Stock Markets (.PPT)

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Stock Markets (.PPT)

  1. 1. Stock Markets Overview <ul><li>Stockholders are the legal owners of a corporation </li></ul><ul><ul><li>they have a residual claim to all earnings and assets after debt and tax claims are satisfied </li></ul></ul><ul><ul><li>voting rights (e.g., to elect board of directors) </li></ul></ul><ul><ul><li>shareholders do not exercise control (elected board chooses CEO, etc.) </li></ul></ul>
  2. 2. Stock Market Securities <ul><li>Two types of corporate stock exist </li></ul><ul><ul><li>Common stock </li></ul></ul><ul><ul><ul><li>the fundamental ownership claim in a public corporation </li></ul></ul></ul><ul><ul><li>Preferred stock </li></ul></ul><ul><ul><ul><li>a hybrid security that has characteristics of both bonds and common stock </li></ul></ul></ul>
  3. 3. Characteristics of Common Stock <ul><li>Dividends </li></ul><ul><ul><li>payment and size of dividends is determined by the board of directors of the issuing firm </li></ul></ul><ul><li>Residual Claim </li></ul><ul><ul><li>in the event of liquidation, common stockholders have the lowest priority in terms of any cash distribution </li></ul></ul><ul><li>Limited Liability </li></ul><ul><ul><li>common stockholders losses are limited to the amount of their original investment in the firm </li></ul></ul><ul><li>Voting Rights </li></ul>
  4. 4. Characteristics of Preferred Stock <ul><li>Similar to common stock in that it represents an ownership interest but, like bonds, pays a fixed periodic dividend </li></ul><ul><li>Senior to common stock but junior to bonds </li></ul><ul><li>Generally do not have voting rights </li></ul><ul><li>Nonparticipating preferred stock </li></ul><ul><ul><li>dividend is fixed regardless of any increase or decrease in the firm’s value </li></ul></ul><ul><li>Cumulative preferred stock </li></ul><ul><ul><li>missed dividend payments go into arrears and must be made up before common stock dividends can be paid </li></ul></ul>
  5. 5. Primary and Secondary Markets Overview <ul><li>Primary Market </li></ul><ul><ul><li>firm can raise equity capital in its initial public offering (IPO) </li></ul></ul><ul><ul><li>firm can raise equity capital in a subsequent seasoned equity offering (SEO) </li></ul></ul><ul><li>Secondary Markets </li></ul><ul><ul><li>trading of shares among investors </li></ul></ul>
  6. 6. Issuance of Stock in the Primary Market Stocks Stocks Issuing Investment Investors Corporation Bank Funds Funds Investment bank conducts primary market sale of stock using firm commitment underwriting (guarantees corporation a fixed price for newly issued securities) or best efforts underwriting (no guarantee to issuer and acts more as a placing or distribution agent) (continued)
  7. 7. Public Offerings <ul><li>Concept of “Due Diligence” – All parties have a duty to insure that information is complete and accurate </li></ul><ul><li>Red herring prospectus - a preliminary version of the prospectus describing a new security – pre-selling of security is based on this document </li></ul><ul><li>Final prospectus </li></ul>
  8. 8. Underwriting Terms <ul><li>Syndicate - process of distributing securities through a group of investment banks </li></ul><ul><li>Originating house - the lead bank in the syndicate negotiates with the issuing company on behalf of the syndicate </li></ul><ul><li>Net proceeds - the guaranteed price at which the investment bank purchases the stock from the issuer </li></ul><ul><li>Gross proceeds - the price at which the investment bank resells the stock to investors </li></ul><ul><li>Underwriters’ spread - the difference between the gross proceeds and the net proceeds </li></ul>
  9. 9. Secondary Markets Characteristics <ul><li>Trading Locations </li></ul><ul><ul><li>Central Exchange </li></ul></ul><ul><ul><li>Over-the-counter </li></ul></ul><ul><li>Market Structure </li></ul><ul><ul><li>Continuous </li></ul></ul><ul><ul><li>Call market </li></ul></ul>
  10. 10. Secondary Markets: Major U.S. Stock Exchanges <ul><li>New York Stock Exchange (NYSE) </li></ul><ul><ul><li>buyers and sellers meet at the trading post to negotiate </li></ul></ul><ul><ul><li>specialist acts as a dealer (market maker), as necessary </li></ul></ul><ul><li>American Stock Exchange (AMEX) </li></ul><ul><ul><li>trading system same as NYSE </li></ul></ul><ul><li>National Association of Securities Dealers Automated Quotation System (NASDAQ) </li></ul><ul><ul><li>multiple dealers (market makers) compete for transactions in a given stock </li></ul></ul><ul><ul><li>each dealer/market maker posts a bid and offer price on the system’s network </li></ul></ul>
