2016/10/12 Contents Chinese financial markets Basic Knowledge in Stock Market Trading Part 3: The stock market Mechanism History of the Chinese Stock Market The Split-share Structure Reform Opening of the Chinese Stock Market Sept. Dec 2016 By Zhang Xiaorong The Stock Market Collapse in Mid 2015 The stock Market The stock market is the aggregation of buyers and 3.1 Basic Knowledge in Stock Market Trading Mechanism (primary market)and traded (secondary market The trade can be done either through exchanges or over-the-counter markets The market can also be a loose network of economic facility or discrete entity The stock Market Liquidity How do you define a"good" stock market? Liquidity is the degree to which an asset or security an be bought or sold in the market without affecting Speed of transaction a market with high liquidity can attract more investors, improve price discovery of securities, and reduce cost of financing. The liquidity of a security can be measured by its w often or turnover The trading volume of a security over its market cap is th
2016/10/12 1 Chinese Financial Markets Part 3: The Stock Market Sept.-Dec.2016 By Zhang Xiaorong Fudan University, Shanghai, China 3-1 Contents • Basic Knowledge in Stock Market Trading Mechanism • History of the Chinese Stock Market • The Split-share Structure Reform • Opening of the Chinese Stock Market • The Stock Market Collapse in Mid 2015 3.1 Basic Knowledge in Stock Market Trading Mechanism 3-3 The Stock Market • The stock market is the aggregation of buyers and sellers of stocks, and where shares are issued (primary market) and traded (secondary market) . • The trade can be done either through exchanges or over-the-counter markets. • The market can also be a loose network of economic transactions and does not have to be a physical facility or discrete entity. 3-4 The Stock Market • How do you define a “good” stock market? – Easy access (and exit) – Speed of transaction – Low transaction cost – Information transparency – Low volatility – High liquidity – Etc. 3-5 Liquidity • Liquidity is the degree to which an asset or security can be bought or sold in the market without affecting the asset's price. • A market with high liquidity can attract more investors, improve price discovery of securities, and reduce cost of financing. • The liquidity of a security can be measured by its trading volume (how often it is bought and sold), or turnover. • The trading volume of a security over its market cap is the turnover ratio. 3-6
2016/10/12 quidity Continuity Liquidity is associated with amount of people trading Price continuity refers to the degree of continuity in and the trading mechani ice change, i.e. price movements between It can also be measured by the trading speed depth ransactions are relatively small idth and price elasticity. Price continuity is associated with liquidity: markets Market depth is the size of an order needed to move ith high depth and low width usually have continuous" prices in trading. Market width is the bid/ask spread Price continuity is also associated with total amount Price elasticity measures how fast a price devia tion of people trading and the trading mechanism, the led by an impact from block trade) can be o the equilibrium. It also reduces transaction cost Transaction Costs Types of Order Transaction costs are the costs that traders have to Market order: an order that is to be executed at the ay in addition to the observed market price of best price available in the market stocks Buy limit order: the stock may be purchased at a no Transaction cost components are associated with higher price than the designated price how the market is organized Sell limit order: the stock may be sold at a no lowe Explicit costs include fees and taxes, such as ice than the desig commissions to brokers(1.5%".5%o in China)and Buy stop order: the stock will not be purchased until it the stamp tax(1% in China). es above the designated price plicit costs include the impact cost, which is the Sell stop order: the stock will not be sold until it drops deviation of prices when a large order of sale or below the designated price urchase impacts on the market. Margin Transactions Margin transactions Margin transaction is the arrangement that ar X Company investor can buy stocks on his own money plus the 50% Initial margin requirement money he/she borrows from a broker. 40% Margin account is the investors deposit to absorb the profit or loss before he sells the stock 1000 No of share purchased The investors should pay interest and fee on his borrowing and uses the stocks as a collatera Initial position of the investor Leverage makes the trades riskier shares $70,000 Borrowed $35, In order to control risk, the margin requirement is in535 necessary
