Stock Markets

  • Corporate stock - can be source of funding for firms, company sell piece of the company --> get funding

    Two types: (all public corporations issue common, some issue preferred)

    1. Common stock

    2. Preferred stock

     

    Stockholders -  part-owners of the company

    Have following rights

    1. Right to companies profit through dividens

    2. Residual claim on firm's asset (if company goes bankrupt after paying all debts the money that is left (residual))

    3. Limited liability (the stockholders are not responsible for companies debts to the amount of their investment, example inverst 500€ the most you can loose is 500€ not more)

    4. Voting rights (on some decisions for example elect board of directors)

     

    Common stock dividens

    • Dividens --> not guaranteed

    • Payment/size of dividens determined by board of directors

    • Taxed twice: firm level --> company pays tax on profit. Personal level --> personal income tax on dividens

    • Growth firms --> reinvest profit instead of paying larger dividens to finance growth

     

    Common stock residual claim

    • Have lowest residual claim if company is bankrupt

    • After all senior claim such as employees, bond holders etc are paid common stock holders are entitled to what's left

    • This makes riskier then bonds as an investment since the bond holder are higher priority to get paid back

     

    Common stock limited liability

    • If company go bankrupt --> common stockholder can only loose up to the amount they invested

    • Personal wealth  of stockholders outisde company is not affected if the company goes bankrupt

    • OTHER: sole proprietorship and partnerships owners have unlimited liability ---> can be liable for firms debt using private wealth in financial difficulties

     

    Common stock voting rights

    • Control firm's acitivies indirectly using their voting rights in choosing board of directors

    • One vote per share of common stock

    • Dual-class firms --> two classes of common stocks different voting/dividens for each class

    • Electing a borad: Comulative voting and straight voting

     

    Common stock proxy votes

    • Proxy is a voting form companies send to stockholder if they can't vote in person

    • Proxy --> stockholder vote when not being there or choose someone to vote on their behalf

     

    Preferred stock - Usually safer than common

    Hybrid security with characteristics of both bond and common stock

    •  Similar common stock --> ownership in company

    •  Similar to bond --> payed fixed periodic dividens payment

    • Generally no voting right can be converted to common stock if investor wants to

    • Nonparticipating preferred stock: dividens is fixed get agreed amount regardless of how the company is doing

    • Participating preferred stock: company does well --> extra dividens

    • Cumulative preferred stock: if company can't pay a dividend to preffered stockholders they owe the missed dividens to them before they pay common stock holders

    • Noncumulative preferred stocl: if a dividens is missed it's gone no need to pay it later won't affect future

     

    Stockholders -  part-owners of the company

    Have following rights

    1. Right to companies profit through dividens

    2. Residual claim on firm's asset (if company goes bankrupt after paying all debts the money that is left (residual))

    3. Limited liability (the stockholders are not responsible for companies debts to the amount of their investment, example inverst 500€ the most you can loose is 500€ not more)

    4. Voting rights (on some decisions for example elect board of directors)

     

    Primary stock markets

    Corporatios raise funds through new issues of stocks

    • Usually works through an investment bank, works like a middle hand

    • Firm commitment writing: investment bank guarantee the corporation a price for the securities

    • Best efforts underwriting: investment bank doesn't guarantee a price tries to sell shares at best price

    • Syndicates: several investments banks join as a team to sell the stocks --> lead bank called originating house

     

    IPO inital public offering -First public issue of finanical instrument by firm

     

    Seasoned offering - already public issues more shares to raise more money

     

    Preemptive rights - current stockholder buy more shares if company issue more --> let them keep their percentage of ownership

     

    Registration of a stock can take long time --> involves careful review --> ensure transparency

     

    Red herring prospectus: preliminary document describes the new stock being issued

     

    Shelf registration: single registration statement that cover multiple issues of stocl not just one over a two year period

     

    Preemptive rights: let shareholder buy new shares before everyone else to keep their % of ownership in company

     

    Example: current ownership own 1000 shares company has 1 million shares in total

    1000/1000000=0,1

     

    Company wants to raise more money --> rights offering each shareholder will be sent 0,5 right for each share owned

