Finance 301 Test 2 CH 8

Two key differences between NYSE and NASDAQ

!. NASDAQ is a computer network and has no physical location where trading takes place. 2. NASDAQ has a multiple market maker system rather than a DMM system.

Why are staggered boards sometimes called classified boards?

directors are placed into different classes with terms that expire at different times.

Total return has two components

dividend yield growth rate, g (Capital Gains Yield)

Spread

difference between bid and ask prices

Staggering has two basic effects:

1. Staggering makes it more difficult for a minority to elect a director because there are fewer directors to be elected at one time. 2. Staggering makes takeover attempts less likely to be successful because it makes it more difficult to vote in a majority of new directors.

The three cases about the pattern of future dividends

1. The dividend has a zero growth rate 2. The dividend grows at a constant rate 3. The dividend grows at a constant rate after some length of time

Shareholders usually have the following rights:

1. The right to share proportionally in dividends paid. 2. The right to share proportionally in assets remaining after liabilities have been paid in a liquidation. 3. The right to vote on stockholder matters of great importance, such as a merger. Voting is usually done at the annual meeting or a special meeting.

A share of common stock is more difficult to value than a bond for three reasons

1. for CS, not even the promised cash flows are known in advance 2. CS has no maturity (life of investment is forever) 3. No easy way to observe rate of return that market requires

DMM's Post

A fixed place on the exchange floor where the DMM operates

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

Arrearage

A past due obligation such as interest, or dividends on a cumulative preferred stock.

Straight Voting

A procedure in which a shareholder may cast all votes for each member of the board of directors the directors are elected one at a time

Cumulative Voting

A procedure in which a shareholder may cast all votes for one member the directors are elected all at once

Dividend Yield

A stock's expected cash dividend divided by its current price D1/P0

Growing perpetuity

An asset with cash flows that grow at a constant rate forever

Members

As of 2006, it is the owner of a trading license on the NYSE NYSE has 1,366 exchange members

Broker

Brings buyers and sellers together an agent who arranges security transactions among investors

Per-share value of dividend formula (Constant Growth Case)

Dt = D0 x (1 + g) / t

Benchmark PE ratio example

For example, suppose we are trying to value Inactivision, Inc., a video game developer known for its hit Slack Ops series. Inactivision does not pay dividends, but after studying the industry, you feel that a PE ratio of 20 is appropriate for a company like this one. Total earnings over the four most recent quarters combined are $2 per share, so you think the stock should sell for 20 × $2 = $40. You might view this stock as an attractive purchase if it is going for less than $40, but not attractive if it sells for more than $40. Ross, Stephen,Ross, Stephen. Fundamentals of Corporate Finance (Kindle Locations 12425-12429). McGraw-Hill Higher Education. Kindle Edition.

Proxy Fight

If shareholders are not satisfied with management, an "outside" group of shareholders can try to obtain votes via proxy. They can vote by proxy in an attempt to replace management by electing enough directors.

Supplemental Liquidity Providers (SLPs)

Investment firms that are active participants in stocks assigned to them. their job is to make a one-sided market. They trade purely for their own accounts (don't represent customers) do not operate on floor

Primary reason for creating dual or multiple classes of stock

It has to do with control of the firm. If such stock exists, management of a firm can raise equity capital by issuing nonvoting or limited-voting stock while maintaining control.

Staggered election note

Many companies have staggered elections for directors. With staggered elections, only a fraction of the directorships (often one-third) are up for election at a particular time. If only two directors are up for election at any one time, it will take 1/(2 + 1) = .3333, or 33.33% of the stock plus one share to guarantee a seat.

Second largest stock market in US

NASDAQ

World's first global exchange

NYSE Euronext

Designated Market Makers (DMMs)

NYSE members who act as dealers in particular stocks. Formerly known as "specialists." maintains two-sided market operate on floor

Floor brokers

NYSE members who execute customer buy and sell orders execute trades between customers. try to get best cost possible operate on floor

Suppose the Paradise Prototyping Company has a policy of paying a $10 per share dividend every year. If this policy is to be continued indefinitely, what is the value of a share of stock if the required return is 20 percent?

P0 = D/R 10/.20 = $50/per share

Per-share value of dividend formula (Zero Growth Case)

P0 = D/R D = dividend R = required return

Dividend Growth Model formula

P0 = D0 x (1 + g) / (R - g)

In other words, what is the present value of the $10 dividend along with the $70 ending value at 25 percent?

