8-1 Chapter Eight Stock Markets Financial Markets and Institutions Javed Anwar International Institute of Islamic Economics International Islamic University, Islamabad
Welcome message from author
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
8-1
Chapter EightStock Markets
Financial Markets and Institutions
Javed Anwar
International Institute of Islamic EconomicsInternational Islamic University, Islamabad
8-2
Chapter Navigator
• What are the major characteristics of common stock?
• What are the major characteristics of preferred stock?
• What is the process by which common stock is issued in primary markets?
• What are the major secondary stock markets?• What is the process by which a trade takes place in
the stock markets?• What are the major stock market indexes?• Who are the major stock market participants?• What are the three forms of market efficiency?
• What are the major characteristics of common stock?
• What are the major characteristics of preferred stock?
• What is the process by which common stock is issued in primary markets?
• What are the major secondary stock markets?• What is the process by which a trade takes place in
the stock markets?• What are the major stock market indexes?• Who are the major stock market participants?• What are the three forms of market efficiency?
8-3
Stock Markets Overview
• Stock markets allow suppliers of funds to efficiently and cheaply get equity funds to public corporations (users of funds).
• In exchange, the fund users (firms) give the fund suppliers ownership rights in the firm as well as cash flows in the form of dividends.
• Thus, corporate stock or equity serves as a source of financing for firms, in addition to debt financing or retained earnings financing.
• Stock markets allow suppliers of funds to efficiently and cheaply get equity funds to public corporations (users of funds).
• In exchange, the fund users (firms) give the fund suppliers ownership rights in the firm as well as cash flows in the form of dividends.
• Thus, corporate stock or equity serves as a source of financing for firms, in addition to debt financing or retained earnings financing.
8-4
Stock Markets Overview
• Stockholders are the legal owners of a corporation– they have a residual claim to all earnings and assets after debt
and tax claims are satisfied
– voting rights (e.g., to elect board of directors)
– while stockholders have no direct control over a firm's day-to-day operations, they do decide on who will oversee these operations and they can replace the board when they feel the firm is not being run efficiently from a value-maximizing perspective.
– The secondary market for corporate stock is the most closely watched and reported of all financial security markets.
• Stockholders are the legal owners of a corporation– they have a residual claim to all earnings and assets after debt
and tax claims are satisfied
– voting rights (e.g., to elect board of directors)
– while stockholders have no direct control over a firm's day-to-day operations, they do decide on who will oversee these operations and they can replace the board when they feel the firm is not being run efficiently from a value-maximizing perspective.
– The secondary market for corporate stock is the most closely watched and reported of all financial security markets.
8-5
Market Value of Common Stock Outstanding, by Type of Issuer ($Bn)
0
2000
4000
6000
8000
10000
12000
14000
1994 1997 2000 2001
Nonfinancial corp. bus Financial corp Rest of world
0
2000
4000
6000
8000
10000
12000
14000
1994 1997 2000 2001
Nonfinancial corp. bus Financial corp Rest of world
8-6
Primary and Secondary Markets Overview
• Primary Market– firm can raise equity capital in its initial public
offering (IPO)– firm can raise equity capital in a subsequent
seasoned equity offering (SEO)
• Secondary Markets– trading of shares among investors
• Primary Market– firm can raise equity capital in its initial public
offering (IPO)– firm can raise equity capital in a subsequent
seasoned equity offering (SEO)
• Secondary Markets– trading of shares among investors
8-7
Stock Market Securities
• Two types of corporate stock exist– Common stock
• the fundamental ownership claim in a public corporation
– Preferred stock• a hybrid security that has characteristics of both
bonds and common stock
• Two types of corporate stock exist– Common stock
• the fundamental ownership claim in a public corporation
– Preferred stock• a hybrid security that has characteristics of both
bonds and common stock
8-8
Calculating Stock Returns
8-9
Calculating Stock Returns
8-10
New Securities Issued ($Bn)
0
20
40
60
80
100
120
140
160
180
1992 1995 1998 2000 2001
Preferred Common
0
20
40
60
80
100
120
140
160
180
1992 1995 1998 2000 2001
Preferred Common
8-11
Characteristics of Common Stock
• Common stock is the fundamental ownership claim in a public corporation. There are many characteristics of common stock that differentiate it from other types of financial securities (e.g., bonds, mortgages, preferred stock).
