Transcript Chapter 1

Risk Cash flows do not match EXPECTATION.
• Is a company with roller-coaster like sales figure
a risky company?
• Why are Pharmaceutical companies so big?
• What kind of company is GE like? Why?
• Why do most people can't sleep tight after
loosing money in the casino/stock while some
can?
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Independent or Correlated Risks
- stand-alone risk (project risk)
- firm risk
- diversified portfolio risk
- market risk
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Special Topic II
Stock
#1 Goal of Firm: MAXIMIZE
SHAREHOLDER WEALTH
• Some questions:
• Is this true in every economy?
Why CEOs invest in money loosing
projecting?
• Why do companies almost always
defend against hostile takeover?
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The Anatomy of Stocks
• Firms issue shares of stock when they
need to raise long-term financial capital
– usually for investment spending
• A share of stock represents equity in a
corporation and entitles the owner to a
share of the corporation’s profits
• Stock may be preferred stock or common
stock
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Preferred Stock
• Owners of preferred stock receive a fixed
dividend to which they are entitled before
owners of common stock receive anything
– similar to the interest payment that a
bondholder receives
– dividends must only be paid to preferred
stockholders if the firm earns a profit (unlike
interest which must always be paid)
– dividend payments are not tax-deductible
(unlike interest payments)
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Common Stock
• Common stockholders receive a variable
dividend after the preferred stockholders
have been paid and retained earnings
have been set aside
– retained earnings are profits not distributed to
stockholders and are usually used to fund
investment projects
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The Anatomy of Stocks
• All companies that issue publicly traded
shares of stock are regulated by the
Securities and Exchange Commission
(SEC)
– the SEC has broad disclosure requirements to
protect investors
• the financial condition of the corporation
• information about key personnel
• any changes that would be important to
stockholders
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The Stock Markets
• When most people think about the stock
market, they think about Wall Street
• Virtual vs. Physical
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The Stock Markets
• The expanded use of computers to
execute trades has accommodated the
greater volume of trading and has
facilitated an increase in program trading
by institutional investors
– allows institutional investors to pre-program
computers to buy or sell a large basket of
stocks
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The New York Stock Exchange
• The New York Stock Exchange (NYSE) is
the world’s largest market for trading
securities
– about 2,800 companies including more than
470 non-U.S. companies
• For a stock to be listed, the corporation
must apply to the exchange and meet
several criteria dealing with the size and
number of shareholders
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The New York Stock Exchange
• The NYSE is a highly-visible auction-type
market where members (acting as agents
for others) buy and sell shares of stock
– each member has purchased a seat on the
exchange
• the price of a seat is determined by supply and
demand
– the benefits of membership include direct
participation in stock trading and charging
commissions to customers for trading stocks
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The New York Stock Exchange
• Each firm whose stock is listed is assigned
to a single post where a specialist in that
stock manages the auction process
– members of the NYSE bring all large buy and
sell orders to the floor
– orders are then funneled to the appropriate
post
– the forces of supply and demand determine
stock prices
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The New York Stock Exchange
• When a new price is reached, a clerk
records the information and sends it out
over the ticker
– provides a constant stream of stock symbols
and prices
• each symbol consist of 3 or fewer letters and
represents the stock of a particular corporation
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Other Exchanges
• The American Stock Exchange
– over 660 corporations
• Regional exchanges that primarily trade
stocks listed on the NYSE are located in
Boston, Chicago, San Francisco, and
Philadelphia
• Many foreign countries also have stock
exchanges
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The Over-the-Counter Market
• The over-the-counter market is composed
of thousands of securities dealers located
all over the country
– transactions are executed over the telephone
or via computer
– dealers buy and sell securities at publicly
quoted prices
– market is regulated by the National
Association of Securities Dealers (NASD)
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The Over-the-Counter Market
• About 3,000 of the companies whose
stocks are traded over the counter are
also members of the National Association
of Securities Dealers Automated Quotation
System (NASDAQ)
– the world’s first electronic stock market
– stocks are traded on an advanced computer
system that provides immediate information
about prices and the number of shares traded
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Stock Market Indexes
• The Dow Jones Industrial Average (the
Dow) measures movements in the stock
prices of the 30 largest companies in the
U.S.
– oldest index in use today (introduced in 1896)
– an unweighted average of the sum of the daily
closing prices (adjusted to take account of the
effects of stock splits and stock dividends)
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Stock Market Indexes
• The Standard & Poor’s 500 (S&P 500) is a
weighted index of prices of 500 broadbased corporations
– weighted by their relative values
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