Finance chp. 8
OTC market
Securities market in which trading is almost exclusively done through dealers who buy and sell for their own inventories.
Other Rights for common stock holders
(i) to share proportionately in dividends paid (ii) to share proportionately in any liquidation value (iii) to vote on matters of importance (e.g. mergers) (iv) a right to purchase any new stock sold -preemptive right
Secondary market
- the market in which previously issued securities trade among investors
Why are stock valuations harder than bond valuations?
1. They have infinite life 2. Cash flows are not explicit 3. Market is hard to observe
A bond that pays interest annually yielded 7.47 percent last year. The inflation rate for the same period was 6.10 percent. What was the actual real rate of return on this bond for last year?
1.29 percent
The preferred stock of ABC Inc. pays an annual dividend of $1.65 a share. The company has promised to maintain a constant dividend. How much are you willing to pay for one share of this stock if you want to earn a 12 percent annual return?
13.75
A Treasury bond is quoted as 99.34375 asked and 99.28125 bid. What is the bid-ask spread in dollars on a $5,000 face value bond?
Bid-ask spread = 99.34375 - 99.28125 = 0.0625 percent of $5,000 = $3.125
Which is traded more stocks or bonds?
Bonds
A corporate bond is quoted at a price of 103.16 and carries a 6.50 percent coupon. The bond pays interest semiannually. What is the current yield on one of these bonds?
Current yield = (0.065 x $1,000)/(1.0316 x $1,000) = 6.30 percent
If the current dividend is $2.00 and the expected growth rate is 5%, what is the value of D5 ?
D5 = D0 x (1 + .05)5 = $2.00 x 1.276 = $2.55.
Three key market participants on the New York Stock Exchange (NYSE):
Designated Market Maker Floor Brokers
The next three dividends for XYZ company are expected to be $0.50, $1.00, and $1.50. Then, the dividends are expected to grow at a constant 5% forever. If the required return on XYZ is 10%, what is P0 ?
Example 1 page 4 26.07
Winter Time Adventures is going to pay an annual dividend of $2.86 a share on its common stock next year. This year, the company paid a dividend of $2.75 a share. The company adheres to a constant rate of growth dividend policy. What will one share of this common stock be worth five years from now if the applicable discount rate is 11.7 percent?
Example 2 page 3 45.19
ABC Co. just paid a $10.46 dividend, but management expects to reduce the payout by 4% per year indefinitely. If you require an 11.5% return on this stock, what will you pay for a share today?
Example 3 page 3 64.78
XUZ, Inc. just paid $1.80 dividend. Dividends are expected to grow at a 30% rate for the next three years. After that, the company has stated that the annual dividend will be $1.25 per share indefinitely. The required rate of return is 13%. (a) What is this stock worth to you per share? (b) What is the expected stock price next year? (c) What is the expected stock price 7 years from today?
Example 3 page 5
The current dividend yield on Clayton's Metals common stock is 2.5 percent. The company just paid a $1.48 annual dividend and announced plans to pay $1.54 next year. The dividend growth rate is expected to remain constant at the current level. What is the required rate of return on this stock?
Example page 6 6.55
Designated Market Maker
NYSE member who acts like a dealer on the exchange floor; formerly known as 'specialist'.
DMM designated market maker
NYSE members who act as dealers in particular stocks.
Floor Brokers
NYSE members who execute customer orders. A middleman who acts as an agent for clients, indirectly giving them the best access possible to the exchange floor. They are generally employees of large brokerage firms such as Merrill Lynch.
Most bond trades are what kind of transaction
Over the counter
Upper Crust Bakers just paid an annual dividend of $2.00 a share and is expected to increase that amount by 5 percent per year. The market rate of return for this type of security is 12 percent and expected to remain unchanged. (a) What is the current stock price? (b)If you are planning to buy 1,000 shares of this stock 3 years from now, how much should you expect to pay per share?
P0 = D1 / r-g = 2.00(1+0.05) / 0.12 - 0.05= $30.00 P3 = D4 / r-g = 2.00(1+ 0.05)^4 / 0.12 - 0.05 = $34.73
A Treasury bond is quoted at a price of 101.4375 with a current yield of 7.236 percent. What is the coupon rate?
