1 introduction to securities domain. 2 objective creation of a foundation in securities domain...
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1
Introduction to Securities Domain
2
Objective
Creation of a foundation in Securities Domain
• Exposure to terminology
• Understanding of basic products
• Understanding of trading markets and regulations
• Understanding of brokerage operations Encourage further exploration of topic areas
Foundation for Domain Certification CourseFoundation for Domain Certification Course
3
Part 1a: Introduction to Financial Instruments
• Stocks, Bonds, Derivatives, Packaged Products.
Part 1b: Introduction to Financial Marketplace
• Market Development, Order Types, Stock Markets, Margin Trading.
Part 2: Introduction to Brokerage Operations
• Execution, Settlement, Clearing
Agenda
4
Why does an institution need money?
Establish New Business Expand Existing Business Pay off Existing Loans Buy other institutions
The needs for capital are numerous, like those of any individualThe needs for capital are numerous, like those of any individual
5
How do one raise capital?
Equity – Share Ownership
Shares / Stocks- High return, Liquidity, Capital appreciation, Limited Liability
Debt – Take Loan
Bond Offerings- Low Risk, Poor Hedge against Inflation,
Fixed Yield
Founders (friends and family)
Banks
Government
Venture Capitalists
Broker Dealers
Founders (friends and family)
Banks
Government
Venture Capitalists
Broker Dealers
Shares and Bonds are fundamental products. Other products are derivedShares and Bonds are fundamental products. Other products are derived
6
Equity – Stock terminology
Authorized stock – Outlined in corporate charter
• Issued Stock (A)– The portion of authorized stock that is actually sold to
investors by a corporation
• Treasury Stock (B)– Stocks that have been bought back by the company that
issued them.
• Outstanding Shares – Stocks remaining with the various investors (A-B)
• Common Stock
• Preferred Stock
Par Value / Face Value- Arbitrary value placed on common stock at the time of its
authorization; Important only for accounting purpose
Market Capitalization- Market value of the company’s stock = Share Price * Number
of shares outstanding (Publicly held)
7
Preferred Stock vs. Common Stock Preferred Stock
• Pays a fixed dividend
• Par Value
• No voting rights
• Acts more like bond than a stock
• In U.S. often bought by other corporations
• Has preference over common stock when it comes to Bankruptcy and Dividends
Common Stock• Junior Status
• Ownership
• Ease of Transfer
• Voting rights
• Dividends and /or capital growth
• Issuer gives up control (ownership)
• Investor may receive dividends/appreciation
Common stock - Ownership; Preferred shares – No OwnershipCommon stock - Ownership; Preferred shares – No Ownership
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Sale of stock to public for the first
• Registration statement filed with Securities and Exchange Commission (SEC)
• Underwriting - The investment banker functions as an intermediary
(Underwriter) between the issuing corporation and the investors
• Underwriter offers stocks to the general public and institutions for sale through
selling group members (e.g. CSFBDirect)
• Prospectus Issue - Legal documents explaining the financial facts important
to an offering;must precede or accompany sale of primary offering
• Issue subscribed to by investors
Stock IPO – Primary Markets
IPO – Initial Public OfferingIPO – Initial Public Offering
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How can a company pay its shareholders?
Stock Dividend – Giving more shares for existing shares at a predefined ratio eg. 2:1- Two shares for every one share currently held
Stock Split – Break a share into multiple shares
Cash Dividend – Give cash at a particular percentage of face value – 10% Dividend
Shares Before Split
Type of
Split
Shares After Split
100 2 for 1 200
100 4 for 1 400
100 3 for 2 150
100 1 for 2 50
Objective is to increase liquidity and shareholder valueObjective is to increase liquidity and shareholder value
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American Depository Receipts Foreign country shares traded in US Bank purchases ordinary shares of the company Shares are deposited in a local custodian bank ADR issued by US depositary bank (e.g. BNY) ADR trade on U.S. exchanges.
