Raza Yaqoob (M.com) Capital Market

8/4/2019 Raza Yaqoob (M.com) Capital Market

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Capital Market (Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)

Capital Market

(New York Stock Exchange)(Share Prices, Insider Trading, Institutional Trading, News Announcement, Efficiency)

Presented to,

Respected Sir, Osman Saeed

Presented by,

Raza Yaqoob

M.Com (Finance)

The University of LahoreBusiness School

47/C3, Gulberg III, Lahore

_____________________________________________________The university of Lahore, City Campus.

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In The Name of ALLAH, the Compassionate The

Merciful Praise be to Allah, Lord of the world, the

Compassionate the Merciful Master of the Day

Judgment, You Alone We Worship, and to You

Alone We Look for Help Guide Us to the Straight

Path the Path of Those upon who bestowed not

Those ho Have Invited Your Worth Not Those

Who Have Goane a Stray?

(AL-FATIHA)

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The university of Lahore, City Campus.

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DEDICATED

TO

MY PARENTS

&

TEACHERS


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ACKNOWLEDGEMENT

I start my work on the assigned topic the name of ALLAH, the most Beneficentand Merciful, the Creator of the universe, Who gave me strength , ability andcourage to fulfill the requirement of this thesis, I offer Darood Pak to the holyprophet Muhammad (Peace be upon him) Who showed the right path to themankind.

I am very thankful of my teacher and University Management that give me chance

of research and assigned the topic which I require I chose this topic because I thinkmay be my research help to economic situation of the world as well as Pakistanand .I would like to thank to my family and especially my parents and brother fortheir underlying love, prayers and encouragement. I admire my family memberstheir determination and sacrifices at this level. It is through their encouragement andcare that i have through all the steps to reach this point in life and would not havedone it without them.

I am highly grateful to my kind natured, dedicated, sincere and devoted supervisorSir Osman Saeed who solves my problems during research. His worthy comments,suggestions and valuable guidance enable me in enhancing and improving my

capabilities. Without his generous help and guidance it was not possible for me tocomplete this work. I can offer just a little acknowledgement for his very kindguidance, cooperation and great care in preparing this thesis. I am highly obligedand owe him deep thanks.

And at the end I am very thankful to all the authors of various books, articles,research papers and journals. During the working I get help from so many articlesand journals.

Raza Yaqoob


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Brief Contents

Details Page No

Acknowledgment 3

Chapter #1Capital Market

1.1 Introduction of Capital Market 91.2 Capital Market Resources 91.3 Today Types of Capital Market 11

Chapter #2New York Stock Exchange 12

2.1 Introduction 122.2 Position of NYSE in World & US Capital Market 122.3 NYSE is a Hybrid Market 13

2.3.1 Floor Brokers 142.3.2 Specialist 14

2.4 Marketplace Technology 142.5 How a Stock is Buy & Sell 152.6 NYSE Regulations 18

2.7 Types of Stock 182.7.1 Income stock 182.7.2 Blue Chip Stocks 182.7.3 Growth Stock 182.7.4 Cyclical Stock 192.7.5 Defensive stock 19

2.8 Mutual Funds 192.9 Exchange Traded Funds 192.10 Fixed Income Securities 192.11 Structured Products 202.12 Options 20

2.13 How to Read a Stock Table 20

Chapter #3


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Share Prices

3.1 What Drives Share Prices 223.2 Demand & Supply 223.3 News 253.4 Price Earning Ratio 253.5 Market Cap 26

3.6 EPS (Earning Per Share) 263.7 Indexes 263.8 A Companys Financial Health 273.9 Industry Information 273.10 Political Instability 273.11 War & Terror 28

3.12 International Relation 283.13 Economic Trends 283.14 World and National Events 28

Chapter #4Insider Trading

4.1 Insider 294.2 Insider Trading US Market 294.3 American Insider Trading Law 30

4.4 Legal Insider Trading 304.5 Illegal Insider Trading 304.6 SEC Regulations 314.7 Liability for Insider Trading 314.8 Trading on Information in General 314.9 Security Analysis and Insider Trading 314.10 Why Follow Insiders? 324.11 Insider Qualification 324.12 One Reason to Buy 324.13 Insider Sentiment 334.14 Who Insider 33

4.14.1 Position 334.14.2 Historical performance 33

4.15 Commitment 344.15.1 Dollar Amount 34

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4.15.2 Change in total holdings 344.16 Consensus 34

4.16.1 How many insiders are purchasing 344.16.2 What the overall trend has been 34

4.17 Summary 354.18 Effects of Insider in the Stock 35

4.18.1 Significant of Insider Trading 354.18.2 Identification of Insider Trading 354.18.3 SEC Disclosure Requirements 364.18.4 Potential Benefits from Insider Trading 364.18.5 Famous example of Insider Trading 36

4.19 The Effects of Insider Trading Regulation on Trading 36Timing and, Litigation Risk and Profitability4.19.1 Hypothesis Development 374.19.2 Insider Trading Profitability 39

4.19.3 Conclusion 39

Chapter #5Institutional Trading

5.1 Institutional Trading, Trading Volumes and Spread 415.2 Introduction 415.3 Effect of Institutional Trading On Securities Prices 415.4 Provide Liquidity 425.5 I.T How Affect the Individual components of the spread 425.6 Our Approach 42

5.7 Buying & Selling 435.8 Negative Slope 435.9 Motivation 435.10 Regression Frame Work 445.11 Components of Spread 44

5.11.1 Effect on Components 445.11.2 According to Some Experts 45

5.12 Regression Model & Data Description 465.13 Data for Institutional Trading 465.14 Regression Results of Panel Model 485.15 Conclusion 49

Chapter #6

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NYSE Sector Indexes

6.1 Methodology Guide 506.2 Index Overview and Description 506.3 Key Feature 50

6.3.1 Membership Criteria 506.3.2 Base Data & Base Value 516.3.3 Calculation and Dissemination 516.3.4 Index Divisor Adjustment 516.3.5 Weighting 536.3.6 Dividend Treatment 53

6.4 Index Maintenance 536.5 Constituent Change 54

6.5.1 Additions 54

6.5.2 Deletion 54

6.6 Changes in Share out Standing 546.7 Index Divisor Adjustment

6.7.1 Formula for Divisor adjustment 55

6.7.2 Adjustment of Corporate Actions 556.8 Index calculation Methodology 57

6.8.1 Input Data 576.8.2 Input Formula 586.8.3 ComputationalPrecision 586.8.4 Intraday Corrections 58

6.8.5 Index-Related Data and Divisor Corrections 596.9 Float Adjustment 596.10 First Regular Index Performance Report 60

Chapter #7News Announcement

7.1 Introduction 627.2 Types of News 62

7.2.1 Positive News 627.3 Affect on Share Prices 62

7.3.1Trade Volume / Index 63

7.4 Demand & Supply 637.4.1 Example 647.4.2 Case 65

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Chapter #8Efficiency

8.1 Market Efficiency 67

8.2 Forms of Efficiency 678.2.1 Weak form Efficiency 68

8.2.1.1 Tests of Weak form efficiency 688.2.1.2 Rules for the efficiency tests 68

8.2.2 Semi Strong Form efficiency 698.3 Technical Analysis 708.4 Behavioral Finance 708.5 NYSE Efficient Hypothesis 708.6 Efficient Market Hypothesis 718.7 Decision Negative Positive Actual Situation 718.8 Discussion 72

Chapter # 9Conclusion 73Bibliography 75References 75


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Chapter # 1

Capital Market1.1 Introduction

The financial markets are an important part of our daily lives. Making sure we arefinancially secure is a vital part of how our economy grows. And investing insecurities is often a significant component of an investors portfolio. Owning stockmeans you own a slice of a public company. These companies span the globaleconomy and form the core of our private enterprise system. They spur job creationand economic growth while creating products and providing services that improveour quality of life. When a company needs to raise money to expand, it sells stocksor bonds to the public through the financial markets.

