IBG 1027
`CBM of U.S. Patent No. 7,412,416
`
`0001
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`

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`Library of Congress Cataloging-in-Publication Data
`
`Weiss, David M.
`After the trade is made : processing securities transactions /
`David M. Weiss.—2nd ed.
`p.
`cm.
`Includes index.
`ISBN 0-13-177601-0
`2. Securities——United States.
`1. Stock-exchange—United States.
`3. Commodity exchanges—United States.
`I. Title.
`HG4910.W365
`1993
`332.64’2_73——dc20
`
`93-25716
`CI.P
`
`
`
`
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`
`’'
`
`VP
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`I5
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`[
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`l
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`© 1993, 1986 by NYIF Corp.
`All rights reserved. No part of this book may be reproduced in anyform or by any means, without
`permission in writing from the publisher.
`
`_
`
`Printed in the United States of America
`10
`9
`8
`7
`6
`
`Thispublicationisdesignedtoprovideaccurateandauthoritativeinformationinregardto
`
`the subject matter covered. It is sold with the understanding that the publisher is not engaged
`in rendering legal, accounting, or other professional service. If legal advice or other expert
`assistance is required, the services of a competent professional person should be sought.
`—From the Declaration ofPrinciples jointly adopted by a Committee of the American Bar
`
`AssociationandaCommitteeofPublishersandAssociations
`
`ISBN El-1.3-].?'?l:E|];-El
`
`
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`I
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`44
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`Part 1: The Multifacetecl Securities Industry
`
`executes because of priority, C executes because of precedence, and B
`executes before D because of time advantage.
`Parity. When two brokers can both fill the order and both
`enter their intentions at the same time, there isn't any logical way
`of awarding the trade. This is parity. In this case, either the
`brokers agree to an equitable distribution, or they flip a coin and
`the winner takes the trade.
`
`Example: The quote is 22-1/2, and the bids are:
`Broker M: 100 shares, 10:14
`Broker N: 100 shares, 10:15
`Broker 0: 100 shares, 10:15
`rket order for 100 shares,
`If Broker Z enters the crowd with a sell ma
`d with a sell market order
`Broker M executes. If Broker Z enters the crow
`for 200 shares, M executes 100 shares. Since Brokers N and O can fill or
`best fill the order and neither has a time advantage, they have parity. So
`Brokers N and 0 either agree to one of these two taking the 100 shares
`or toss a coin, and the winner of the toss executes 100 shares.
`When an execution takes place, thefloor is cleared, all remain-
`ing bids or offers at that price must be resubmitted. This proce-
`dure keeps quotes updated while reaffirming all orders.
`
`The Specialist's Book
`Specialists enter public orders, that are away from the market, in
`their books by price and in the order they are received.
`Example: See Figure 4-2. If this specialist’s book represents the highest
`bid and lowest offer of the crowd, the quote is 22 1/4-5/8. The highest
`bid is 221/4, the lowest offer, 225/8. If these orders are the only shares
`comprising the quote, the size is 5 by 9. The largest order for a buy at
`221/4 is for 500 shares (200 by Broker D and 300 by Broker E). The largest
`order for sale at 225/8 is 900 shares (300 by Broker F and 600 by Broker
`G).
`
`Specialists execute orders from their books by price on 3
`first-in/first-out (FIFO) basis. The first order in is the first order
`out.
`
`Example: If Broker Z enters the crowd with a 200-share buy order at the
`market, the specialist executes 200 of Broker F's 300—share order at 225/5'
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`0003
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`

`
`/Iultifaceted Securities Industry
`
`Chapter 4: The Exchanges
`
`45
`
`because of precedence, and B
`tage.
`
`both fill the order and both
`3, there isn't any logical way
`ity. In this case, either the
`.1tion, or they flip a coin and
`
`.ds are:
`
`11 market order for 100 shares,
`2 crowd with a sell market order
`.nce Brokers N and O can fill or
`advantage, they have parity. So
`these two taking the 100 shares
`5 executes 100 shares.
`
`thefloor is cleared, all remain-
`: be resubmitted. This proce-
`affirming all orders.
`
`are away from the market, in
`r they are received.