    If you own 1000 --> 1000x0,5=500

    Each right let you buy 1 share at discounted price --> you can then buy 500 new shares

    Market price 40€ and discounted price 36€

     

    You can also sell you rights

    Each right is worth difference between market price and and discounted price

     

    Secondary Stock market

     

    Secondary stock -Buying and selling of stocks that are already issued, closely watch

    • Usually with a security broker or firm acting as a middle man

    • US ones NASDAQ and NYSE euronext (first to create a global stock market)

     

    Trading process:

    • Trading happen on the "trading floor"

    • "specialist" Every stock has a specialist (or market maker), who is a person or firm responsible for managing trades in that stock

     

    Types of transactions:

     

    Market Orders: broker buy/sell directly for a customer at market price

    Limit Orders :customer tells broker a maximum/minimum for the stock

    Specialist’s Own Transactions:transactions for their own account

     

    Market order: buy/sell right now at the current price

     

    Limit order: buy/sell only if the prices hits what you want

     

    Program trading

    • You have a large group of stocks at least 15 and worth more then 1million dollars --> these are bought and sold at the same time using computer alghoritms 

    • Critiscism: can cause sudden swings in stock prices --> when the trades happen fast have high volatility and create spikes or  drops in the market --> more unpredictable

    • Circuit breakers: Temporary pauses in trading if market starts to swing to wildly --> gives buyers/sellers time to understand incoming information --> before trading starts again.

    • LULD - Limit up limit down: For individual stocks (rule to prevent extreme prices) --> if pricev of stock moved outside of the price band --> trading of that stock stops

    • Price band = (Reference price) (Referen ± × [ ce price) (Percentage parameter)]

     

    Controversial trading practices

    • Flash trading: certain traders pay extra fee to be able to see new buy/sell orders milliseconds before others --> react to price changes fast than others

    • Naked access: trader use broker's access to make trades on the stock exchange directly without a broker --> exchange not knowing who the trader is --> banned in 2010 because it was hard to keep track of who did the trades.

    • Dark pools of liquidity: private trading platforms --> big investors like banks, hedge funds and FI can buy/sell large amount of stocks without revealing their trades to the public market --> use this to avoid moving stock prices too much  --> do this by not display it to public --> new rules require dark pools to be more transparent


    OTC and NASDAQ market

    • OTC- securites not sold on of the organized exchanges are traded over the counter

    • Nasdaq- first ever electronic stock market , dealer market --> market makers, known as a negotiated market --> multiple dealers provide a price--> buyer/seller can then choose the best offer

    • NYSE (new york stock exchange) --> auction market --> trades matched between buyers and sellers directly

    • Small order execution system (soes) --> automatic order execution small efficient trades --> order of less or equal to 1000 shares.

    • Reasons a NYSE listing is attractive to a firm: • Improved marketability of the firm’s stock. • Publicity for the firm. • Improved access to the financial markets.

    • Firms that do not meet the requirements of the NYSE Euronext exchange listings trade on the NASDAQ

     

    Stock market indexes- A score that shows how a specific group of stocks is doing.

    • Dow Jones Industrial Average (DJIA) is the most widely reported stock market index and includes the values of 30 large corporations selected by the editors of The Wall Street Journal (price weighted- A price-weighted index means that stocks are weighted in the index based on their stock price rather than their market value)

    • NYSE Composite Index includes all NYSE-listed common stocks (value-weighted index market capitalization (total stock value), which is calculated by multiplying a company’s share price by the total number of outstanding shares)

    • S&P 500 Index consists of the stocks of the top 500 of the largest U.S. corporations listed on the NYSE and the NASDAQ.

    • NASDAQ Composite Index consist of stocks traded through NASDAQ that are industrials, banks, and insurance companies

    • Wilshire 5000 index --> broadest stock market indices It aims to reflect the overall market performance more accurately than other indexes, value weighted index

    It includes nearly every U.S. stock that meets three conditions:

    1. The company is based in the U.S.

    2. The stock is actively traded on a U.S. stock exchange.

    3. The stock has easy-to-access price information (excluding smaller, over-the-counter stocks).

     

    Market participation

    • Households (individual investors) are the largest holders of corporate stocks, owning 38% of all shares in 2019.

