2

Chapter
Buying and Selling Securities

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 First you buy a stock.
First you buy a stock.
If it goes up, sell it. If it doesn’t go up,
don’t buy it. – Will Rogers

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 Buying and Selling
Securities
This chapter covers the
Goal basics of the investing
process.
 We begin by describing how you go
about buying and selling securities
such as stocks and bonds.
 Then we outline some important
considerations and constraints to
keep in mind as you get more
involved in the investing process. 3
 Getting Started
Open aa brokerage
Open brokerage
or trading
or trading account
account

Deposit money
Deposit money
into account
into account Buy securities
Buy securities

Withdraw money
Withdraw money Sell securities
Sell securities
from account
from account

Close account
Close account
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 Choosing a Broker
• Brokers are traditionally divided into
three groups.
 full-service
brokers
 discount brokers
 deep-discount brokers

• These three groups can be

distinguished by the level of service
provided, as well as the resulting
commissions charged.
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 Choosing a Broker
Commissions Level of
# of shares ($50/share) 200 500 Service
1000 Provides
Full-Service Brokers extensive
A.G. Edwards $150 $200 $300 investmen
Merrill Lynch t advice
Discount Brokers
Charles Schwab $100 $125 $150 Maintains
Fidelity Brokerage account
Deep-Discount Brokers and
Olde Discount $50 $75 $100 executes
Quick & Reilly buy/sell
orders6
 Choosing a Broker
• However, as the brokerage industry
becomes more competitive, the
differences among the broker types seem
to be blurring (mờ nhạt).
• Another important change is the rapid
growth of online brokers, also known as e-
brokers or cyberbrokers.
• Online investing has fundamentally
changed the discount and deep-discount
brokerage industry by slashing costs
dramatically.
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 Choosing a Broker
Broker Commission for
Simple Trade
Charles Schwab $29.95, up to 1000
shares
 http://www.schwab.com
Fidelity Investments $25, up to 1000
shares
 http://www.fidelity.com
CSFBdirect $20, up to 1000
shares
 http://www.csfbdirect.com
E*Trade $14.95, up to 5000
shares
 http://www.etrade.com
TD Waterhouse $12, up to 5000 8
 Security Investors Protection
Corporation
Security Investors Protection
Corporation (SIPC)
Insurance fund covering investors’
brokerage accounts with member
firms.
• Most brokerage firms belong to the
SIPC, which insures each account for up
to $500,000 in cash and securities, with
a $100,000 cash maximum.
• Note that SIPC does not guarantee the
value of any security.
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 Broker-Customer Relations
• There are several important things to keep in
mind when dealing with a broker.
 Any advice you receive is not guaranteed.
 Your broker works as your agent and has a legal duty
to act in your best interest. On the other hand,
brokerage firms are in the business of generating
brokerage commissions.
 Your account agreement will probably specify that any
disputes will be settled by arbitration (tòa án) and that
the arbitration is final and binding.

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 Brokerage Accounts
Cash account
A brokerage account in which all
transactions are made on a strictly
cash basis.
Margin account
A brokerage account in which,
subject to limits, securities can be
bought and sold on credit.

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 Margin Accounts
• In a margin purchase, the portion of
the value of an investment that is not
borrowed is called the margin.
• The portion that is borrowed incurs an
interest that is based on the broker’s
call money rate, which is the rate
brokers pay to borrow bank funds for
lending to customer margin accounts.

12
 Margin Accounts
Example: The Account Balance Sheet
• You want to buy 1000 Wal-Mart shares at
$24 per share. You put up $18,000 and
borrow the rest.
 Amount borrowed = $24,000 – $18,000 =
$6,000
Assets Liabilities & Account
 Margin = $18,000 / $24,000 = 75%
Equity
1000 WM shares$24,000 Margin loan
$ 6,000
Account equity18,000
Total $24,000 Total $24,000
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 Margin Accounts
• In a margin purchase, the minimum
margin that must be supplied is called
the initial margin.
• The maintenance margin is the
minimum margin that must be present
at all times in a margin account.
• When the margin drops below the
maintenance margin, the broker may
demand for more funds. This is known as
a margin call.
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 Margin Accounts
Example: Margin Requirements
• Your account requires an initial margin of
50% and a maintenance margin of 30%.
Stock A is selling at $50 per share. You
have $20,000, and you want to buy as
much of stock A as you possibly can.
 You may buy up to $20,000 / 0.5 =
$40,000 worth of shares.
Assets Liabilities & Account
Equity
800 A shares $40,000 Margin loan $20,000
Account equity20,000
Total $40,000 Total $40,000
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 Margin Accounts
Example: Margin Requirements
• After your purchase, the share price of
stock A falls to $35 per share.
Assets Liabilities & Account
Equity
800 A shares $28,000 Margin loan $20,000
Account equity 8,000
Total $28,000 Total $28,000

 New margin = $8,000 / $28,000 = 28.6%

< 30% Therefore, you are subject to a
margin call. 16
 Margin Accounts
• Margin is a form of financial
leverage.
– When you borrow money to make an
investment, the impact is to magnify
both your gains and your losses.