Individuals become investors in this company by purchasing those securities. Morethan 90 million Americans own shares of stock through individual investments orthrough mutual funds. And many more participate in the stock market through theinvestments of retirement funds, insurance companies, universities and banks.Owning stock allows investors, large and small, to share in the worlds economicgrowth and vitality. Central to this activity is the NYSE marketplace, where billionsof dollars worth of stock change hands each day. Only the highest qualitycompanies can choose to list their securitieson the NYSE. And once they do, the NYSE plays a unique role in providing deepand liquid markets for the trading of those securities, benefiting all investors, large

1.2 Capital Market Resources

A capital market is simply any market where a government or a company usually acorporation can raise money capital to fund their operations and long terminvestment. Selling bonds and selling stock are two ways to generate capital, thusbond markets and stock markets (such as the Dow Jones) are considered capitalmarkets

Capital markets in the United States provide the lifeblood of capitalism. Companiesturn to them to raise funds needed to finance the building of factories, office


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buildings, airplanes, trains, ships, telephone lines, and other assets; to conductresearch and development; and to support a host of other essential corporateactivities. Much of the money comes from such major institutions as pension funds,insurance companies, banks , foundations, and colleges and universities.

Increasingly, it comes from individuals as well. More than 40 percent of U.S.families owned common stock in the mid-1990s.

Very few investors would be willing to buy shares in a company unless they knewthey could sell them later if they needed the funds for some other purpose. Thestock market and other capital markets allow investors to buy and sell stockscontinuously.The markets play several other roles in the American economy as well. They are asource of income for investors. When stocks or other financial assets rise in value,investors become wealthier; often they spend some of this additional wealth,bolstering sales and promoting economic growth. Moreover, because investors buy

and sell shares daily on the basis of their expectations for how profitable companieswill be in the future, stock prices provide instant feedback to corporate executivesabout how investors judge their performance.

Stock values reflect investor reactions to government policy as well. If thegovernment adopts policies that investors believe will hurt the economy andcompany profits, the market declines; if investors believe policies will help theeconomy, the market rises. Critics have sometimes suggested that Americaninvestors focus too much on short-term profits; often, these analysts say, companiesor policy-makers are discouraged from taking steps that will prove beneficial in thelong run because they may require short-term adjustments that will depress stock

prices. Because the market reflects the sum of millions of decisions by millions ofinvestors, there is no good way to test this theory.In any event, Americans pride themselves on the efficiency of their stock marketand other capital markets, which enable vast numbers of sellers and buyers toengage in millions of transactions each day. These markets owe their success in partto computers, but they also depend on tradition and trust the trust of one broker foranother and the trust of both in the good faith of the customers they represent todeliver securities after a sale or to pay for purchases. Occasionally, this trust isabused. But during the last half century, the federal government has played anincreasingly important role in ensuring honest and equitable dealing. As a result,markets have thrived as continuing sources of investment funds that keep the

economy growing and as devices for letting many Americans share in the nation'swealth.


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To work effectively, markets require the free flow of information. Without it,investors cannot keep abreast of developments or gauge, to the best of their ability,the true value of stocks. Numerous sources of information enable investors tofollow the fortunes of the market daily, hourly, or even minute-by-minute.

Companies are required by law to issue quarterly earnings reports, more elaborateannual reports, and proxy statements to tell stockholders how they are doing. Inaddition, investors can read the market pages of daily newspapers to find out theprice at which particular stocks were traded during the previous trading session.They can review a variety of indexes that measure the overall pace of marketactivity; the most notable of these is the Dow Jones Industrial Average (DJIA),which tracks 30 prominent stocks. Investors also can turn to magazines andnewsletters devoted to analyzing particular stocks and markets. Certain cabletelevision programs provide a constant flow of news about movements in stockprices. And now, investors can use the Internet to get up-to-the-minute informationabout individual stocks and even to arrange stock transactions and small.

1.3 Today Types of Capital Markets in USA & World

Capital markets which consist of Stock markets, which provide financing throughthe issuance of shares or common stock, and enable the subsequent trading thereof.

Commodity markets

Money markets

Derivatives markets

Futures markets

Insurance markets

Foreign exchange markets

Securities market

Debt market

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transfers from other markets or as non-U.S. companies cross-listing at exchangesworldwide

Listed companies pay both initial listing fees and annual fees. In return, their stock

is bought and sold on the NYSE or NYSE Arca, following rules set by theSecurities and Exchange Commission (SEC), a U.S. federal government agency,and NYSE Regulation Inc. S M, the independent NYSE Group subsidiary thatregulates the NYSE and NYSE Arca markets. This publication focuses on theNYSE, the worlds premier equities marketplace. In addition to having the highestoverall listing standards of any securities marketplace in the world, the NYSE isamong the worlds most well-recognized brand names. For 214 years, the NYSEhas facilitated national and global capital formation and symbolized the strengthand vitality of the U.S. securities markets. Issuers that list with the NYSE benefitfrom association with this brand name while gaining access to the worlds largest,most liquid market for the trading of their securities. When companies first list on

the NYSE, the companys top officials are often invited to ring the opening BellSMon the NYSE Trading Floor. Ringing the Bell, which signals the start and close ofthe trading day, is part of the NYSEs rich heritage and signifies the opportunitiesthe financial markets provide

2.3 NYSE is a Hybrid Market

The NYSE has long been the leader in providing the best prices and lowest tradingcosts. Its unique market model allows it to accomplish this. The NYSE blends thebest aspects of electronic trading and traditional, open-outcry, auction markettrading. Buyers and sellers meet directly in a fair, open and orderly market to

compete for the best possible price through the interplay of supply and demand. Atthe NYSE, investors have the broadest choice of trade-execution preferences withthe opportunity for price improvement. As the NYSE market continues to evolve,The NYSE Hybrid Market SM initiative will build on these attributes bybroadening customers ability to trade quickly and anonymously. To be able totrade securities on the Trading Floor, an Exchange-issued trading license isrequired. Only qualified and approved NYSE broker-dealer entities may acquireand hold trading licenses. Most of those holders are either floor brokers orspecialists:

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2.3.1 Floor Brokers

Brokers represent public orders to buy or sell shares and work to get their customersthe best price. Brokers participate both in person and electronically on the Trading

Floor and have advanced tools to assist them in handling trades on behalf of theirclients. Two main types of floor brokers work on the Trading Floor: house brokersand independent brokers. House brokers are employed by brokerage firms that holdaccounts for public investors. These market professionals buy and sell securities asan agent for their customers. The majority of independent brokers are directaccess brokers who deal with institutional investors at low commission rates.