2016/10/12 2 Liquidity • Liquidity is associated with amount of people trading and the trading mechanism. • It can also be measured by the trading speed, depth, width and price elasticity. • Market depth is the size of an order needed to move the market a given amount. • Market width is the bid/ask spread. • Price elasticity measures how fast a price deviation (led by an impact from block trade) can be rebalanced to the equilibrium. 3-7 Continuity • Price continuity refers to the degree of continuity in price change, i.e., price movements between transactions are relatively small. • Price continuity is associated with liquidity: markets with high depth and low width usually have “continuous” prices in trading. • Price continuity is also associated with total amount of people trading and the trading mechanism, the tick size. • It also reduces transaction cost. 3-8 3-9 Transaction Costs • Transaction costs are the costs that traders have to pay in addition to the observed market price of stocks. • Transaction cost components are associated with how the market is organized. • Explicit costs include fees and taxes, such as commissions to brokers (1.5‰~2.5‰ in China) and the stamp tax (1‰ in China). • Implicit costs include the impact cost, which is the deviation of prices when a large order of sale or purchase impacts on the market. Types of Order • Market order: an order that is to be executed at the best price available in the market • Buy limit order: the stock may be purchased at a no higher price than the designated price • Sell limit order: the stock may be sold at a no lower price than the designated price • Buy stop order: the stock will not be purchased until it rises above the designated price • Sell stop order: the stock will not be sold until it drops below the designated price 3-10 3-11 Margin Transactions • Margin transaction is the arrangement that an investor can buy stocks on his own money plus the money he/she borrows from a broker. • Margin account is the investor’s deposit to absorb the profit or loss before he sells the stocks. • The investors should pay interest and fee on his borrowing and uses the stocks as a collateral. • Leverage makes the trades riskier. • In order to control risk, the margin requirement is necessary. X Company $70 50% Initial margin requirement 40% Maintenance margin 1000 No. of share purchased Initial position of the investor shares $70,000 Borrowed $35,000 Margin $35,000 (equity) Margin Transactions 3-12
2016/10/12 Margin Transactions Margin Transactions ppose the stock price drops to s60/share How far can the stock price fall before a margin call? position of the investor (1000°P-S35000)*/1000°P=40% S60,000 Borrowed $35,000 (Maintenance margin Margin $25,000 P=S5833 Equity =1000*P-borrowed money Margin%=525,000/560000=4167% 1000*5833-35,000=23330 Short Selling Stock Indexes The sale of a security that is not owned by the seller In every stock market, stock indexes are compiled or that the seller has borrowed and released everyday to reflect to whole market. The motivation of short selling is the belief that the The functions of stock indexes include stocks price will decline, and the sell intends to Track average returns ake a profit by buying it back at a lower price Comparing performance of managers The seller is"borrowing"stocks from other investors ase of derivatives through the dealer. The seller has to pay interest to the dealer and pay The generally market indexes should be representative enough, while other indexes are also created to give more information Examples of Indexes-China Examples of Indexes-Int hanghai Stock Exchange Composite Index Other Markets Shanghai Stock Exchange A shares'Index SSE&SZSE 300 Index Index SE 180 Index(most representative in size, liquidity and NASDAQ Composite SGX Index SSE 50 Index(even more representative) Dow Jones industrial SSE 380 Index(growth, blue chip verage(30 stocks London) Shenzhen Stock Exchange Composite Index P100:S&P500 SZSE 300 Index(representative in size, liquidity) CAC 40 Index SZSE 100 Index(most representative in size, liquidity