ADR
Stock
India
US
ADRs - Selling Foreign Shares in America indirectlyADRs - Selling Foreign Shares in America indirectly
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Introduction to Bonds
Bonds are debt securities sold by a company or government to raise
money (Fixed Income Instruments) • Bond holder becomes a Creditor but not owner of bond issuing corporation
• Bond holder receives interest yield in addition to principal amount
• Bonds characterized by finite life span (determined by Maturity period) Issuer is responsible for repayment of principal and interest
Investor Issuer
More Income Greater Safety Known Maturity Not an Owner Poor Inflation Hedge
Control Issues Risk of Default “Leverage” in a
Capital Structure
Bond is the other fundamental product giving fixed returnsBond is the other fundamental product giving fixed returns
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Bond Terminology
Par Value- The value of a bond assigned by the issuer; also called face value.
Coupon - Paper that evidences an issuer's promise to pay interest when due
Coupon rate- The interest as a percent of par paid by a bond
Premium. The amount by which a bond sells above its par value
Maturity date- The date on which a bond is to be redeemed and its principal and
interest returned to the owner
Yield- The rate of return on an investment, described as a percentage of the amount
of the investment
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8% IBMIssuer
$1,000 Face Amount
$80/2= $40 Semi-annual interest
1/15/25
Maturity Date
Interest Payment dates are: 1/15 and 7/15Semi Annual
Bond in a Nutshell
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Bond Categories Issuer Based Categories
• Government Securities- Issued by The U.S. government from the U.S.
Treasury and several government agencies.
• Outstanding securities on 01/19/2005 ---- $7,613,772,338,689.34
• Corporate Bonds- Bonds issues by various corporations to borrow money for
operations
• Municipal Bonds- Bonds issued by states, cities, counties and various districts
to raise money to finance their operations or to pay for infrastructure projects.
Convertible Bonds
• Bonds convertible into common stock
• Generally lower coupons as there is upside for investors
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Derivatives
$1,000Buy
Today
$1,200One Month Later
$ 850One Month Later
Pay $25 and Book TVBuy One Month Later
Pay Today’s Price
$ 175Save
$ 175Lose
There is no deal without a TV here – Fundamental ProductThere is no deal without a TV here – Fundamental Product
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Options
Terminology• Rights and Obligations (to buy or sell)• Specific Stock (Round lot)• Specific Time Frame (Expiration date)• Specific Price (strike)• Premium
Reasons to buy Options• Directional Speculation• Volatility Speculation• Protection of Stock Position• Income Generation
Getting out of options• Liquidate or Buy Back in Market• Exercise• Expiration
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Option Buyer
Option Writer
“I have a Right” (Control) “I have an Obligation”
(No Control)
“I paid $”“I got paid $ ”
Buyers Have rights“are in Charge”
Pay for the privilege
Sellers take on obligations
“Are Passive”Get paid for their
promise
Options Trading
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Call Buyer Call Writer
Right to Buy(Control)
Obligation toSell
(No Control)
BullishBearish
Call Options
Call Option – Right to Buy assumes price would go upCall Option – Right to Buy assumes price would go up
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Put Buyer Put Writer
Right to Sell(Control)
Obligation toBuy
(No Control)
BearishBullish
Put Options
Put Option – Right To Sell, Assumes Price to Go DownPut Option – Right To Sell, Assumes Price to Go Down
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Rights & Warrants Rights
• Securities issued by corporation
• Shareholders maintain percentage ownership
• Rights offering and standby underwriting Warrants
• Right to buy shares of stock at a specific price.
• Warrants are issued by a corporation
• Warrants may be long-term or perpetual.
• Attached to bond or part of unit
• Low cost capital raise
Rights and Warrants - Issued by Corporation , not between two partiesRights and Warrants - Issued by Corporation , not between two parties
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Mutual Funds
Pool of Investors Money Financial Expert Manages
money Buys Multiple Company
Shares Investors own units that are
priced proportionately Value of units change based
on fluctuations in share prices
Dividends and Capital Appreciation
Diversification at low cost
Stock Number Market Price Total Price
IBM 100 $ 20 $ 2,000
MSFT 200 $ 30 $ 6,000
Oracle 500 $10 $ 5,000
Total - - $13,000
No. of Units 1000
Per Unit Price $ 13
Mutual Funds – Owning shares indirectlyMutual Funds – Owning shares indirectly
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Fund Terminology Net Asset Value - The value of a single unit of the fund determined on a daily basis
Management fee - The fee charged to compensate those who run the fund's portfolio;
Approximate around one percent of the fund's assets
Fund Types - Sales Charges i.e. fees payable while buying/redeeming shares in the fund
• Front end load Funds- Charges levied when shares in the fund are purchased
• Back end load Funds- Charges levied when shares in the fund are redeemed
• No load Funds- No sales charge
Fund Types - Continuous / Time Bound
• Open end funds- Issue new units continuously as investors buy them. Investors
redeem their units directly to the fund,
• Closed end funds- Issue a fixed number of units. Fund may redeem only upon
termination of the fund's trust. Unit holders may sell their units to other investors.