  11. 11. Stock Exchanges in U.S. <ul><li>New York Stock Exchange (NYSE) </li></ul><ul><li>American Stock Exchange (AMEX) </li></ul><ul><li>NASDAQ (not technically an exchange) </li></ul><ul><li>Regional Exchanges </li></ul><ul><ul><li>Midwest </li></ul></ul><ul><ul><li>Pacific </li></ul></ul><ul><ul><li>Philadelphia </li></ul></ul><ul><ul><li>Boston </li></ul></ul><ul><ul><li>Cincinnati </li></ul></ul>
  12. 12. International Stock Exchanges <ul><li>Japan – Tokyo plus 7 others </li></ul><ul><li>United Kingdom – London </li></ul><ul><li>Germany – Frankfurt </li></ul><ul><li>France – Paris </li></ul><ul><li>Hong Kong </li></ul><ul><li>Canada – Toronto </li></ul>
  13. 13. Trading on NYSE and AMEX Order Order Order Investor Shares Broker Shares Floor Shares Market Broker Maker or Cash Cash Cash Other Floor Broker
  14. 14. Functions of Brokers <ul><li>Receive and track orders </li></ul><ul><li>Find other parties </li></ul><ul><li>Negotiate prices </li></ul><ul><li>Server as focal point trading </li></ul><ul><li>Execute orders </li></ul>
  15. 15. Functions of Dealers (Market Makers) <ul><li>Smooth out temporary supply/demand imbalances </li></ul><ul><ul><li>Supplies “immediacy” </li></ul></ul><ul><li>Provide better price information </li></ul><ul><ul><li>Privileged access to order flow and limit order information </li></ul></ul><ul><li>Act as auctioneer </li></ul>
  16. 16. Two Common Types of Orders <ul><li>Market order </li></ul><ul><ul><li>an order for the broker and market specialist to transact at the best price available when the order reaches the post </li></ul></ul><ul><li>Limit order </li></ul><ul><ul><li>an order to transact at a specified price (the limit price) </li></ul></ul>
  17. 17. Short Selling <ul><li>A way to “bet” that a security will fall in value </li></ul><ul><ul><li>Borrow the security and sell it </li></ul></ul><ul><li>Economic value of short selling </li></ul><ul><ul><li>Limit upward bias </li></ul></ul><ul><li>Limits on short selling </li></ul><ul><ul><li>“Tick” rules </li></ul></ul><ul><ul><li>Risk </li></ul></ul>
  18. 18. Margin Transactions <ul><li>Borrow funds using securities as collateral </li></ul><ul><li>Margin Requirements </li></ul><ul><ul><li>Initial margin </li></ul></ul><ul><ul><li>Maintenance margin </li></ul></ul><ul><ul><li>Margin call </li></ul></ul>
  19. 19. Stock Market Indexes <ul><li>The Dow Jones Industrial Average (the DJIA) </li></ul><ul><ul><li>a price-weighted index of the values of 30 large (in terms of sales and total assets) corporations </li></ul></ul><ul><li>The NYSE composite index </li></ul><ul><ul><li>a value-weighted index of all common stocks listed on NYSE </li></ul></ul><ul><li>the Standard & Poor’s 500 index </li></ul><ul><ul><li>a value-weighted index of the stocks of 500 of the largest U.S. corporations listed on the NYSE and NASDAQ </li></ul></ul><ul><li>The NASDAQ composite index </li></ul><ul><ul><li>a value-weighted index of three categories of NASDAQ companies: industrials, banks, and insurance companies </li></ul></ul>
  20. 20. Major US Market Indices <ul><li>Dow Jones Industrial Average (DOW) </li></ul><ul><li>S&P 500 </li></ul><ul><li>NYSE </li></ul><ul><li>AMEX </li></ul><ul><li>NASDAQ </li></ul><ul><li>Wilshire 5000 (also 4500) </li></ul><ul><li>Russell 2000 (also 3000 and 1000) </li></ul><ul><li>Value Line </li></ul>
  21. 21. Major International Indices <ul><li>World </li></ul><ul><ul><li>Morgan Stanley (EAFE) </li></ul></ul><ul><li>Country </li></ul><ul><ul><li>Japan – Nikkei 225, Nikkei 300, Topix </li></ul></ul><ul><ul><li>UK – FTSE 100, FTSE 250 </li></ul></ul><ul><ul><li>Germany – DAX </li></ul></ul><ul><ul><li>France – CAC </li></ul></ul><ul><ul><li>Hong Kong – Hang Seng </li></ul></ul><ul><ul><li>Canada – Toronto 300 Composite </li></ul></ul>
  22. 22. Efficient Market Hypothesis: Summary <ul><li>Three forms of market efficiency </li></ul><ul><ul><li>Weak form (random walk) </li></ul></ul><ul><ul><ul><li>Current prices reflect past prices </li></ul></ul></ul><ul><ul><ul><li>Technical analysis is useless </li></ul></ul></ul><ul><ul><li>Semi-strong form </li></ul></ul><ul><ul><ul><li>Prices reflect all public information </li></ul></ul></ul><ul><ul><ul><li>Most financial analysis is useless </li></ul></ul></ul><ul><ul><li>Strong form </li></ul></ul><ul><ul><ul><li>Prices reflect all that is knowable </li></ul></ul></ul><ul><ul><ul><li>Nobody consistently makes superior profits </li></ul></ul></ul>