2.3.2 Specialists

Each stock listed on the NYSE is allocated to a specialist, a market professionalwho acts as the contact point between brokers with orders to buy shares and brokers

with orders to sell shares. Specialists act as auctioneers in the specific stocks theyare designated to trade at a designated location, called a trading post. All buyingand selling of a given stock occurs at that location. Specialists use enhancedtechnology to bring buyers and sellers together, improve prices, and serve as a pointof accountability for the smooth functioning of the market. The Hybrid Marketautomates much of what specialists do, helping them become much more efficient.

2.4 Marketplace Technology

The NYSEs highly sophisticated and robust trading platform includes a broadrange of technology tools that help specialists and floor brokers provide value to

customers. The NYSE employs advanced communications and computingtechnologies to deliver fast, efficient, reliable and cost-effective trade executions

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2.5 How a Stock is Bought and Sold

1. Tom Smith of Sarasota, Floridadecides top invest in the stockmarket.

1a. Diane Whit ford of Hartford,Connecticut decides to sell 300 sharesof XYZ Corp. (XYZ) stock to help payfor a new car

2. Tom has been thinking ofinvesting in the XYZ Corp. Hecalls his broker, who is a member

of the New York Stock Exchange,to get a quote on XYZ; that is, tofind out the highest bid to buy andthe lowest offer to sell

2a. Diane checks nyse.com to find outwhat price XYZ is trading at by typingin the companys ticker symbol, XYZ.

3. Toms broker and Diane findout the current quote and price forXYZ from an electronic datasystem that continually updatesinformation directly from theFloor of the NYSE.

4. Taking into account what he

already knows about XYZ andafter a discussion with his brokerTom instructs his broker topurchase 300 shares of XYZ atthe current market price.

4a. Diane logs into her online brokerage

account, which is linked to a brokeragefirm that is a member of the New YorkStock Exchange, and places an order tosell her 300 shares at the current marketprice

5. Both orders are sentelectronically to the NYSETrading Floor either via the SuperDOT System to the specialistsworkstation.

6. The customer can either use the

auction market with the specialistor, to obtain an electronicexecution, use NYSE Direct+

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7. At the specialist workstation both orders are represented asauction market orders in order tohave the opportunity for price

improvement. The specialist whohandles XYZ makes sure thetransactions are executed fairlyand in an orderly manner.

8. After the transaction isexecuted, the specialistsworkstation sends notice to thefirms originating the orders and tothe consolidated tape so that awritten record is made of everytransaction

9. The transaction is reported bycomputer and appears on theconsolidated tape displays acrossthe country and around the world.

10. The transaction is processedelectronically, crediting Toms brokerage firm and debiting theaccount of Dianes brokeragefirm. Toms broker calls him andtells him at what price he bought300 shares of XYZ. In a couple of

days, Tom receives a writtenconfirmation in the mail.Diane receives confirmation fromher brokerage firm electronicallyon her computer within seconds.These confirmations describe thetrade, its terms and conditions,and the exact amount to be paid orreceived.

11. Tom settles his account withinthree business days after the

transaction by submittingpayment to his brokerage firm forthe 300 shares of XYZ, plus any

11a. Dianes trade is also settled inthree business days. Her account will be

credited with the proceeds of the sale ofstock, minus any applicablecommissions. Tom settles his account


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applicable commissions. within three business days after thetransaction by submitting payment tohis brokerage firm for the 300 shares ofXYZ, plus any applicable commissions.

2.6 NYSE Regulations

A comprehensive network of safeguards, from individual broker- dealers all theway up to the U.S. government, serves to protect investors, the health of thefinancial system and the integrity of the capital-formation process. The federalgovernment is at the top of the regulatory pyramid: The SEC, which the U.S.Congress established in 1934, monitors the securities industry and enforces

penalties against those that violate the industrys regulations. This federal agencyoversees every securities firm participating in the financial markets as well as theU.S. markets themselves. Congress adopts laws governing the securities industryand is responsible for ensuring that the SEC functions effectively.

The NYSE is a self-regulatory organization, as are various other U.S. stockexchanges. As such, the NYSE, through its independent, not-for-profit subsidiaryNYSE Regulation Inc., regulates member organizations through the enforcement ofmarketplace rules and federal securities laws. More than 300 of the largestsecurities firms in America are NYSE member organizations. These firms service98 million customer accounts, or 84 percent of the total public customer accounts

handled by broker-dealers, with total assets of $4 trillion. They operate from 20,000branch offices around the world and employ 195,000 registered personnel.

These NYSE member organizations must meet rigorous regulatory standards. Firmsare obliged to monitor their own compliance with applicable rules and regulationsfor possible violations. Each year, NYSE Regulation examines every memberorganization that does business with the public to determine whether theserequirements are met. NYSE Regulation also works with other government andlaw-enforcement agencies, including the SEC and U.S. Attorneys office, andbelongs to a group of domestic and non-U.S. markets and agencies that shareregulatory and financial information.

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2.7 Types of Stock

The two main categories of stocks are common stock and preferred stock. Preferredstockholders have priority over common stockholders in terms of dividend payoutand in recouping their investment if the company fails or liquidates. However,preferred stockholders, unlike common stockholders, cannot vote for directors ofthe company. There are five basic categories of stock:

2.7.1 Income Stockspay unusually large dividends that can be used as a meansof generating income without selling the stock, but the price of the stock generallydoes not rise very quickly.

2.7.2 Blue-Chip Stocks are issued by very solid and reliable companies withlong histories of consistent growth and stability. Blue-chip stocks usually pay smallbut regular dividends and maintain a fairly steady price throughout market ups anddowns.

2.7.3 Growth Stocks are issued by young, entrepreneurial companies that are

experiencing a faster growth rate than their general industries. These stocksnormally pay little or no dividend because the company needs all of its earnings tofinance expansion. Since they are issued by companies with no proven track record,


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amounts at a specified coupon, or interest rate, with a set maturity date at whichtime the obligation must be repaid. Many debt issues may be redeemed, or called,by the issuer prior to the maturity date if specified in the issues indenture. TheNYSE operates the largest centralized bond market of any U.S. securities exchange.

It offers investors a broad selection of bonds: corporate (including convertibles),agency and government bonds. The majority of NYSE bond volume is in corporatedebt issues. NYSE bonds trade through the Exchange's Automated Bond System(ABS), a screen-based system used by NYSE member firm subscribers. ABSreports real-time quotes and trades to market data vendors.

2.11 Structured Products

The NYSE also trades debt and equity structured corporate issues. Thesespecialized products are categorized into four main classifications: capitalsecurities, retail debt securities, mandatory convertible securities and equity-linked

debt securities. The NYSE trades more than 550 structured products with a totalmarket value greater than $120 billion.

