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Week 7 (Chapter 8) Financial Systems

by: Whitney Smith

Week 7 (Chapter 8) Financial Systems FIN 3113

Marketplace > Mississippi State University > Finance > FIN 3113 > Week 7 Chapter 8 Financial Systems
Whitney Smith

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About this Document

Week 7 notes on Chapter 8 in Financial Systems
Financial Systems
Wei He
Class Notes
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This 5 page Class Notes was uploaded by Whitney Smith on Friday March 4, 2016. The Class Notes belongs to FIN 3113 at Mississippi State University taught by Wei He in Summer 2015. Since its upload, it has received 27 views. For similar materials see Financial Systems in Finance at Mississippi State University.


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Date Created: 03/04/16
Chapter 8 Stock Markets I. Common Stock  Common stock is the fundamental ownership claim in a public or private corporation  Dividends are discretionary and are thus not guaranteed  Common stockholders have the lowest priority claim in the event of bankruptcy (i.e., a residual  claim)  Limited liability implies that common stockholders can lose no more than their original  investment  Common stockholders control the firm’s activities indirectly by exercising their voting rights in  the election of the board of directors  Dual­class firms have two classes of common shares outstanding, with different voting rights assigned to each class  With cumulative voting, the number of votes assigned to each stockholder equals the  number of shares held multiplied by the number of directors to be elected  A proxy vote allows stockholders to vote by absentee ballot (e.g., by mail)  Return on a stock investment  R = Before Tax Return on a stock investment = Capital gain yield + dividend yield = [(P1­P0)/P0] + [D1/P0] R = After Tax Return on a stock investment = Capital gain yield + dividend yield = [(P1­P0)/P0]*(1­tax rate on capital gains) + [D1/P0]*(1­tax rate on dividend) Example 1: Jane purchased 100 shares of ABC stock at price of $44. One year later, she  received a $1 per share dividend payment, and ABC's stock price had rise to $45. Her  ordinary income tax rate is 28% and her capital gain tax rate is 20%. What was her one­year  return on this stock? R = Return on a stock investment = Capital gain yield + dividend yield = [(P1­P0)/P0]*(1­tax rate on capital gains) + [D1/P0]*(1­tax rate on dividend) = [(45­44)/44]*(1­20%) + [1/44]*(1­28%) =3.45% II. Preferred Stock  Preferred stock is a hybrid security that has characteristics of both bonds and common stock  Generally has fixed dividends that are paid quarterly 1  Generally does not have voting rights unless dividend payments are missed  Nonparticipating versus participating   Cumulative versus noncumulative III. Primary Stock Markets  Primary markets are markets in which corporations raise funds through new issues of stock,  most of the time through investment banks  Investment banks act as distribution agents in best efforts underwriting  Investment banks act as principals in firm commitment underwriting              gross proceeds – net proceeds = underwriter’s spread  A syndicate is a group of investment banks working in concert to issue stock; the lead  underwriter is the originating house  An initial public offering (IPO) is the first public issue of financial instruments by a firm  A seasoned offering is the sale of additional securities by a firm whose securities are already  publicly traded  preemptive rights give existing stockholders the ability to maintain their proportional  ownership  A red herring prospectus is a preliminary version of the prospectus that describes a new  security issue  Shelf registration allows firms to offer multiple issues of stock over a two­year period with only  one registration statement IV. Secondary Stock Markets  Secondary stock markets are the markets in which stocks, once issued, are traded among  investors  The U.S. has two major stock markets  the New York Stock Exchange Euronext (NYSE Euronext)  Deutsche Bourse has made a buyout offer for NYSE/Euronext   the National Association of Securities Dealers Automated Quotation (NASDAQ)  NYSE Euronext  NYSE/Euronext was created by the merger of NYSE Group, Inc. and Euronext N.V. on  April 4, 2007 to become the first truly global stock market  Trading occurs at a specific place on the floor of the exchange called a trading post  Each stock has a special market maker called a specialist that maintains liquidity for the  stock at all times   Three types of transactions occur at trading posts  a market order is an order to transact at the best price available when the order  reaches the trading post  a limit order is an order to transact at a specified price  specialists transact for their own account  Program trading is 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 breakers give investors time to make informed choices during periods of high  market volatility 2  NASDAQ and OTC Markets  NASDAQ is the world’s first electronic market and has no physical trading floor  Provides continuous trading for the most active stocks traded over­the­counter (OTC)  Primarily a dealer market where many, often more than 20, dealers act as market makers  A small 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  Choice of market listings  NYSE has extensive listing requirements (e.g., firm market value and trading  volume)  NASDAQ requirements are less so 3 V. Online Trading        Households, mutual funds, and private pension funds are the largest holders of corporate stocks. Online trading via the internet is becoming increasingly popular with both individual and  professional investors­online­brokers/stock­trading­accounts/ VI. Stock Market Indexes A stock market index is the composite value of a group of secondary market­traded stocks  Price­weighted index  the Dow Jones Industrial Average (DJIA), composed of 30 companies, is the most widely know stock market index  Value­weighted indexes  NYSE Composite  Standard & Poor’s 500  NASDAQ Composite  Wilshire 5000 VII. Stock Market Regulations  The Securities and Exchange Commission (SEC) is the primary regulator of stock markets  Securities Act of 1933/Securities Exchange Act of 1934 Recently imposed regulations aim to reduce excessive price fluctuations and increase auditing  oversight  The Financial Industry Regulatory Authority (FINRA) is the regulator for all U.S. securities  firms.  FINRA oversees registering and educating brokers and dealers, examining securities  firms, promulgating rules, enforcing federal securities laws, and conducting dispute arbitration 4  Dodd Frank Act­frank­financial­regulatory­reform­bill.asp VIII. International Aspects of Stock Markets  U.S. stock markets are the world’s largest  European markets have increased their share of the global market with the advent of a common  currency, the Euro  Growth has recently strengthened in the U.K., Canada, Japan, and Pacific Basin countries  International stock markets allow investors to diversify by holding stocks issued by corporations  in foreign countries  International diversification can increase risk due to incomplete information about foreign stocks  as well as foreign exchange and political risk 5


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