  23. 23. Relationship among Three Different Information Sets Information set of past prices Information set of publicly available information All information relevant to a stock
  24. 24. Reaction of Stock Price to New Information in Efficient and Inefficient Markets Stock Price Days before (+) and after (-) announcement – 30 – 20 – 10 0 +10 +20 +30 Overreaction and reversion Delayed response Efficient-market response to new information
  25. 25. Market Efficiency “Nuclear Weapons” <ul><li>Argument for Efficiency: </li></ul><ul><ul><li>Performance of mutual funds – actively managed mutual funds don’t beat the market </li></ul></ul><ul><li>Argument against Efficiency </li></ul><ul><ul><li>Asset bubbles – Prices depart from fundamental value on the high side for an extended period </li></ul></ul>
  26. 26. Market Anomalies <ul><li>Small firm </li></ul><ul><li>Price to book (earnings) </li></ul><ul><li>Neglected firm </li></ul><ul><li>Calendar effects </li></ul><ul><ul><li>January </li></ul></ul><ul><ul><li>Turn of the month </li></ul></ul><ul><ul><li>Weekend </li></ul></ul><ul><li>Weather </li></ul>
  27. 27. Efficient Market Hypothesis: Summary <ul><li>Does Not Say: </li></ul><ul><ul><li>Prices are uncaused </li></ul></ul><ul><ul><li>Investors are foolish and too stupid to be in the market </li></ul></ul><ul><ul><li>All shares of stock have the same expected returns </li></ul></ul><ul><ul><li>Investors should throw darts to select stocks </li></ul></ul><ul><ul><li>There is no upward trend in stock prices </li></ul></ul><ul><li>Does Say </li></ul><ul><ul><li>Prices reflect underlying value </li></ul></ul><ul><ul><li>Financial managers cannot time stock and bond sales </li></ul></ul><ul><ul><li>Sales of stock and bonds will not depress prices </li></ul></ul><ul><ul><li>You cannot cook the books </li></ul></ul>
  28. 28. Efficient Market Hypothesis: Summary <ul><li>Why Doesn’t Everyone Believe It? </li></ul><ul><ul><li>There are optical illusions, mirages and apparent patterns in charts of stock and market returns </li></ul></ul><ul><ul><li>The truth is less interesting </li></ul></ul><ul><ul><li>There is some evidence against efficiency </li></ul></ul><ul><ul><ul><li>Seasonality </li></ul></ul></ul><ul><ul><ul><li>Small vs large stocks </li></ul></ul></ul><ul><ul><ul><li>Value vs growth stocks </li></ul></ul></ul><ul><ul><li>Tests of market efficiency are weak </li></ul></ul>
  29. 29. Implications of Market Efficiency for Investors <ul><li>If believe market IS NOT mostly semi-strong form efficient </li></ul><ul><ul><li>Active strategies </li></ul></ul><ul><li>If believe market IS mostly semi-strong form efficient </li></ul><ul><ul><li>Passive strategies </li></ul></ul>
  30. 30. Stock Market Regulation <ul><li>Stock markets and participants are subject to regulations imposed by the Securities and Exchange Commission (SEC) </li></ul><ul><li>Main emphasis of SEC regulation is on full and fair disclosure of information on securities </li></ul><ul><li>Securities Act of 1933/Securities Exchange Act of 1934 </li></ul><ul><li>Delegates certain regulatory responsibilities to the markets for the day-to-day surveillance of activity </li></ul><ul><li>Recently imposed regulations on financial markets intended to reduce excessive price fluctuations </li></ul>
  31. 31. International Aspects of Stock Markets <ul><li>European markets becoming an increasing force with introduction of a common currency, the Euro </li></ul><ul><li>International stock markets allow investors to diversify by holding stocks issued by corporations in foreign countries </li></ul><ul><li>Increased risk due to less complete information about foreign stocks, foreign exchange risk, and political risk </li></ul>
  32. 32. World Capital Markets <ul><li>Why Raise Funds Outside Domestic Markets? </li></ul><ul><ul><li>Domestic market not sufficiently developed to supply the funds needed </li></ul></ul><ul><ul><li>Reduced costs (assumes markets not completely integrated) </li></ul></ul><ul><ul><li>Diversify funding sources </li></ul></ul><ul><ul><li>Foreign currency exposure management </li></ul></ul>

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