`
`ist’s book represents the highest
`quote is 22 1 /4-5 / 8. The highest
`:hese orders are the only shares
`9. The largest order for a buy at
`and 300 by Broker E). The largest
`ID by Broker F and 600 by Broker
`
`-m their books by price on a
`first order in is the first order
`
`with a 200—share buy order at the
`iroker F's 300-share order at 225/8-
`
`FIGURE 4-2. A page in the specialist’s book_
`
`SELL
`
`BI
`EEK‘
`0*’ER:‘:-.'+.:3l
`.h__§
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`0004
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`

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`46
`
`Part 1: The Multifaceted Securities Industry
`
`The NYSE specialist’s book is maintained on a CRT and
`referred to as display book. This electronic book sorts all orders
`coming to the specialist in time and price sequence; it also keeps
`track of executed orders, so that inquiries from member firms
`may be quickly researched.
`Display book is part of a larger system, known as DOT
`(designated order turnaround). DOT orders are executed by the
`specialist either against other DOT orders (orders entered by
`member firms into the DOT system), or against brokers in the
`”crowd” or against the specialist’s own position.
`
`TEE AMERICAN STOCK EXCHANGE (AMEX)
`
`The Amex membership is basically like the NYSE’s. On the floor
`are commission house brokers, two—do1la; brokers, specialists,
`and traders. Their functions are very similar to those of their
`counterparts on the NYSE.
`One notable difference from the NYSE is the way the mem-
`ber firms communicate with their employees. Conversations
`regarding security, shares, price, and the like are carried on
`through a system of hand signals. The individuals actually dis-
`cuss quote, size, and other terms without speaking or writing a
`word.
`The Amex trading floor also operates differently than the
`NYSE. its procedure for awarding trades is known as priority
`prorata. Under this system, one broker may have priority, as an
`the NYSE. After priority, however, shares are allocated in round
`lots among the other participating brokers. Precedence and parity
`do not play a part in the Amex procedure.
`
`
`
`
`
`Example: Three brokers enter bids for ABC at 26, as follows:
`Broker A: 100 shares, 10:14
`Broker B: 200 shares, 10:15
`Broker C: 300 shares, 10:15
`e sell market Order‘
`Broker X enters the crowd with a 400-shar
`then buys
`Broker A executes a trade for 100 shares (priority). Broker B
`iniI‘8
`100 shares, and Broker C takes 200 shares. In other words, the rema
`300 shares are distributed ”prorata.”
`
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`0005
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`

`
`CHAPTER 21
`
`Corporate
`Bonds and Notes
`
`Type: Debt
`Form: Registered (usually)
`Denomination: Terms established in indenture (usually
`$1,000)
`Income payment: Interest
`Traded: Stock exchanges or OTC
`Duration: Varies, usually a 30-year maximum
`
`Market conditions, the dilution of ownership, and a host of
`other reasons may lead a corporation to decide against issuing
`shares of stock to raise capital. Instead, because the corporation is
`a legal individual, it borrows money from the public sector in its
`own name.
`(cid:149) Corporations borrow long-term capital through debt instr
`ments known as bonds.
`notes.
`(cid:149) They borrow intermediate-term financing through
`(cid:149) Short-term financing, referred to as
`commercial loans, is ar-
`ranged through commercial banks. (Some corporations ,
`especially finance corporations, issue a short-term
`iflS
`ment known as commercial paper.)
`
`u-
`
`172
`
`0006
`
`

`
`Chapter 21: Corporate Bonds and Notes (cid:9)
`
`173
`
`This chapter focuses on corporate bonds and notes. Bond-
`holders and noteholders are creditors, or lenders, to the corpora-
`tion. As such, they do not own the company or have any vote in
`corporate matters. They lend their money to the corporation, in
`return for interest payments as they become due and the repay-
`ment of their principal at the conclusion of the loan’s term.
`Corporate bonds and notes are brought to the public market
`through underwritings, which are usually negotiated but are
`sometimes competitive. (See Chapter 23, "Municipal Bonds and
`Notes," for an explanation of the competitive underwriting.) In
`the negotiated underwriting, corporate management and the un-
`derwriters meet and decide to issue bonds.
