Financial Markets & Institutions Ch08

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Financial Markets & Institutions

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  • 1. 8- McGraw-Hill/Irwin Chapter Eight Stock Markets

2. Overview of Stock Markets

  • Primary stock markets allow suppliers of funds to raise equity capital
  • Secondary stock markets are the most closely watched and reported of all financial markets
  • Stockholders are the legal owners of a corporation
    • have a right to share in the firms profits (e.g., through dividends)
    • are residual claimants
    • have limited liability
    • have voting rights (e.g., to elect board of directors)

8- McGraw-Hill/Irwin 3. Stock Returns

  • The returns on a stock over one period ( R t ) can be divided into capital gains and dividend returns:
      • P t = stock price at timet
      • D t= dividends paid over timet 1tot
      • ( P t P t 1 ) /P t 1= capital gain over timet 1tot
      • D t/P t 1 = return from dividends paid over timet 1tot

8- McGraw-Hill/Irwin 4. Common Stock

  • Common stock is thefundamental ownership claimin a public or private corporation
  • Dividendsare discretionary and are thus not guaranteed
  • Common stockholders have the lowest priority claim in the event of bankruptcy (i.e., aresidual claim)
  • Limited liabilityimplies that common stockholders can lose no more than their original investment
  • Common stockholders control the firms activities indirectly by exercising theirvoting rightsin the election of the board of directors

8- McGraw-Hill/Irwin 5. Common Stock

  • Dual-class firmshave two classes of common shares outstanding, with different voting rights assigned to each class
  • Withcumulative voting , the number of votes assigned to each stockholder equals the number of shares held multiplied by the number of directors to be elected
    • the number of shares needed to electpdirectors,N p , is:
    • N p= [( p x# of shares outstanding)/(# of directors to be elected +
    • 1)] +1
  • Aproxy voteallows stockholders to vote by absentee ballot (e.g., by mail)

8- McGraw-Hill/Irwin 6. Preferred Stock

  • Preferred stockis a hybrid security that has characteristics of both bonds and common stock
  • Generally hasfixed dividendsthat are paid quarterly
  • Generallydoes not have voting rightsunless dividend payments are missed
  • Nonparticipatingversusparticipating
  • Cumulativeversusnoncumulative

8- McGraw-Hill/Irwin 7. Primary Stock Markets

  • Primary marketsare markets in which corporations raise funds through new issues of stock, most of the time throughinvestment banks
  • Investment banks act as distribution agents inbest efforts underwriting
  • Investment banks act as principals infirm commitment underwriting
    • gross proceedsnet proceeds=underwriters spread
  • Asyndicateis a group of investment banks working in concert to issue stock; the lead underwriter is theoriginating house

8- McGraw-Hill/Irwin 8. Primary Stock Markets

  • Aninitial public offering (IPO)is the first public issue of financial instruments by a firm
  • Aseasoned offeringis the sale of additional securities by a firm whose securities are already publicly traded
    • preemptive rightsgive existing stockholders the ability to maintain their proportional ownership
  • Ared herring prospectusis a preliminary version of the prospectus that describes a new security issue
  • Shelf registrationallows firms to offer multiple issues of stock over a two-year period with only one registration statement

8- McGraw-Hill/Irwin 9. Secondary Stock Markets

  • Secondary stock marketsare the markets in which stocks, once issued, are traded among investors
  • The U.S. has three major stock markets
    • theNew York Stock Exchange Euronext (NYSE Euronext)
    • theNational Association of Securities Dealers Automated Quotation (NASDAQ)
    • theAmerican Stock Exchange (AMEX)

8- McGraw-Hill/Irwin 10. NYSE Euronext

  • Created by themergerofNYSE Group, Inc.andEuronext N.V.on April 4, 2007 to become the first truly global stock market
  • Over 3,200 different stocks trade on NYSE Euronext
  • Trading occurs at a specific place on the floor of the exchange called atrading post
  • Each stock has a special market maker called aspecialistthat maintains liquidity for the stock at all times

8- McGraw-Hill/Irwin 11. NYSE Euronext

  • Three types of transactions occur at trading posts
    • amarket orderis an order to transact at the best price available when the order reaches the trading post
    • alimit orderis an order to transact at a specified price
    • specialists transact for their own account
  • Program tradingis the simultaneous buying and selling of a portfolio of at least 15 different stocks valued at more than $1 million using computer programs to initiate the trades
  • Circuit breakersgive investors time to make informed choices during periods of high market volatility

8- McGraw-Hill/Irwin 12. Trading on NYSE Euronextand AMEX 8- McGraw-Hill/Irwin OrderOrderOrder InvestorShares BrokerShares Comm.Shares MarketorMaker or CashCashFloorCashOther Floor BrokerBroker 13. Stock Market Quotes

  • Name
  • Symbol
  • Open
  • High
  • Low
  • Close
  • Net Chg
  • % Chg
  • Volume
  • 52 Wk High
  • 52 Wk Low
  • Div
  • Yield
  • P/E
  • YTD % Chg

8- McGraw-Hill/Irwin 14. AMEX

  • Generally lists smaller firms than NYSE Euronext
  • Operates as a broker-specialist market-maker system similar to NYSE Euronext
  • Pioneeredexchange traded funds (ETFs)
    • ETFs are index funds that are listed on an exchange and can be traded intraday

8- McGraw-Hill/Irwin 15. NASDAQ and OTC Markets

  • NASDAQ is theworlds first electronic marketand has no physical trading floor
  • Provides continuous trading for the most active stocks tradedover the counter (OTC)
  • Primarily a dealer market in which often more than 20 dealers act as market makers
  • Asmall order execution system (SOES)provides automatic order execution for orders of less than or equal to 1,000 shares
  • The NASD maintains an electronic OTC bulletin board and pink sheets for small firms that are not part of the NASDAQ

8- McGraw-Hill/Irwin 16. Secondary Stock Markets

  • Choice of market listings
    • NYSE has extensive listing requirements (e.g., firm market value and trading volume)
    • AMEX listing requirements are less stringent than NYSE and NASDAQ requirements are even less so
  • Electronic communication networks (ECNs)
    • normal trading occurs between 9:30 a.m. and 4:00 p.m. eastern standard time
    • extended-hours trading occurs through computerizedalternative trading systems (ATSs)a.k.a. ECNs
  • Online tradingvia the internet is becoming increasingly popular to both individual and professional investors

8- McGraw-Hill/Irwin 17. Stock Market Indexes

  • Astock market indexis the composite value of a group of secondary market-traded stocks
  • Price-weighted index
    • the Dow Jones Industrial Average (DJIA), composed of 30 companies, is the most widely know stock market index
  • Value-weighted indexes
    • NYSE Composite
    • Standard & Poors 500
    • NASDAQ Composite
    • Wilshire 5000

8- McGraw-Hill/Irwin 18. Stock Markets

  • Households, mutual funds, and private pension funds are the largest holders of corporate stock
  • Does the stock market forecast the economy?
  • Market efficiencyis the speed with which financial security prices adjust to unexpected news
    • weak form market efficiency
    • semistrong form market efficiency
    • strong form market efficiency

8- McGraw-Hill/Irwin 19. Stock Market Regulations

  • TheSecurities and Exchange Commission (SEC)is the primary regulator of stock markets
  • The main emphasis of SEC regulation is on full and fair disclosure of information on securities