17
 A Note on Annualizing
Returns
• To compare investments, we will usually
need to express returns on a per-year, or
annualized, basis.
• Such a return is often called an effective
annual return (EAR).
• 1 + EAR = (1 + holding period % return)m
where m is the number of holding periods
in a year.

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Hypothecation and Street Name
Registration
Hypothecation
Pledging securities as a collateral
against a loan, so that the
securities can be sold by the broker
if the customer is unwilling or
unable
Street to meetregistration
name a margin call.
An arrangement under which a
broker is the registered owner of a
security.
The account holder is the
“beneficial owner.”
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 Other Account Issues
• Trading accounts can also be differentiated by the
ways they are managed.
– Advisory account - You pay someone else to make buy
and sell decisions on your behalf.
– Wrap account - All the expenses associated with your
account are “wrapped” into a single fee.
– Discretionary account - You simply authorize your
broker to trade for you.
– Asset management account - Provide for complete
money management, including check-writing privileges,
credit cards, and margin loans.

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 Other Account Issues
• To invest in financial securities, a
brokerage account is not a necessity.
– One alternative is to buy securities
directly from the issuer.
– Another alternative is to invest in
mutual funds.

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 Short Sales
Short sale
A sale in which the seller does not
actually own the security that is
sold.
Borrow
Borrow Buy
Buy Return
Return
shares
shares Sell the
Sell the shares
shares the
the
from
from shares
shares from
from shares
shares
broker
broker market
market

Note that an investor who buys and owns

shares of stock is said to be long in the stock
or to have a long position.
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 Short Sales
• An investor with a long Bu
se y low
position benefits from price ll h
igh ,
!
increases.

 On the other hand, an Se

bu ll hig
investor with a short yl
ow h,
!
position benefits from
price decreases.

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 Short Sales
Example: Short Sales
• You want to short 100 Sears shares at $30
per share. Your broker has a 50% initial
margin and a 40% maintenance margin on
short sales.
 Assets
Worth of stock borrowedLiabilities & Account
= $30 × $100 =
$3,000 from sale$3,000 Equity
Proceeds Short position
$ 3,000
Initial margin deposit1,500 Account equity
1,500
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 Short Sales
Example: Short Sales …continued
• Scenario 1: The stock price falls to $20 per
share. Assets Liabilities & Account
Equity
Proceeds from sale$3,000 Short position
$ 2,000
Initial margin deposit1,500 Account equity
2,500
 Total
New margin $4,500 Total = 125%
= $2,500 / $2,000 $4,500

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 Short Sales
Example: Short Sales …continued
• Scenario 2: The stock price rises to $40
per share.
Assets Liabilities & Account
Equity
Proceeds from sale$3,000 Short position
$ 4,000
Initial margin deposit1,500 Account equity
500
 Total
New margin $4,500 Total = 12.5%
= $500 / $4,000 $4,500
<
40% Therefore, you are subject to a
margin call. 26
 Short Sales
Short interest
The amount of common stock held
in short positions.
• In practice, short selling is quite common and a
substantial volume of stock sales are initiated
by short sellers.
• Note that with a short position, you may lose
more than your total investment, as there is no
limit to how high the stock price may rise.

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 Risk and Return
• In formulating investment objectives,
the individual must balance return
objectives with risk tolerance.

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 Investor Constraints
• Resources. What is the minimum sum needed? What
are the associated costs?
• Horizon. When do you need the money?
• Liquidity. How high is the possibility that you need to
sell the asset quickly?
• Taxes. Which tax bracket are you in?
• Special circumstances. Does your company provide
any incentive? What are your regulatory and legal
restrictions?

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 Strategies and Policies

Be e! Pa Be
ssi
c ti v ve
!
A

• Investment management. Should you

manage your investments yourself?
• Market timing. Should you try to buy
and sell in anticipation of the future
direction of the market?
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 Strategies and Policies

Be e! Pa Be
ssi
c ti v ve
!
A

• Asset allocation. How should you distribute your

investment funds across the different classes of
assets?
• Security selection. Within each class, which
specific securities should you buy?

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 Chapter Review
• Getting Started
– Choosing a Broker
– Online Brokers
– Security Investors Protection
Corporation
– Broker-Customer Relations

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 Chapter Review
• Brokerage Accounts
– Cash Accounts
– Margin Accounts
– A Note on Annualizing Returns
– Hypothecation and Street Name
Registration
– Other Account Issues

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 Chapter Review
• Short Sales
– Basics of a Short Sale
– Some Details
• Investor Objectives, Constraints, and
Strategies
– Risk and Return
– Investor Constraints
– Strategies and Policies

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