Summary - Business Finance - ثاني ثانوي

pul 172 Business Finance SUMMARY Securities are traded on organized exchanges, such as the Saudi Exchange. Securities are bought through brokers, who buy and sell for their customers accounts. The brokers submit orders for the securities to market maker dealers, who "make markets" in them. These market makers offer to buy and sell at specified prices (quotes), which are called the bid and the ask prices. Brokers and investors obtain these prices through electronic systems that transmit the quotes from the various dealers. After securities are purchased, investors must pay for them with either cash or a combination of cash and borrowed funds. When investors use borrowed funds, they are buying on margin. Investors may establish long or short positions. With a long position, investors purchase stock in anticipation of its price rising. If the price of the stock rises, Investors may sell it for a profit. With a short position, Investors sell borrowed stock In anticipation of its price declining. If the price of the stock falls, Investors may repurchase the stock at the lower price and return it to the lender. The position generates a profil if the selling price exceeds the purchase price. Both the long and short positions are the logical outcomes of securities analysis. If the investor thinks a stock is underpriced, a long position (purchase of the stock) should be established. If an investor believes a stock is overvalued, a short position (the sale of borrowed securities) is established. In either case, if the Investor is correct, the position will generate a profit. Either position may, however, generate a loss if prices move against the investor's expected price change. Investors may purchase securities issued by foreign firms. This is usually accomplished through the purchase of depositary receipts, or Dẞs, which are issued by financial institutions and represent the foreign securities. Investors may also acquire securities such as Eurobonds-debit instruments issued abroad by firms that are denominated in the firm's currency instead of the foreign currency, Securities markets are very competitive and efficient. New Information is: disseminated rapidly, and prices adjust quickly in response to the new information. The efficient market hypothesis suggests that few investors will be able to outperform the market over an extended period of time. Although an Investor may outperform (or underperform) the market for a given period. consistently superior returns may be impossible to achieve.

PROBLEMS 1. Explain what a bid-ask spread is. Which price would you pay if you are purchasing a stock? Which would you receive if you were selling a stock? 2. Explain the role of brokers in modern stock markets. Why are they important? 3. Contrast long and short positions in stocks. 4. Illustrate the mechanics of a short sale. 5. List several market indices used to measure the performance of Saudi securities حرارة التعليم CHAPTER 4 An Introduction to Financial Markets 173)

174 Business Finance LI 6. Determine how Depositary Receipts (DRS) facilitate trading in foreign securities. 7. Explain why an investor should not expect to outperform the market on a consistent basis. EXERCISES 1. You purchase 100 shares for SAR 500 a share (SAR 50,000), and after a year the price rises to SAR 600. What will be the return on your investment if you bought the stock on margin and the margin requirement was: a. 25%? b. 50%? c. 75%? 2. Repeat Problem 1 to determine the return on your investment, but in this case suppose the price of the stock falls to SAR 400 per share. What generalization can be inferred from your answers to Problems 1 and 2?

3. A stock is currently selling for SAR 45 a share. What is the gain or loss on the following transactions? a. You take a long position and the stock's price declines to SAR 41.50. b. You sell the stock short and the price declines to SAR 41.50 c. You take a long position and the price rises to SAR 54. d. You sell the stock short and the price rises to SAR 54. 4. A sophisticated investor, Nasira, wanted to engage in a short sale. Nasira borrowed from a broker 500 shares of a green energy company and sold the stock at SAR 20 a share. The price of the stock subsequently fell to SAR 15 at which time Nasira covered the position (that is, closed the short position by buying 500 shares at SAR 15 a share and returning those to the broken. What was the amount of profit or loss on this short sale? 5. Abdullah purchased 200 shares of a pharmaceutical company for SAR 25 on margin. The margin requirement was 40%. How much does Abdullah need to provide to make the purchase of the shares? حرارة التعليم CHAPTER 4 An Introduction to Financial Markets 175

P176 Business Finance M 6. Thana buys 100 shares of a software company, DEM, at SAR 35 a share and 200 shares of GOP at SAR 40 a share. She buys on margin. a. If the margin requirement is 50%, what is the maximum amount she can borrow? b. If the margin requirement is 70%. what is the maximum amount she can borrow? 7. After an analysis of an electronics store, Omar has concluded that the firm will face financial difficulty within a year. The stock is currently selling for SAR 50 and Omar wants to sell it short. If he does, what is the return he will receive if the stock price drops to SAR 10? 8. Lina buys stock on margin at SAR 20 per share. The margin requirement Is 50%. What is the amount that Lina should provide to make the purchase of this stock? 9. All sells short stock which is currently priced at SAR 20. He is able to repurchase it for SAR 16. What return does he make?