`The bonds must be made attractive to the investment public,
`because corporate bonds and notes, by paying a fixed rate of
`interest, compete with other debt instruments for the investor’s
`dollars. Yet the interest, as set, must be paid or the debt holders
`can foreclose on the corporation. So the set rate of interest must
`be high enough to compete with other debt instruments but not
`so high that the corporation cannot pay it.
`How, then, does the corporation set the interest rate? One
`factor is the rate of return that the corporation can expect when it
`invests the borrowed funds.
`Example: The issuing company wants to build a new factory. Based on
`their estimates, the factory will return 10% on money invested to build
`it. If the corporation must pay 8% on the money they are borrowing, the
`factory may be worth building. If they have to pay 11% interest, the
`factory may not.
`Another term for using borrowed money to make money is
`leverage. The corporation knows that the income they earn fluc-
`tuates while the long-term financing is paid for at a fixed rate.
`They will therefore be "hedging" the borrowed funds against the
`Possible income.
`Hedging is a two-edged sword. On one side, the corporation
`can earn revenue on someone else’s money. On the other side, if
`the interest cost is fixed, the corporation can lose money as a
`result of leverage.
`
`Example: If the corporation can borrow money at 8% interest, it will
`eam 2% on the bondholders’ money: 10% return less 8% cost of money
`
`ru-
`
`aT-
`
`rU
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`-
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`0007
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`

`
`ii t
`
`FIGURE 21-1a. A bond certificate, front
`
`0008
`
`

`
`FIGURE 21-1b. A bond certificate, back.
`
`W. R. GRACE & CO.
`12b7- NOTE DUE 1990
`
`Note is one of a duly authorized issue of Notes of the Company (cid:9)
`Tfi (cid:9)
`Os 12NH% Notes Doe 1990 (herein called the ’’Notes’’), limited (cid:9)
`tste (cid:9)
`5
`therwise provided in the Indenture refereed to below) in aggrega te (cid:9)
`(except as mount to $100,000 1 000. issued and to be issued under an indenture (cid:9)
`pneOip Hu alled the ’’Indenture’’) dated as of September 15, 1980 between the (cid:9)
`9 (cid:9)
`t C mo
`II d to (cid:9)
`which (cid:9)
`o I (cid:9)
`i (cid:9)
`t (cid:9)
`(h (cid:9)
`9 k (cid:9)
`¶cd (cid:9)
` tot (cid:9)
`Iseynl u des any suocnssr0 rusee nden the
`I.
`ent (cid:9)
`is rnde yr ’d
`t1ffd (cid:9)
`t th (cid:9)
`rightsthereunder f the Company Oh 0 (cid:9)
`d th H Id (cid:9)
`t (cid:9)
`leiP t(cid:176)t ed the terms upon which the Notes are, and art to be authenticated (cid:9)
`yote’ o
`ared (cid:9)
`d (cid:9)
`I (cid:9)
`b (cid:9)
`0 (cid:9)
`Oh (cid:9)
`are
`30 (cid:9)
`by t t II (cid:9) m I (cid:9)
`Ph (cid:9)
`ft (cid:9)
`y t w (cid:9)
`S Pt mb (cid:9)
`T5 1986 (cid:9)
`notice
`or from t
` to time Jr part, at the election so the Company, at
`a
`ice equal to 100% of their principal amount, together with accrued (cid:9)
`a (cid:9)
`0yewpliOt (cid:9)
`Redemption Date but irtrr050 instalments whose Stated Maturity (cid:9)
`slerest to (cid:9)
`to the Redemption Date will be payable to the Holders of such Notes, (cid:9)
`ee 50 pri (cid:9)
`predecessor Notes, at record at the nose of business on the relevant (cid:9)
`see or mo re
` ferred to on the tarn hereof), all as provided in the Indenture, (cid:9)
`5ysoid Data
`event of redemption of this Note in part only, a new Note no Notes (cid:9)
`the
`rrdeemed portion hereot shall be issued in the name of the Holder hereof (cid:9)
`
`0 (cid:9)
`
`No reference herein to the Indenture and no provision of this Note on of
`the Indenture shall alter or impair the Obligation of the CoNpary, which is absolute
`and u000ndi floral, to pay the pninoipal Ot and interest on this Note at the fumes
`places, and rate, and in the coin on currency, herein prescribed.
