Stock Markets Overview and Investment Strategies

1. Chapter Eight Stock Markets McGraw-Hill/Irwin

2. 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) McGraw-Hill/Irwin

3. 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 McGraw-Hill/Irwin

4. 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 McGraw-Hill/Irwin

5. 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 • Nonparticipating versus participating • Cumulative versus noncumulative McGraw-Hill/Irwin

6. Primary Stock Markets • Primary markets are markets in which corporations raise funds through new issues of stock, most of the time through investment banks. McGraw-Hill/Irwin

7. IPO’s • Primary market activities can be divided into two as best effort selling and underwriting activities. • Best Effort Selling: The financial intermediary does not buy the entire issue from the issuer but agrees to use its expertise to sell the securities. McGraw-Hill/Irwin

8. IPO’s • Underwriting: The intermediary buys the securities from the issuer. • Stand-by Underwriting • Firm Commitment (Bought Deal) • Underwriting discount (fee) McGraw-Hill/Irwin

9. Investment banks act as distribution agents in best efforts selling • Investment banks act as principals in firm commitment underwriting • A syndicate is a group of investment banks working in concert to issue stock; the lead underwriter is the originating house McGraw-Hill/Irwin

10. Primary Stock Markets • An initial public offering (IPO) is the first public issue of financial instruments by a firm • A seasoned offering is the sale of additional securities by a firm whose securities are already publicly traded • preemptive rights give existing stockholders the ability to maintain their proportional ownership McGraw-Hill/Irwin

11. Right Issues • Right Issues: Capital Raises Registered capital system allows the board of the campanies to call for capital increases without having to go-through the stipulation of Turkish Commercial Code. McGraw-Hill/Irwin

12. Joint Stock Companies • They are established upon the permission of Ministry of Commerce with at least 5 shareholders. Shareholders are responsible only for the money they put to the company. McGraw-Hill/Irwin

13. Publicly held (owned) companies • the securities of the company are listed on exchange whatever the nr. of its shareholders, it will subject to the CM Law and called as publicly held companies. • If the nr. of the shareholders of a joint stock company exceed 250, it will be considered as publicly held company and subject to CM Law. McGraw-Hill/Irwin

14. Pre-emptive Right (Subscription Warrant) • It gives its holder the right of first initiate to buy new shares to be issued by the company. • Dilution Effect. McGraw-Hill/Irwin

15. Stock Split • When the companies believe that the price of their stock exceeds the amount smaller individual investors would afford to pay for the stock, they split their stock. McGraw-Hill/Irwin

16. Scrip Issues • Extra shares awarded by the company to its investors. • The number of shares that the investor receives is based on: • The number of shares investor already have in the company and • The company's ratio for awarding scrip issues. McGraw-Hill/Irwin

17. Secondary Stock Markets • Secondary stock markets are the markets in which stocks, once issued, are traded among investors • The U.S. has three major stock markets • the New York Stock Exchange Euronext (NYSE Euronext) • the National Association of Securities Dealers Automated Quotation (NASDAQ) • the American Stock Exchange (AMEX) McGraw-Hill/Irwin

18. NYSE Euronext • Created by the merger of NYSE Group, Inc. and Euronext N.V. on April 4, 2007 to become the first truly global stock market • Over 3,200 different stocks trade on NYSE Euronext • Trading occurs at a specific place on the floor of the exchange called a trading post • Each stock has a special market maker called a specialist that maintains liquidity for the stock at all times McGraw-Hill/Irwin

19. Secondary Market transactions • Priorities • Price priority • Time priority • Customer priority • Customer Order • Limited Customer Order • Free-priced Order • Exchange Order • Three types of transactions occur at trading posts • a market order is an order to transact at the best price available when the order reaches the trading post • a limit order is an order to transact at a specified price • specialists transact for their own account McGraw-Hill/Irwin

20. TYPES OF ORDERS • Market Order: It is an order to buy or sell the security at the best price available. When this order reaches to the trading floor, its execution is sure and immediate. • Limit Orders: These are the orders to buy or sell a security at a specified price or better. • Stop-loss Order (Stop Order): It is usually used to sell the security when its market price reaches or falls below a specified level. It is designed to protect profits or limit looses. • Stop-limit Orders: Combination of stop order and limit orders to buy or sell at a specified price or better only after a given stop price has reached or passed. McGraw-Hill/Irwin

21. Trading on NYSE Euronext and AMEX Order Order Order Investor Shares Broker Shares Comm. Shares Market or Maker or Cash Cash Floor Cash Other Floor Broker Broker McGraw-Hill/Irwin

22. Name Symbol Open High Low Close Net Chg % Chg Volume 52 Wk High 52 Wk Low Div Yield P/E YTD % Chg Stock Market Quotes McGraw-Hill/Irwin

23. AMEX • Generally lists smaller firms than NYSE Euronext • Operates as a broker-specialist market-maker system similar to NYSE Euronext • Pioneered exchange traded funds (ETFs) • ETFs are index funds that are listed on an exchange and can be traded intraday McGraw-Hill/Irwin

24. NASDAQ and OTC Markets • NASDAQ is the world’s first electronic market and has no physical trading floor • Provides continuous trading for the most active stocks traded over the counter (OTC) • Primarily a dealer market in which often more than 20 dealers act as market makers • A small order execution system (SOES) provides automatic order execution for orders of less than or equal to 1,000 shares • The NASD maintains an electronic “OTC bulletin board” and “pink sheets” for small firms that are not part of the NASDAQ McGraw-Hill/Irwin

25. Secondary Stock Markets • Choice of market listings • NYSE has extensive listing requirements (e.g., firm market value and trading volume) • AMEX listing requirements are less stringent than NYSE and NASDAQ requirements are even less so • Electronic communication networks (ECNs) • normal trading occurs between 9:30 a.m. and 4:00 p.m. eastern standard time • extended-hours trading occurs through computerized alternative trading systems (ATSs) a.k.a. ECNs • Online trading via the internet is becoming increasingly popular to both individual and professional investors McGraw-Hill/Irwin

26. Stock Market Indexes • A stock market index is the composite value of a group of secondary market-traded stocks • Price-weighted index • the Dow Jones Industrial Average (DJIA), composed of 30 companies, is the most widely know stock market index • Value-weighted indexes • NYSE Composite • Standard & Poor’s 500 • NASDAQ Composite • Wilshire 5000 McGraw-Hill/Irwin

27. Stock Markets • Households, mutual funds, and private pension funds are the largest holders of corporate stock • Does the stock market forecast the economy? • Market efficiency is the speed with which financial security prices adjust to unexpected news • weak form market efficiency • semistrong form market efficiency • strong form market efficiency McGraw-Hill/Irwin

28. International Aspects of Stock Markets • U.S. stock markets are the world’s largest • European markets have increased their share of the global market with the advent of a common currency, the Euro • Growth has recently strengthened in the U.K., Canada, Japan, and Pacific Basin countries • International stock markets allow investors to diversify by holding stocks issued by corporations in foreign countries • International diversification can increase risk due to incomplete information about foreign stocks as well as foreign exchange and political risk McGraw-Hill/Irwin