• These include(1) discretionary dividend payments,
(2) residual claim status,
(3) limited liability,
(4) voting rights.
• Common stock is the fundamental ownership claim in a public corporation. There are many characteristics of common stock that differentiate it from other types of financial securities (e.g., bonds, mortgages, preferred stock).
• These include(1) discretionary dividend payments,
(2) residual claim status,
(3) limited liability,
(4) voting rights.
8-12
Characteristics of Common Stock
• Dividends– payment and size of dividends is determined by the board of directors of
the issuing firm– Further, unlike interest payments on debt, a corporation does not default if
it misses a dividend pay ment to common stockholders. – common stock dividends, from an investor's viewpoint, is that they are
taxed twice—once at the firm level (at the corporate tax rate, by virtue of the fact that dividend payments are not tax deductible from the firm's profits or net earnings) and once at the personal level (at the personal income tax rate).
• Residual Claim– in the event of liquidation, common stockholders have the lowest priority
in terms of any cash distribution• Limited Liability
– common stockholders losses are limited to the amount of their original investment in the firm
• Voting Rights
• Dividends– payment and size of dividends is determined by the board of directors of
the issuing firm– Further, unlike interest payments on debt, a corporation does not default if
it misses a dividend pay ment to common stockholders. – common stock dividends, from an investor's viewpoint, is that they are
taxed twice—once at the firm level (at the corporate tax rate, by virtue of the fact that dividend payments are not tax deductible from the firm's profits or net earnings) and once at the personal level (at the personal income tax rate).
• Residual Claim– in the event of liquidation, common stockholders have the lowest priority
in terms of any cash distribution• Limited Liability
– common stockholders losses are limited to the amount of their original investment in the firm
• Voting Rights
8-13
Characteristics of Common Stock
8-14
Characteristics of Preferred Stock
• Preferred stock is a hybrid security that has characteristics of both a bond and a common stock.
• Similar to common stock in that it represents an ownership interest but, like bonds, pays a fixed periodic dividend
• Senior to common stock but junior to bonds
• Generally do not have voting rights
• Nonparticipating preferred stock
– dividend is fixed regardless of any increase or decrease in the firm’s value
• Cumulative preferred stock
– missed dividend payments go into arrears and must be made up before common stock dividends can be paid
• Preferred stock is a hybrid security that has characteristics of both a bond and a common stock.
• Similar to common stock in that it represents an ownership interest but, like bonds, pays a fixed periodic dividend
• Senior to common stock but junior to bonds
• Generally do not have voting rights
• Nonparticipating preferred stock
– dividend is fixed regardless of any increase or decrease in the firm’s value
• Cumulative preferred stock
– missed dividend payments go into arrears and must be made up before common stock dividends can be paid
8-15
Issuance of Stock in the Primary Market
Stocks Stocks
Issuing Investment InvestorsCorporation Bank Funds Funds
Investment bank conducts primary market sale of stock using firm commitment underwriting (guarantees corporation a fixed price for newly issued securities) orbest efforts underwriting (no guarantee to issuer and acts more as a placing or distribution agent)
Stocks Stocks
Issuing Investment InvestorsCorporation Bank Funds Funds
Investment bank conducts primary market sale of stock using firm commitment underwriting (guarantees corporation a fixed price for newly issued securities) orbest efforts underwriting (no guarantee to issuer and acts more as a placing or distribution agent)
(continued)
8-16
• Net proceeds - the guaranteed price at which the investment bank purchases the stock from the issuer
• Gross proceeds - the price at which the investment bank resells the stock to investors
• Underwriters’ spread - the difference between the gross proceeds and the net proceeds
• Syndicate - the process of distributing securities through a group of investment banks
• Originating house – the lead bank in the syndicate negotiates with the issuer on the syndicate’s behalf
• Red herring proxy - a preliminary version of the prospectus describing a new security
• Net proceeds - the guaranteed price at which the investment bank purchases the stock from the issuer