2.12 Options

An option is a contract to buy or sell a specific financial product, which is called theoptions underlying instrument or underlying interest. For equity options, theunderlying instrument is a stock, ETF or similar product. The contract itself is veryprecise. It establishes a specific price, called the strike price, at which the contractmay be exercised. And it has an expiration date. When an option expires, it nolonger has value and no longer exists. Options are most frequently used to remove

market risk in owning or trading in an individual security or market segment

2.13 How to Read a Stock Table

52 weeks

Hi Lo Stock (Sym)

Div Yld.

Vol.100s Close NetChange

132.94

80.06

Fut.Comm.

(FTC)

00.56

0.6 100927

96.47

-0.12

52-weeks Hi/Lo:


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The highest and lowest prices paid for Future Comm. stock during the past year.The numbers used to be expressed in fractions but now all prices have beenconverted to decimals so they can be read as dollars and cents. In this case, thestocks price has been between $80.06 and $132.94 per share over the past year.

Knowing the past years high and low can help an investor evaluate a stockscurrent price.

Stock: The name of the company.

Sym: The stocks trading symbol. To avoid confusion and simplify the orderprocess, every stock that is traded on a securities market is assigned a symbol.Some newspapers do not provide the stocks trading symbol but instead provide anabbreviation of the companys name. Many financial websites let you type in acompanys name and quickly find out its symbol.

Div: Short for dividend. For each share of stock owned, a Future Comm.shareholder should receive 56 cents from the companys annual profits. Payment is

usually made on a quarterly basis. Not all companies pay dividends all the time.The companys board of directors decides whether a dividend will be paid and itsamount. When companies are just starting out they usually do not pay a dividendbecause if they are making a profit they are reinvesting it back into the company toaccelerate growth.

Yld: The yield, or the rate of return, on a stockholders investment. It is figured bydividing the annual dividend by the current price of the stock. Future Comm.Stockholders earn 0.6% of todays stock price from dividends.

PE: Short for price/earnings ratio. The price of a share of stock divided by thecompanys earnings per share for the last year.

Vol 100s: The total amount of stock traded during the previous day. On that day,10,092,700 shares of Future Comm. stock changed hands. The number does notinclude odd lots, which are sales of less than 100 shares.

Close: The last price paid for this stock at the end of the previous day was $96.47.

Net Chg: The last price on the previous day, $96.47, was 12 cents less than thelast price on the preceding day.

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Chapter # 3

Share Prices

3.1 What Drives Share Prices

Theres truth to the old Wall Street adage that says a stock is worth what somebodyis willing to pay for it. In essence, thats because the price of a stock is determinedby buyers and sellers. As they weigh information about the company, the economyand their own investment goals, investors decide whether they are willing to paymore or less for a stock.

Like any other commodity, in the stock market, share prices are also dependent onso many factors. So, it is hard to point out just one or two factors that affect theprice of the stocks. There are still some factors that are that directly influence theshare prices.

3.2 Demand and Supply

This fundamental rule of economics holds good for the equity market as well. Theprice is directly affected by the trend of stock market trading. When more peopleare buying a certain stock, the price of that stock increases and when more people

are selling he stock, the price of that particular stock falls. Now it is difficult topredict the trend of the market but your stock broker can give you fair idea of theongoing trend of the market but be careful before you blindly follow the advice.

Simply put, the price of an individual stock is determined by supply and demand.The supply of stock is based on the number of shares a company has issued. Thedemand is created by people who want to buy those shares from investors whoalready own them. The more that people desire to own a stock, the more they arewilling to pay for it. But the supply of shares of any stock is limited. Investors onlycan buy shares of stock that are already owned by someone else. So if one personwants to buy, somebody else has to sell, and vice versa. If a lot of people want to

buy at the current price and not a lot of people want to sell, the price goes up untilmore people are willing to sell. When the price gets so high that buyers no longerwant the stock, the price starts to drop

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The downward sloping line is the demand curve, while the upward sloping line isthe supply curve. The demand curve indicates that if the price were $10, thedemand would be zero. However, if the price dropped to $8, the demand wouldincrease to 4 units. Similarly, if the price were to drop to $2, the demand would befor 16 units.

The supply curve indicates how much producers will supply at a given price. If the price were zero, no one would produce anything. As the price increases, moreproducers would come forward. At a price of $5, there would be 5 units produced

by various suppliers. At a price of $10, the suppliers would produce 10 units.

The intersection of the supply curve and the demand curve, shown by (P*, Q*), is themarket clearing condition. In this example, the market clearing price is P*= 6.67and the market clearing quantity is Q*=6.67. At the price of $6.67, variousproducers supply a total of 6.67 units, and various consumers demand the samequantity.

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By now, the attentive reader may have noted a quirk specific to the analysis ofdemand and supply. In the analysis, it is the price that is first set (i.e., it is theindependent variable) and the quantity is the result of the analysis (i.e., thedependent variable). However, on a Demand and Supply graph, the quantity isshown on the horizontal axis and the price on the vertical axis. This reverses thenorm for charting, in which the horizontal axis represents the independent variableand the vertical axis the dependent variable.

Excel sticks to the norm and expects that in a two-column XY Scatter chart, the firstcolumn is the independent variable to be shown on the horizontal (x) axis. In ouranalysis, we put the price -- the independent variable -- in the first column, but then plot it on the vertical axis. The easiest way to handle this 'difference inexpectations' is with an extra column as shown on the right. Note that column D isa copy of column A. It is possible to plot the data without use of the extra columnbut it requires a little extra work.

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Scatter Chart

Once price data set is duplicated in column D, plot columns C and D in a XYScatter chart as shown on the right.

3.3 News

News is undoubtedly a huge factor when it comes to stock price. Positive news

about a company can increase buying interest in the market while a negative pressrelease can ruin the prospect of a stock. Having said that, you must alwaysremember that often times, despite amazingly good news, a stock can show leastmovement. It is the overall performance of the company that matters more thannews. It is always wise to take a wait and watch policy in a volatile market or whenthere is mixed reaction about a particular stock.

3.4 Market Cap

If you are trying to guess the worth of a company from the price of the stock, youare making a huge mistake. It is the market capitalization of the company, rather

than the stock, that is more important when it comes to determining the worth of thecompany. You need to multiply the stock price with the total number of outstanding


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stocks in the market to get the market cap of a company and that is the worth of thecompany.

3.5 Earning Per Share

Earning per share is the profit that the company made per share on the last quarter.It is mandatory for every public company to publish the quarterly report that statesthe earning per share of the company. This is perhaps the most important factor fordeciding the health of any company and they influence the buying tendency in themarket resulting in the increase in the price of that particular stock. So, if you wantto make a profitable investment, you need to keep watch on the quarterly reportsthat the companies and scrutinize the possibilities before buying stocks of particularstock.

3.6 Price/Earning Ratio

Price/Earning ratio or the P/E ratio gives you fair idea of how a company's shareprice compares to its earnings. If the price of the share is too much lower than theearning of the company, the stock is undervalued and it has the potential to rise inthe near future. On the other hand, if the price is way too much higher than theactual earning of the company and then the stock is said to overvalued and the pricecan fall at any point.