`As provided in the Indenture and sobiruf to certain limitation therein set
`t th fir (cid:9)
`N 0 (cid:9)
`0 (cid:9)
`0 (cid:9)
`bI (cid:9)
`th N I H 0 I (cid:9)
`0th C mp y (cid:9)
`p
`of this Note ton registoetior of transten at the off,re on agercr of the Company in
`tlr 0 (cid:9)
`Or tt (cid:9) Oh Cty I N (cid:9)
`ph 0 M
`d (cid:9)
`
`P thd
`y0 t t (cid:9)
`C m (cid:9)
` strar duly executed by, the Holder her est or his at
`Note
`(cid:9) hilly uthonieed
`
`Reg’ in writing, and theneupor urn or more new Notes, Of authorized denominations and
`0 (cid:9)
`th (cid:9)
`m (cid:9)
`II b (cid:9)
`pal amount, (cid:9)
`gg g t p (cid:9)
`d t the d (cid:9)
`nated trans.
`
`g
`forse or transferees.
`The Notes are issuable only in registered 000w without coupons in denomira.
`turns sO 11.000 and any integral multiple therrot As pcsuided in the Indenture and
`subject to certain limitations therein set tOrth, Notes are neohargeeble ton a like
`aggregate principal amount of Notes 00 a different authorised denomination, as
`requested by the Holder surrendering the same. (cid:9)
`-
`i (cid:9)
`9 (cid:9)
`N (cid:9)
`Oh II be (cid:9)
`de Or any such transfer (cid:9)
`S (cid:9)
`ut
`S
`the Company may require payment 50 a sum sufficient to ’in", any too OrŁthen
`the (cid:9)
`governmental charge payable in connectiOr therewith.
`lue (cid:9)
`Default, as defined in the Indenture, shall scour end be roe. (cid:9)
`If an principal 50 all the Notes may be declared due and payable in the (cid:9)
`The Company, the Trustee and any agent of the Company on the Trustee may
`ysuieg, the (cid:9)
`P
`to the effect provided in the Indenture. (cid:9)
`treat the Person in whore name this Note is registered as the owner hereof for alt
`I ns5r and (cid:9)
`denture permits, with certain esreptions as therein provided, the (cid:9)
`purposes, whether or cot Ohm (cid:9) Note be overdue. and neither the Company, the
`modi (cid:9)
`ffoation of the sights and obligations of the (cid:9)
`the
`and
`Toustee noc any such agent shall be affected by estlue to the contrary.
`The thereof
`theHolders
`Of the Notes under th
`e Indenture at enytirne (cid:9)
`
`theight snnnd ye r d (cid:9) ss St (cid:9)
`The Notes are hereby designated as Supeniss indebtedness for the purposes
`loop Com pany and the Trustee with the consent (cid:9)
`Ho ms a 60/0,. in (cid:9)
`00 (a) the Indenture oOuenirg the Compant’s 4… % Convertible Subordinate Deber.
`ate prinOrpal amount of the Not (cid:9)
`at the tim 0 t (cid:9)
`d ng, en d ned in tho (cid:9)
`tones Doe Mar09 I, 1990 issufd pvrOuart to thy Indenture dated as of Marsh 1.
`The md ecture also rontains provisions p (cid:9)
`itting the Ho ders of (cid:9)
`1905 between the Compocy lcd Chemioal eank New York Trust Company, Trustee,
`gupon
`i5 esre (cid:9)
`-rica proeotage5 in aggrege e pninoipa smou t 0
`0 (cid:9)
`of o at 0 e time Out. (cid:9)
`within the meaning so. and ar derined in, Sestion 3.01 Of suoh Indenture and (b(
`as defined in the Irderturn, on behalf St the HO dm5 Ot all the Notes, to (cid:9)
`the Indenture covering the Company’s ff(cid:176)/o% Convertible Subordinate Debentures
` vin provinis 5 of the ndenture and Due 1990 issued Pon suart to the Indenture dated 55 of November iS. 1971 betweno
`ooeplianoe by (he Company with o
`III e
`art
`o Id both H Id (cid:9)
`dh ii b (cid:9)
`tO C mp (cid:9)
`d Tb
`T (cid:9)
`t (cid:9)
`w th
`I (cid:9)
`f to (cid:9)
`t (cid:9)
`db d
`Chd (cid:9) M h Sec to (cid:9)
`i Is I d f (cid:9)
` and a
`(cid:176) (cid:9)
`,
`0 (cid:9)
`551
`ed upon all future Holders Of this Note and Of any Note issued upon (cid:9)
`e‘c rut Hold teieOt or ir esoharge heretor on in lieu heneot whether or not notation
`
`Term (cid:9) used herein which are defined in the Indenture shall have the
`nrtrsens soenn t or waiver is made upon this Note, (cid:9)
`respective meanings assigned thereto in the Indenture.
