SIE 2

Authorized Stock

When a corporation is formed, its corporate charter authorizes that a fixed number of common shares may be issued

Market capitalization

The number of shares outstanding times the current market price is used to find

Treasury Stock/Shares

Buy back some of these previously issed shares

Settlement

When the securities and the purchase price have changed. The buyer becomes the owner of record

Cash Dividends

• Enable a company to share a part of the corporation’s profits with shareholders

• Declared by BOD and paid quarterly

Stock Dividends

• Giving additional shares to exitsing stockholders

• The total number of shares outstanding increases, but the value decreases

• No immediate economic value/tax cost basis

• Less than 25% of the outstanding shares

Stock Split

Larger distribution of shares

Forward Stock Split

• 2:1, A shareholder with 100 shares would now have 200 shares

• Be twice as many shares outstanding, the price per share would be reduced by 50% outstanding

• The price per share is more affordable for small shareholders

Reverse Stock Split

• 1:10, Fewer shares outstanding, but a higher price per share

• For a company whose share price has fallen below the minimum price required by an exchange (NYSE)

Preemptive Rights

• Distributed to shareholders prior to the issuance of new shares to the public

• Short-term securities that give the owner the option to buy a certain number of shares at a reduced price

• 30-60 days

3 options for rights

1. Exercise their right and buy new shares at a price below the current marklet price

2. Sell the right to another investor

3. Do nothing and the let the right expire worthless

Balance Sheet

“Snapshot” of all the company’s assets and liabilities

TA -TL = Net Worth

TA = Neth Worth + TL

Income Statement

Details all sources of revenue and expenses

Earnings per Common Share

Earnings Available for common / Common Shares Outstanding

Dividend or Current Yield

Annual Income / Market Price

Price / Earnings Ratio

Market Price of Security / Earnings per Share

Shareholders rights

• Right to inspect books and records

• Right to transfer ownership

• Preemptive right

• Right to corporate distributions

• Right to corporate assets upon dissolution

• Right to vote

Require a Shareholder Vote

• Declare a stock split

• Declare a reverse stock split

• Issue convertible bonds or preferred stock

• Issue stock options to officers on preferential basis

Do not require a Shareholder Vote

• Declare a cash dividend

• Declare a stock dividend

• Declare a preemptive rights distribution

Statutory Voting

Votes must be evenly cast (more common)

Cumulative Voting

• May divide their total votes in whatever manner they choose

• Advantage for “small investor”

Cumulative Preferred

• If the issuer does not pay, the missed payments and must be paid before the issuer can resume making any other dividend payments

• Does not allow an investor to share an issuing company’s profits

Callable Preferred

• The issuer has the right to redeem the shares after a set date

• Redeemed by the issuer if interest rates fall

Convertible Preferred

• Shareholders can exchange their preferred shares for common stock based on a predetermined price

• Typically driven by the price of the issuer’s common shares (least dependent on interest rates)

• Offers an opportunity for growth and benefits if the common stock rises

Participating Preferred

Shareholders may also be given additional dividends and must be declared by the BOD

Preferred Stock’s Market Price Fluctuates

Changes in interest rates and creditworthiness of the issuer

Non-convertible preferred stock

Will have a higher yield than similar convertible shares of the same issuer

Warrant

• Long-term option to buy stock at a fixed price

• Only valuable if the stock price rises/above (Sweeteners)

• The exercise price of a warrant is set at a premium to the stock’s current market price, and the warrants are exercised when the exercise price is below the market price

American Depositary Receipts (ADRs)

Trading of foreign securities in the USA

Exchange Rate Risk/Currency Risk

Priced in U.S. dollars, the market price will depend in part on changes in foreign currency markets

Outstanding Shares

Issued shares - Treasury Shares

Reverse Stock Split Math

Multiply amount of shares to the stock split and divide the price per share with the stock split

Term Bond Issue

Every bond has the same interest rate and maturity (Corporate and U.S. government)

Zero-Coupon Bonds

• No interest payments are made

• No reinvestment risk/phantom interest

• Purchased at a discount and redeemed at par

Balloon Maturity

A serial bond issuance where the largest amount of the total of all bonds issued will mature on the latest date

Serial Bond

Issue with differing maturity dates (Municipal bonds)

Series Bonds

• An issue of bonds with the same maturity but different dates of issuance

• Used to finance long-term construction where all money is not needed at once

Sell a bond

At ask

Buy a bond

At bid

10 basis points

.10%

Basis Points

Bond qoutes include a measure of yield to maturity

20 basis points

0.002

Discount

Coupon Rate/Nominal < Current Yield < YTM < YTC

Premium

Coupon Rate/Nominal > Current Yield > YTM > YTC

Bond’s Nominal Yield is

The percentage of par value recevied by the bondholder annually

Equation for Current Yield

Annual coupon payment/current market price of bond

A bond is selling at a discount when its

YTM is higher than its coupon rate

Trading at discount

The YTC will be higher than the YTM for a bond trading at a discount

Trading at premium

The YTC will be lower than the YTM for a bond trading at a premium

YTW at a discount

The YTW for a bond trading at a discount will be the YTM

YTW at a premium

The YTW for a bond trading at a premium will be the YTC

Beta Coefficient

Measure of an asset’s systematic risk (market risk) compared to the overall market

