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Chapter Eight. Stock Markets. Overview of Stock Markets. Primary stock markets allow suppliers of funds to raise equity capital Secondary stock markets are the most closely watched and reported of all financial markets Stockholders are the legal owners of a corporation
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Chapter Eight Stock Markets McGraw-Hill/Irwin
Overview of Stock Markets • Primary stock markets allow suppliers of funds to raise equity capital • Secondary stock markets are the most closely watched and reported of all financial markets • Stockholders are the legal owners of a corporation • have a right to share in the firm’s profits (e.g., through dividends) • are residual claimants • have limited liability • have voting rights (e.g., to elect board of directors) McGraw-Hill/Irwin
Stock Returns • The returns on a stock over one period (Rt) can be divided into capital gains and dividend returns: Pt= stock price at time t Dt = dividends paid over time t – 1 to t (Pt – Pt – 1) / Pt – 1 = capital gain over time t – 1 to t Dt / Pt – 1= return from dividends paid over time t – 1 to t McGraw-Hill/Irwin
Common Stock • Common stock is the fundamental ownership claim in a public or private corporation • Dividends are discretionary and are thus not guaranteed • Common stockholders have the lowest priority claim in the event of bankruptcy (i.e., a residual claim) • Limited liability implies that common stockholders can lose no more than their original investment • Common stockholders control the firm’s activities indirectly by exercising their voting rights in the election of the board of directors McGraw-Hill/Irwin
Preferred Stock • Preferred stock is a hybrid security that has characteristics of both bonds and common stock • Generally has fixed dividends that are paid quarterly • Generally does not have voting rights unless dividend payments are missed • Nonparticipating versus participating • Cumulative versus noncumulative McGraw-Hill/Irwin
Primary Stock Markets • Primary markets are markets in which corporations raise funds through new issues of stock, most of the time through investment banks. McGraw-Hill/Irwin
IPO’s • Primary market activities can be divided into two as best effort selling and underwriting activities. • Best Effort Selling: The financial intermediary does not buy the entire issue from the issuer but agrees to use its expertise to sell the securities. McGraw-Hill/Irwin
IPO’s • Underwriting: The intermediary buys the securities from the issuer. • Stand-by Underwriting • Firm Commitment (Bought Deal) • Underwriting discount (fee) McGraw-Hill/Irwin
Investment banks act as distribution agents in best efforts selling • Investment banks act as principals in firm commitment underwriting • A syndicate is a group of investment banks working in concert to issue stock; the lead underwriter is the originating house McGraw-Hill/Irwin
Primary Stock Markets • An initial public offering (IPO) is the first public issue of financial instruments by a firm • A seasoned offering is the sale of additional securities by a firm whose securities are already publicly traded • preemptive rights give existing stockholders the ability to maintain their proportional ownership McGraw-Hill/Irwin
Right Issues • Right Issues: Capital Raises Registered capital system allows the board of the campanies to call for capital increases without having to go-through the stipulation of Turkish Commercial Code. McGraw-Hill/Irwin
Joint Stock Companies • They are established upon the permission of Ministry of Commerce with at least 5 shareholders. Shareholders are responsible only for the money they put to the company. McGraw-Hill/Irwin
Publicly held (owned) companies • the securities of the company are listed on exchange whatever the nr. of its shareholders, it will subject to the CM Law and called as publicly held companies. • If the nr. of the shareholders of a joint stock company exceed 250, it will be considered as publicly held company and subject to CM Law. McGraw-Hill/Irwin
Pre-emptive Right (Subscription Warrant) • It gives its holder the right of first initiate to buy new shares to be issued by the company. • Dilution Effect. McGraw-Hill/Irwin
Stock Split • When the companies believe that the price of their stock exceeds the amount smaller individual investors would afford to pay for the stock, they split their stock. McGraw-Hill/Irwin
Scrip Issues • Extra shares awarded by the company to its investors. • The number of shares that the investor receives is based on: • The number of shares investor already have in the company and • The company's ratio for awarding scrip issues. McGraw-Hill/Irwin