`
`0 (cid:9)
`
`ABBREVIATIONS
`The twltwniwg sbheeeias’sooa, wheo wsed is. the in.eeipsiwn on she tore of this Nose, shalt be cootnewed as
`shossgh then west nnittses our in tsstt amending to applicable tows we
`TEN COM(cid:151)assseaessinmwtsomwn
`UNIF GIFT MtN ACT(cid:151) ........Caatodise ........
`TEN ENT (cid:151)asteo,wsa b, be
`fCwae) (cid:9)
`yMinwel (cid:9)
`iT TEN (cid:151)as bolos tenants snith eight of
`000ee Ueifwem Gifts to Mioos (cid:9)
`sosns’twestaip and nof mr, tensest (cid:9)
`Are ................
`
`- (cid:9)
`
`-
`
`-
`
`-
`- (cid:9)
`- (cid:9)
`
`Adstisiwnat abbreeittiwna stsae aaaw be osed sh009h Cot in the shone lint,
`
`-. -
`
`
`
`FOR VALUE RECEIVED,
`
`the undersigned hereby sells, assigns and transfers unto
`
`-
`
`OENT""N I NUMBER OF ASS(cid:151)NEE
`
`PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS OF ASSIGNEI
`
`iOn wsshso Note of W, R. GRACE & CO. and does hereby irrevocably constitute and appoint (cid:9)
`
`- . -
`
`- (cid:9)
`0
`
`transfer site said Note on the books of the withies’named Corporation, with full power of substitution in the premises.
`
`Attorney
`
`£
`
`0009
`
`(cid:9)
`(cid:9)
`(cid:9)
`(cid:9)
`(cid:9)
`(cid:9)
`(cid:9)
`(cid:9)
`(cid:9)
`(cid:9)
`(cid:9)
`(cid:9)
`(cid:9)
`(cid:9)
`

`
`176 (cid:9)
`
`Part 3: Types of Securities
`
`equals a 2% profit. On the other hand, if the return on the investment
`turns out to be only 7%, the corporation will lose 1% on the borrowed
`sum: 8% cost of money less 7% return equals 1% loss.
`
`PAYMENT OF INTEREST
`Interest is paid to bondholders usually on a semiannual basis.
`The periods are:
`(cid:149) January and July (J&J).
`(cid:149) February and August (F&A).
`(cid:149) March and September (M&S).
`(cid:149) April and October (A&O).
`(cid:149) May and November (M&N).
`(cid:149) June and December (J&D).
`The actual payment date can be any day of the month, but it
`instrument. For ex-
`is the same day throughout the life of the
`ample, an F&A 15 pays interest on February 15 and August 15; an
`A&O (no date mentioned) pays April 1 and October 1. Because
`most bonds may pay interest on the first day of the interest
`month, the number "1" is often omitted; such bonds are referred
`to simply as "A&O," "M&N," and so on.
`Corporate bonds are traded on national exchanges as well as
`over the counter. The typical bond transaction settles regular way,
`five business days after trade date.
`Bonds trade at the market price plus accrued interest. When
`you buy a bond, you pay the agreed-upon price plus whatever
`interest has accrued to the former owner (the seller) of the bond.
`Let’s look at the price of the bond first.
`
`Pricing of a Corporate Bond
`The quoted price of the bond represents a percentage of the
`face value, or par value.
