Chapter 8 Stock Markets Lecture Review

Flashcards covering key terminology, regulatory acts, and financial models regarding stock markets including common and preferred stock, trading processes, and market efficiency.

Stockholders

The legal owners of a corporation who have a right to share in profits after payments to bond holders and taxes, a residual claim on assets, limited liability, and voting rights.

Common stock

The fundamental ownership claim in a public or private corporation characterized by discretionary dividend payments, residual claim status, limited liability, and voting rights.

Standard Return Formula

The return to a stockholder over a period $t-1$ to $t$ calculated as $R_t = \frac{P_t - P_{t-1}}{P_{t-1}} + \frac{D_t}{P_{t-1}}$.

Residual claim

The feature of common stock where stockholders have the lowest priority claim in the event of bankruptcy, entitled only to assets remaining after all senior claims (employees, bond holders, government, preferred stockholders) are paid.

Limited liability

A feature implying that common stockholder losses are limited to the amount of their original investment if the company's asset value falls below the value of the debt it owes.

Dual-class firms

Firms organized with two classes of common stock outstanding, each having different voting and/or dividend rights.

Proxy

A voting ballot sent by a corporation to its stockholders, allowing them to vote by absentee ballot or authorize representatives to vote on their behalf.

Preferred stock

A hybrid security with characteristics of both bonds and common stock; it represents ownership and usually pays a fixed periodic dividend, but typically lacks voting rights.

Cumulative preferred stock

A type of preferred stock where any missed dividend payments go into arrears and must be paid before any common stock dividends can be distributed.

Firm commitment underwriting

A primary market transaction where the investment bank guarantees the corporation a specific price for newly issued securities.

Best efforts underwriting

A primary market transaction where the underwriter does not guarantee a price to the issuer.

Syndicate

A group of investment banks working together to sell and distribute a new security issue, led by an originating house.

Initial public offering (IPO)

The first public issue of a financial instrument by a firm.

Seasoned offering

The sale of additional securities by a firm whose securities are already currently publicly traded.

Preemptive rights

Rights giving existing stockholders the ability to maintain their proportional ownership when new shares are issued.

Red herring prospectus

A preliminary version of a prospectus that describes a new security issue while it is being reviewed by the SEC.

Shelf registration

A procedure allowing firms to submit one master registration statement to offer multiple issues of stock over a two-year period.

Specialist

A special market maker assigned to a specific stock on the NYSE floor to organize transactions at a trading post.

Market order

An order to transact at the best price available at the time the order reaches the trading post.

Limit order

An order to transact only at a specified price.

Program trading

The simultaneous buying and selling of a portfolio of at least 15 different stocks valued at more than $1$ million dollars using computer programs.

Circuit breakers

Imposed halts in trading designed to give buyers and sellers time to assimilate incoming information during periods of high volatility.

Flash trading

A practice where certain traders, for a fee, are allowed to see incoming orders milliseconds earlier than the general market.

Dark pools of liquidity

Trading networks that provide liquidity without displaying trades on public order books.

NASDAQ

The world's first electronic stock market, operating primarily as a negotiated dealer market without a physical trading floor.

Electronic Communications Networks (ECNs)

Computerized alternative trading systems (ATSs) that automatically match orders between buyers and sellers, often used for extended-hours trading.

Dow Jones Industrial Average (DJIA)

A price-weighted index consisting of the values of 30 large corporations selected by the editors of The Wall Street Journal.

NYSE Composite Index

A value-weighted index that includes all common stocks listed on the New York Stock Exchange.

Wilshire 5000 Index

The broadest value-weighted stock market index, containing virtually every stock headquartered and actively traded in the U.S. with available price information.

Weak form market efficiency

The theory that investors cannot earn more than a fair return using information based solely on historic price movements.

Semistrong form market efficiency

The theory that security prices reflect all publicly available information, meaning investors cannot earn excess returns by trading on news releases.

Strong form market efficiency

The theory that stock prices fully reflect all information about a firm, both public and private.

Financial Industry Regulatory Authority (FINRA)

The largest independent regulator for all securities firms doing business in the U.S., formed in July 2007.

American Depository Receipts (ADRs)

Certificates representing ownership of a foreign stock, typically created by a U.S. bank and backed by foreign shares held by a custodian.

Capital Asset Pricing Model (CAPM)

A model defining the relationship between risk and return, expressed as $E(R_A) = R_f + \beta_A(E(R_M) - R_f)$, where expected return depends on systematic risk.

Reward-to-risk ratio

In equilibrium, the market risk premium calculated as $E(R_M) - R_f$, which must be equal for all assets when adjusted for beta.