Price = 101.4375 percent of face = 1.014375 x $1,000 = $1,014.375 Annual coupon payment = 0.07236 x $1,014.375 = $73.40 Coupon rate = $73.40/$1,000 = 7.34 percent
The outstanding bonds of ABC Products provide a real rate of return of 3.03 percent. The current rate of inflation is 4.68 percent. What is the actual nominal rate of return on these bonds?
R = (1 + 0.0303) x (1 + 0.0468)-1 = 7.85 percent
ABC Corp. just issued some new preferred stock. The issue will pay a $5 quarterly dividend in perpetuity, beginning 20 years from now. If the market requires a 6.4% return on this investment, how much does a share of preferred stock cost today?
Stock price a quarter before 20th year = 5 / 0.016 = $312.50 P0 = 312.50 x 1 / (1 0.016)^79 = $89.18
Inside quotes
The highest bid quotes and the lowest ask quotes for a security
Non-constant Growth
Usually a mix of "supernormal" growth early on and then a constant "normal" growth rate later. In this case, discount individual "high" growth dividends and discount the dividend growth model stock value at the future, constant growth date.
Common Stock
a claim against the earnings and assets of the firm with lowest precedence, but usually with voting rights. Shareholders have the right to elect corporate directors who set corporate policy and select operating management.
Dividends
a return on capital directly or indirectly contributed to the corporation by the shareholders. (a) Payment of dividends is at the discretion of the board of directors. (b) Dividends are not tax deductible to the paying firm. (c) Dividends received by individuals are usually considered ordinary income, while dividends paid by one corporation to the other are 70% tax-exempt to the recipient.
NASDAQ
computer network of securities dealers who disseminate timely security price quotes to NASDAQ subscribers.
ABC Inc. is growing quickly. Dividends are expected to grow at a 30% rate for the next two years, with the growth rate falling off to a constant 6% thereafter. The required rate of return is 13% and the company just paid a $1.80 dividend. (a) What is the current share price? (b) What is the expected stock price next year? (c) What is the expected stock price 7 years from today?
example 2 page 4 38.46 43.46 61.64
Proxy Voting
grant of authority by a shareholder to someone else to vote his or her shares. Proxy fight: struggle between management and outsiders for control of the board, waged by getting shareholders' proxies.
Preferred stock
has precedence over common stock in the payment of dividends and in case of liquidation. Its dividend is usually fixed, and the stock is often without voting rights. -Stated value is the value to be paid to preferred holders in the event of liquidation, usually $100 per share. For example, "$5 preferred" indicates 5% dividend yield. -Cumulative dividends: current preferred dividend plus all arrearage to be paid before common stock dividends can be paid.
SLPs (Supplemental liquidty providers)
investment firms that are active participants in stocks assigned to them. Their job is to make a one-sided market (offering to either buy or sell) they trade purely from their own accounts
Supplemental Liquidity Providers
investment firms that are actively participating in stocks assigned to them. They do not represent customers and use sophisticated high-speed computers and algorithms for their own accounts to create high volume on exchanges in order to add liquidity to the markets. Unlike the DMM and Floor broker, SLPs do not operate on the floor of the NYSE.
Broker
one who arranges security transactions among investors.
Dealer
one who buys and sells securities from inventory.
Difference between nominal and real interest rates
real rates have been adjusted for inflation
Spread
the difference between the bid and ask prices.
Straight (Majority) Voting
the directors are elected one at a time, and every share gets one vote. Good for freezing out minority shareholders.
Primary market
the market in which new securities are originally sold to investors
Bid price
the price a dealer is willing to pay to acquire a security.
Ask price
the price at which a dealer is willing to sell a security.
ECN
the website that allow investors to trade directly with one another.
Exchange member
those who purchase trading licenses (annual fees).
Cumulative Voting
when the directors are all elected at once. Total votes that each shareholder may cast is usually equal to the number of shares times the number of directors to be selected. Good for getting minority shareholder representation on the board.