When interest rates fall

Use callable bonds

When interest rates rise

Use puttable bonds

Standard and Poor’s Investment Grade

AAA to BBB; measures default risk

Standard and Poor’s Speculative Grade

BB to C

Moody’s Investment Grade

Aaa to Baa

Moody’s Speculative Grade

Ba to C

Interest Rate Risk (market risk)

• That rising interst rates will cause bond prices to fall

• EX: Long-term maturities, low coupon rates, deep discount

Price Volatility

Affected by time to maturity and coupon rate

More Volatile

Lower coupn rates and Long-term bonds; price-sensitive

Less Volatile

Higher coupon rates and short-term bonds; price-stable

Adjustable-rate bonds

Suitable for investors looking for protection from interest rate risk

Duration

Maturity + Coupon; express a bond’s overall sensitivity

Capital Risk

Risk that investors lose money (junk)

Purchasing Power Risk (inflation risk)

The investor will be able to buy fewer goods and services when the bond matures if inflation has caused prices to rise since the bond was issued. Use REIT and ADR to protect against

Treasury inflation-Protected Security (TIPS)

Only bond that gives protection against purchasing power risk

Liquidity/Marketability Risk

• The security will be difficult to sell in the future; issue’s size and number of traders

• Nonexistent for Treasury Bonds but concerning for municipal

Legislative Risk

New laws could reduce the value of a security

Call Risk

• The bonds may be redeemed prior to maturity, forcing the investor to reinvest the principal at a lower interest rate

• Most susceptible are high coupon rates and low call premiums

Business Risk

A company that underperforms investor expectations

Prepayment Risk

Investor’s principal will be repaid prior to maturity; Mortgage (MBSs)

Reinvestment Risk

Interest rates will fall over the bond’s life, leaving the bondholder with no choice but to reinvest the bond’s interest payments at a lower rate, lowering the bond’s overall return (default risk); use STRIPS to protect against

Currency Risk

The value of the foreign currency in which the investment is denominated weakens, causing the value of the security to fall

Political Risk

Investing in foreign countries that have a weak political and legal systems

Nonsystematic Risks

Unique to individual securities, industries, or countries. Not properly diversified; Business risk and credit risk

Systematic Risk

An investment’s value will decline because the entire market declines; Interest rate risk, inflation and market risk

Credit Risk/Default Risk

A downgrade by a rating agency

If interest rates decline, what will happen?

Issuers will sell new issues with longer maturities and call outstanding bonds with high interest rates

Bearer Bonds

Issued in physical form with coupons attached and no longer issued

Trust Indenture Act of 1939

• All corporate issued of $50 million or more must have a trust indenture

• Municipal and governemtn issues are exempt

Commercial Paper

• Used for short-term corporate financing needs and sold at discount within $100,000

• 14 to 90 days, with 30 days being common

Debentures

Intermediate and long-term unsecured corporate debt; subject to credit risk (Mortgage bonds)

Subordinated Debentures

A junior (lower) status. Equipment trust certificates

Income bonds

• Are not suitable for investors seeking income because payemnts are not guaranteed. If there is a missed payment, it is not considered to be in default

• Trade flat

Conversion Ratio

Par Value of Bond / Conversion Price

Parity Price of Bond

Conversion Ratio X Stock’s Market Price

Parity Price of Stock

Bond Market Value / Conversion Ratio

Arbitrage

When the trader buys the lower priced security and simultaneously sells the equivalent higher price security to lock in profit. Only works when the bond trades below parity

Who Receives Payment at first-last

1. Secured Creditors, mortgage, and equipment

2. Unpaid claims and wages

3. Unsecured creditors (debenture)

4. Subordinated creditors

5. Preferred stockholders

6. Common stockholders

Treasury Bonds

• Long-term with maturities of 30 years.

• With a minimum of $100, paying semiannually, and are noncallable

• Pays Federal taxes only

Separate Trading of Registered Interest and Principal of Securities (STRIPS)

• To avoid reinvestment risk

• Also called Treasury receipts

• Safe, long-term

• Susceptible to interest rate risk

Treasury Inflation-Protected Securities (TIPS)

• To avoid purchasing power risk

• By Consumer Price Index (CPI)

• Fixed interest amount semiannually

• Lower interest rate

Treasury Notes (T-notes)

• Intermediate-term ranging from 2-10 years

• Minimum of $100,pay semiannually and noncallable

Treasury Bills (T-bills)

• Short-term with 1-12 month maturities or 4-52 weeks

• Discounted (without coupon rate) earnings are the interest income and quoted on a discount yield basis

• Paid at maturity

Mortgage-Backed Securities are issued by

• Federal Home Loan Banks (FHLB)

• Federal National Mortgage Association (Fannie Mae)

• Government National Mortgage Association (Ginnie Mae)

• Federal Home Loan Mortgage Corporation (FHLMC, Freddie Mac)

• Susceptible to prepayment risk (increases when interest rates fall)

The Student Loan Marketing Association (Sallie Mae)

Loans are purchased from colleges, universities, state agencies, and banks. Does NOT deal in mortgage

Government National Mortgage Association (GNMA)

• Payments are made monthly

• Payments are made up of both interest and principal only

• These securities are subject to more prepayment risk in a falling interest rate environment

• Taxed the same as for corporate obligations (Both federal and state income tax)

OTC

• Large commercial banks

• Foreign banks

• U.S. government securities dealers

• Full-service brokerage firms

• The Fed

To Loosen Credit

The Fed will buy Treasury securities from primary dealers (Dovish) to spur economic growth