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)
Common stock
Preferred stock
Stockholders - part-owners of the company
Have following rights
Right to companies profit through dividens
Residual claim on firm's asset (if company goes bankrupt after paying all debts the money that is left (residual))
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)
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
Right to companies profit through dividens
Residual claim on firm's asset (if company goes bankrupt after paying all debts the money that is left (residual))
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)
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 marketOTC- 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:
The company is based in the U.S.
The stock is actively traded on a U.S. stock exchange.
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:
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.
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.
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:
Level 1: The simplest type, with very few rules, usually traded outside major stock exchanges.
Level 2: These can be traded on big U.S. stock exchanges like the NYSE but have to follow more rules.
Level 3: The highest level, with the strictest rules, allowing the foreign company to raise money directly in the U.S. markets
