Topic 6 - Stock market

• Common stock


  Shares in a firm's ownership
• Ownership of common stock

  • Stockholder is entitled to participate in the profits of the enterprise
  • Stockholders are entitled to vote at the firm's annual meeting
• Stockholder return

  • Price of the stock rises over time
  • Dividends are paid to the stockholders
• Stockholder


  Merely a residual claimant, paid last after all other creditors have been paid
• Stockholder liability

  Limited liability, maximum amount shareholders can lose is their initial investment
• Going public

  1. Changes the firm's ownership structure by increasing the number of owners

  2. Changes the firm's capital structure by increasing the equity investment in the firm, which allows the firm to pay off some of its debt, expand its operations, or both
• Initial Public Offer (IPO)


  Privately owned company issues shares of stock to be sold to the general public
• IPO process

  1. Developing a prospectus

  2. Pricing

  3. Allocation of IPO shares

  4. Transaction costs
• Leaving money on the table


  Selling the shares for a lower price than the possible offer price
• IPOs tend to occur more frequently during bullish stock markets
• Flipping shares


  Purchasing the stock at its offer price and sell it shortly afterwards
• Google's IPO

  • Used a Dutch auction process instead of relying almost exclusively on institutional investors
  • Resulted in a price of $85 per share
  • Share price increased by 18% to $100.34 by the end of the first day
• Organized exchanges


  Auction markets that use floor traders who specialise in particular stocks
• Over-the-counter

  Collection of dealers who trade with one other electronically
• Order Driven Market


  All participants are natural buyers and natural sellers with no dealer acting as an intermediary
• Quote Driven Market


  Price is determined by the dealer, based on prevailing market conditions
• Bid


  Buy order specifying a price
• Offer


  Sell order specifying a price
• Best Bid


  Standing buy order that bids the highest price
• Best offer


  Standing sell order that has the lowest price
• Bid-ask spread

  Difference between the best offer and the best bid
• Orders


  Instructions to trade that traders give to brokers and exchanges that arrange their trades
• Order specifications

  • Security to be traded
  • Quantity to be traded
  • Side of the order (buy or sell)
  • Price specifications
  • How long the order is valid
  • When the order can be executed
  • Whether they can be partially filled or not
• Proprietary orders


  Orders submitted by traders for their own account
• Agency orders


  Orders from traders who cannot directly access financial markets, so they have to send their requests to buy/sell through an intermediary who can trade on their behalf, i.e. a broker
• Market orders


  To buy or sell at the best price currently available in the market
• Limit orders


  Designate a price threshold for the trade
• Short selling


  Selling borrowed securities not owned at time of sale to be purchased later and returned
• Buying on margin


  Borrows to buy securities using them as collateral
• Short sale


  Trader borrows a security, sells it, and expects the price to decline so they can buy it back at a lower price and return it to the lender
• Stock market indexes

  • Tell us how much the value of an average stock has changed
  • Tell us how much total wealth has gone up or down
  • Provide benchmarks for performance of money managers
• Dow Jones Industrial Average Index (DJIA)


  • Based on the stock prices of 30 of the largest companies in the U.S.
  • Measures the value of purchasing a single share of each of the stocks in the index
  • Price-weighted average index, which gives greater weight to shares with higher prices
• Standard and Poor's 500 Index (S&P 500)


  • Based on the value of 500 largest firms in the U.S. economy
  • Value-weighted index, where larger firms carry more weight
• About a third of all the countries in the world have a stock market and each has an index
• Most world stock indexes are value-weighted
• There is now increased correlation of global stock markets
• Stocks are risky

  • Stockholders get part of the profits, but only after everyone else is paid, including bondholders
  • The borrowing creates leverage, and leverage creates risk
  • The more debt, the more leverage and the greater the owners' risk
• Value-weighted index


  Changes in the index accurately mirror changes in the economy's overall wealth
• Most stock indexes are value-weighted
• Investors view global stock markets

  As a means to diversify risk away from domestic markets