Week 5: Investing in Stocks
Week 5: Investing in Stocks FIN 331
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This 4 page Class Notes was uploaded by Nj on Saturday October 3, 2015. The Class Notes belongs to FIN 331 at Towson University taught by Moon-Whoan Rhee in Summer 2015. Since its upload, it has received 60 views. For similar materials see Principles Financial Management in Finance at Towson University.
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Date Created: 10/03/15
Chapter 14 Investing In Stocks Why corporations issue sell common Stock 1 Because the money doesn39t have to be repaid the company doesn39t have to buy back shares from stockholders Stock is equity financing money reveived from the sale of shares of ownership in a business 0 Common stock a security that represents ownership in a corporation Holders of common stock exercise control by electing a board of directors and voting on corporate policy 0 Preferred stock Capital stock which provides a specific dividend that is paid before any dividends are paid to common stock holders and which comes before common stock in the event of a liquidation The selling price is determined by how much a buyer is willing to pay for the stock The price for a share changes when information about the company or its future prospects is released to the general public 2 Because dividends are not mandatory Dividends are money stocks or other properties that companies pay to stockholders A stockholder must be registered on a corporation39s book in order to receive dividend payments The date in which the stockholder is registered is called a record date Some companies such as Ebay and Google follow a policy of smaller or no dividend distributions to stockholders They keep a large share of their earnings for research and development expansion acquisitions or major projects Proxy A legal form that lists the issues to be decided at a stockholders39 meeting and requests that stockholders transfer their voting rights to some individual or individuals Stock split procedure in which the shares of stock owned by existing stockholders are divided into a larger number of shares Earnings Earnings per share EPS aftertax incomenumber of shares outstanding Ex Assume that in 2010 Great Exploration Corporation has aftertax earnings of 25000000 Also assume that Great Exploration has 10000000 shares of common stock EPS 25000000 10000000 250 PriceEarnings PE Ratio Price per share Earnings per share Ex Assume Great Exploration Corporation39s common stock is selling for 50 a share As determined earlier the corporation39s earnings per share are 250 PE 5000 250 20 Dividend payout of a company39s earnings paid to stockholders in cash Dividend payout annual dividend amountearnigns per share Ex Assume you own stock issued by Caterpillar Corporation and the construction equipment manufacturer pays an annual dividend of 168 Also assume that Caterpillar earns 195 a share 168 195 086 86 Dividend Yield annual dividend amount generated by an investment divided by the investment39s current price per share Annual dividend amount Price per share Ex Assume Caterpillar is currently selling for 65 a share and the annual dividend is 168 a share 168 65 0026 26 Total return calculation that includes not only the yearly amount of dividends but also any increase or decrease in the original purchase price of the investment Total return dividends capital gain Ex Assume that you own 100 shares of Caterpillar stock that you purchased for 57 a share and that you hold your stock for four years before deciding to sell it at the current market price of 65 a share Also assume that during the four year period Caterpillar paid total dividends of 608 608 800 1408 Annualized Holding Period Yield Annual Return takes into account the total return the original investment and the time the investment is held They can be misleading Annualized holding period yield Total return Original investment x 1 N N Number of years investment is held Ex Assume that 4 years ago that you invested 5700 to purchase 100 shares of Caterpillar stock and that your total return when you sold your stock was 1408 1408 5700 X 14 0062 62 Beta Used to measure stock risk Using statistics we can correlate the returns of an individual stock or mutual fund against movements in the overall market and develop a beta Perfect correlation1 index fund No correlation0 more unpredictable Volatility for a Stock Increase in overall market x Beta for a specific stock Ex Assume that the overall stock market increases by 10 and that Procter amp Gamble has a beta of 060 10 x 060 6 Book value Assets Liabilities Shares Outstanding Markettobook ratio Market value per share Book value per share Numeric measures that influence investment decisions Investment theories o Fundamental analysis based on the assumption that a stock s intrinsic or real value is determined by the company s future earnings 0 Technical analysis no theories based on what you observe A stock s market value is determined by the demand and supply 0 Efficient market hypothesis a price should be very close to value b price only changes when there is new information about the value of the product c impossible for an investor to outperform the stock market in an exante before it happens sense The opposite of Exante is Expost Efficient market hypothesis is based on the assumption that stock price movements are purely random Buying and selling stocks 0 Primary market a where brand new securities are issued b an influx of capital money to the issuer 2 types of primary market IPO initial public offers and Seasoned PO public offers 0 Secondary market existing shares traded among investors nothing to do with issuers 2 types of secondary market Exchanges where brokers buy and sell securities and OTC over the counter OTC uses computer system such as Nasdaq to connect the dealers Brokers vs Dealers brokers are facilitators they connect buyers and sellers Dealers buy and resell carry inventory asked bid FDIC Federal agency covering investment up to 100000 Completing stock transactions Market order request to buy or sell stock at the current market order Limit order request to buy or sell at a specified price you specify the price Stoploss order request to buy or sell a stock at a specified price or the next negative opportunity to settle with minimum loss
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