The Stock Markets

Stock Ownership 1An ownership stake in the issuing firm that reflects the percentage of the corporate stock held. 2The right to share in the issuing firm’s profits after payment of interest to bond holders and taxes. 3A residual claim on the firm’s assets if the Company fails or is dissolved after debt and tax liabilities are paid. 4Voting privileges (not in all cases).

Types of Corporate Stock Common Preferred

Equity Shareholder Return Capital gains Dividend payments R t = ( P t - P t-1 / P t-1 ) + D t /P t-1

Common Stock - Differentiating Features Discretionary dividend payments- the Board of Directors determines the payment and size of dividends. Stockholders have no legal recourse if dividends are not received. Dividends are taxed 2X the corp level and the personal income tax rate). Residual claim- common stockholders have the lowest priority claim on a corporation’s assets in the event of bankruptcy. Limited liability- no matter what financial difficulties the issuing corporation encounters, neither it nor its creditors can seek repayment from the firm’s common stockholders. In other, words it is implied that shareholder’s losses are limited to the original investment. Voting rights- typically one vote per share. However some firms have dual classes in which two classes of stock are outstanding. In such cases, one class usually has inferior voting rights.

Election of Board of Directors Two methods of electing a Board of Directors: –1. Cumulative voting- all directors up for election are voted on at the same time. The number of votes assigned to each share holder equals the number of shares held multiplied by the number of directors to be elected. Shareholders may assign all their votes to a single candidate or spread them out. –2. Straight Voting - the vote on the Board of Directors occurs one director at a time. The number of votes eligible for each director equals the number of shares outstanding.

Preferred Stock A hybrid security with characteristics of both a bond and common stock. Preferred is senior to common but junior to bonds. Preferred holders cannot force the firm into bankruptcy. Dividends are generally fixed and are expressed as either a dollar amount or a % of face or par value. Preferred stockholders typically do not have voting rights.

Preferred Stock Types 1Non-participating- the stock dividend is fixed regardless of any increase or decrease in the issuing firm’s profits. 2Cumulative preferred- any missed dividends go into arrears and must be made up before any common stock dividends. 3Participating preferred- dividend can vary with a firm’s profits. 4Non-cumulative- often comes with voting rights.

The Corporate Pecking Order Senior Bonds Junior (subordinated bonds) Government Preferred Common

Equity Primary Markets Issuance (IPOs and seasoned offerings) generally done through investment banks –Firm commitment underwriting- the I-bank purchases the stock at a guaranteed price, called net proceeds and then tries to sell the shares at a higher price called the gross proceeds. The difference is called the underwriters spread. –Best efforts- no guaranteed price. –Shelf Registration- allows firms to offer multiple issues of stock over a 2 yr. Period with one registration statement. When shares are taken “off the shelf, a short form is filed.

Seasoned Equity Offerings Preemptive rights- often assigned when seasoned offerings are made. The rights give existing shareholders the first right to new shares so that they can maintain their proportional ownership –“Rights offering”- generally allows stockholders to purchase shares at a price slightly below the market price or to sell the rights.

Major U.S. Stock Markets New York Stock Exchange (NYSE) American Stock Exchange (AMEX) - located in New York. Organized as a floor- broker - specialist system National Association of Securities Dealers Automated Quotation System (NASDAQ)

NYSE An exchange system in which transactions occur at a trading post with each stock assigned a specialist- exchange members who have an obligation to keep the market going (maintain liquidity). Two types of brokers on the floor –Commission- acting on behalf of their firm. –Floor- working for themselves. Two general types of orders –Market orders- order to transact at best available price –Limit orders- order to transact at a specified price.

NASDAQ An over-the-counter (OTC) market (no physical location) where transactions are completed via an electronic market. Primarily a dealer market where dealers act as market makers. The original underwriter can also become a dealer in the secondary market (unlike the NYSE).

Stock Market Indices Composite values of groups of secondary market- traded stocks. –Dow Jones Industrial Average- the most widely reported. 30 large corporations selected by the editors of the WSJ. The Dow is a price weighted average. –NYSE Composite- a composite of all the stocks traded on the NYSE. It is market cap weighted (or value weighted). –S&P of the largest stocks listed on the NYSE and NASDAQ. Market cap weighted. –NASDAQ- composite of stocks traded on the NASDAQ. Market cap weighted.

Stock Market Efficiency Three methods of efficiency 1Weak form- current prices reflect all historic public info about a company. Empirical evidence generally confirms the “weak form” or the “random walk hypothesis”. However, there are exceptions. Investor perceptions can change. 2Semi-strong form- as public information arrives about a company, it is immediately impounded into its stock price. Investors cannot make more than the fair (required) return by trading on public news releases. Markets are generally semi-strong efficient. 3Strong form- stock prices fully reflect all info about a firm, both public and private. Limited ability to find emperical evidence. There is however, evidence that insiders can earn abnormal returns..