Chapter 22 PPT (375.0K)

Money and Capital Markets

2222C h a p t e r

Eighth Edition

Financial Institutions and Instruments in a Global Marketplace

Peter S. Rose

McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu

Corporate StockCorporate Stock

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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Learning Objectives

To learn about the characteristics of common and preferred corporate stock.

To understand the organization and operation of the stock market today.

To compare and contrast the roles and functions of the organized stock exchanges and the over-the-counter market.

To explore the issue of market efficiency.

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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Characteristics of Corporate Stock

All corporate stock represents an ownership interest in a corporation, conferring on the holder a number of rights as well as risks.

Common stock represents a residual claim against the assets of the issuing firm, entitling the owner to share in the net earnings of the firm when it is profitable and to share in the net market value (after all debts are paid) of the company’s assets if it is liquidated.

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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Characteristics of Corporate Stock

Preferred stock carries a stated annual dividend expressed as a percent of the stock’s par value.

Preferred stockholders have a prior claim over the firm’s assets and earnings relative to the claims of common stockholders, although creditors must still be paid first.

Preferred shares generally provide less income but are less risky than common stock.

Stock Market Investors22 - 5

Data Source: Board of Governors of the Federal Reserve System

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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Recent Movements in Common Stock Prices

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

1971 1976 1981 1986 1991 1996 2001

0

2,000

4,000

6,000

8,000

10,000

12,000NYSE CompositeS&P 500Nasdaq compositeDJIA

Data Source: Economic Report of the President

DJIANYSE / S&P / Nasdaq

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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Recent Movements in Common Stock Yields

0

2

4

6

8

10

12

14

16

1971 1976 1981 1986 1991 1996 2001

Dividend price ratio

Earnings price ratio

Data Source: Economic Report of the President

%

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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Characteristics of the Corporate Stock Market

There are two main branches of the market for trading corporate stock.

Organized exchanges – Trading is governed by regulations and formal procedures designed to ensure competitive pricing and an active market for the stock of the largest firms.

Over-the-counter (OTC) market – This more informal market involves the trading of stock through brokers.

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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The Major Organized Exchanges

The New York Stock Exchange (NYSE) and Chicago Board of Trade (CBOT) are organized exchanges. They have: a physical location for trading trading posts formal trading rules listing requirements a board of directors member firms and seats

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The Informal Over-the-Counter Market

There is no central trading location for the OTC market, but only an electronic communications network.

Many traders also act as principals, taking “positions of risk” by buying securities outright for their own portfolios in addition to the portfolios of their customers.

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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The Third Market

The market for securities listed on a stock exchange but traded over the counter is known as the third market.

Broker and dealer firms that are not exchange members are active in this market.

The third market was set up to supply large blocks of shares to institutional investors, and it has been a catalyst in reducing brokerage fees and promoting trading efficiency.

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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The Structure of the Market for Corporate Stock

Flow of savings from

individuals &

businesses

Pension plans

Mutual funds

Banks & their affiliated security

companies

Insurance companies &

other institutional

investors

Stock brokers, dealers, & specialists

Exchange-traded shares

Over-the-counter share trading

The third market

Private equity markets

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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The Private Equity Market

New businesses, privately held companies and partnerships, troubled firms, and even larger publicly traded companies can conduct a private sale of stock in the private equity market to finance their acquisitions and other investments, as well as to support out-of-the-ordinary financial transactions.

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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The Private Equity Market

Pension plans

Nonfinancial companies

Insurance firms

Foundations

Investment banks & security dealers

Wealthy families & individuals

Banks & bank holding

companies

Primary Equity Investors

Mutual funds

Small business investment companies

Limited partnerships

Venture capital firms

Other investment

conduits

Indirect Equity Investors

New businesses

Existing companies expanding, switching owners, or

restructuring their funding

base

Larger, publicly held

companies seeking capital

Sellers of Private Equity

Direct flow of capital

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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The Market for Stock Options

Paralleling the exchange and OTC markets for stock are markets for stock options.

Today, listed or exchange-traded call and put options are popular, along with OTC or negotiated options purchased through brokers and dealers.

The options markets have also grown to include options and futures contracts for stock indexes.

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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The Rise of Program Trading

Many analysts believe that stock markets have become more volatile due to the widespread use of computerized program trading.

One type of program trading involves buying and selling stock index futures contracts for protection against stock price declines.

Another type involves dynamic hedging strategies that adjust a portfolio to limit its exposure to adverse market developments.

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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The Development of A Unified International Market for Stock

One of the most significant developments in recent decades has been a movement to weld all parts of the equities market together into a single market for all traders and investors.

The 1975 Securities Act Amendments instructed the Securities and Exchange Commission (SEC) to “facilitate the establishment of a national market system for securities.”

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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The Development of A Unified International Market for Stock

The development of the Intermarket Trading System (ITS) enabled brokers and specialists to compare bid and ask prices on all the major U.S. exchanges for about 700 stocks.

The National Association of Security Dealers (NASD) also moved to promote a broader market system by further automating price quotations on OTC stock.

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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The Development of A Unified International Market for Stock

The 1982 Shelf Registration Rule allowed many large firms to sell new corporate stocks and bonds any time during the two years after the issue has been registered with the SEC.

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The Development of A Unified International Market for Stock

A rapid growth area in the internationalization of the stock market is the cross-listing of stocks on various exchanges around the globe across different time zones.

In response, U.S. exchanges have announced plans for extended trading hours as well as after-hours trading.

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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The Development of A Unified International Market for Stock

The development of international financial instruments like the American depository receipts (ADRs) has also strengthened the links between U.S. and foreign stock markets.

ADRs are dollar-denominated claims on foreign shares of stock that are kept in safekeeping by U.S. financial institutions.

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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Random Walk and Efficient Markets

One popular modern theory regarding the valuation of stocks is the random walk theory.

According to the theory, successive changes in the price of a stock are random fluctuations around that stock’s intrinsic value, and these changes are independent of the sequence of price changes that occurred in the past.

But of course, many analysts still subscribe to technical analysis.

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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Random Walk and Efficient Markets

The random walk notion is supplemented by the broader efficient markets hypothesis.

In a perfectly efficient securities market, existing stock prices fully reflect the latest information available on the profitability and risk of business firms.

Most researchers agree that financial markets are efficient, though they may disagree on the degree of efficiency.

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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Money and Capital Markets in Cyberspace

Find out more about the performance of corporate stock by visiting: http://www.cfonews.com/ http://money.cnn.com/ http://www.stocktabloid.com/index.shtml http://www.newsmax.com/moneynews/ http://www.nyse.com/

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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Chapter Review

Characteristics of Corporate Stock Common Stock Preferred Stock

Stock Market Investors Characteristics of the Corporate Stock Market

The Major Organized Exchanges The Informal Over-the-Counter Market

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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Chapter Review

The Third Market: Trading in Listed Securities Off the Exchange

The Private Equity Market The Market for Stock Options

The Growth of Options Markets

The Rise of Program Trading

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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Chapter Review

The Development of a Unified International Market for Stock The National Market System NASD and Automated Price Quotations The Advent of Shelf Registration Global Trading in Equities The Development of ADRs

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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Chapter Review

Random Walk and Efficient Markets The Efficient Markets Hypothesis Recent Research Findings about the EMH