Finance Chapter 8

Order Flow

The flow of customer orders to buy and sell securities

Stock Valuation using Multiples

The idea here is to have some sore t of benchmark or reference PE ratio, which is multiplied by earnings to come up with price. Price at Time t = Benchmark PE ratio * EPS

Over-the-Counter (OTC) Market

Securities market in which trading is almost exclusively done through dealers who buy and sell for their own inventories. NASDAQ is often referred to as this market

Forward PE ratio

Security analysts spend a lot of time forecasting future earnings, particularly for the coming year. A PE ratio that is based on estimated future earnings

Stock Valuation

The price (value) of a share of stock is equal to the present value of the stock's future cash flow

Non-Constant Growth Rate

The main consider this case is to allow for "supernormal" growth rates over some finite length of time 1. Make a timeline 2. Deal with the right hand side 3. Bring everything back to zero

Primary Market

The market in which new securities are originally sold to investors. Companies sell securities to raise money

Ask Price

The price at which the dealer will sell

Other 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.

Dividend Yield

A stock's expected cash dividend divided by its current price CF/PV

Dmm's post

A fixed place on the exchange floor where the DMM operates

Electronic Communications Network (ENC)

A website that allows investors to trade directly with each other

Dealer

An agent who buys and sells securities for inventory. In securities markets, a dealer stands ready to buy securities to investors wishing to buy them.

Common Stock Cash Flows

Equity without priority for dividends or in bankruptcy PV = (CF + P) / (1+r)^t

Stock Market Reporting

In recent years, the reporting of stock prices are related information has increasingly moved from traditional print media to various websites. Provides information about: -Issue (Stock and Symbol) - Volume - Price (Close) - Change (Net Change) - Percentage Change

Preemptive Rights

Stockholders sometimes have the right to share proportionally in any stock sold. This means that a company that wishes to sell stock must first offer it to the existing stockholders before offering it to the general public. The purpose is to give stockholder the opportunity to protect their proportionate ownership in the corporation.

Noncumulative Dividend

Unpaid preferred dividends are not debts of the firm. Directors elect by the common shareholder can defer preferred dividends indefinitely. However, in such cases, common shareholders must also forgo dividends. In addition, holders of preferred shares are often granted voting and other rights if preferred dividends have not been paid for some time.

Growing Perpetuity

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

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. PV = CF/(r-g)

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. The only way to guarantee a seat is to own 50 percent plus one share. This guarantee that you will win every seat.

Member

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

Cumulative Dividends

If preferred dividends are cumulative and are not paid in a particular year, they will be carried forward as an arrearage. Usually, both the accumulated (past) preferred dividend and the current preferred dividends must be paid before the common shareholder can receive anything.

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.

Designated Market Makers (DMMs)

NYSE members who act as a dealers in particular stocks. Formally known as specialist

PE ratio

The ratio of a stock's price per share to its earning per share (EPS). The benchmark PE ratio could come from one of several possible sources. It could be based on similar companies, or it could be based on company's historical values.

Shareholder Rights

Shareholders hold the ultimate control of the corporation through the right to elect the directors. The general idea is "one share, one vote." Directors are elected at an annual shareholder's meeting by a vote of the holders of a majority of shares who are present and entitled to vote.

Bid Price

The price the dealer is willing to pay

Floor Brokers

NYSE members who execute customer buy and sell orders

Spread

The difference between the bid and ask prices; it is the basic source of profit for the dealer

Cumulative Voting

A procedure in which a shareholder may cast all votes for one member of the board of directors. The effect is to permit minority participation. IF permitted, the total number of votes that each shareholder may cast is determined first, This is usually calculated as the number of shares (owned or controlled) multiplied by the number of directors to be elected. All directors are elected at once

Zero Growth Rate

A share of common stock in a company with a constant dividend is much like a share of preferred stock. PV = CF/r

Broker

An agent who arranges securities among investors. A securities broker arranges transaction between the investors wishing to sell securities. the distinctive characteristic of security broker is that the do not buy or sell securities for their own accounts. Facilitating trades by others is their business.

Required Return Rate

r = dividend yield + capital gains yield = (CF/PV) + g

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.

NASDAQ

In terms of the total dollar volume of trading, the second largest stock market in the United States. A computer network of securities dealers and others that disseminates timely security price quotes to computer screens worldwide. NASDAQ is a computer network and has no physical location where trading takes place. NASDAQ has a multiple market maker system rather than a DMM system. NASDAQ network operates with three levels of information access. Level 1 is designed to provide a timely, accurate source of price quotation. These prices are freely available over the internet. Level 2 allows users to view prices quotes from all NASDAQ market makers. Level 3 is for the use of market makers only. This access level allows NASDAQ dealers to enter or change their price quote.

New York Stock Exchange (NYSE)

It has occupied its current location on Wall Street since the turn of the twentieth century. Measure in terms of the total value of shares listed, it is the largest stock market in the world. In 2006, all of this changed when the nYSE became a publicly owned corporation. With the merger, NYSE Euronet became the world's first global exchange. With electronic trading, orders to buy and orders to sell are submitted electronically. There are three different types of license holders: designated market makers (DMMs), floor brokers, and supplemental liquidity providers (SLPs)

Preference

Only that the holders of the preferred shares must receive a dividend (in the case of an ongoing firm) before holders of common shares are entitled to anything

Dividends

Payment by a corporation to shareholders, made in either cash or stock. The payment is at the discretion of the board of directors. 1. Unless declared by the board of directors, it is not a liability of the corporation, A corporation cannot default on an undeclared dividend. As a consequence, corporations cannot become bankrupt because of nonpayment of dividends. The amount of the dividend and even whether it is paid are decisions based on the business judgement of the board of directors. 2. The payment of dividends by the corporation is not a business expense, thus not deductible for corporate tax purposes. 3. Dividends received by individual shareholders are taxable

Classes of Stock

Some firms have more than one class of common stock. Often classes are created with unequal voting rights. The primary reason for creating dual or multiple classes of stock has to do with control of the firm. If such stock exist, management of a firm can raise equity capital buy issuing nonvoting or limited voting stock while maintaining control.

Preferred Stock

Stock with dividend priority over common stock, normally with a fixed dividend rate, sometimes without voting rights. A form of equity from a legal and tax standpoint. Have a stated liquidated value, usually $100 per share. Dividends payable on this stock are either cumulative or noncumulative. Because preferred stockholders receive no interest on the accumulated dividends, some have argued that the firms have an incentive to delay paying preferred dividends, However, for tax purposes, preferred dividends are treated like common stock dividends.

Capital Gains Yield

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

Constant Growth Rate

The dividends for some company always grows at a steady rate. CF1 = CF0 (1+g)

Inside Quotes

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

Secondary Market

The market in which previously issued securities are traded among investors