3.7 Indexes

When you hear on the news that stock prices or the market was up, reporters aregenerally referring to an index. A stock index is a specific group of stocks, andwhether its value is up or down reflects the combined price movements of thestocks in the index. The stock market reports its moves through a variety of indexes,because no single index can tell investors everything they need to know. Widelycited indexes include the Dow Jones Industrial Average, which tracks the stockprices of 30 key blue chip1 companies; the S&P 500, which tracks the stockprices of 500 large U.S. companies; and the NYSE Composite Index, whichtracks the prices of all the common stocks listed on the New York Stock Exchange

3.8 A Companys Financial Health

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Supply and demand explains why individual stock prices fluctuate. But how doinvestors decide whether it is a good idea to buy or sell a particular stock at a givenprice? First, they need to consider the financial health of the company whose stock

they are considering buying or selling. If it looks like a company is going to losemoney perhaps the company just announced poor earnings then its stock has lessvalue.Investors will pay more for a company with a history of earning strong profits andconsistently paying healthy dividends.

3.9 Industry Information

Another important factor in gauging the prospects of a company is the health of itsentire industry. A companys stock price may go up or down depending on whetherinvestors think its industry is growing or contracting. For example, a company may

be doing well financially, but if its industry is declining, investors might questionthe companys ability to keep growing. In that case, the companys stock pricemight fall. Some industries are considered cyclical, meaning they expand andcontract in cycles. For example, home building declines when interest rates rise.Consumer electronics typically do best at the end of the year, when many peoplebuy these products as holiday gifts.

External Factors

3.10 Political Instability

Political instability is also a big factor that affects the share prices. Due to politicalinstability investors not interested to invest in stocks Elections and political criseseffect the economic situation of the country and financial markets of the country.When situation shows to the future political situation will not be good than investorsells the stock and prices move to downward automatically

3.11 War and Terror

War and terror is a factor that effect the NYSE stock Prices.9/11 is a example due tothat accident prices drive to negative side. Afghanistan and Iraq wars are great

factors that NYSE bears the situation so these activities also directly effect tocountry economy.

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3.12 International Relations

If the International relation is good then ultimately economic relation will be goodand economy of the country will be growing. Capital markets of the country also

depend upon the international relation. Due to good International relation DFI(Direct Foreign Investment) volumes will be going to upward.

3.13 Economic Trends

In addition to events surrounding a specific industry or company, investors maycarefully watch various economic indicators general trends that signal changes inthe economy. Signs that the economy is healthy and perhaps that most companiesare making money include a rising Gross Domestic Product (GDP), low inflation,low interest rates, low unemployment rates, and a U.S. budget surplus (or adecreasing deficit), which means that the federal government is taking in more

money than it is spending. When interest rates raise, for example, individuals,businesses and the government must pay more to borrow money. That means abusiness may put off plans to take a loan for a new project, thus needing fewerworkers and buying less materials and services from other businesses. Forindividual consumers, their car or house payment could go up and interest rates ontheir credit cards rise, making it more expensive to buy on credit

3.14 World and National Events

National or world events can affect stock prices. When investors think a news eventwill be good for the economy, such as a federal tax cut, stock prices will likely goup. If news, such as massive layoffs, will mean an economic slowdown oruncertainty, stock prices generally drop. This effect can last for an hour, a day,several weeks or longer.

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Chapter # 4

Insider Trading

It is the trading of a corporation's stock or other securities (e.g. bonds or stockoptions) by individuals with potential access to non-public information about thecompany. In most countries, trading by corporate insiders such as officers, keyemployees, directors, and large shareholders may be legal, if this trading is done ina way that does not take advantage of non-public information. However, the term isfrequently used to refer to a practice in which an insider or a related party tradesbased on material non-public information obtained during the performance of the

insider's duties at the corporation, or otherwise in breach of a fiduciary duty or otherrelationship of trust and confidence or where the non-public information wasmisappropriated from the company.

4.1 Definition of "insider"

In the United States, for mandatory reporting purposes, corporate insiders aredefined as a company's officers, directors and any beneficial owners of more thanten percent of a class of the company's equity securities. Trades made by these typesof insiders in the company's own stock, based on material non-public information,are considered to be fraudulent since the insiders are violating the trust or the

fiduciary duty that they owe to the shareholders. The corporate insider, simply byaccepting employment, has made a contract with the shareholders to put theshareholders' interests before their own, in matters related to the corporation. Whenthe insider buys or sells based upon company owned information, he is violating hiscontract with the shareholders

4.2 Insider Trading US Market

In the United States and several other jurisdictions, trading conducted by corporateofficers, key employees, directors, or significant shareholders (in the U.S., definedas beneficial owners of ten percent or more of the firm's equity securities) must bereported to the regulator or publicly disclosed, usually within a few business days ofthe trade. Many investors follow the summaries of these insider trades in the hopethat mimicking these trades will be profitable. While "legal" insider trading cannot


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be based on material non-public information, some investors believe corporateinsiders nonetheless may have better insights into the health of a corporation(broadly speaking) and that their trades otherwise convey important information(e.g., about the pending retirement of an important officer selling shares, greater

commitment to the corporation by officers purchasing shares, etc.)

4.3 American Insider Trading Law

The United States has been the leading country in prohibiting insider trading madeon the basis of material non-public information. Thomas Newkirk and MelissaRobertson of theSEC summarize the development of U.S. insider trading laws

4.4 Legal Insider Trading

Legal trades by insiders are common, as employees of publicly-traded corporations

often have stock or stock options. These trades are made public in the US throughSEC filings, mainly Form 4. Prior to 2001, US law restricted trading such thatinsiders mainly traded during windows when their inside information was public,such as soon after earnings releases. SEC Rule 10b5-I clarified that the U.S.prohibition against insider trading does not require proof that an insider actuallyused material nonpublic information when conducting a trade; possession of suchinformation alone is sufficient to violate the provision, and the SEC would imputean insider in possession of material nonpublic information uses this informationwhen conducting a trade. However, Rule 10b5-I also created for insiders anaffirmative defense if the insider can demonstrate that the trades conducted onbehalf of the insider were conducted as part of a preexisting contract or written,

binding plan for trading in the future. For example, if a corporate insider plans onretiring after a period of time and, as part of his or her retirement planning, adopts awritten, binding plan to sell a specific amount of the company's stock every monthfor the next two years, and during this period the insider comes into possession ofmaterial nonpublic information about the company, any subsequent trades based onthe original plan might not constitute prohibited insider trading.

4.5 SEC Regulations

S.E.C. regulation FD ("Full Disclosure") requires that if a company intentionallydiscloses material non-public information to one person, it must simultaneouslydisclose that information to the public at large. In the case of an unintentionaldisclosure of material non-public information to one person, the company mustmake a public disclosure promptly.


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Insider trading, or similar practices, are also regulated by the SEC under its rules ontakeovers and tender offers under theWilliams Act

4.6 Illegal Insider Trading

Rules against insider trading on material non-public information exist in mostjurisdictions around the world, though the details and the efforts to enforce themvary considerably. The United States is generally viewed as having the strictestlaws against illegal insider trading, and makes the most serious efforts to enforcethem.[4]

4.7 Liability for Insider Trading

Liability for insider trading violations cannot be avoided by passing on theinformation in an "I scratch your back, you scratch mine" or quid pro quo

arrangement, as long as the person receiving the information knew or should haveknown that the information was company property.

