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Forms of business ownership

Forms of business ownership. Sole proprietor An individual owns & operates the business Partnership A group of people own and operate Corporation Stockholders own the corporation Stockholders elect board of directors Directors hire management Stockholders have limited liability.

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Forms of business ownership

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  1. Forms of business ownership • Sole proprietor • An individual owns & operates the business • Partnership • A group of people own and operate • Corporation • Stockholders own the corporation • Stockholders elect board of directors • Directors hire management • Stockholders have limited liability

  2. Closely held corporation • Stock ownership confined to a few qualified individuals • Shares are not publicly traded • Shareholders wishing to sell must first offer them back to the corporation

  3. Initial Public Offering • Corporation offers its shares for sale to the public for the first time • Purposes • Raise capital to expand the business • Reward early investors who typically take big risks • Notable recent examples • Google, 2004 • Facebook, 2012 (fumbled) • Twitter, 2013

  4. Secondary trading • Trading of shares of stock among people not necessarily related to the corporation • Traditional U.S. trading venues • New York Stock Exchange (since 1792) • American Stock Exchange (ca. 1865) • NASDAQ (1971) • Newer venues • Electronic trading platforms • Dark pools

  5. Stock Brokerages • Firms that buy and sell stocks on behalf of clients • Most brokerages offer many other services • Almost all trading now done online • Commission rates have dropped precipitously since May 1, 1975. • Market orders are executed almost instantly during market hours (6:30AM to 1:00 PM Pacific time)

  6. Stock purchases: timing • Good Till Cancelled (GTC) • Order remains open until executed or cancelled • Applies only to limit or stop orders • Day order • If the market is open: canceled if not executed before the close of today’s trading • If the order is closed: cancelled if not execute before the close of the next business day’s trading

  7. Types of “buy” orders • Market order: buy at the current ask price • Limit order: buy when and if the stock drops below the specified price • Usual intent: avoid over-paying • Stop order: buy if and when the stock exceeds the specified price • Usual intent: avoid runaway losses on a short position

  8. Example “buy” orders • Assume HPQ bid $24.22, ask $24.25 • Market order will be filled at $24.25 • Order to buy at 24.50 limit will be filled at 24.25 • Order to buy at 24.00 limit will not be filled • Order to buy at 24.00 stop will be filled at 24.25 • Order to buy at 25.00 stop will not be filled • Note: orders may be filled slightly above or below 24.25

  9. Types of “sell” orders • Market order: sell at the current ask price • Limit order: sell when and if the stock rises above the specified price • Usual intent: take profits when stock has reached target • Stop order: sell if and when the stock drops below the specified price • Usual intent: avoid runaway losses on a long position

  10. Example “sell” orders • Assume IBM bid $187.44, ask $187.50 • Market order will be filled at $187.44 • Order to sell at 187.00 limit will be filled at 187.44 • Order to sell at 190.50 limit will not be filled • Order to sell at 187.00 stop will not be filled • Order to sell at 190.50 stop will be filled at 187.44 • Note: orders may be filled slightly above or below $187.44 bid price

  11. Buying on margin • Your broker will lend up to half the cost of shares of stock that you buy • Example: buy 100 IBM at $185, cost $18,500. Put up $9,250 in cash, borrow $9,250 at 8% per annum • Wait one year, sell at $250, gross proceeds $25,000. Pay back loan ($9,250 principal + $750 interest). Gross profit = 15,000 or 81%. • Wait one year, sell at $125, gross proceeds $12,500. Pay back loan, net proceeds $3,200, a big loss

  12. Short sales • Short sale: sale of a stock you have borrowed and sold in hopes of a price drop. Youm ust eventually buy the stock in the market and return them to the lender • Example: selling 100 IBM short means • Your broker borrows 100 shares which are sold for you at $180/share. Broker keeps the $18,000 proceeds. • If the stock drops to $150 and you decide to “cover” your short, you pay $15,000 to acquire 100 IBM and return them. • Gross profit: $3,000

  13. Long and short • If you buy shares of IBM, you are said to be “long” IBM. You believe the IBM share price will rise. • If you sell shares of IBM short, you are said to be “short” IBM. You believe the IBM share price will fall.

  14. Short sales are risky • If you are long in a stock, the most you can lose is 100% of your investment (the stock becomes worthless). This assumes no margin borrowing has been used. • If you are short a stock, your potential losses are unlimited. • Example: short 100 IBM at $185, proceeds $18,500 • If IBM falls to $105 and you cover for $10,500 your gross profit is $8,000 • If IBM rises to $500 and you cover for $50,000 your gross loss is $31,500 • Lesson: always enter a buy stop (e.g., buy $225 stop) to prevent runaway loss on a short position

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