FIN3244 FINAL EXAM REVIEWCHAPTER 11: COMMON STOCKTERMS TO KNOW:- Residual Ownerso Their claim is subordinate to the claims of other investors, such as lenders- Publicly Traded Issues o The shares that are readily available to the general public and bought andsold in the open marker- Public Offeringo The corporation offers the investing public a certain number of shares of its stock at a certain price - Rights Offeringo Existing stockholders are given the first opportunity to buy the new issue Right but not the obligation to purchase new shares in proportion to his or her current ownership Ex: If a stockholder currently owns 1% of the firms stock and the firm issues 10,00 additional shares, the rights offering will give them the opportunity to purchase 1%(100 shares) of the new issue If they don’t want to use the rights they can sell it- Stock Spin-Offo When a company gets rid of one of its subsidiaries or divisions- Stock Split o In declaring a spit a firm merely announces that it will increase the number of shares outstanding by exchanging a specified number of new shares for each outstanding share of stock- Treasury Stocko Simple shares of stock that have been issued and subsequently repurchased by the issuing firm - Classified Common Stocko When a firm issues different classes of common stock, each of which entitles holders to different privileges and benefits- Par Valueo Stated, or face, value of stocko Except for accounting purposes its relatively uselesso Because it has little to no meaning to investors many stocks today are issued as no-par or low-par stocks (have par values of a penny or two) - Book Valueo Another accounting measure representing the amount of stockholders equity in the firmo Indicates the amount of stockholder funds used to finance the firmo Calculated by subtracting the firms liabilities and preferred stock from its assets. o Can be converted to a per share basis by dividing it by the number of common shares outstanding- Market Valueo The prevailing market price of an issueo Easiest to calculate, indicates how the market participants as a whole have assessed the worth of a share of stock o If we multiply market price of stock by the number of shares outstanding we can also find the market value of a firm itself AKA its market capitalizationo Of considerable importance to stockholders- Investment Valueo Most important measure for a stock holder, indicates the worth investors place on stock (what they think it should be traded for)- DRIP (Dividend reinvestment plan)o Corporate sponsored programs, shareholders can have their cash dividends automatically reinvested into additional shares of the company’s common stock (Partial participation is available)- Buy-and-holdo Most common investment strategy. Buy and hold to gain capital (retirement, college funds) - Current incomeo Investment strategy high dividends that tend to increase over time- Quality Long-term Growtho Investment strategy seeks capital gains as primary source of returnNOTES:- Common stock enables investors to participate in the profits of a firm. Every shareholder is a part owner of the firm and, s such, has a claim on the wealth created by the company. - As residual owners, holders of common stock have no guarantee that they will receive any return on their investments - The market has bad days (months) but those are the exception to the rule - Stock returns take into account both price behavior and dividend income - If you would of invested $10,000 in in the S&P500 in 1950 it would have been work $6.1 million by 2000 and by the end of 2008 down to 4.1 million (given average market performance)- The advantages of stock ownershipo Substantial return opportunities Over the last century, high grade corporate bonds earned annual returns that were about half as large as the returns on common stocks o Stocks typically outperform bondso Provide protection from inflation Overtime their returns exceed the inflation rate o Easy to buy and sell and the transaction costs are modesto Price and market information is widely disseminated in the news and financial media o The unit cost of a share of common stock is usually within the reach of most individual investors Bonds carry minimum denominations of $1,000- The disadvantages of stock ownershipo Risk is the most significanto The earning and general performance of stocks are subject to wide swings, so its difficult to value common stockso The sacrifice in current income Many types of investments, and bonds pay higher levels of current income and do so with much greater certainty In most years, the dividend yield on stocks is less than half the coupon yield on bonds - Stock spin-offo An example would be when Ralston Purina spun off its Energizer subsidiary and made it its own new stand alone company, distributing stock in that company to its existing stockholders - Stock splito An example: in a 2-for-1 stock split, two new shares are exchanged for each old share - Corporations sometimes find it desirable to reduce the number of shares by buying back their own stock, generally because they view it as undervalued in the marketplace - A round lot is 100 shares of stock or multiples thereofo The sale of 400 shares of stock would be a round lot transaction o Trading 250 shares would be a round and odd lot. o Relatively high costs of odd lots makes I better to deal in round lots- An odd lot transaction is less than 100o Ex: 75 shares is an odd lot transaction - The main transaction cost is the brokerage fee paid by both the buyer and seller- Common stock Dividends:o Many investors, particularly younger ones, put little value on dividends. To a large extent, that’s because capital gains provide a much bigger source of return than dividends o Dividends provide a nice cushion when the market stumbleso New tax laws put dividends on the same plane as capital gains. Both are now taxed at the same (max 15%) tax rate (2009-not recent)o Board decides whether the firm will pay dividends and how much by: Firms earnings- EPS (earnings per share):EPS = Net Profit after taxes− Preferred Dividends¿ of shares of common stock outstanding Firms growth prospect Firms cash position Meeting all legal and contractual constraints Certain market effects and responses o Important Dates when board decided to declare a dividend: Date of record- Date on which the investor must be a registered shareholder of the firm to be entitled to
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