Fin 340 Chapter 3 Securities Markets Reading Assignment ✓ Solved

Fin 340/Chapter 03 – Securities Markets Reading assignment

Fin 340/Chapter 03 – Securities Markets Reading assignment: Please write one or two paragraphs answering each of the following questions.

1) Read section 3.2 ‘How Securities Are Traded’ - Describe one type of markets. - Describe one type of orders.

2) Read section 3.7 ‘Trading Costs’ - Describe full-service and discount brokers. - Look at the website of one discount broker (for example Schwab, E*Trade, or Ameritrade). What is the commission you have to pay for buying/selling stocks? bonds? or options?

3) Read section 3.9 ‘Short Sales’ - Describe the difference between buying stocks and short selling stocks? When would you do short sales? - You sold short one stock of Google for $500. After one month Google price was $450 and during the month Google paid a dividend of $2. What was your profit? What if the Google’s price was $550 at the end of the month?

Paper For Above Instructions

The securities market is a critical component of the financial system, enabling the trading of various financial instruments including stocks, bonds, and derivatives. One prevalent type of market is the secondary market, where investors buy and sell previously issued securities. The secondary market plays a critical role in providing liquidity and price discovery, allowing individuals and institutions to either acquire new investments or divest unwanted ones. In the context of securities, orders can be categorized, for instance, into market orders and limit orders. A market order is executed immediately at the current market price, while a limit order sets a specific price at which the investor is willing to buy or sell a security, ensuring that they do not pay more than they want or sell for less than they are willing to accept.

In examining trading costs, we distinguish between full-service brokers and discount brokers. Full-service brokers offer comprehensive services including investment advice, retirement planning, and asset management, often charging higher fees for these services. Conversely, discount brokers, such as Charles Schwab, E*Trade, or TD Ameritrade, provide essential trading services with minimal personal interaction, significantly reducing the associated costs. For instance, the commission for buying or selling stocks at Schwab can be $0, making them an appealing choice for cost-conscious investors. However, fees for options may vary; Schwab charges $0.65 per contract for options, which is competitive within the industry.

Regarding short sales, they represent a strategy to profit from the anticipated decline in a stock's price. The primary difference between buying stocks and short selling lies in the ownership dynamics: buying stocks involves purchasing and owning shares, while short selling involves borrowing shares to sell, hoping to buy them back at a lower price. Investors typically engage in short sales when they believe a stock is overvalued or set to decline significantly. For instance, if you sold a stock of Google short at $500 and, at the end of a month, the stock price decreased to $450, you would calculate your profit as follows. Initially, you gained $50 from the price drop (selling price - buying price), but since Google paid a dividend of $2 during this period, this dividend would be a cost due to your short position. Therefore, your profit would be $50 - $2 = $48.

Conversely, if Google’s price increased to $550 at the end of the month, your short position would result in a loss. The loss would be the difference between the selling price and the purchase price after covering the short, amounting to $500 (selling price) - $550 (price after one month) + $2 (dividend cost). This means your total loss would be $50 + $2 = $52.

Engaging in short selling requires careful consideration of market trends and potential risks. It can lead to substantial losses since there is no limit on how high a stock's price can rise, in contrast to the finite profit achievable from shorting. Hence, investors must exercise caution and conduct thorough analysis before deciding to short any stock.

References

  • Bodie, Z., Kane, A., & Marcus, A. J. (2014). Investments (10th ed.). McGraw-Hill Education.
  • Fabozzi, F. J. (2018). Handbook of Fixed Income Securities (8th ed.). McGraw-Hill Education.
  • Investopedia. (2021). What Is a Market Order? Retrieved from https://www.investopedia.com/terms/m/marketorder.asp
  • Investopedia. (2021). What Is a Limit Order? Retrieved from https://www.investopedia.com/terms/l/limitorder.asp
  • Schwab. (2023). Commissions & Fees. Retrieved from https://www.schwab.com/pricing
  • E*TRADE. (2023). Pricing & Commissions. Retrieved from https://us.etrade.com/what-is-etrade/pricing-and-commissions
  • TD Ameritrade. (2023). Commission and Fees. Retrieved from https://www.tdameritrade.com/pricing/commissions.page
  • Black, F., & Scholes, M. (1973). The Pricing of Options and Corporate Liabilities. Journal of Political Economy, 81(3), 637-654.
  • Markowitz, H. (1952). Portfolio Selection. The Journal of Finance, 7(1), 77-91.
  • Lintner, J. (1965). The Valuation of Risky Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets. The Review of Economics and Statistics, 47(1), 13-37.

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