Hey guys, I am Derek, welcome to my channel. In this video, I'm gonna explain to you the stock markets and transactions. Securities markets can be classified as money market and capital market.
In the money market, short-term securities are bought and sold such as certificates of deposit. In the capital market, long-term securities are bought and sold such as stocks and bonds. Capital markets can be further classified as primary market and secondary market.
Primary market, the market in which new issues of securities are sold to the public. In the primary market, the issuer of the equity or debt securities receives the proceeds of sales. The main vehicle in the primary market is the initial public offering, IPO. This is the first public sale of a company's shares. The primary markets also sell new securities.
called Seasoned New Issues, for companies that are already public. Before securities can be offered for public sale, the issuer must lodge a prospectus, which is a public offer document, and obtain approval from Securities Commission, SE. To market its securities in the primary market, a company has three choices.
First, a public offering. The company offers its securities for sale to the general public. Second, a rights offering. The company offers shares to existing shareholders on a pro-rata basis.
Third, a private placement. The company sells new securities directly to selected groups of investors, such as insurance companies and pension funds. Secondary market, the market in which securities are traded after they have been issued.
Secondary market is also called the aftermarket. The secondary market provides a way for the investors to sell their securities to others. In the secondary market, unlike the primary market, the transaction does not involve the company that issued the securities. Instead, the transactions happen directly between investors. The seller sells securities while the buyer pays money to the seller.
As such, secondary markets play two important roles. First, the secondary market provides liquidity to the security purchasers. Next, secondary market provides continuous pricing mechanism for the securities to reflect their value at any point in time on the basis of the best available information. For the trading of securities, there are two types of forums for buyers and sellers in secondary markets.
Organized Securities Exchange is a centralized marketplace where securities such as stocks, bonds and options are bought and sold. These exchanges are highly regulated. and have rules and procedures that must be followed by all participants. Buyers and sellers place their orders through intermediaries called brokers. Examples of organized securities exchanges include the New York Stock Exchange NYSE and NASDAQ.
However, the over-the-counter OTC market is a decentralized market where buyers and sellers trade directly with each other without the involvement of a centralized exchange. The OTC market is less regulated than organized securities exchanges and trade securities that are not listed on an exchange. OTC trading is conducted through a network of dealers, who act as intermediaries between buyers and sellers.
Examples of OTC securities include stocks of smaller companies, corporate bonds, and derivatives. Conditions in the securities markets are commonly classified as bull market or bear market. depending on the securities prices that are rising or falling over time.
Changing market conditions are usually caused by the changes in investor attitudes, changes in economic activity, and government policies to stimulate or to slow down the economic activity. Bull markets are favorable markets, normally associated with rising prices, investor and consumer optimism, economic growth and recovery, and government stimulus. In general, during a bull market, Investors earn higher returns on share investments.
While bear markets are unfavorable markets normally associated with falling prices, investor and consumer pessimism, economic slowdown, and government restraint. When an investor places an order to buy or to sell a stock, there are two fundamental execution options, either place the order at market or at limit. Market orders are the orders to buy or sell shares at the present market price when order is placed. This is the fastest way to fill an order.
So if the share price is now $10 per share, when you place a market order to buy, you will buy the shares at $10 per share. However, a limit order sets the maximum or minimum price at which you are willing to buy or sell. For example, if the current market price is $6 per share, you may place a limit order to buy the shares at $5 per share.
The limit order will be executed only when price drops to $5. If the price limits are not met, order will not be filled. Stop-loss orders.
This is an order to sell a share. when its market price reaches or drops below a specified price. It is also called a stop loss or stop order. This is a type of limit order.
Long purchase and short selling are the two basic types of securities transactions. A long purchase is a transaction when an investor buys and holds the securities with an expectation that the price will rise in the future. A long purchase is the most common type of transaction.
The objective is to buy low and sell high. Investors will make profit when stock prices go up. However, short selling is quite different.
When investors expect that the market price will drop in the future, probably they will go for short selling. Investors sell securities they don't own by borrowing securities from the broker. On the other hand, broker lends securities owned by other investors that are held in street name.
So short-selling transaction starts with a selling. Investor sells the shares first. Later on, when price drops, they will buy back the shares and return the shares to the broker.
A short seller must make an initial equity deposit with the broker, which means in the investor's account, there must be a certain amount of money to be kept as collateral. The objective is to sell high and buy low. Investors will make profit. when stock prices go down. Let's take an example.
