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FSU FIN 3244 - Chapter 11: Common Stock

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Chapter 11: Common StockFinance Study GuideChapter 11: Common StockCommon Stock: represents a person’s ownership of a firm.Residual ownership: gives the entitlement to dividends as a share of the firm’s earnings.- No guarantee of receiving dividends.Attributes of Common Stock:1) It has high returns2) It is versatile3) Simpler than other investments4) NOT easy to value5) Highly liquid6) Easy to buy with low Transaction costsDividends are an important source of income with stocks but do not provide the “bang” that capital gains do. - Dividends represent stability and can provide returns in off years.Advantages of Common Stock:1) High returns2) Unlimited potential of CG3) Annual Dividends, tend to grow over time4) Highly liquid5) Low pricesDisadvantages of Common Stock:1) Risky2) No guarantee of dividends3) Opportunity costsStock Split- firms increases outstanding shares by exchanging new shares for existing shares.- Enhance trade appeal (Trade Range Theory) by reducing price- Shows stock is not overpriced- Signaling Theory- showing a firm believes its stock is undervalued- Attention-getting events- Viewed as POSITIVE events- Firms that split stocks have abnormal returns the following yearsStock Spin-Off-: conversion of firms division to a stand-alone by distributing stock in a new company to existing shareholders.- Investors keep shares in old brand while being given new company shares- Investors can do what they wish with the stocks.Treasury Stock: stock that a firm has repurchased.- Done when a firm views itself as an attractive investment- Most treasury stock is later reissued- NOT classified stockClassified stock- common stock that is groups separately based on higher dividend rates or different voting rights in the company.Par Value- the face value of a stock- Exists for accounting purposesMarket value- the # of outstanding shares times the price per share.Book value- the accounting measure of stockholders equity in a firm- Shows how much stockholder funds are financing the firm.Investment value- value that an investor places on a stock, also known as intrinsic value- Shows the MAX price an investor is willing to pay for a stock.Boards of directors make dividend decisions based on1) Current profits2) Growth prospects3) Cash position/liquidity4) Legal and contracts5) Dividend expectations to shareholdersEx-dividend date: determines who is eligible to receive a dividend.- If stock is sold on or after, the seller receives dividend. - If the stock is sold before, the buyer receives it.- The stock price falls by the amount of the dividend on the ex-dividend date.Going “ex- dividend” means the buyer is not entitled to the dividend because the stock is being sold without it.Cash dividend: dividend paid in cash- Considered to have greater value than stock dividendsDividend paid in stock: market value of stock stays the same, but the investor receives the dividend in the form of more shares.- These are a form of Stock Split.- After dividends, the firms stock price decreasesDividend reinvestment plan (DRIP) - allows the investor to automatically reinvest in shares.- No brokerage commissions- But taxed like cash/personal income.Income stocks- limited capital gains because they pay most of their earnings in the form of dividends.- Most income stocks are highly profitableChapter 13 Mutual FundsMutual Fund- represents ownership in a managed portfolio of securities.- Revolves around diversification- Reduced overall risk, without reducing average return.- Open ended investmentsAdvantages of Mutual Funds:1) Diversification2) Professionally managed3) Mutual funds handle all paperwork and reinvest dividendsDisadvantages of Mutual Funds:1) Can be expensive with load funds or 12(b)1 fees2) Lower returns than the market index generally3) High expenses reduce investor returnsOpen ended investment:1) Contains unlimited # of shares2) Bought and sold directly from Mutual Fund3) Most common type of mutual fundClose ended investment:1) Fixed number of shares2) More rare than open ended investments3) Trade in secondary market4) Listed on the NYSEExchange Traded Funds: hybrid of mutual funds and close ended funds1) Open ended, but trade like stocks2) Less regulated3) No capital gains, but give dividends4) Tax efficient5) “payment in kind creation unit” instead of cashHedge Funds: 1) Sell shares in professionally manages portfolio2) PRIVATE- limit investors to accredited people3) Manager is a general partner, while investors are limited partners.4) Limit partners to less than 100.5) No SEC regulationsLoad Funds: funds that charge commission to purchase shares.No-load fund: does not charge commission, and has higher return.12(b)1 fund- annual fee of .25 to 1% on mutual funds. Can be a no load fund if less than .25%Back end load- fee that investor pays when he sells fund shares. - Create incentive for stock holders to retain their shares for long periods of time, because the feedisappears within 3-5 years.- Fees and commission can be found on a fund’s prospectus .- SEC sets rules, but the funds can also have their own specific rules.Automatic reinvestment plan- enables fund owners to keep capital fully invested.- Let’s investors earn fully compounded rates of return- Avoided brokerage costs and front end loadsMutual funds generally mimic the market, but it depends on which sector of funds the mutual fund


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