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Lecture Financial markets and institutions (4/e) – Chapter 8

In the previous chapter, we were occupied with questions concerning the optimal level of current assets for the firm. By examining the trade-off between profitability and risk, we were able to determine, generally, the proper level of current assets that the firm should carry. Once the overall level of current assets is determined, other questions remain. How much should be carried in cash? How much should be carried in marketable securities? We are going to find out how to answer these questions. We will also find out how to improve the efficiency of cash management and how to invest funds in marketable securities. | Chapter Eight Stock Markets 8- Overview of Stock Markets Primary stock markets allow suppliers of funds to raise equity capital Secondary stock markets are the most closely watched and reported of all financial markets Stockholders are the legal owners of a corporation have a right to share in the firm’s profits (e.g., through dividends) are residual claimants have limited liability have voting rights (e.g., to elect board of directors) 8- Stock Returns The returns on a stock over one period (Rt) can be divided into capital gains and dividend returns: Pt = stock price at time t Dt = dividends paid over time t – 1 to t (Pt – Pt – 1) / Pt – 1 = capital gain over time t – 1 to t Dt / Pt – 1 = return from dividends paid over time t – 1 to t 8- Common Stock Common stock is the fundamental ownership claim in a public or private corporation Dividends are discretionary and are thus not guaranteed Common stockholders have the lowest priority claim in the event of bankruptcy (i.e., a residual claim) Limited liability implies that common stockholders can lose no more than their original investment Common stockholders control the firm’s activities indirectly by exercising their voting rights in the election of the board of directors 8- Common Stock Dual-class firms have two classes of common shares outstanding, with different voting rights assigned to each class With cumulative voting, the number of votes assigned to each stockholder equals the number of shares held multiplied by the number of directors to be elected the number of shares needed to elect p directors, Np, is: Np = [(p x # of shares outstanding)/(# of directors to be elected + 1)] +1 A proxy vote allows stockholders to vote by absentee ballot (e.g., by mail) 8- Preferred Stock Preferred stock is a hybrid security that has characteristics of both bonds and common stock Generally has fixed dividends that are paid quarterly Generally does not have voting rights unless dividend payments are missed | Chapter Eight Stock Markets 8- Overview of Stock Markets Primary stock markets allow suppliers of funds to raise equity capital Secondary stock markets are the most closely watched and reported of all financial markets Stockholders are the legal owners of a corporation have a right to share in the firm’s profits (e.g., through dividends) are residual claimants have limited liability have voting rights (e.g., to elect board of directors) 8- Stock Returns The returns on a stock over one period (Rt) can be divided into capital gains and dividend returns: Pt = stock price at time t Dt = dividends paid over time t – 1 to t (Pt – Pt – 1) / Pt – 1 = capital gain over time t – 1 to t Dt / Pt – 1 = return from dividends paid over time t – 1 to t 8- Common Stock Common stock is the fundamental ownership claim in a public or private corporation Dividends are discretionary and are thus not guaranteed Common stockholders have the lowest priority claim in the event of bankruptcy (i.e.,