For example, if Company A's CEO did not trade on the undisclosed takeover news,but instead passed the information on to his brother-in-law who traded on it, illegalinsider trading would still have occurred.

4.8 Trading on Information in General

Not all trading on information is illegal inside trading, however. For example, whiledining at a restaurant, you hear the CEO of Company A at the next table telling theCFO that the company will be taken over, and then you buy the stock, you mightnot be guilty of insider trading unless there was some closer connection betweenyou, the company, or the company officers.

4.9 Security Analysis and Insider Trading

Security analysts gather and compile information, talk to corporate officers andother insiders, and issue recommendations to traders. Thus their activities mayeasily cross legal lines if they are not especially careful. The CFA Institute in itscode of ethics states that analysts should make every effort to make all reports

available to all the broker's clients on a timely basis. Analysts should never reportmaterial nonpublic information, except in an effort to make that informationavailable to the general public. Nevertheless, analysts' reports may contain a varietyof information that is "pieced together" without violating insider trading laws, under


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the mosaic theory. This information may include non-material nonpublicinformation as well as material public information, which may increase in valuewhen properly compiled and documented.

In May 2007, a bill entitled the "Stop Trading on Congressional Knowledge Act, orSTOCK Act" was introduced that would hold congressional and federal employeesliable for stock trades they made using information they gained through their jobsand also regulate analysts or "Political Intelligence" firms that research governmentactivities. The bill has not passed

4.10 Why Follow Insiders?

When looking for investment ideas, keep a close eye on insiders who are purchasing stock

in their own companies. Consider the following two points:

1.Insiders know their own company and market-space better than anyone and are the best-qualified people to assess the future prospects for the stock.

2.No one buys a stock thinking that its price will go down they do so to make money

4.11 Insider Qualifications

The term "insider" is defined by the SEC to include corporate officers (CEO, CFO, COO,

etc.), members of the board of directors, and large shareholders (those who own more than

10% of a company). Given their position, corporate officers and members of the board of

directors have deeper insight into a company's operations than any outside analyst could

ever hope to attain, and are also highly skilled businesspeople. With their knowledge andexperience, it's not a stretch to say that insiders are the best-qualified people in the world to

evaluate a company's future prospects. Quite simply, they are the smart money.

4.12 There is only one reason to buy

Anyone who buys a stock does so because they expect the price to rise - no one invests to

lose money and insiders are no exception. There are two main reasons why insiders would

invest in their own companies:

1.They think their business is about to get better and the stock price will go up, or

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2.They think that their company is undervalued and they believe that with time the market

will correct by increasing the stock price.

4.13 Insider Sentiment

With thousands of insiders reporting transactions each day, what are the companiesthat you should be focusing on? While we can't arrange personal meetings with topcompany leadership to ask them directly how confident they are, we can infer theiroverall sentiment by looking at their buying and selling behavior.

4.14 Who

When researching insider activity at a company, first look to see who is doing the

purchasing. Not all insiders are created equal, and identifying the best insiders tofollow will help you prioritize the companies to investigate further. When

evaluating a purchaser, take a look at their:

4.14.1 Position

While all insiders are well-qualified to evaluate a company's future prospects, takea close look at purchases made by top executives (e.g. CEO, COO, CFO, etc.).These C-Level officers have the most comprehensive insight into a company and

are the company's most skilled and experienced businesspeople. Members of theboard of directors and other corporate officers (Vice Presidents, etc.) also have deepinsight into a company's operations.

4.14.2 Historical performance

Look also at how insiders have performed with their past purchases. Some insidersare better than others at identifying and taking advantage of situations where themarket has temporarily undervalued their company. An insider who has done well

on a number of past purchases is a good bet to perform well on a recent purchase aswell.


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4.15 Commitment

When investors are more confident in a company, they're willing to commit largeramounts of money to it. When evaluating an insider's commitment to their

company, take a look at:

4.15.1 Dollar Amount

When insiders are more confident of their company's future prospects, they investmore so that they can make more. Disregard small or regular purchases that can beattributed to retirement plan contributions or participation in an employee stockpurchase program, and are not indicative of bullish behavior.

4.15.2 Change in total holdings

For those insiders who are not multi-millionaires, even a relatively small purchasecan significantly increase their personal holdings. This significant increase in

holdings signals a strong confidence in the company and the insider'scorrespondingly bullish outlook.

4.16 Consensus

While any purchase by an insider is a vote of confidence in that company's future,you should also look to see what other insiders at that company have been doing tosee if there is a consensus of opinion forming. If multiple insiders are showingbullish signs, you can be more confident in that company's future. When evaluating

consensus within a company, take a look at:

4.16.1 How many insiders are purchasing

When two or more insiders are purchasing at the same time, it shows that aconsensus of opinion has formed in the company regarding its future prospects.This reduces the chance that any one insider has misinterpreted data and increasesthe likelihood that the stock price will raise.

4.16.2 What the overall trend has been:

As a group, insiders sell their own stock far more often than they buy it. This is in

no small part due to the fact that they have a large part of their compensation in theform of options and/or grants, and this selling is in essence cashing part of their


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paycheck. However, if insiders are selling less than they historically have, this maysend a signal a change in sentiment about the company's future prospects.

4.17 Summary of Above

There are clearly a large number of factors that investors can weigh against eachother to effectively use insider trading data, which may seem like a daunting task atfirst. OurInsider Sentiment report seeks to take the hard work out of analyzing all

of the companies reporting trades and presents the most promising companies toyou as determined by their insider trading activity. Investors who want to siftthrough the raw data themselves can also easily do so with our moregeneral reports and our custom search functionality.

4.18 Effects of Insider Trading in the Stock Market

Illegal insider trading is the buying or selling of an investment based on informationnot generally available to the investing public. Officers of companies often buy andsell stock in their company. While this is technically insider trading, it is not illegalin of itself. Insider trading has the potential to manipulate stock prices to the harmof the investing public and to make insiders considerable profits based on unfairaccess to information about the company.

4.18.1 Significance of Insider Trading

Insider trading undermines the integrity of the investing system and therefore

discourages non-insiders from investing unless they believe they are on somethingapproaching the same footing as insiders who are investing. Allowing insidertrading to go unchecked would reduce the number of investors willing to investcapital and therefore could potentially harm the economy as a whole.

4.18.2 Identification of Insider Trading

Illegal insider trading can be conducted by people who are not employed by thecompany in question. For example, someone who is given a tip by a friend whoworks in the company in question could be guilty of illegal insider trading. Becausethe reach of people who could potentially invest based on information not generally

available to the public is broad, it can be difficult to identify insider trading,especially small scale investments.


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4.18.3 SEC disclosure requirements and insider trading

The SEC has a full disclosure requirement (SEC Regulation FD) intended tomitigate the potential for illegal insider trading. Regulation FD requires that a

company make a public disclosure of material information anytime that materialinformation becomes available to stock analysts or holders of the issuer's securitieswho might rely on that information in investing decisions. The net effect ofRegulation FD is to put all investors on the same footing in making investingdecisions.