P0=(D1+P1)/(1+R) Present value =($10+70)/1.25=$64

Per-share value of dividend formula (Two-stage Growth)

P0=D1R−g1[ 1−(1+g11+R)t ]+Pt(1+R)t

Dividends

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

is preferred stock really debt?

Preferred shareholders receive a stated dividend only; and if the corporation is liquidated, preferred shareholders get a stated value. Often, preferred stocks carry credit ratings much like those of bonds. Furthermore, preferred stock is sometimes convertible into common stock, and preferred stocks are often callable. In addition, many issues of preferred stock have obligatory sinking funds.

Stated Value

Preferred shares have a stated liquidating value, usually $100 per share. The cash dividend is described in terms of dollars per share. For example, General Motors "$5 preferred" easily translates into a dividend yield of 5 percent of stated value.

PE Ratio formula

Price at Time t = Pt = Benchmark PE ratio x EPSt

Bid Price

Price dealer is willing to pay

Using the Dividend Growth Model formula to get the stock price at any point in time formula

Pt = Dt x (1 + g) / (R - g) = Dt+ 1 / (R - g)

Suppose we observe a stock selling for $20 per share. The next dividend will be $1 per share. You think that the dividend will grow by 10 percent per year more or less indefinitely. What return does this stock offer if this is correct? The dividend growth model calculates total return as:

R=$1/20+10% =5%+10% =15%

Over-the-counter (OTC) market

Securities market in which trading is almost exclusively done through dealers who buy and sell for their own inventories

Common Stock

Stock that has no special preference either in receiving dividends or in bankruptcy.

Preferred Stock

Stock that has preference over common stock in the payment of dividends and in the distribution of corporation assets in the event of liquidation. sometimes these holders have no voting rights

Preemptive Right

Stockholders sometimes have the right to share proportionally in any new stock sold a company that wishes to sell stock must first offer it to the existing stockholders before offering it to the general public

Capital Gains Yield

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

Order Flow

The flow of customer orders to buy and sell securities

Proxy

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

Inside quotes

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

Hybrid Market

Trading takes place both electronically and face-to-face

The major difference in voting regarding shares

Voting cumulatively or Voting straight

Dividends payable on preferred stock are either

cumulative (most area) or noncumulative

Unless a dividend is __________ by the board of directors of a corporation, it is not a liability of the corporation.

declared a corporation cannot default on an undeclared dividend

Electronic communications networks (ECNs)

a website that allows investors to trade directly witch each other

The price of the stock today is equal to the present value of

all of the future dividends

Dividends are or are not deductible for corporate tax purposes

are not

Unpaid preferred dividends are / are not debts of the firm

are not preferred dividends can be delayed indefinitely (they'll just give them more voting rights instead)

Dividends received by individual shareholders are or are not taxable

are taxable

If preferred dividends are not paid in a particular year, they will be carried forward as an

arrearage

The price at which the dealer will sell

ask price

Corporations can or cannot become bankrupt because of nonpayment of dividends

cannot

Three different types of NYSE license holders

designated market makers (DMMs) floor brokers supplemental liquidity providers

Forward PE Ratio example

example, suppose you felt that Inactivision's earnings for the coming year were going to be $2.50, reflecting the growing popularity of the company's World of Slackcraft massively multiplayer online role-playing game (MMORPG). In this case, if the current stock price is $40, the forward PE ratio is $40/$2.50 = 16.

A PE ratio that is based on estimated future earnings is a called a

forward PE ratio

A preferred dividend is or is not like interest on a bond

is not

The payment of dividends by the corporation is or is not a business expense

is not

NASDAQ'S three levels of information access

level 1 timely, accurate prices free for everyone level 2 private quotes from all market makers (access to inside quotes) level 3 for use of market makers only

Dealer

maintains an inventory and stands ready to buy and sell at any time. an agent who buys and sells securities from inventory

For shareholder voting, the general rule is not one shareholder, one vote; but, it is...

one share, one vote

A share of common stock in a company is much like a share of

preferred stock

The stock market contains two markets:

primary market secondary market

Forecast prices such as the $40 in slide 22 are often called

target prices

primary market

the market in which new securities are originally sold to investors

secondary market

the market in which previously

If the constant growth rate exceeds the discount what happens?

the stock price is infinitely large the PV of the dividends keeps getting bigger same thing if GR = D Thus, results are bogus unless GR < D

no matter what the stock price is, the present value is essentially _______ if we push the sale of the stock far enough away.

zero