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Financial News

Feb 2009 Financial News

JSE adopts new formula for pricing stocks - Seeks end to manipulation -Waste of time, says Jackson

Feb 25, 2009

In a matter of days, the Jamaica Stock Exchange (JSE) will launch a new pricing structure for stocks traded on the market, immediately changing the way equities are valued on the exchange.

Analysts say investors' stock portfolio will not necessarily be affected, at least not to any significant degree, saying that clients' equity portfolios.

The new weighted average pricing model goes into effect March 2, replacing the 'last-sale' methodology now in use by JSE to determine the closing price of a stock.

The calculation is based on the volumes of a stock purchased at different prices divided by the cumulative volumes of the stock unit that trade throughout the day (see insert for example).

Market manipulation

But already market watcher and senior analyst John Jackson has taken a jab at the plan, saying it would not address the issue of market manipulation - which the JSE contends is its primary objective - and was therefore a wasted effort.

The price of a stock is currently determined by the JSE as the last price at which its units traded on that day.

But now the JSE says come Tuesday it will move to a system that weights the bid prices posted throughout the trading day.

JSE General Manager Marlene Street-Forrest says she is trying to close a loophole in the current system used by brokers whom she says tactically place last minute trades near market close.

"In some instances, based on trading activity by a trader towards the end of close of the day, the price at which the last sale is transacted - usually using small volumes - affects the price of a company's share and ultimately the overall market capitalisation," said Street-Forrest.

"This, while it is the closing price, in these instances, do not reflect the best indication of the price of that security for that given day," she said.

Still, there is a limit on how much manipulation can occur, given that a 15 per cent price movement in either direction triggers the circuit breaker.

And Jackson insists that it is not the closing price of the stock that is important to stockbrokerages, rather it is the bid price.

"The stock exchange did not deal with the fundamental issue of market manipulation because what fund managers are using to value portfolios is the bid price," said Jackson.

"What they need to do is to raise the board lot and monitor and police the system more to identify the people who manipulate the system and penalise them."

Closing price

Mark Croskery of Stocks and Securities Limited said, however, that most brokers use the closing price to value portfolios.

"The price used to value portfolios depends on the accounting policy of the company. Some use the bid price but most in general use the closing price," said Croskery.

"With the change in the calculation of the closing price, it will prevent a dramatic fall-off in market capitalisation that can result with the use of the last sale price," he said, essentially agreeing with Street-Forrest.

Indeed, all the analysts polled by Wednesday Business, except for Jackson, said the new pricing model would be a plus.

"All brokers now use the closing price to value an investor portfolio and with the change in calculation, this will be better as it will prevent an individual company's market capitalisation from falling drastically in one day," said Jason Dear of First Global Financial Services.

Street-Forrest said that the route of increasing the board lot was given consideration but thrown out as discriminatory.

A board lot is a standardised number of shares defined by a stock exchange as a trading unit, often determined by a round number, say, of 100 share units. Its purpose is to avoid trading in 'odd lots' or small and uneven volumes of a stock. In effect, it standardises the terms under which volumes of stock are traded in order to promote market efficiency.

JSE's board lot is 100 units.

"In some markets, consideration is given to increasing board lots to combat any real or perceived problem," said Street-Forrest.

"This was considered," she added, "however, in analysing this option, it was apparent that small investors would not be in a position to purchase certain securities on the market."

Weighted average price

The use of a weighted average price to calculate the closing price of a security is a feature of several stock exchanges trading platform and is used by several exchanges, Street-Forrest said.

The weighted average basis is expected to be implemented come March 2, 2009 and has already been tested in the market by a simulation of several days trading.

"In moving to a closing price which is based on a weighted average of the trades of the security throughout the day, the opportunity for any form of 'market manipulation', if it exists, would be difficult," explained Street-Forrest.

"This approach provides a better measurement of the closing price of the share as it is not influenced by a single transaction but a composite of transactions," she added.

The weighted average price will become the closing price of the security as well as the opening price for that security on the following trading day.

And it will also be used as the basis for the calculation of the trigger for the circuit-breaker.

Limit the impact of ad hoc trades

Market analysts said the new system would limit the impact of ad hoc trades or dramatic price movements, and provide the market with a better guide to the value of the stocks that trade on the exchange.

"Both heavily weighted stocks and thinly traded stocks have the potential to fall more than 15 per cent in one day with the current system, but with this new method those variables will be protected," said Dear.

Added Christopher Chin-Loy, head of brokerage services at Scotia DBG Investments: "We anticipate that it will help in terms of mark-to-market pricing of portfolios. With a market as shallow as ours we get a level that is unreal with the use of last-sale price."

sabrina.gordon@gleanerjm.com

The formula to be used for the weighted average close price of stocks on the Jamaica Stock Exchange

Example: Company ABC Limited at different

prices and volumes trades three times at different prices and volumes, as follows:

a) 3,000 units at $50

b) 400 units at $45

c) 1,000 units at $52

The closing pricing will be computed as follows:

Close price: (3000x50 + 400x45 + 1000x52)/(3000+400+1000) = $50


Source:
Sabrina Gordon, Business Reporter
Jamaica Gleaner
Wednesday February 25, 2009

http://www.jamaica-gleaner.com/gleaner/20090225/business/business2.html