4.18.4 Potential Benefits from Insider Trading

There is a small school of thought that contends illegal insider trading may actuallybenefit the market. The theory contends the insider trading accelerates the pace atwhich new information is used to adjust the price of the stock and therefore brings it

to its "proper" level more quickly. Similarly, there are those who contend thatindividuals who sell stock to an insider illegally relying on insider information stillbenefits because he is selling the stock at a price that he views as a fair profit.

4.18.5 Famous Examples of Insider Trading

Martha Stewart provides probably the most famous example of insider trading inrecent history. Ms. Stewart had owned shares in ImClone. A day before an ImClonedrug was denied approval by the Food and Drug Administration, she sold hershares. The next day the shares plummeted. Ms. Stewart was accused of receivinginsider information from an ImClone executive and relying on that information to

sell the stock. Ultimately, Ms. Stewart spent five months in prison, five months onhouse arrest and two years on probation.

4.19 The Effects of Insider Trading Regulation on Trade Timing,Litigation Risk, and Profitability

The working on Insider Trading show how firms and insiders respond to changes ininsider trade-related litigation risk by analyzing the effects of changes in insidertrade regulation on firm-level litigation risk and on insiders trade distributionbefore and after earnings announcements. Prior literature documents that insiders

modify trade patterns when faced with increased litigation risk.1 However, there islittle evidence of the net effect of insider trade regulation on total firm-levellitigation risk when considering the changes in trading patterns documented in priorresearch. This study utilizes a simultaneous equations approach to directly examine


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H1B: The proportion of insiders trade volume after earnings announcements

relative to before earnings announcements is positively associated with the

passage of regulatory acts that increase illegal insider trade-related penalties.

Firms at risk of shareholder lawsuits are especially sensitive to revelations ofinsiders trading on price-relevant information. Johnson et al. (2006) show thatabnormal insider selling correlates with the initiation and outcomes of shareholderlawsuits. Similarly, Griffin and Grandest (2002) show that firms sued byshareholders exhibit higher insider selling than control firms. It is possible thatfirms that face higher litigation risk will enforce more stringent restrictions oninsiders trade activity before material news events like earnings announcements. Itis also possible that insiders at firms that face higher litigation risk infer highertrade-related litigation costs associated with trades executed before material newsevents like earnings announcements. In either case, we hypothesize that:

H2A: The proportion of insiders trade volume after earnings announcements

relative to before earnings announcements is positively associated with a firms

expected level of litigation risk.

Since insider trade activity is a key component of firm level litigation risk (Johnsonet al., 2006), presumably less timely trade should be associated with lower overallfirm-level litigation risk. If firms restrict insiders trades or if insiders simplychoose to trade less before material news events like earnings announcements, thisshould, in turn, reduce the likelihood that the firm will face litigation costs.Specifically, we hypothesize that:

H2B: Firm-level litigation risk is negatively associated with the proportion of

insiders trade volume after earnings announcements relative to before

earnings announcements.

Our final hypothesis investigates the economic effects of insider-trading legislation.Similar to Seyhun (1992), we investigate whether insider profits have declined afterincreases in regulation. Seyhun (1992) does not find evidence of a reduction ininsiders trade profitability associated with the increased penalties from either ITSAor ITSFEA.

H3A: Active (passive) profits from insiders trades are negatively (positively)associated with the passage of regulatory acts that increase illegal insider

trade-related penalties.

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H3B: Active profits from insiders trades are negatively associated with the

response of firms and insiders to the passage of regulatory acts that increase

illegal insider trade-related penalties.

4.19.2 Insider-Trading Profitability

Our final set of results concern changes in the profitability of insider trading overtime. If changes in regulation and litigation risk have prompted insiders to tradeduring times of low litigation risk (or prompted firms to better monitor insiderstrade activity), we would expect to see reductions in the ability of insiders to exploittheir private information. We test this proposition by examining changes (post-ITSA and post-ITSFEA) in abnormal returns to insider-trading events. We measurechanges in profitability by regressing firms monthly excess returns on risk factors andindicator variables that capture mean profit shifts across insider-trading event

4.19.3 Conclusion

This study examines how insider trades are affected by increases in insider-tradingregulation. We find that insider-trading legislation is positively associated with thetendency of insiders to trade after, relative to before, earnings announcements. Thisis consistent with firms and insiders adopting self-imposed limits on trading duringtimes of high information asymmetry when the penalties for trading on privateinformation increase. Examining the simultaneous relation between litigation riskand insider timing, we find some evidence of a positive association betweenincreased litigation risk and insiders trade volume after, relative to before, earnings

announcements, consistent with insiders seeking to avoid litigation risk or withfirms increasing restrictions on insiders trade. Our results also suggest thatincreased trade after, relative to before, earnings announcements, is negativelyassociated with firms overall litigation risk (as measured by the incidence ofshareholder lawsuits).

Regarding insiders trade strategies, the evidence suggests that insiders passiveprofits (earned when insiders delay trades until after the revelation of price-relevantinformation such as selling after good news) are positively associated with thepassage of the Insider Trading and Securities Fraud Enforcement Act of 1988. Thedocumented increase in passive trading seems a rational response to the regulation

since passive strategies are much less likely to trigger insider-trading violations.Evidence also suggests, however, that insiders active profits (earned when insiderstrade prior to the revelation of price-relevant information such as selling before badnews) are positively associated with the passage of ITSFEA. However, examining


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subsets of firms defined by whether they respond to ITSFEA by moving tradingafter earnings announcements, we provide some evidence that responding firmshave lower increases in abnormal profits to insider trading than non-respondingfirms. Thus, ITSFEA appears to have some effects on the ability of insiders to

exploit their private information.

Our results provide evidence regarding the economic impact of insider-tradingregulation, specifically documenting that regulation appears endogenouslyassociated with insider-trading patterns and with overall litigation risk. Our resultsalso confirm that there does not appear to be evidence of overall insider tradingprofit declines for trades that execute after increased trade regulation enactment;rather the key factor affecting trading profits is the firms apparent response to thelegislation in moving trading after earnings announcements. Thus, in this case,private enforcement of public regulation appears necessary for the regulation toaffect firms and insiders.

Chapter # 5

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Institutional Trading

5.1 Institutional trading, Trading Volume, and Spread

The effect of institutional trading on the bid-ask Spread is of interest to regulatorsand market makers. It is often argued that Greater institutional participation resultsin increased volatility in the market. On the other hand, some argue that greaterliquidity trading by institutions reduces spread. There is no direct empiricalevidence and little theoretical knowledge to suggest a Convincing relation betweeninstitutional trading and spread. , we present some evidence on the nature and effectof institutional trading on spreads and share Prices. We argue that Institutionaltrading is not completely information driven; part of it is liquidity trading in nature.We find evidence that information induced institutional trading increases theadverse selection component. However, large volume (liquidity) trading reduces theorder processing costs. We find the net effect of institutional trading on spread isconsistently negative. Moreover, institutional buys have differential informationfrom sells. Institutional trades per se reduce spreads, but only sells increase theadverse selection component. Both effective and relative spreads impound thedifferential nature of institutional buys and sells.