• Gross proceeds - the price at which the investment bank resells the stock to investors
• Underwriters’ spread - the difference between the gross proceeds and the net proceeds
• Syndicate - the process of distributing securities through a group of investment banks
• Originating house – the lead bank in the syndicate negotiates with the issuer on the syndicate’s behalf
• Red herring proxy - a preliminary version of the prospectus describing a new security
8-17
8-18
Secondary Markets: Major U.S. Stock Exchanges
• New York Stock Exchange (NYSE)– buyers and sellers meet at the trading post to negotiate
– specialist acts as a dealer (market maker), as necessary
• American Stock Exchange (AMEX)– trading system same as NYSE
• National Association of Securities Dealers Automated Quotation System (NASDAQ)– multiple dealers (market makers) compete for transactions in
a given stock
– each dealer/market maker posts a bid and offer price on the system’s network
• New York Stock Exchange (NYSE)– buyers and sellers meet at the trading post to negotiate
– specialist acts as a dealer (market maker), as necessary
• American Stock Exchange (AMEX)– trading system same as NYSE
• National Association of Securities Dealers Automated Quotation System (NASDAQ)– multiple dealers (market makers) compete for transactions in
a given stock
– each dealer/market maker posts a bid and offer price on the system’s network
8-19
Trading on NYSE and AMEX
8-20
Trading on NYSE and AMEX
Order Order Order
Investor Shares Broker Shares Comm Shares Market or Maker or Cash Cash Floor Cash Other Floor Broker Broker
Order Order Order
Investor Shares Broker Shares Comm Shares Market or Maker or Cash Cash Floor Cash Other Floor Broker Broker
8-21
Two Common Types of Orders
• Market order – an order for the broker and market specialist to
transact at the best price available when the order reaches the post
• Limit order – an order to transact at a specified price (the limit
price)
• Market order – an order for the broker and market specialist to
transact at the best price available when the order reaches the post
• Limit order – an order to transact at a specified price (the limit
price)
8-22
Stock Market Indexes
• The Dow Jones Industrial Average (the DJIA)– a price-weighted index of the values of 30 large (in terms of
sales and total assets) corporations
• The NYSE Composite index– a value-weighted index of all common stocks listed on NYSE
• the Standard & Poor’s 500 index– a value-weighted index of the stocks of 500 of the largest
U.S. corporations listed on the NYSE and NASDAQ
• The NASDAQ Composite index– a value-weighted index of three categories of NASDAQ
companies: industrials, banks, and insurance companies
• The Dow Jones Industrial Average (the DJIA)– a price-weighted index of the values of 30 large (in terms of
sales and total assets) corporations
• The NYSE Composite index– a value-weighted index of all common stocks listed on NYSE
• the Standard & Poor’s 500 index– a value-weighted index of the stocks of 500 of the largest
U.S. corporations listed on the NYSE and NASDAQ
• The NASDAQ Composite index– a value-weighted index of three categories of NASDAQ
companies: industrials, banks, and insurance companies
8-23
Stock Market Participants
Holders of Corporate Stock (in billions of dollars) % of 1994 1997 2001 Total Household sector $3,070.9 $5,689.6 $5,832.2 38.4State and local gov. 10.6 79.0 126.3 0.8Rest of world 397.7 919.5 1,692.8 11.2Depository inst. 180.6 331.4 261.0 1.7Life ins. co. 246.1 558.6 935.2 6.2Other ins. co. 112.1 186.0 185.2 1.2Private pension funds 996.3 1,863.9 1,902.3 12.5Public pension funds 557.4 1,431.7 1,215.7 8.0Mutual funds 709.6 2,018.7 2,919.8 19.2Closed-end funds 31.9 50.2 31.9 0.12Brokers and dealers 20.1 51.9 82.8 0.16
Holders of Corporate Stock (in billions of dollars) % of 1994 1997 2001 Total Household sector $3,070.9 $5,689.6 $5,832.2 38.4State and local gov. 10.6 79.0 126.3 0.8Rest of world 397.7 919.5 1,692.8 11.2Depository inst. 180.6 331.4 261.0 1.7Life ins. co. 246.1 558.6 935.2 6.2Other ins. co. 112.1 186.0 185.2 1.2Private pension funds 996.3 1,863.9 1,902.3 12.5Public pension funds 557.4 1,431.7 1,215.7 8.0Mutual funds 709.6 2,018.7 2,919.8 19.2Closed-end funds 31.9 50.2 31.9 0.12Brokers and dealers 20.1 51.9 82.8 0.16
8-24
Other Issues Pertaining to Stock Markets
• Does the stock market forecast the economy?– Some evidence suggests that the stock market forecasts the
economy but evidence is not reliable
• Market efficiency– the speed with which financial security prices adjust to
unexpected news pertaining to interest rates or a stock-specific characteristics, etc.
