Characteristics Of Common Equity (Common Stocks)

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Characteristics Of Common Equity (Common Stocks)

  1. 1. CHARACTERISTICS OF COMMON STOCKS
  2. 2. THE CORPORATE FORM <ul><li>FEATURES OF THE CORPORATE FORM </li></ul><ul><ul><li>common stock with limited liability </li></ul></ul><ul><ul><li>charter issued to begin </li></ul></ul><ul><ul><li>stock certificates </li></ul></ul><ul><ul><ul><li>ownership claim </li></ul></ul></ul><ul><ul><ul><li>transfer agent conducts title change </li></ul></ul></ul><ul><ul><ul><li>registrar issues certificates </li></ul></ul></ul>
  3. 3. THE CORPORATE FORM <ul><li>FEATURES OF THE CORPORATE FORM </li></ul><ul><ul><li>voting </li></ul></ul><ul><ul><ul><li>cumulative voting system does not give majority owner control </li></ul></ul></ul><ul><ul><ul><li>majority voting system: straight voting and allows majority owner control </li></ul></ul></ul>
  4. 4. THE CORPORATE FORM <ul><li>FEATURES OF THE CORPORATE FORM </li></ul><ul><ul><li>takeovers </li></ul></ul><ul><ul><ul><li>usually done with a tender offer by a bidder to a target firm </li></ul></ul></ul><ul><ul><ul><li>bidder usually offers to buy at a stated price some or all of the shares held by current stockholders </li></ul></ul></ul><ul><ul><ul><li>WHITE KNIGHT is a firm making a better offer </li></ul></ul></ul><ul><ul><ul><li>GREENMAIL is an attempt to buy share held by bidder at above-market price </li></ul></ul></ul>
  5. 5. THE CORPORATE FORM <ul><li>FEATURES OF THE CORPORATE FORM </li></ul><ul><ul><li>ownership v. control </li></ul></ul><ul><ul><ul><li>know as principal-agent problem </li></ul></ul></ul><ul><ul><ul><li>stockholder motive is to maximize wealth </li></ul></ul></ul><ul><ul><ul><li>agent may make decisions for other reasons </li></ul></ul></ul><ul><ul><ul><li>a solution: </li></ul></ul></ul><ul><ul><ul><ul><li>give management stock options giving incentive to maximize their own wealth as well as stockholders </li></ul></ul></ul></ul>
  6. 6. COMPONENTS OF STOCKHOLDERS’ EQUITY <ul><li>Par Value </li></ul><ul><ul><ul><li>the value authorized by the charter for initial capital stock </li></ul></ul></ul>
  7. 7. COMPONENTS OF STOCKHOLDERS’ EQUITY <ul><li>Book Value Formula: </li></ul><ul><ul><ul><ul><li>Cumulative retained earnings </li></ul></ul></ul></ul><ul><ul><ul><ul><li>+Capital Contributed in </li></ul></ul></ul></ul><ul><ul><ul><ul><li>excess of par </li></ul></ul></ul></ul><ul><ul><ul><ul><li>+Common stock </li></ul></ul></ul></ul><ul><ul><ul><ul><li>BOOK VALUE OF THE EQUITY </li></ul></ul></ul></ul>
  8. 8. COMPONENTS OF STOCKHOLDERS’ EQUITY <ul><li>Reserved and Treasury Stock </li></ul><ul><ul><ul><li>some corporations repurchase some of the stock outstanding </li></ul></ul></ul><ul><ul><ul><li>this becomes known as treasury stock </li></ul></ul></ul>
  9. 9. CASH DIVIDENDS <ul><li>DEFINITION: the portion of profits paid in cash to the stockholders </li></ul><ul><ul><li>Process of Payment </li></ul></ul><ul><ul><ul><li>declaration date </li></ul></ul></ul><ul><ul><ul><li>date of record </li></ul></ul></ul><ul><ul><ul><li>ex-dividend date </li></ul></ul></ul><ul><ul><ul><li>payment date </li></ul></ul></ul>
  10. 10. STOCK DIVIDENDS AND SPLITS <ul><li>STOCK DIVIDENDS AND SPLITS </li></ul><ul><ul><li>Stock Dividend </li></ul></ul><ul><ul><ul><li>issued in place of a cash payment </li></ul></ul></ul><ul><ul><ul><li>a 5% stock dividend results in </li></ul></ul></ul><ul><ul><ul><li>example: 5% of 100 shares = 5 shares </li></ul></ul></ul>
  11. 11. STOCK DIVIDENDS AND SPLITS <ul><li>Stock Split </li></ul><ul><ul><ul><li>new shares issued after the split </li></ul></ul></ul><ul><ul><ul><li>example: a 2 for 1 split (par=$1) </li></ul></ul></ul><ul><ul><ul><li>a 200 share holder receives 400 new shares </li></ul></ul></ul><ul><ul><ul><li>at $.50 par </li></ul></ul></ul><ul><ul><ul><li>thus, there is no dilution of the shareholder’s equity position </li></ul></ul></ul>
  12. 12. STOCK DIVIDENDS AND SPLITS <ul><li>EX-DISTRIBUTION DATES </li></ul><ul><ul><li>similar to ex-dividend date </li></ul></ul><ul><ul><li>2 business days before the date of record </li></ul></ul>
  13. 13. STOCK DIVIDENDS AND SPLITS <ul><li>REASONS FOR STOCK DIVIDEND AND SPLITS </li></ul><ul><ul><li>some believe splits signal the stock is undervalued in the market </li></ul></ul><ul><ul><li>splits will bring market price to a more desirable (usually lower) range </li></ul></ul><ul><ul><li>following a split, research shows investors receive a positive abnormal return </li></ul></ul>
  14. 14. STOCK DIVIDENDS AND SPLITS <ul><li>PREEMPTIVE RIGHTS </li></ul><ul><ul><li>a legal right interpreted differently depending upon the country </li></ul></ul><ul><ul><li>in the U.S. the stockholders have an inherent legal right to maintain the proportion of ownership they may control </li></ul></ul><ul><ul><li>when new shares are issued </li></ul></ul><ul><ul><ul><li>current owners must be given first right of refusal </li></ul></ul></ul>
  15. 15. COMMON STOCK BETAS <ul><li>Role of Beta </li></ul><ul><ul><ul><li>DEFINITION: it is a measure of a stock’s sensitivity to future market movements </li></ul></ul></ul>
  16. 16. COMMON STOCK BETAS <ul><li>Calculation using linear regression the model equation is specified </li></ul><ul><ul><li>r i =  r I  i </li></ul></ul><ul><ul><li>where r i is the return of stock i </li></ul></ul><ul><ul><li>  is the average return of stock i </li></ul></ul><ul><ul><li>  is the stock i’s beta </li></ul></ul><ul><ul><li> r I is the return on the index </li></ul></ul><ul><ul><li>  i is the error term </li></ul></ul>
  17. 17. COMMON STOCK BETAS <ul><li>the standard error of beta indicates the extent of standard deviation of the estimates </li></ul>
  18. 18. COMMON STOCK BETAS <ul><li>correlation coefficient indicates how closely the stock’s returns were explained by the index returns </li></ul>
  19. 19. COMMON STOCK BETAS <ul><li>coefficient of determination represents the proportion of variance in the stock’s return to variance in the index’s returns </li></ul>
  20. 20. COMMON STOCK BETAS <ul><li>1-the coefficient of determination represents the amount of the stock’s variance that cannot be explained by variances in the index returns </li></ul><ul><ul><ul><li>i.e. nonsystematic risk </li></ul></ul></ul>

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