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Annuities
Guarantees returns over a period of time, based on initial
investment Monthly income plan, Purchasing power risk Fixed Annuities
Money invested in general account Pays a fixed monthly income at retirement
Variable Annuities Pays variable monthly payment at retirement Investment risk
Immediate or deferred Payout
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Reading Material
http://www.brokerage101.com/ - Section on Marketable Securities http://www.invest-faq.com/ http://www.fool.com http://www.investopedia.com
http://stocks.about.com/ - Equities http://mutualfunds.about.com/ - Mutual Funds http://www.annuityfyi.com – Annuities - Futures and Options http://stocks.about.com/od/bonds/ - Bonds
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Financial Marketplace
Development of Trading Markets
Order Types
Secondary Markets• NYSE• NASDAQ
Margin Trading
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Buy 300 shares @ $19.50
Sell 500 shares@ $20.25Potential Buyer
= Bid Potential Seller =Ask
Buyers and Sellers exist like any other market “Bidders” are Buyers “Askers” are Sellers Difference between the Bid and Ask is the Spread
Market Development
Price Differences prevent a dealPrice Differences prevent a deal
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Buy 750 shares @ $20.00
Sell 500 shares@ $20.25Potential Buyer
= Bid Potential Seller =Ask
New bidders and Askers enter Old Bidders and Askers exit Existing Bidders and Askers change price and quantity
Market Development
Prices match ultimately for a deal; Volume Not necessarilyPrices match ultimately for a deal; Volume Not necessarily
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Trading Positions
Long position - Buy Followed by Sale
• Securities owned by an investor
Short Position – Sale Followed by Buy
• Securities not owned by an investor, Relevant only when you sell
Selling Short - The sale of a security that the investor does not own in order to
take advantage of an anticipated decline in the price of the security.
• To sell short, the investor must borrow the security from his broker in order to
make delivery to the buyer
• The short seller will eventually have to buy the security back, or buy to cover,
in order to return it to the broker
In the long run, any investor is expected to close the positionIn the long run, any investor is expected to close the position
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Market Order
CUSTOMER SIZE BIDS (BUYERS)
Hard Line Brokerage 30,000 $ 60.00
Top Notch Advisors 15,000 $59.95
Reckless Securities Inc 25,000 $59.89
Lighting Execution Inc 20,000 $59.81
Rumor Mill Brokerage 10,000 $59.73
HI IQ Capital 30,000 $59.65
Order to buy or sell a stock as soon as possible at the best price availableOrder to buy or sell a stock as soon as possible at the best price available
“Sell 100,000 Shares at the Market”
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“Buy 100,000 Shares at the Market”
CUSTOMER SIZE Offers (Sellers)
Blue-Chip Brokerage 30,000 $60.00
EZ Trade Corporation 15,000 $59.85
Walck Discounters 5,000 $59.80
Klick Quick Trade 35,000 $59.60
Halasy Investors 15,000 $59.55
Murphy Retail Investors 30,000 $59.40
Market Order
Price , Time, Quantity – Order of Preference for any tradePrice , Time, Quantity – Order of Preference for any trade
Order Format - XYZ, Sell, 100
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Limit Orders
Placing a price parameter on order
Not guaranteed execution, but if executed, will receive a better price than the current market price.
Order to buy or sell a stock only at the specified price (the limit price) or better; Safer way for trading
Format for order
• XYZ, Sell, 100, $20.25 $18.50
$18.75
$19.00
$19.50
$20.00
$20.25
$20.50
Current Price
Buy Limit Orders
Sell Limit Orders
Buy limit price < Current market price, Sell limit price > Current market priceBuy limit price < Current market price, Sell limit price > Current market price
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Sell Stop Order
$20
$18 Sell Stop Order(stop-loss order)
Buy @ Market
Used to protect a long position Placed below the market
Two Step Process:
• 1. “Activation price” or “Trigger price”
• 2. Once “activated”, it becomes a market order
Order Format – XYZ, Sell, 100, $18
• Market Price could be $ 20
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1. Buy 100 XYZ @ the market price of $20.00 (long position)2. Places the following order to protect his long position:Sell 100 XYZ $18.00 stop GTC
Three days later the following trades take place:
Activation Price / Execution Price ?