– Forms of market efficiency• Weak Form Market Efficiency• Semistrong Form Market Efficiency Semistrong Form Market
Efficiency• Strong Form Market Efficiency
• Does the stock market forecast the economy?– Some evidence suggests that the stock market forecasts the
economy but evidence is not reliable
• Market efficiency– the speed with which financial security prices adjust to
unexpected news pertaining to interest rates or a stock-specific characteristics, etc.
– Forms of market efficiency• Weak Form Market Efficiency• Semistrong Form Market Efficiency Semistrong Form Market
Efficiency• Strong Form Market Efficiency
8-25
Other Issues Pertaining to Stock Markets
• Weak Form Market Efficiency– According to the weak form of market efficiency, current stock prices
reflect all historic public information about a company. Old news and trends are already impounded in historic prices and are of no use in predicting to day's or future stock prices. Thus, weak form market efficiency concludes that in vestors cannot make more than the fair (required) return using information based on historic price movements.
• Semi-Strong Form Market Efficiency– The semi-strong form market efficiency hy pothesis focuses on the speed
with which public information is impounded into stock prices. According to the concept of semi-strong form market efficiency, as public in formation arrives about a company, it is immediately impounded into its stock price.
• Strong Form Market Efficiency– The strong form of market efficiency states that stock prices fully reflect
all information about the firm, both public and private. Thus, according to strong form market efficiency, even learning inside information about the firm is of no help in earning more than the required rate of return.
• Weak Form Market Efficiency– According to the weak form of market efficiency, current stock prices
reflect all historic public information about a company. Old news and trends are already impounded in historic prices and are of no use in predicting to day's or future stock prices. Thus, weak form market efficiency concludes that in vestors cannot make more than the fair (required) return using information based on historic price movements.
• Semi-Strong Form Market Efficiency– The semi-strong form market efficiency hy pothesis focuses on the speed
with which public information is impounded into stock prices. According to the concept of semi-strong form market efficiency, as public in formation arrives about a company, it is immediately impounded into its stock price.
• Strong Form Market Efficiency– The strong form of market efficiency states that stock prices fully reflect
all information about the firm, both public and private. Thus, according to strong form market efficiency, even learning inside information about the firm is of no help in earning more than the required rate of return.
8-26
Stock Market Regulation
• Stock markets and participants are subject to regulations imposed by the Securities and Exchange Commission (SEC)
• Main emphasis of SEC regulation is on full and fair disclosure of information on securities
• Securities Act of 1933/Securities Exchange Act of 1934• Delegates certain regulatory responsibilities to the
markets for the day-to-day surveillance of activity• Recently imposed regulations on financial markets
intended to reduce excessive price fluctuations
• Stock markets and participants are subject to regulations imposed by the Securities and Exchange Commission (SEC)
• Main emphasis of SEC regulation is on full and fair disclosure of information on securities
• Securities Act of 1933/Securities Exchange Act of 1934• Delegates certain regulatory responsibilities to the
markets for the day-to-day surveillance of activity• Recently imposed regulations on financial markets
intended to reduce excessive price fluctuations
8-27
International Aspects of Stock Markets
• European markets becoming an increasing force with introduction of a common currency, the Euro
• International stock markets allow investors to diversify by holding stocks issued by corporations in foreign countries
• Increased risk due to less complete information about foreign stocks, foreign exchange risk, and political risk
• European markets becoming an increasing force with introduction of a common currency, the Euro
• International stock markets allow investors to diversify by holding stocks issued by corporations in foreign countries
• Increased risk due to less complete information about foreign stocks, foreign exchange risk, and political risk
Related Documents
