short Selling?
• How speculators make profits in short selling?
• Measuring the Short Position of a Stock.
• Using a stop-Buy Order to Offset Short
Selling.
SHORT SELLING
In a short sale, investors place an order to sell a stock that they do not
own. They sell a stock short (or “short the stock”) when they anticipate
that its price will decline. When they sell short, they are essentially
borrowing the stock from another investor and will ultimately have to
provide that stock back to the investor from whom they borrowed it.
Demand for the shares attracts more buyers, which pushes the stock
higher, causing even more short-sellers to buy back or cover their
positions.

Short-selling example. A trader believes that stock SS which is trading at

TK 50 will decline in price, and therefore borrows 100 shares and sells
them. The trader is now “short” 100 shares of SS since he has sold.

A week later, SS reports dismal financial results for the quarter, and the
stock falls to TK45. The trader decides to close the short position, and
buys 100 shares of SS at TK 45 on the open market to replace the
borrowed shares. The trader’s profit on the short sale – excluding
commissions and interest on the margin account – is therefore BDT500.
Effect of the Spread on Transaction Costs:
1. Order Cost.
2. Inventory Cost.
3. Competition.
4. Volume.
5. Risk.
 Effect of the Spread on Transaction Costs
When investors place an order, they are quoted an ask price, or the
price that the broker is asking for that stock. There is also a bid
price, or the price at which the broker would purchase the stock. The
spread is the difference between the ask price and the bid price and
is commonly measured as a percentage of the ask price.
Example: Boletto Company stock is quoted by a broker as bid
BDT39.80, ask BDT40.00. The bid-ask spread is
40.00 - 39.80
Spread 
40.00
.5%
This spread of .5 percent implies that if investors purchased the stock
and then immediately sold it back before market prices changed,
they would incur a cost of .5 percent of their investment for the
round-trip transaction.
The transaction cost due to the spread is separate from the commission
charged by the broker. The spread has declined substantially over
time due to more efficient methods of executing orders and
increased competition from electronic communications
networks. The spread is influenced by the following factors:
• Order Costs Order : costs are the costs of processing orders,
including clearing costs and the costs of recording transactions.
• Inventory Costs Inventory : costs include the cost of maintaining an
inventory of a particular stock. There is an opportunity cost because
the funds could have been used for some other purpose. If interest
rates are relatively high, the opportunity cost of holding an inventory
should be relatively high. The higher the inventory costs, the larger
the spread that will be established to cover these costs.
• Competition: The specialist for a particular stock on the NYSE faces
competition from other electronic markets where the stock can be
traded.
• Volume Stocks: that are more liquid have less chance of
experiencing an abrupt change in price. Those stocks that have a large
trading volume are more liquid because there is a sufficient number of
buyers and sellers at any time. This liquidity makes
it easier to sell a stock at any point in time and therefore reduces the
risk of a sudden decline in the stock’s price.
• Risk: If the firm represented by a stock has relatively risky
operations, its stock price is normally more volatile over time. Thus,
the specialist or market-maker is subject to more risk from holding
an inventory in this type of stock and will set a higher spread as a
result.
 Regulations of Stock Trading
• Circuit Breakers: A trading curb is a temporary restriction on
program trading in a particular security or market, usually to
reduce dramatic price movements. Also known as a collar or
circuit breaker. +/- 10%.

• Trading Halts: A trading halt is a temporary suspension in

the trading of a particular security on one or more exchanges,
usually in anticipation of a news announcement or to correct
an order imbalance. A trading halt may also be imposed for
purely regulatory reasons. During a trading halt, open
orders may be canceled and options may be exercised.
• SEC Oversight of Corporate Disclosure: Fair Disclosure (FD).
• Record date: The record date, or date of record, is the cut-off date
established by a company in order to determine which shareholders are
eligible to receive a dividend or distribution. The determination of a
record date is required to ascertain who exactly a company's
shareholders are as of that date, since shareholders of an actively traded
stock are continually changing. The shareholders of record as of the
record date will be entitled to receive the dividend or distribution,
declared by the company.
• Spot Date: The spot date refers to the day when a spot transaction is
typically settled, meaning when the funds involved in the transaction
are transferred. The spot date is calculated from the horizon, which is
the date when the transaction is initiated. In forex, the spot date for
most currency pairs is usually two business days before the record
date.

1-39
• Dividend declaration date: The declaration date is
the date on which a company announces its
next dividend payment. On this date, it will be announced
the dividend size, the ex-dividend date, and the payment date.

• Dividend disbursement date: Shareholders owning the stock

on the record date will receive the dividend on the payment
date. The day after the record date is the ex-dividend date or
ex-date, meaning it's the first day the stock is trading ex-
dividend. The payment date for the dividend may be up to one
month after the ex-dividend date passes.

1-40
Barriers to International Stock Trading
• Transaction Costs: Transaction costs
settlement from one country to another country.
• Information Costs: Purchasing information
from third party research report is usually very
costly.
• Exchange Rate Costs: Exchange rate
fluctuations also create complex situation in the
settlement system.
 STOCK BROKERS
• Brokerage Accounts:
– Cash account
• Pay full cost of all securities purchased
• 2 business day settlement
– Margin account
• Finance portion of purchases (interest charges)
• Same day settlement
MARKET TRADING DYNAMICS
• Market Order:
– Buy or sell at the best current price
– Settlement in three business days for A category and 12
days for Z category shares.
– Round lot = 1 shares
• Limit Order:
– Puts a limit on price
– Time period can vary: day, GTC
• Stop Order:
– Becomes order if price reaches specified price
– No guarantee of execution at specified price
MARKET TRADING DYNAMICS
• Long Position
– Expectation - market heading higher
– Purchase stock via market order at the Ask
– Purchase stock via limit order at specified price
• Selling Short
– Expectation - market heading lower
– Stock borrowed from broker
– Profits on drop in prices
– NYSE uptick rule discontinued
End of Chapter