10. Nawaf sells short 100 shares of a stock priced at SAR 50. He repurchases them for SAR 53 each. What return does he make? ASSESSMENT QUESTIONS Choose the correct answer. T. The Tadawul Exchange: a. is a financial intermediary. b. is a secondary market. c. transfers funds to businesses. d. forbids buying stock on margin. 2. The major types of traded securities on the Tadawul exchange are: a. stocks only. b. bonds only. c. stocks, bonds and sukuk. d. stocks and bonds. 3. Available exchange orders in the Tadawul exchange include: a. hit order. c. market order. b. take order. d. all of the above. 4. The use of borrowed funds to magnify the investor's return is referred to as financial leverage. True/False 5. Buying stock on margin 1. is an example of financial leverage, 2. is buying stock with borrowed funds, 3. requires leaving the stock with the broker. a. 1 and 2 b. 1 and 3 c. 2 and 3 d. 1, 2, and 3 6. If the margin requirement is 65% and the investment is SAR 10,000. the investor must supply how much in cash? a. SAR 3,500 b. SAR 6,500 c. SAR 10,000 d. The answer cannot be determined from this information. قرارة التعليم CHAPTER 4 An Introduction to Financial Markets 177)

178Business Finance 7. An investor can also earn a profit from a decline in the price of a stock by taking a; a. long position. b. short position. c. declining position. d. parallel position. 8. The MSCI Tadawul 30 measures the stock price of publicly traded companies on the Saudi Stock Exchange. True/False 9. Foreign securities can be listed on the Tadawul exchange. True/False 10. The CMA can place reporting and other requirements for companies outside of Saudi Arabia. True/False 11. Stock prices tend to adjust rapidly to new information. True/False 12. It is impossible for a trader to beat the market in the short term. True/False 13. When someone trades a company's securities because they have confidential or non-public information about the company, they are engaging in: a. insider trading. b. co-conspiracy trading. c. security trading d. non-competitive trading. 14. The efficient market hypothesis: a. suggests that the market for securities is becoming less efficient. b. implies that investors can consistently outperform the market. is built upon competition and the rapid dissemination of information. d. suggests that security prices change slowly over time.

KEY TERMS Match the terms listed with their definitions. Write the letters of the correct definitions. Term Your Choice Definition 1. Bid and ask prices 2. Bonds 3. Day order 4. Depositary receipts (DRS) 5. Derivatives 6. Efficient market hypothesis (EMH) 7. Eurobonds 8. Exchange-traded funds 9. Financial leverage 10. Futures contract 11. Good-till- canceled order 12. Good-till-date order 13. Insider trading 14. Limit order 15. Long position 16. Margin 17. Margin requirement وزارة التعليم a. The theory that when new information comes into the market, it is immediately reflected in stock prices and, as a result, all stock prices are fair values b. The percentage of a purchase price that must be paid up front when buying securities c. A dealer who engages in the business of buying and selling securities for their own account d. Contracts between two parties that take their price from the value of an underlying asset, such as stock, group of stocks (an index), or other measure e. The use of borrowed funds in return for agreeing to pay a fixed return; use of debt financing f. An order to buy or sell that is active until a specific date g. An investor's equity in a security position h. The total value of all a firm's shares listed on the market on a day divided by the total value of all the shares the firm previously listed on the index i. An item that costs more than its worth j. The difference between the bid and ask prices k. Like mutual funds, but passive and traded like stacks I. An item that costs less than its worth m. A Shariah-compliant bond-like instrument used in Islamic finance representing a direct asset ownership interest n. Order to buy or sell at a specified price (limit price) that remains in effect until it is executed by the broker or canceled by the investor o. An assortment of securities developed by investment firms and offered to investors p. The capital raised by a firm through the issue of shares, which also gives their holders ownership of the company q. The sale of borrowed securities in anticipation of a price decrease CHAPTER 4 An Introduction to Financial Markets 179

Term 18. Market capitalization- weighted index 19. Market maker Your Choice Definition r. Prices quoted by market maker's at which they are willing to buy and sell securities 20. Market order 21. Market return 22. Mutual funds 23. Overpriced 24. Short position 25. Spread 26. Stocks 27. Sukuk 28. Underpriced s. The purchase of securities in anticipation of a price increase t. An agreement to buy or sell a commodity contract or security at some point in the months or years to come u. Order to buy or sell at a specified price that is canceled at the end of the day if it is not executed v. A direction given to a broker to buy or sell a security at a specific price w. A situation where someone who works for a firm, or has access to information about it, trades the firm's securities because they have confidential or non-public information about the firm x. Instructions to buy or sell a security at the best current price y. Receipts issued for foreign securities held by a trustee z. Bonds sold in a foreign country but denominated in the currency of the issuing firm za. The amount of money that a firm gets back from the overall value of its equities zb. A debt obligation issued by entities such as governments and businesses P100Business Finance KEY FORMULAS Margin Equity Total value of portfolio