Step 1. Short sale initiated. There are 100 shares of borrowed stock sold at $50 per share. So the proceeds from sale to investor is $5,000, which means the seller will receive $5,000. Step 2. Short sale covered.
It happens later when investor purchases 100 shares of the stock. at $30 per share and returns the shares to the broker. So the cost to the investor is $3,000. That's the money that the investor will pay. Then taking $5,000 minus $3,000, the investor will make a net profit of $2,000.
You might ask, what if the share price goes up after the short selling? Then the investor will still have to buy back the shares at a higher price and make a loss. The main advantage of short selling is the chance to make profit when the stock price declines.
However, short selling does have some disadvantages. It has limited return opportunities as the stock price cannot go below $0. But it has unlimited risk because the stock price can go up to an unlimited amount.
If the stock price goes up, no matter how expensive the price is, short seller still needs to buy back the shares. and return the borrowed shares to the broker. Also, short sellers may not earn dividend from the shares.
Margin trading is a common way in trading securities. Investors may use borrowed funds to purchase securities, but not on cash basis. Margin trading is used for one basic reason, that is to magnify returns. A bank, brokerage company, or other financial institution, lends the investor the needed funds. and retains the purchased securities as collateral.
The margin requirements are set by Securities Commission, SC. It determines the minimum amount of equity required to be paid by the investors. Let's take an example. On $10,000 purchase, with 60% margin requirement, it means investor will have to pay 60% and borrow 40%.
So investor will pay $6,000. and broker will lend the remaining $4,000. Margin trading can be used for common stocks, preferred stocks, bonds, mutual funds, options, warrants, and futures.
About the advantages of margin trading, it magnifies the profits because you can use a smaller amount of money to purchase the shares. That's what we call a financial leverage. Margin trading also allows greater diversification of security holdings. because investors can spread their capital over a greater number of investments.
The main disadvantage of margin trading is the potential for magnified losses if the price of the security falls. Another disadvantage is the cost of the margin loan. Investors who borrow money to invest will have to pay for the interest expense, which can be quite costly. Margin call is another concern. If the market price drops, investors will be called to deposit more money into the margin loan account.
Sometimes, investors may be forced to sell their investments to repay the margin loan. The following is an example to show you. the effect of margin trading on security returns. It is divided into two categories.
First is without margin which means you pay 100%. Second is with margins of 80%, 65% or 50%. 80% margin means you pay 80% and borrow 20%. The current market price is $50 per share and you purchase 100 units. So the cost of investment is $5,000.
Less borrowed money. Without margin, it will be $0. 80% margin, it will be $1,000.
65% margin, $1,750. 50% margin, $2,500. So the equity in investment, which means the portion of money that you pay will be $5,000, $4,000. $3,250 and $2,500. If the share price rises by $30 to $80 per share, share value will become $8,000.
Original cost of investment is $5,000. Under all scenarios, capital gain will be $3,000. But, for the return on investors'equity which is calculated by taking capital gain over equity in investment, 50% margin has the highest return, 120%, but without margin, the return is only 60%.
On the other hand, if the share price falls by $30 to $20 per share. Now, the share value is only $2,000. Original cost of investment is still the same, $5,000. So you will have a capital loss of $3,000. Based on the return on investors'equity, you will find that, with 50% margin, your loss is 120%.
But without margin, your loss is only 60%. As a conclusion, for using margin trading, the profits and losses will be magnified, and your risk exposure is higher. Next, let's talk about the market indexes. A market index is a hypothetical portfolio of investments, such as common stocks, which represents a segment of the financial market. The calculation of the index value comes from the prices of the underlying investments.
Stock market indexes measure the general behavior of stock prices over time. These indexes reflect the arithmetic average price behavior at a given point in time. They also measure the current price behavior relative to a base value set at an earlier point in time. Reasons to use market indexes include. Market indexes can gauge general market conditions.
If a market index goes up, it means the stock market goes up. You can compare your portfolio performance to a large, diversified portfolio represented by market index. If your portfolio return is 10% while the market index return is 8%, then your portfolio performs better than the market.
Market indexes can also be used to study market cycles, trends, and behaviors to forecast the future market behavior. Alright, that's all for this video. Thanks for watching. See you in the next one.
Bye!