5.2 Introduction

Some of the significant determinants of spread found in the literature are order size,number of trades, competition in the dealers market, ownership structure, and thenative characteristics of a stock e.g., price, and volatility. Trading rules andmechanics of trading that proxy for information flow are also found to affect thespread. There is very little empirical evidence on institutional trading and spreadand their interrelationship. Keim and Madhavan (1997) find execution costs forinstitutional trades are different between listed and NASDAQ stocks.

5.3 Effect of Institutional Trading on Securities Prices

There is some evidence of the effect of institutional trading on securities prices.Empirical studies using order size or trading volume as a proxy for institutionaltrading1 suggest an increased price effect associated with institutional trading.Using proprietary data on institutional trading, Chan and Lakonishok (1993) find

the average price effect to be small for institutional trades, but the price effect forbuys and sells to be asymmetric; and Sias and Starks (1997) find that institutionaltrading contributes to serial correlation of returns.

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The role of institutional trading in the determination of spread is interesting since itis often argued (casually) that increased institutional participation in the U.S. equityMarket during the past decade has led to an increase in the volatility, and haswidened the

Bid-ask spread in the equity market.

5.4 Institutional Trading Provide LiquidityOn the other hand, some argue that institutional trades provide liquidity, and hencedecrease spread. Show how optimal trading strategies may be devised by executioncost minimizing investment mangers. In any case, there is very little empiricalevidence or theoretical knowledge to conclude how institutional trading affectsspread. Further since spread is considered to be a sum of two different components,

adverse selection, and order processing2 it is unclear.

5.5 How Institutional Trading Affects the Individual Componentsof the Spread

In these analyses, we investigate if institutional trading has any information contentbeyond what has been documented as a size or volume effect. In a multivariate,panel regression framework, we determine if there exists a relation between bid-askspread and institutional trading after adjusting for size and price effects. Moststudies on the Determinants of spread focus on the supply side of dealership marketi.e., competition inThe dealer market, and use a cross sectional regression approach.

5.6 Our approach

Our approach is different from previous studies in two important ways.First, we focus on the demand side (investors characteristics) to determine therelation between spread and institutional trading and

Second, we use a panel data approach accounting specifically for both serial andcontemporaneous correlation in the error terms. We report regression results usingboth effective ($) and relative spread as the dependent variable in a set of regressionequations.

5.7 Buying and Selling


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Further we decompose the spread into order processing and adverse selectioncomponents and investigate how those components vary with changes in tradingvolume, net order flow (buy vs. sell), and institutional trading. We assume

contemporaneous correlation between the disturbances and use an SUR (SeeminglyUnrelated Regression) Analysis to find the significant determinants of the adverseselection and the order processing components of the spread for our sample firms.We use a unique data set (TORQ) that identifies institutional trading. Prior studiesproxy institutional participation by using measures based on trade size that issubject to measurement error. Our results show that institutional trading proportionis inversely related to both effective and relative spreads.

5.8 Negative Slope

We also find that the negative slope (suggestive of the inverse relation) is not

constant and flattens out at higher concentrations of institutional trading. We findthat this negative slope is provided by both institutional buys and sells alike. Resultsfrom a SUR analysis show that the adverse selection costs tend to increase and theorder processing costs tend to decrease with increases in institutional trades. Therest of this paper is organized as follows. In section II, we present the motivation forthis study. In section III, we describe an empirical model for spread using panelregressions, provide data description, and explain the results. Further, we describethe decomposition of the spread into order processing and adverse selection costscomponents and report results from a SUR analysis of the determinants of thosecomponents.

5.9 Motivation

Relation between Spread and Institutional trading

An economist identifies four classes of variables, namely,

Activity

Risk

Information

competition

As determinants of spread, existing literature find trade size, number of trades,ownership structure, and extent of market power in the dealership market to be thekey determinants of bid-ask


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Dealer market competition represents the supply side of the market for liquidityservices5. On the other hand, trade size, ownership structure, and frequency oftrading measure the activity in securities markets and represent the demand side of

the market for liquidity services.

Prior research suggests an inverse relationship between spread and trading activitymeasured by order size, and number of trades institutions trade large sizes, and alsotrade frequently.Thus institutional trading will induce low spread. However, tradingactivity also contributes to both information and risk associated with a security7.Provides evidence that large trades contain more information than small trades andcause spreads to widen. Linefeed evidence of an increasing (although notcontinuously), nonlinear relation between spread and trade size report.

5.10 Regression Framework

There is in a multivariate regression framework, we determine whether institutionaltrading has information content beyond that provided by trade size denoted bytrading volume, and number of trades. Specifically, we hypothesize that thevariation in bid-ask spread can be explained by trading volume, number of trades,price, and institutional trading. Further, we hypothesize that institutional tradingperse and not the direction of institutional trading - buy or sell affects the bid-askspread. Stated in alternate form, we hypothesize:

H1: The bid-ask spread should vary significantly with institutional tradingafter controlling for number of trades, price, and trading volume. Further,

institutional trades per se affect bid ask spread, and thus institutional buys and sellsdo not have any differential effect on the bid-ask spread after controlling fornumber of trades, price, and trading volume

5.11 Components of the spread

5.11.1 Effect of Institutional Trading on Component

We extend our analysis of the relation between institutional trading and spread bydecomposing the spread into its order processing and adverse selection componentsand investigating the effect of institutional trading on the individual components.

We use a technique from LSB to decompose the spread into order processing andadverse Selection components and hypothesize a relation between the individualcomponents and institutional trading.

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5.11.2 According some Experts (References)

Sias (1996) reports positive correlation between institutional activity and

market Volatility;

Cohen et al (1987) suggest that institutions trade frequently because of theirlow order processing costs.

We conjecture that if institutional trading is a mix of information and liquiditytrading then the information effect should increase the adverse selection componentand the liquidity effect should decrease the order processing costs.

We also recognize that while gross volume is important for the determination of

order processing cost, trade direction or net volume (buy volume - sell volume), isimportant in the determination of adverse selection costs. We therefore include log(buy/sell) as a variable in the regression model for the adverse selection componentwe determine through a set of simultaneous equations how institutional tradingaffects the order processing and the adverse selection components of the spreadafter controlling for number of trades, volume, and trade direction. Thesimultaneous equations approach uses the cross correlation between the tworegression equations to improve the estimates. Further we determine how theasymmetric information content and the liquidity motive in institutional buys andinstitutional sells affect the adverse selection (information) component of thespread. Stated in alternate form, our hypotheses are:

H2a. The adverse-selection component should increase with institutionaltrading, and the order-processing component should decrease with institutionaltrading.

H2b. Institutional buys should have a differential effect on the adverse selectioncomponent of the spread from institutional sells.

5.12 Regression Models, Data Description, and Results

Panel Data Regression Model

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Capital Market (Share Prices, Insider Trading, Institutional Trad

Raza Yaqoob (M.com) Capital Market

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Transcript of Raza Yaqoob (M.com) Capital Market