FIN 3403 - Chapter 8

A share of common stock is more difficult to value in practice than a bond for at least three reasons

1. With common stock, not even the promised cash flows are known in advance 2. The life of the investment is essentially forever because common stock has no maturity 3. No way to easily observe the rate of return that the market requires

constant dividend

a share of stock pays out a flat dividend amount forever, i.e. the dividend has a growth rate of zero

ordinary perpetuity

stock equal cash flow paid every period

dividend growth model

used to calculate the current price of a stock that has a continuously growing dividend. It is like a growing perpetuity!

Dividend yield

a stock's expected cash dividend divided by its current price

capital gains yield

the rate at which the value of an investment grows

if a company is profitable (i.e., has positive earnings), we can use

The PE Price-Earnings Ratio

Some companies do not pay dividends nor are they profitable. In this case, use the

PS price-sales ratio

Common stock

equity without priority for dividends or in bankruptcy

cumulative voting

votes=Shares X Seats. A shareholder may cast all votes for one member of the board of directors; all directors are elected at once

straight voting

votes=Shares, but EACH director elected via separate round of independent votes cast. A shareholder may cast all votes for each member of the board of directors separately.

Staggering has two basic effects

1. Makes it more difficult for a minority to elect a director 2. Makes takeover attempts less likely to be successful

proxy

a grant of authority by a shareholder allowing another individual to vote his or her shares

If shareholders are not satisfied with management, an "outside" group of shareholders can try to obtain votes via proxy, with the resulting battle called a

proxy fight

In addition to the right to vote for directors, shareholders usually have the following rights

Right to share proportionally in dividends paid. Right to share proportionally in assets remaining after liabilities have been paid in a liquidation. Right to vote on stockholder matters of great importance (e.g., a merger), with voting usually done at the annual meeting or a special meeting

preemptive right

the right to share proportionally in any new stock sold

Dividends

payments by a corporation to shareholders, made in either cash or stock

Preferred stock

has dividend priority over common stock, normally with a fixed dividend rate, sometimes without voting rights

Preferred dividend is not like interest on a bond

Board of directors may decide not to pay dividends on preferred share, (which may have nothing to do with the current net income of the corporation), in which case - Common shareholders must also forgo dividends. Holders of preferred shares are often granted voting and other rights if preferred dividends have not been paid for some time

primary market

new shares issued to buyers

secondary market

existing shares between various parties

Dealer

an agent who buys and sells securities from inventory

Broker

an agent who arranges security transactions among investors

bid price

The price the dealer is willing to buy

ask price

The price at which the dealer will sell

NYSE member

the owner of a trading license on the NYSE

hybrid market

market where trading taking place both electronically and face-to-face

Designated market makers (DMMs)

NYSE members who act as dealers in particular stocks; formerly known as "specialists"

Floor brokers

NYSE members who execute customer buy and sell orders

Supplemental liquidity providers (SLPs)

investment firms that are active participants in stocks assigned to them. Their job is to make a one-sided market (i.e., offering to either buy or sell), and they trade purely for their own accounts

DMM's post

a fixed place on the exchange floor where the DMM operates. DMMs normally operate in front of their posts to monitor and manage trading in the stocks assigned to them

Two key differences between the NYSE and Nasdaq

1. Nasdaq is a computer network and has no physical location where trading takes place. 2. Nasdaq has a multiple market maker system rather than a DMM system

Over-the-counter (OTC) market

a securities market in which trading is almost exclusively done through dealers who buy and sell for their own inventories

inside quotes

the highest bid quotes and the lowest ask quotes for a security

electronic communication networks (ECNs)

websites that allow investors to trade directly with each other