Secondary Stock Markets • Secondary stock markets are the markets in which stocks, once issued, are traded among investors • The U.S. has three major stock markets • the New York Stock Exchange Euronext (NYSE Euronext) • the National Association of Securities Dealers Automated Quotation (NASDAQ) • the American Stock Exchange (AMEX) McGraw-Hill/Irwin
NYSE Euronext • Created by the merger of NYSE Group, Inc. and Euronext N.V. on April 4, 2007 to become the first truly global stock market • Over 3,200 different stocks trade on NYSE Euronext • Trading occurs at a specific place on the floor of the exchange called a trading post • Each stock has a special market maker called a specialist that maintains liquidity for the stock at all times McGraw-Hill/Irwin
Secondary Market transactions • Priorities • Price priority • Time priority • Customer priority • Customer Order • Limited Customer Order • Free-priced Order • Exchange Order • Three types of transactions occur at trading posts • a market order is an order to transact at the best price available when the order reaches the trading post • a limit order is an order to transact at a specified price • specialists transact for their own account McGraw-Hill/Irwin
TYPES OF ORDERS • Market Order: It is an order to buy or sell the security at the best price available. When this order reaches to the trading floor, its execution is sure and immediate. • Limit Orders: These are the orders to buy or sell a security at a specified price or better. • Stop-loss Order (Stop Order): It is usually used to sell the security when its market price reaches or falls below a specified level. It is designed to protect profits or limit looses. • Stop-limit Orders: Combination of stop order and limit orders to buy or sell at a specified price or better only after a given stop price has reached or passed. McGraw-Hill/Irwin
Trading on NYSE Euronext and AMEX Order Order Order Investor Shares Broker Shares Comm. Shares Market or Maker or Cash Cash Floor Cash Other Floor Broker Broker McGraw-Hill/Irwin
Name Symbol Open High Low Close Net Chg % Chg Volume 52 Wk High 52 Wk Low Div Yield P/E YTD % Chg Stock Market Quotes McGraw-Hill/Irwin
AMEX • Generally lists smaller firms than NYSE Euronext • Operates as a broker-specialist market-maker system similar to NYSE Euronext • Pioneered exchange traded funds (ETFs) • ETFs are index funds that are listed on an exchange and can be traded intraday McGraw-Hill/Irwin
NASDAQ and OTC Markets • NASDAQ is the world’s first electronic market and has no physical trading floor • Provides continuous trading for the most active stocks traded over the counter (OTC) • Primarily a dealer market in which often more than 20 dealers act as market makers • A small order execution system (SOES) provides automatic order execution for orders of less than or equal to 1,000 shares • The NASD maintains an electronic “OTC bulletin board” and “pink sheets” for small firms that are not part of the NASDAQ McGraw-Hill/Irwin
Secondary Stock Markets • Choice of market listings • NYSE has extensive listing requirements (e.g., firm market value and trading volume) • AMEX listing requirements are less stringent than NYSE and NASDAQ requirements are even less so • Electronic communication networks (ECNs) • normal trading occurs between 9:30 a.m. and 4:00 p.m. eastern standard time • extended-hours trading occurs through computerized alternative trading systems (ATSs) a.k.a. ECNs • Online trading via the internet is becoming increasingly popular to both individual and professional investors McGraw-Hill/Irwin
Stock Market Indexes • A stock market index is the composite value of a group of secondary market-traded stocks • Price-weighted index • the Dow Jones Industrial Average (DJIA), composed of 30 companies, is the most widely know stock market index • Value-weighted indexes • NYSE Composite • Standard & Poor’s 500 • NASDAQ Composite • Wilshire 5000 McGraw-Hill/Irwin
Stock Markets • Households, mutual funds, and private pension funds are the largest holders of corporate stock • Does the stock market forecast the economy? • Market efficiency is the speed with which financial security prices adjust to unexpected news • weak form market efficiency • semistrong form market efficiency • strong form market efficiency McGraw-Hill/Irwin
International Aspects of Stock Markets • U.S. stock markets are the world’s largest • European markets have increased their share of the global market with the advent of a common currency, the Euro • Growth has recently strengthened in the U.K., Canada, Japan, and Pacific Basin countries • International stock markets allow investors to diversify by holding stocks issued by corporations in foreign countries • International diversification can increase risk due to incomplete information about foreign stocks as well as foreign exchange and political risk McGraw-Hill/Irwin