$18.25
Open
$18.15 $18.05 $18.00 $17.90 $17.85 $17.75
Sell Stop Order
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Buy Stop Order
$22
$20 Short Sale
Buy Stop Order
Used to protect a short position Placed above the market
Two Step Process:
• 1. “Activation price” or “Trigger price”
• 2. Once “activated”, it becomes a market order
Order Format – XYZ, Buy, 100, $22
• Market Price could be $ 20
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1. Sell Short 100 XYZ @ the market price of $20.00 (Short position)2. Places the following order to protect short position:Sell 100 XYZ $22.00 Stop GTC
Three days later the following trades take place:
Activation Price / Execution Price ?
$21.75
Open
$21.85 $22.00 $22.10 $22.15 $22.25 $22.30
Buy Stop Order
Stop-Limit Order- Like a stop Order but after activation becomes a limit Order instead of Market Order
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More Order Types All-or-None Order (AON)
• No partial executions
• Broker has all day to execute order (no urgency) Immediate-or-Cancel Order (IOC)
• Partials are acceptable
• Fill immediately (urgency), and cancel unfilled balance
Fill-or-Kill Order (FOK)
• Fill immediately
• No partials
• If entire order cannot be filled immediately, then cancel order
Day Order
• Good for the day
• If not executed within the course of day, order is canceled. GTC Order
• Also known as an “open order”.• Order is in effect until executed or canceled by the customer
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CUSTOMER SIZE Offers (Sellers)
Blue-Chip Brokerage 30,000 $60.00
EZ Trade Corporation 15,000 $59.85
Walck Discounters 5,000 $59.80
Klick Quick Trade 35,000 $59.60
Halasy Investors 15,000 $59.55
Murphy Retail Investors 30,000 $59.40
All Fall in Line
Building Block for a stock exchangeBuilding Block for a stock exchange
Someone records and tracks order information to ensure the best deal for everyone
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Quiz
I placed a sell order for CSCO, even though I never bought any shares of
CSCO. What have I done?
Bought GOOG at $230, am hoping it will go up, but I also want some
protection in case it goes down, what can I do?
If MSFT issues 85 Million shares and decides to buy back 6 Million
shares, how many shares are outstanding in the market?
How many shares of MSFT are authorized in the above case?
What is the market capitalization of MSFT if the market price is $10 per
share?
If MSFT declares a 10% dividend, what amount would I get if I own 2000
shares?
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Securities and Exchange Commission (SEC) www.sec.gov
• Responsible for administering and enforcing the federal securities laws, and
regulating brokerage firms, investment companies and advisers
• Ensures orderly market performance and information availability to investors
• Establish accounting norms for securities transactions
National Association of Securities Dealers (NASD) www.nasd.com
• Works to aid and safeguard investors by regulating markets, formulating
guidelines, facilitating dispute resolution and monitoring member activities
Regulatory Bodies
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Stock Market Players Broker – A person or firm that facilitates trades between customers
• Acts only as an intermediary and does not assume risks for the trade
• Charges commissions
Dealer – A person or firm that buys and sells from his or her own inventory of
securities as well as for others
• Assumes risk for the transactions
• Marks securities up or down to make a profit on their transactions
Registered Representatives – An individual who has passed the NASD's
registration process and is therefore licensed to work in the securities industry
• Follows NASD rules.
• Usually a brokerage firm employee acting as an account executive for clients
• Sell to the public; they do not work on exchange floors
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Secondary Markets - Market for outstanding issues
OTC MarketsExchange Markets
Hybrid Market
Stock Exchange(NYSE, AMEX etc) Private association of brokers Auction type of trading Central meeting place where members trade in listed securities
Over the Counter (OTC)market (NASDAQ)
Negotiated market, without a central trading floor Composed of network of brokers and dealers Bid/ask quotes given by market makers
Market Classification
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Exchange Markets
Auction Markets Specialists Centralized Listing standards NYSE is the model NYSE - SRO
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The New York Stock Exchange
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What does the NYSE do? Trading and trading services
• NYSE charges (directly and indirectly) for trades that occur and for software supplied to its members.