MINI CASE 4.1 Investment Decisions Ali is new to investing and wants to set up a brokerage account. Ali has heard that investors have many options for investing. Ali wants to be prepared before he talks to a broker. He knows that he needs to understand the major investment options for individual investors. He also needs to understand the difference between the Tadawul exchange and the Nomu Parallel Market. Task 1. Considering the information presented in this chapter, what are the investment options All has for his brokerage account? 2. Help All understand the difference between the Tadawul exchange and the Nomu Parallel Market by describing each market. قرارة التعليم CHAPTER 4 An Introduction to Financial Markets 181

p1.82 Business Finance M MINI CASE 4.2 Efficient Market Hypothesis Orner is convinced that he can beat the market by making short-term decisions in his investments. You are Omer's friend and you want to tell him that he needs to be careful because of the efficient market hypothesis (EMH). You decide to make a plan to explain the EMH to Omer. Task 1. Define in your own words the efficient market hypothesis. 2. Use the efficient market hypothesis to explain why it is very difficult to beat the market

MINI CASE 4.3 Long and Short Sales Omer has heard that investors can make the most money in the fastest time by purchasing long and short sales. Omer is considering buying Company ABC stock at SAR 25 because he thinks it will rise to SAR 30 within a year. He is also considering selling CGQ short. CGQ currently sells for SAR 25, but Omer believes it will drop to SAR 20 within a year. Task 1. Determine Omer's return on his investment in Company ABC, long position, if Omer buys at SAR 25 and the stock rises to SAR 30 within a year. 2. Determine Omer's return on his investment in CGQ using a short sale if he borrows a share of CGQ from his broker and sells this for SAR. 25 and then purchases a share of CGQ for SAR 20 within a year to repay the broker (assume no related fees). 3. Justify which of these investment strategies you would recommend to Ömer. حرارة التعليم CHAPTER 4 An Introduction to Financial Markets 183)

p184 Business Finance CASE STUDY: INVESTMENT STRATEGIES Yasser, like many young Saudi professionals, is considering opening a brokerage account to both invest for retirement and to take advantage of the growing Saudi economy. Yasser is aware that under Saudi Vision 2030, small to medium-sized enterprises (SMEs) are expected to grow in the Saudi economy. Yasser is also looking to diversify his investments for his retirement by purchasing shares of stocks, investment funds, sukuk and bonds, and exchange-traded funds. Yasser also needs to understand the trading cycle and his purchase and sales options. Yasser knows that his first stop for research is the Tadawul exchange website to use the Invest Wisely section of the Knowledge Center to learn how to invest wisely. Yasser has reviewed the table providing a comparison between financial instruments available in the Saudi capital market table. Yasser understands that there is a tradeoff between the risk of an Investment and the expected return of an investment. Some of the investment options have higher risks and others have lower returns. Yasser doesn't know if he should invest in one area or develop a portfolio of multiple options. The Invest Wisely website outlines common mistakes made when investing and how to avoid them. This sounds like good advice to Yasser but he isn't sure how much time he has to follow markets. The site also recommends strategies for using financial statements and ratios for evaluating companies, but he finds this confusing. The more Yasser reads, the more he thinks he will need professional advice to help him invest. Yasser decides to find a brokerage firm authorized to work with the Saudi Arabian exchange. Yasser checks the Members Directory on the Tadawul website to find firms authorized by the Saudi Arabian Capital Market Authority to provide brokerage services in Saudi Arabia and finds a very long list. Yasser identifies SNB Capital as the largest brokerage firm by trading volume with close to 18% market share in Saudi Arabia, SNB is also the largest Shariah-compliant asset manager globally. SNB Capital was founded in 2007 as the investment banking and asset management arm of the Saudi National Bank. This is a large bank-based brokerage company and Yasser thinks this may be the right fit for his investing strategy. SNB will allow Yasser to trade independently online, by phone, or with the help of a personal broker. SNB is registered for trading in Tier 1 countries such as the US and parts of Europe and Asia. SNB has an online trading platform, AlAhli Tadawul, which is designed to allow trading through an easy to control platform, with analytical tools to help make decisions. With the online platform Yasser can trade in the US stock market.

Yasser has also found many other Saudi brokers in the Members Directory. He also looked at large international investment banking companies such as the US based Citi and Goldman Sachs, European companies Credit Suisse and Deutsche Securities, and Asian companies such as HSBC He wonders if these may be too large to take care of his personal needs. Yasser has a decision to make. He wants to have a brokerage account that will meet his needs in making long-term investments to support his retirement, but at the same time, he wants to invest in exciting growth opportunities. Study Questions 1. Use the Invest Wisely website to make a recommendation on how Yasser should develop his financial plan. 2. List the reasons that Yasser should consider using a personal broker to help him invest. Online Activity Research a broker in Saudi Arabia other than SNB. Identify the services offered by this broker including the countries where someone can purchase equities. Identify the trading platform offered by this broker and list the advantages and disadvantages of using this broker. حرارة التعليم CHAPTER 4 An Introduction to Financial Markets 185