`Example: An XYZ bond is quoted 96-1/2. In other words, the bond ’S
`trading at 96% to 961/2% of the par value. For a $1,000 par value bond, a
`seller with a market order receives $960 ($1,000 x .96). A buyer with a
`market order pays $965.00 ($1,000 x .965).
`
`0010
`
`

`
`7 Chapter 21: Corporate Bonds and Notes (cid:9)
`
`177
`
`$1,000
`8%
`1 year
`
`When the bond is trading at 100%, it is said to be trading at
`par, or par value. Bonds over par are said to be at a premium,
`whereas bonds trading below par are said to be selling at a discount.
`The price at which a bond is trading has a direct impact on
`the investor’s return, because interest is paid on the face amount
`of the bond, not on its market value. A bond pays the same dollar
`amount of interest regardless of its current market price. If the
`bond is trading at a discount, the investor’s rate of return is
`higher than the stated interest rate on the bond, which is called
`the coupon rate.
`Example: The $1,000 XYZ bond carries a coupon rate of 8%. If the bond
`is purchased at par, the owner receives an 8% return on the investment.
`Here’s the interest calculation:
`Face amount (cid:9)
`Coupon rate (cid:9)
`Interest period (cid:9)
`$1000x
`x=$80
`1
`Bond price (par) (cid:9)
`$1,000
`Annual interest (cid:9)
`$80
`If a bond is trading below par, the rate of return is greater
`than the coupon rate.
`Example: If the bond is trading at 80 (at a discount), the investor
`receives a return of 10% on the investment.
`Bond price (cid:9)
`$800
`Annual interest (cid:9)
`$ 80
`Rate of return (cid:9)
`10% (greater than the
`coupon rate)
`If the bond is trading at a premium, the rate of return is less
`than the coupon rate.
`Example: The XYZ bond is trading at a price of 120. The interest com-
`putation is as follows:
`$1,200
`Bond price (cid:9)
`Annual interest (cid:9)
`$ 80
`.06667 or 6.67%
`Rate of return (cid:9)
`The rate of return can also be called yield. The formulas just
`demonstrated are used for current yield. In the fixed income
`
`A
`
`0011
`
`

`
`178 (cid:9)
`
`Part 3: Types of Securities
`
`security environment, many other formulas are used to calculate
`different yields, such as yield-to-maturity or yield-to-first sinking
`fund. We do not explore these formulas here.
`
`Accrued Interest
`
`The trade price, however, is only part of what you pay the seller.
`You must also pay any interest that has accrued to the seller since
`the last interest payment.
`Interest is computed on a 360-day basis, with each half-year
`interest period comprising 180 days.
`Example: An 8% bond pays $80 per year per $1,000 of face value, or $40
`semiannually.
`
`Interest continues to accrue to the bond’s seller up to but not
`including settlement day, on which date the accrued interest is
`paid to the seller. The formula for calculating accrued interest is:
`
`Accrued Face amount Rate of Number of days
`
`(cid:9) is owned
`= (cid:9)
`<
`of bond (cid:9)
`
`interest interest (cid:9)
`interest (cid:9)
`360
`Example: On April 4, you purchase $1,000 XYZ 8% A&O 2005 @ 96,
`which settles on April 11. Because the bond pays interest on April 1 and
`October 1 (A&O), you owe the seller interest from April 1 through April
`10. Counting the days from April 1, the first day of the interest period,
`up through but not including the settlement date of April 11, you get 10
`days. You owe 10 days of interest. Let’s calculate the accrued interest:
`
`Accrued (cid:9)
`interest (cid:9)
`
`= (cid:9)
`
`Face Amount (cid:9)
`$1,000 x (cid:9)
`
`Interest Rate (cid:9)
`8 (cid:9)
`100 (cid:9)
`
`x (cid:9)
`
`Days
`10
`360
`
`= $2.23
`
`You pay the seller $960 (.96 x $1,000 face value) plus the accrued
`interest of $2.23.
`On August 29, you sell the bonds at a price of 96 for settlement on
`September 5.
`Now let’s see the calculations on the sale of the bond. From April
`11 through September 4, you accrue interest. Counting from April 11
`through but not including the settlement date of September 5, you get
`144 days, during which interest has accrued to you. You are entitled to
`144 days of accrued interest.
`
`I
`
`0012