FIN chapter 7

Classes of common stock

Class A (you and i) and Class B (founders shares, have special rights) are issued to differentiate between specific rights and allowances stockholders may have.

Stock price sensitivity to required return, R

NEGATIVE RELATIONSHIP

Stock price sensitivity to dividend growth, g

POSITIVE RELATIONSHIP

supernormal growth

Dividend growth is not consistent initially, but settles down to constant growth eventually

Constant Dividend Growth

Firm will increase the dividend by a constant percent every period

Newly issued securities are sold to investors in which one of the following markets?

Primary

Dividend Yield

a stock's expected cash dividend divided by its current price

broker (think match maker)

an agent who arranges security transactions among investors - match buyer/seller with a fee

dealer (think used car dealer)

an agent who buys and sells securities from inventory

NYSE members

as of 2006, a member is the owner of a trading license on the NYSE

Gordon Growth Model

assumes a constant dividend growth and implies that stock prices grow at the same rate

A broker is an agent who:

brings buyers and sellers together

An agent who buys and sells securities from inventory is called a:

dealer

Dividends ARE NOT A LIABILITY OF THE FIRM UNTIL

declared by the board of directors - a firm cannot go bankrupt for not declaring dividends

price of the stock is the present value of these cash flows:

dividends- (cash income) selling- (capital gain/loss) (all future expected cash flows)

common stock

equity without priority for dividends or in bankruptcy

preferred stock

stock with dividend priority over common stock, normally with a fixed dividend rate, sometimes without voting rights

capital gains yield

the dividend growth rate, or the rate at which the value of an investment grows

inside quotes

the highest bid quotes and the lowest ask quotes for a security

primary market

the market in which new securities are originally sold to investors (IPO, raise capital for company)

secondary market

the market in which previously issued securities are traded among investors (does not raise capital)

If you own a share of stock, you can receive cash in two ways

-If the company pays dividends - you sell your shares either to another investor (secondary) in the market or you sell it back to the company

Constant growth model conditions

-dividend expected to grow at g forever -stock price expected to grow at g forever -expected dividend yield is constant -expected capital gains yield is constant and equal to g -expected total return, R must be >g

Constant Dividend/ Zero Growth g=0

-firm will pay a constant dividend forever - like preferred stock - price is computed using the perpetuity formula P0= D/R

Common stock

-share proportionally in declared dividends -share proportionally in remaining assets during liquidation

Zero Growth Example: Suppose stock is expected to pay a $0.50 dividend every quarter and the RR is 10% with quarterly compounding. What is the price?

0.50/(.10/4)= $20

Solinux, Inc., is a young start-up company and will not pay dividends on its stock for the next 8 years, since the firm needs to plow back its earnings to fuel growth. The company will then pay a $1 per share dividend in year 9 and will increase the dividend by 3.4 percent per year thereafter. If investors require 7.3 percent return to invest in this stock, what is its current share price? (Do not include the dollar sign ($). Round your answer to 2 decimal places (e.g., 32.16)

14.59 Here, dividends are delayed by 9 years, and the constant growth model estimates the value one period before the first dividend, or in year 8. So, that value must be discounted 8 years to today.P0 = D1/ (r - g) / (1+r)8 For example, if the dividend per share is expected to start at $2.40 in year 9, and if it is expected to grow at 6% per year thereafter, and if you require 9% return, thenP0 = $2.40 / (.09 - .06) / (1 + .09)8= $80.00 / (1 + .09)8 = $40.15 price per share today

ASD Corp. will pay a dividend of $2.12 on each of its common shares next year. The company has stated that it will maintain a constant growth rate of 5.6% per year forever. If you require 7.1% return to invest in ASD stock (and assuming you agree with ASD's growth projections), how much will you pay per share? (Do not include the dollar sign ($). Round your answer to 2 decimal places (e.g., 32.16).)

141.33 P0 = D1/ (r - g)For example, if next year's dividend per share is expected to be $2.40, and if it is expected to grow at 6% per year forever, and if you require 9% return, thenP0 = $2.40 / (0.09 - 0.06) = $80.00 price per shareIf investors required a higher return than that, then the price per share they would be willing to pay today would be lower.

Mackery, Inc., has an outstanding issue of preferred stock that pays a $5.06 dividend every year. If this issue currently sells for $104.49 per share, what return to market investors require on it currently? (Do not include the percent sign (%). Round your answer to 2 decimal places (e.g., 32.16)

4.84

Which one of the following types of securities has no priority in a bankruptcy proceeding?

Common stock

Which one of the following generally pays a fixed dividend, receives first priority in dividend payment, and maintains the right to a dividend payment, even if that payment is deferred?

Cumulative preferred

supplemental liquidity providers (SLPs)

Investment firms that are active participants in stocks assigned to them. Their job is to make a one-sided market (i.e., offering to either buy or sell). They trade purely for their own accounts.

A specialist is a(n):

NYSE member who functions as a dealer for a limited number of securities.

designated market maker (DMM)

NYSE members who act as dealers in particular stocks. Formerly known as "specialists"

floor brokers

NYSE members who execute customer buy and sell orders emphasis on getting the best price possible -generally employees of large brokerage firms

Features of common stock

VOTING RIGHTS -stockholders vote to elect directors -cumulative voting (LOUDER VOICE) your number of votes = the number of electors being elected times the number of shares you own -straight voting: one share=one vote -Boards are often staggered or "classified" -proxy voting

proxy

a grant of authority by a shareholder allowing another individual to vote his or her shares

Dividend Growth Model

a model that determines the current price of a stock as its dividend next period divided by the discount rate less the dividend growth rate

Inside quotes are defined as the:

lowest asked and highest bid offers.

dividends

payments by a corporation to shareholders, made in either cash or stock

Stocks

potentially perpetual securities

bid price

price that a dealers is willing to pay for a security and is lower than the ask price