Listing• To be listed on the NYSE, a corporation must meet/maintain certain financial
standards and pay listing fees.• An NYSE listing is a certification that enhances a firm’s credibility.
Information• NYSE is (indirectly) an information vendor.
Regulation• NYSE monitors and regulates the trading activity of its members.• Through the listing relationship and the listing standards, it can affect corporate
governance behavior. Other Information
• Traditional Auction Market with 2800 Companies Listed and 460 Non US Listings from 48 countries
• Listings war with NASD / Overseas markets
• Ownership Structure-1366 Seats (constant since 1953)
46
Specialist Role The Post
• Each security is assigned a particular spot on the trading floor.
• All activity for each security takes place at the security’s post through open outcry.
The specialist as auctioneer
The specialist may act as either principal or agent Role of the Specialist
• Maintains a fair and orderly market
• Provides liquidity
• Resolves order imbalances Floor Brokers
• Act in an agency capacity
• No risk is assumed on transaction
• Compensation is a commission
47
OTC Markets Transactions that occur off the floor of
an exchange Negotiated Market Market makers Decentralized Nasdaq is the model for OTC markets NASD – SRO Not face to face Bids and offers entered via phone or
computer Market Makers willing to sell or buy
48
NASDAQ
49
NASDAQ ? Electronic communication and execution network
Market Makers post prices to buy and sell
Think of shopping @ 100s of stores
Inventory of stocks
Computer automatically finds the best prices- inside market
Nasdaq is an NASD operated electronic quote system .
Two tiers of Nasdaq:1. Nasdaq National Market (NNM)2. Nasdaq SmallCap
2872 Company Listings 11,000 registered traders with 790 firms 1.2 million terminal users in 82 countries
50
Role of the Market Maker
A Dealer Market uses multiple dealers, known as Market Makers.
Compete for investor orders Commit capital Maintain inventories Seek the other side of a trade Trade on both sides of the market Generate investor interest
51
Margin Trading
A process whereby a brokerage client uses credit to finance securities
transactions
Allows its clients to buy securities with money borrowed from the broker
Margin requirements can be met by the investor with cash, eligible
securities, or any combination thereof
Governed by regulations of Federal Reserve, NYSE and the brokerage
firm’s internal rules
Not all securities can be traded through margin account-
Federal Reserve Board specifies “Margin securities” i.e. securities eligible
for trading through Margin account
Margin Account - Collateralized loan from a broker-dealer regulated by Reg TMargin Account - Collateralized loan from a broker-dealer regulated by Reg T
52
Customer Broker
Bank
Rehypothecation Hypothecation
Call Loan RateMargin Interest Rate
Margin Trading Process
53
Quiz
I placed a market order for AAPL, but my order did not find its way into
the specialists’ book. Why?
If you own a security, would you ask for an ASK or a BID quote?
Name one auction exchange in the US?
Name one OTC exchange in the US?
If a $1000 15-year par value bond paying 6% semi-annual coupon is
selling in the Market at $1007, is the bond selling at a Premium or at a
discount?
In the above case, what is the coupon amount that the investor receives
every 6 months?
If I have a put option on BONY / BK at $29 today and the market price is
$32.20, should I exercise the option?
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Part 2 – Brokerage Operations
Execution Processes Clearing Processes Settlement Processes Post Settlement Processes Benefits of Outsourced Clearing
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Stock Trading : A Client Perspective
What’s so difficult about buying and selling stock?What’s so difficult about buying and selling stock?