    • Mutual funds (which pool money from many people to invest in stocks) and foreign investors (people and institutions outside the U.S.) are also major stockholders, with 23.5% and 15.9% ownership, respectively.

    • Many households don’t buy stocks directly but invest indirectly through mutual funds and pension funds, which together made up about 74% of all stock holdings in 2019

    • Adults aged 30 to 64 have the highest ownership rates, with 62% owning stocks.

    • Younger adults (18 to 29) are less likely to own stocks (31%), while older adults (65 and up) have a 54% ownership rate

     

    Stock market indexes give hints about the economy for the future

    • When stock market indexes go up, it often suggests that investors expect companies to make more profits and pay higher dividends. This could mean the economy is likely to grow.

    • On the other hand, when stock indexes go down, it might indicate that investors expect lower profits, which could mean slower economic growth

    • Stock prices are one of the 10 variables included in the index of leading economic indicators used by the Federal Reserve as it formulates economic policy.

    Market efficency

    There are three levels of market efficiency:

    1. Weak form efficiency: Stock prices reflect all past price information, so investors can’t gain extra profits by studying past prices. Research supports that markets have this level of efficiency.

    2. Semistrong form efficiency: Stock prices quickly adjust to any public news, so investors can’t make more than the fair return by trading based on news releases.

    3. Strong form efficiency: Stock prices reflect all information, even private (insider) information. In this case, no one could consistently earn more than the fair return.

     

    Stock market regulations- main emphasis of SEC regulation is on full and fair disclosure of information on securities issues.

     

    • The SEC’s main goal is to ensure that companies provide complete and accurate information to investors.

    • Key laws include:

      • The Securities Act of 1933, which requires companies to file a registration and a prospectus to give investors detailed information before they invest.

      • The Securities Exchange Act of 1934, which created the SEC to oversee and regulate the secondary stock markets (where stocks are traded among investors).

    • The Sarbanes-Oxley Act of 2002 strengthened SEC oversight by:

      • Creating an independent board for auditing,

      • Increasing penalties for corporate fraud,

      • Requiring faster and more thorough financial reporting,

      • Giving shareholders more power to seek justice if they are harmed by corporate misconduct

    • The SEC allows some responsibilities to be handled by the stock markets themselves, like the NYSE and NASDAQ, which act as self-regulatory organizations for certain matters.

    • FINRA (Financial Industry Regulatory Authority) is the largest independent regulator for all U.S. securities firms. It was created in 2007 and oversees the securities industry to ensure fair practices.

    • The Wall Street Reform and Consumer Protection Act of 2010 expanded the SEC’s and other regulators' powers to improve oversight and protect investors in the stock markets

     

    International aspects of stock markets

     

    • The U.S. stock markets are the largest in the world.

    • European stock markets became more significant in the 2000s, especially after the euro was introduced in 2002.

    Investors are interested in international stock markets because investing in foreign stocks can reduce some investment risks by diversifying. However, international investing also has its own risks:

    • Information on foreign stocks is often less complete or slower to reach investors.

    • There’s foreign exchange risk, meaning currency value changes can affect returns.

    • There’s also political risk (or sovereign risk), where government instability or policies in other countries can impact investments.

     

    American depositary receipts

     

    • An ADR (American Depositary Receipt) is like a "ticket" that allows people in the U.S. to buy shares of a company from another country, but in U.S. dollars.

    • Here’s how it works: a U.S. bank buys the foreign stock in the company’s local currency and holds onto it. Then, the bank issues ADRs in dollars, so American investors can buy shares in that company without dealing with foreign currency.

    There are three levels of ADRs:

    1. Level 1: The simplest type, with very few rules, usually traded outside major stock exchanges.

    2. Level 2: These can be traded on big U.S. stock exchanges like the NYSE but have to follow more rules.

    3. Level 3: The highest level, with the strictest rules, allowing the foreign company to raise money directly in the U.S. markets