2016/10/12 3 Margin Transactions Suppose the stock price drops to $60/share New position of the investor shares $60,000 Borrowed $35,000 Margin $25,000 (equity) Margin%= $25,000/$60,000 = 41.67% 3-13 Margin Transactions How far can the stock price fall before a margin call? (1000*P - $35,000)* / 1000*P = 40% (Maintenance margin) P = $58.33 Equity =1000*P – borrowed money =1000*58.33-35, 000=23,330 3-14 3-15 Short Selling • The sale of a security that is not owned by the seller, or that the seller has borrowed. • The motivation of short selling is the belief that the stock’s price will decline, and the sell intends to make a profit by buying it back at a lower price. • The seller is “borrowing” stocks from other investors through the dealer. • The seller has to pay interest to the dealer and pay dividend if there is any. Stock Indexes • In every stock market, stock indexes are compiled and released everyday to reflect to whole market. • The functions of stock indexes include – Track average returns – Comparing performance of managers – Base of derivatives • The generally market indexes should be representative enough, while other indexes are also created to give more information. 3-16 Examples of Indexes –China • Shanghai Stock Exchange Composite Index • Shanghai Stock Exchange A shares’ Index • SSE&SZSE 300 Index • SSE 180 Index (most representative in size, liquidity and industry) • SSE 50 Index (even more representative) • SSE 380 Index (growth, blue chip) • Shenzhen Stock Exchange Composite Index • SZSE Component Index • SZSE 300 Index (representative in size, liquidity) • SZSE 100 Index (most representative in size, liquidity) 3-17 Examples of Indexes - Int’l The US – NYSE Composite Index – NASDAQ Composite – Dow Jones Industrial Average (30 stocks) – S&P 100; S&P 500 Other Markets – Nikkei 225 & Nikkei 300 – Hang Seng Indexes (HIS) – SGX Index – FTSE (Financial Times of London) – S&P/TSX (Toronto) Composite Index – DAX Index – CAC 40 Index – Etc. 3-18
2016/10/12 Circuit Breaker Circuit Breaker a circuit breaker is the arrangement to curb the Example: the 3 level circuit breaker by S&P 500 emotion (greed and fear)and the overreaction in the Used to be the 3 level breaker by DJIA in points market to avoid crash d by nyse with the circuit breaker by S&P from Feb The market trade would be halted if key market 4 2013, 3 levels at 7%, 13%(15 minutes break]and 20% indexes decline over a certain percentage in a single (market close), respectively trading day. For individual stock: +10% in 5 minutes trading The circuit breaker is extremely important for the US stock market, but also requires coordination among Example: circuit breaker for SSE&SZSE 300 in China Adopted on Jan 4th 2016, ca 5% for 15 minutes break. 7% for market close Limit-up and Limit-down(Circuit Breaker for Individual Stocks) Market Structure Limit-ups and-downs are commonly used in futures Market structure is the organizational and other contracts where a maximum amount of price haracteristics of a market which affect the nature of increase/decrease is allowed in a single trading day to reduce volatility in the market. competition and pricing It can also d to individual stocks by halting Distinguish markets in term of cost, information and the trading he price change reaches a 0%or 5%, upon the opening Direct search market Dealers market hanges goes back within the limit, trading on the Auction market Chinas stock Exchange 3. 2 History of the Chinese Stock A(brokered)and auction market with computerized Market automatic matching of buyers and sellers according Only commission brokers and proprietary traders are rading in the stock exchange, no specialists that take Limits-up and Limits-down(10%)resumed in Dec 19th.1996 Limits-up and Limits-down(5%)for ST stocks
2016/10/12 4 Circuit Breaker • A circuit breaker is the arrangement to curb the emotion (greed and fear) and the overreaction in the market to avoid crash. • The market trade would be halted if key market indexes decline over a certain percentage in a single trading day. • The circuit breaker is extremely important for the US stock market, but also requires coordination among the markets 3-19 Circuit Breaker • Example: the 3 level circuit breaker by S&P 500 – Used to be the 3 level circuit breaker by DJIA in points – Replaced by NYSE with the circuit breaker by S&P from Feb. 4 2013, 3 levels at 7%, 13% (15 minutes break)and 20% (market close), respectively – For individual stock: 10% in 5 minutes trading • Example: circuit breaker for SSE&SZSE 300 in China – Adopted on Jan.4th 2016, cancelled on Jan. 8th – 5% for 15 minutes break, 7% for market close 3-20 Limit-up and Limit-down (Circuit Breaker for Individual Stocks) • Limit-ups and -downs are commonly used in futures contracts where a maximum amount of price increase/decrease is allowed in a single trading day to reduce volatility in the market. • It can also be applied to individual stocks by halting the trading when the price change reaches a maximum, usually 10% or 5%, upon the opening price. • If the stock price declines/grows and percentage changes goes back within the limit, trading on the individual stock resumes. 