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The Reality
Trade processing is complex Many different areas of a firm are involved in a trade Trade processing methodologies grew up in a paper-driven environment. Complex system of checks, double checks and triple checks to safeguard the
firm and client Today: Intermediaries (e.g. Pershing; DTCC)
Brokerage Services is a multi-billion dollar industryBrokerage Services is a multi-billion dollar industry
Old World• Examination of trade processing in
a paper-based environment• Low volume• Trade by trade settlement• Firms deals directly with one-
another• Slower and volume sensitive
Modern World• Examination of trade processing in
an electronic environment
• High volume
• Net settlements
• Firms deal with Centralized Counter party
• Volume insensitive and high speed
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Life of a Trade
Order SettlementExecution Clearing
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Pershing’s View
4.Trade Agreement
3.Trade Allocation
2.Trade Processing
1.Order Management
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Order InitiationOrder Initiation
Order Capture
Order Handling
Order Routing
Execution Match and Reporting
Execution Order Creation
Incoming Orders Solicited by RR or at client’s direction
• In person• Phone Call• Internet
Solicitation or Receipt of Customer Orders is Order InitiationSolicitation or Receipt of Customer Orders is Order Initiation
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Order Ticket Information
Purchase or Sale Long sale vs. Short Sale Security Quantity Type of order
(market/limit/stop) Solicited vs. unsolicited RR Identifier GTC or day
Obtaining correct information is critical for execution and other subsequent activitiesObtaining correct information is critical for execution and other subsequent activities
SELL
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Order CaptureOrder Initiation
Order Capture
Order Handling
Order Routing
Execution Match and Reporting
Execution Order Creation
More Work Prior to placing the Order (System checks & Reviews)
• Internal checking of order
• Is the “ticket” filled out correctly?
• Is all information there?
• Is client cleared to do this type of trading?
• Does the client have sufficient assets ($/securities) in account? (credit limits)
• Shorting? Are securities available?
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Order HandlingOrder Initiation
Order Capture
Order Handling
Order Routing
Execution Match and Reporting
Execution Order Creation
Order Rooms• Receipt of incoming orders from
RRs
• Branch level or centralized for entire firm
• Organize pending orders based on security type, market, client type, size, etc.
• Determination if trade is internal or goes to the street
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Dealer or Principal CapacitySubject to risk on transaction
Mark-up or markdown
Broker or Agency Capacity No risk on transaction
Commission
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Order RoutingOrder Initiation
Order Capture
Order Handling
Order Routing
Execution Match and Reporting
Execution Order Creation
Routing• Client’s preferences?
• Broker Dealer’s preferences? Routing to NYSE floor Regional exchange Relationships with specialists Speed vs. Liquidity vs. Cost Execution occurs at this stage
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Life of a Trade
Order SettlementExecution Clearing
66
Execution Match and ReportingOrder Initiation
Order Capture
Order Handling
Order Routing
Execution Match and Reporting
Execution Order Creation
Internal• Receipt of execution reports from trading venue
• Tie together orders and executions
• Correct security / quantity / client?
• Clean up of execution errors
• Research of un-entered/unexecuted orders SRO
• Report of executions to SRO
• Exchanges have systems to track executions
• SROs looking for violations/patterns Client
• Record executions (partial or full)
• Report executions to RR
• Report NDs to RR
• RR gives verbal/email report to client
67
Execution Order Creation
Before We Leave the Order Room • Order – Potential Business
• Execution is contract between the BD and contra firm
• BD-to-client transaction is a separate agreement
• Clients do not transact business on NYSE or NASDAQ!
Order Initiation
Order Capture
Order Handling
Order Routing
Execution Match and Reporting
Execution Order Creation
68
Life of a Trade
Order SettlementExecution Clearing
69
Clearing Operations
4.Trade Agreement
3.Trade Allocation
2.Trade Processing
1.Order Management
Recording of executions Computing monetary amounts Comparison of trades with contra broker Confirmation of trade with client Booking
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Trade Validation
Trade Validation
Trade Enrichment
Street SideSubmission
Trade Matching(Customer and
/or street)
Trade ExceptionHandling
BDs, branches, RRs all given distinct identifiers
Securities have CUSIP #s Think of a CUSIP as a barcode which
contains issuer and issue identifiers Trade itself is given transaction (ID) # Contra-brokers have ids If problem: Exception
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Trade Enrichment
Trade Validation
Trade Enrichment
Street SideSubmission
Trade Matching(Customer and
/or street)
Trade ExceptionHandling
Adding Information• Commissions/mark-up or mark down
• Sec fees
• Taxes
• Regulatory Disclosures
• The end result is a “fully figured trade”
72
Street Side Submission
Trade Validation
Trade Enrichment
Street SideSubmission
Trade Matching(Customer and
/or street)
Trade ExceptionHandling
Comparing the details• Comparing trades with contra broker
• Old days: trade-by-trade or itemized comparison
• Street acknowledgement of trade
• If OK trade is affirmed or “locked in”
• Details may differ (uncompared)
• Contra broker does not know the trade
• Right security/right contra-party?
