FINANC 3000 1st Edition Lecture 12 Outline of Last Lecture I. Interest Rate RiskII. YieldIII. Municipal BondsIV. RiskOutline of Current Lecture I. Stock MarketsII. Trading StocksIII. Basic Stock ValuationCurrent LectureCommon Stock- Represents ownership in corporationo Limited liabilityo Voting right- Market value of common stock based on o Company’s profitabilityo Growth potentialo Current market interest rateso Overall stock market conditions- Common stock owners are residual claimants – ownership of cash flows and value after other claimants are paid- Value of the company is reflected in its stock priceo Many different ways to estimate valueStock Markets- Stock exchanges provide liquidity and price transparencyThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.o New York Stock Exchange – largest U.S. stock exchangeo Has 2,300 companies listedo Trading posts – 17 stations where trading occurso Each post is staffed with a specialist (designated market maker) – matches buyersand sellers. Raises or lowers price depending on demand. Sometimes buys and sells on its own account to create marketo Brokers acts as agent for investors to buy or sell securities- MCD exampleNYSE- To list on NYSE a company must meet minimum requirementso Total number of stockholderso Level of trading volumeo Corporate earningso Firm size- NYSE charges a fee for listing and an annual fee- Being listed on NYSE can improve company’s visibility and prestigeNASDAQ- Electronic market without a physical floor- Lists many of the largest names in tech, AAPL, MSFT, INTC and NFLX- Ranks second in terms of total dollar volume, lists 2,800 different companies- Uses market makers or dealers who compete with other dealers to buy and sell stocks they represent- Place order -> electronic system routes the order to the dealer offering the best (lowest) priceEvolution of Exchanges- Mergers and Acquisitionso American Stock Exchange purchased by NYSE in 2008o NYSE merged with Euronext in 2007 to form an international exchangeo http://www.nyse.com/pdfs/NYSEEuronextTimeline-web.pdfo In 2013 NYSE Euronext is merging with Intercontinental exchangeo Trading moving away from physical floors to electronic systemsStock Indexes- To identify general direction of the market, stock indexes are useful- Three most recognized indexes:o Dow Jones Industrial Averageo Standard & Poor 500o NASDAQ Composite Index- Dow created in 1884o Represents 30 largest companies- Standard & Poor 500 created in 1957o Chooses companies to represent 10 different sectors of economy Financial, information technology, health care, industrials, consumer discretionary, consumer staples, energy, telecom services, utilities, materialsCalculating Index- Dow Jones is a price average of share prices- Changes like stock split and changes to index alter the sum of component prices, to ensure continuing divisor is updated accordingly- Presently, every $1 change in price in a particular stock within the average, equates to a 7.68 (1/0.130216081) point movement- S&P 500 and NASDAQ use company’s market capitalization (# of shares times share prices) to compute index- NASDAQ is heavily weighted to tech shares, represents movement of tech sectorTrading Stocks- Can trade stocks by opening brokerage account- Traditional brokerages (Merrill Lynch, UBS, Morgan Stanley) provide investors with advice and access to research, charge high commissions- Discount brokerages (Charles Schwab, TD Ameritrade, E-Trade) charge very minimal commissions but do not provide any services- Brokerage will forward orders to market makers at a stock exchange- Quoted bid is highest price at which dealer will buy- Quoted ask is lowest price at which dealer will sell- Difference between bid and ask is a cost to investor and profit to market maker- Market ordero Order to buy or sell stock will be filled immediately at current ask price when routed to the exchange- Limit ordero Investor specifies the purchase or sales price. If ask or bid price match investor’s price transaction goes through- Advantageo Allows investor to know the transaction price- Disadvantageo If prices don’t match, the transaction won’t occurBasic Stock Valuation- Stock valuation technique is similar to valuing bonds, need to find present value of future dividends and future selling price- Uncertainty complicates the valuation- To find the price of stock to be held for a year, need to find P0 – today’s price, need to find present value of D1 (dividends received in year 1) plus P1 (expected sales price in one year)- Will discount using i (required rate of return)- Using TVM equation we can figure out today’s price- How to figure out the future dividend?o Examine dividend history for patterns- How to figure out price if you plan to sell in 2 years?o- To find PV we will use annuity TVM equationo- For holding period n, the present value calculated by adding PV of dividends over the n years and the eventual sales price