3-21 Market Structure • Market structure is the organizational and other characteristics of a market, which affect the nature of competition and pricing. • Distinguish markets in term of cost, information and price discovery – Direct search market – Brokered market – Dealers’ market – Auction market 3-22 3.2 History of the Chinese Stock Market China’s Stock Exchange • A (brokered) and auction market with computerized trading system • automatic matching of buyers and sellers according to price and time • Only commission brokers and proprietary traders are trading in the stock exchange, no specialists that take the role of market maker. • Limits-up and Limits-down (10%) resumed in Dec 19th.1996 • Limits-up and Limits-down (5%) for ST stocks. 3-24
2016/10/12 China's Stock Exchange Example the Auto-matching Trading System Only limit orders and market orders available Reverse transaction "T+1" Brokerage fee:1.5‰~25‰ Stamp tax: 1% on stock selling Tick size 1 cent Index future launched in April 2010 Short sell and margin trading started from April 2010 Simulation trading on stock index option launched in 012and2013 ETF 50 Index option launched in Feb. 2015 黑四留 tock markets in China since 1980 Early Stage: 1980-1990 Early Stage: 1980-1990, experimental period Earliest Stocks Issued Second Stage: 1991 1998, rapid development Some small-size SOEs and collective firms began without regulation to issue stocks in early 1980s Third Stage: 1999-2008, development under The shares were issued at the face value with regulation promised dividends and maturity to the Fourth Stage: 2009-present, more rational market employees and local residents after the global financial crisis Year 2015: stock market collapse in June Early Stage: 19801990 Early Stage: 1980-1990 Earliest Stocks Issued By1990, only 8 stocks were traded in Shanghai Company first publicly issued shares at RMB 100 quity financing 1980-1990 in China(in BIn RMB) nd raised capital of 3 million RMB Example: In Dec. 1984, Feile Acoustics in Shanghai issued 10,000 shares at RMB 50 to the public In January 1985, Yanzhong Industrial Company in Shanghai raised equity capital of 5 million Yuan On April 11th 1988, Shenzhen Development Bank sued stocks with Shenzhen Security Company
2016/10/12 5 China’s Stock Exchange • Only limit orders and market orders available • Reverse Transaction “T+1” • Brokerage fee: 1.5‰~2.5‰ • Stamp tax: 1‰ on stock selling • Tick size：1 cent • Index future launched in April 2010 • Short sell and margin trading started from April 2010 • Simulation trading on stock index option launched in 2012 and 2013 • ETF 50 Index option launched in Feb. 2015 3-25 Example: the Auto-matching Trading System 3-26 3-27 Stock Markets in China since 1980 • Early Stage: 1980~1990, experimental period • Second Stage: 1991~1998, rapid development without regulation • Third Stage: 1999~2008, development under regulation • Fourth Stage: 2009-present, more rational market after the global financial crisis • Year 2015: stock market collapse in June Early Stage: 1980~1990 • Earliest Stocks Issued – Some small-size SOEs and collective firms began to issue stocks in early 1980s – The shares were issued at the face value with promised dividends and maturity to the employees and local residents – No underwriter involved; limited secondary market 3-28 Early Stage: 1980~1990 • Earliest Stocks Issued – Example: On July 25th 1984, Beijing Tianqiao Company first publicly issued shares at RMB 100 and raised capital of 3 million RMB. – Example: In Dec. 1984, Feile Acoustics in Shanghai issued 10,000 shares at RMB 50 to the public. – In January 1985, Yanzhong Industrial Company in Shanghai raised equity capital of 5 million Yuan. – On April 11th 1988, Shenzhen Development Bank issued stocks with Shenzhen Security Company 3-29 3-30 Early Stage: 1980~1990 • By1990, only 8 stocks were traded in Shanghai Equity Financing 1980-1990 in China (in Bln RMB) 1980-1987 1988 1989 1990 Total 1 2.5 0.66 0.43 4.59