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Trade Matching
Trade Validation
Trade Enrichment
Street SideSubmission
Trade Matching(customer and
street)
Trade ExceptionHandling
Notification-Generating a Customer Confirm
Trade particulars (security price, size, etc)
TD/SD Where / when executed Capacity in which the form acted Cash or Margin SRO Rule: Customer confirms must be
generated by completion of the transaction
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Trade Exception Handling
Trade Validation
Trade Enrichment
Street SideSubmission
Trade Matching(Customer and
/or street)
Trade ExceptionHandling
Trade Problems • Looking for problems (exceptions)• Wrong stock / Bond ( maturity)/ Quantity• Problem “real” (error) or “typo” (discrepancy)?• Does the problem affect contra-broker?• Can the trade be repaired? • Cancels and re-bills
“As of” Trades and Corrections • Fixing a customer/contra broker problem• Trades mistakenly not entered• Execution problems• Error accounts• Internal corrections and or contra broker
notification• Compliance Notification -
• Is a client being showed favoritism• Does a particular RR/trader/branch exhibit
a pattern?• Is there a system problem?
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Clearing Operations
4.Trade Agreement
3.Trade Allocation
2.Trade Processing
1.Order Management
Block Trades Investment Managers (MFs etc) Individual clients selected A given trade may be split up and
confirmations generated to many clients
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Clearing Operations
4.Trade Agreement
3.Trade Allocation
2.Trade Processing
1.Order Management
Booking - Everyone agrees the trade is now processed and balanced or booked into the firms records
77
Life of a Trade
Order SettlementExecution Clearing
78
If Trade Clears: Goal = Settlement
Settling Compared Trades• On settlement date, the selling broker delivers to the buying broker and gets paid
(formerly trade-by-trade)• Firm to Firm transfer• $ vs. securities
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Can Clients Cause a Failure to Settle? Firms agree on trade particulars Client (seller) does not deliver Client (buyer) does not pay Settlement will still occur…. Contract is between firms!
Analyze reasons for fails Record keeping to age items One “fail” may affect multiple trades Fails cost $ Issue buy-in to client or street Obtain stock from safekeeping or stock loan
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Post Settlement Events
Cashiering (Cash Management)• Receipt/disbursement of client funds
• Receipt/disbursement of contra broker funds Checks Fed Funds Credits or debits internally Third party payments Accounting
• Keeps track of the cash - daily cash record
• Invoicing and payments
• Trial balance - monthly
• P&L statements
• Balance sheet
• Regulatory reports
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Post Settlement Events Stock Record
• Record of positions • Tracking movements• Identification/investigation of Breaks • Auditing positions - physical vs. stock Record
Client Records (Customer Reporting) • Statements • Tax reporting• P&L (cost basis etc)
SEC/SRO Records (Regulatory Reporting)• Net capital• Operational Issues• Client extensions• $ Laundering• Complaints
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Corporate Actions
Communications• Receive information from Issuer / DTC etc.
• Review Information (Prospectus / Letter)
• Mailing Announcements
• Communications with depositories or agent banks
Outcomes• Receipt of customer instructions
• Research and reconciliation of exceptions
• Stock record must be consulted
• Crediting/debiting accounts for $/stock
Examples• Mergers, Spin-offs, Splits / Reverse splits
• Cash and stock, Interest allocations, Rights offerings
• Calls, Proxies, Dividends, Voting
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Why Not Self-Clear?
Cost Issues - Inefficient; Cheaper to Outsource Financial Benefits - Cheaper cost of funds (margin), Stock loan opportunities, Reduced
net capital Needs, Reduction of contra party risk, Bulk buying opportunities Reduced Paperwork – Confirms, Statements, Mailings, Proxies, Tax Reports Regulations Concerns / Compliance - Patriot Act /Money Laundering, Trade
Monitoring, Net Capital Issues, 144 Sales/Accounts of Deceased/Accts -Associated Persons Activities, DNC Lists, Archiving Records
Technology Advantages - Access to trading software, Data feeds (News and Quotes), Access to ECNs, Trading Technology/Relationships, Access to risk management software (Trading), Client profiling software (Compliance)
Client Peace of Mind
Why Hire Pershing? (Why Third Party Clearing Services?)
• Saves time and $
• Think of clearing on a unit cost basis
• Permits small firms to focus on what they do best (Sales and/or Trading)
Q&A
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