Lecture 5 - Financial securities 2 Flashcards
(24 cards)
1
Q
What is Equity?
A
- Equity (share): a share representing an ownership
stake in a company, the holder is entitled to
periodic dividends and can sell the shares to
other parties at the market price. - A pizza and a slice (a firm and a share).
- Shares are issued in primary markets.
- Underwriting and distribution
- Traded in secondary markets at the market price.
2
Q
Equity (stock) markets
A
- Major international stock markets
- USA, Japan, UK and China
- Measurement of stock markets
- Stock market capitalization: the total value of the
companies listed on the stock market. - Why is stock market important?
- A country’s relative importance is influenced by
the current state of its stock market and
performance of its currency.
3
Q
big stock markets
A
- NYSE (New York Stock Exchange)
- Biggest stock exchange in the world, capitalization
accounts for ¼ of the world total. - NASDAQ (USA)
- Where high potential and high technology firms listed.
- Tokyo Stock Exchange (Japan)
- Post-war economic growth.
- London Stock Exchange (UK)
- Operated by a computer-based trading system, highly
efficient. - Emerging countries (China and India)
4
Q
classification of stock markets
A
- Stock markets can be classified by following
features - Public or private
- Cash or forward markets
- Fixed or continuous quotation
- Computerizered or floor trading
5
Q
continue
A
- Private or public
- Private: Self-regulating (UK, US, Japan, Hong
Kong) - Public: Government influenced (France, Spain,
Italy) - Trading via commercial banks (Germany,
Switzerland and Austria)
6
Q
cash or forward markets
A
- Most of markets are cash (spot) markets. The
stocks are delivered as quickly as the
settlement procedures permit. - Paris bourse is a forward market. All major
stocks are delivered at the end of month.
7
Q
fixed or continuous quotation
A
- Most major stock markets have a high degree
of liquidity and therefore quote most stocks
on a continuous basis. (e.g. NYES, London,
Toyko) - In some low liquidity stock markets, quoted
prices are for a particular day.
8
Q
computerised or floor trading
A
- Computerizered trading is necessary for
trading international stocks. (London,
NASDAQ) - Floor trading is still a popular feature in the
NYSE. High degree of interaction and rapid
exchange of information.
9
Q
stock market participants
A
- Investors (institutional and individual)
- Pension funds
- Mutual funds
- Insurance funds
- Brokers (on behalf of clients)
- Market-makers (providing information)
10
Q
The primary stock market
A
- Privatization: the sale of state-owned enterprises
to the private sector, often through the sale of
shares to the public and institutions - Allotment policy: the policy of distributing shares
from an initial public offering (IPO) to
underwriters and investors. - Listing requirements: the set of conditions and
standards that a company must meet in order to
gain and then maintain a stock exchange listing.
11
Q
Types of share
A
- Ordinary shares: shares which represent partial
ownership of a company, entitling the owner to
vote. The holder may or not receive dividends
depending on profits. - Preference shares: shares which entitle the
holder to a given dividend, holders have priority
over ordinary shareholders. Holders entitled to a
share of the assets if the firm goes into
liquidation, but have lower priority than debt
holders. Holders are not entitled to vote.
12
Q
Preference shares
A
- Cumulative preference shares: holder is entitled to any
missed dividends if earnings recover sufficiently before
any dividends are made to ordinary shareholders. - Convertible preference shares: holders have the right
to convert their shares into ordinary shares at
predetermined conditions if a certain number of
dividend payments are missed. - Redeemable preference shares: the company can buy
back the shares at their original price. - Participating preference shares: allow greater dividend
in the event that profits are above certain levels.
13
Q
A rights issue
A
- If a company wishes to raise further capital by
method other than the issue of debt, it can
choose to issue new equity in the form of a rights
issue. - Rights issue: the issuance of new shares by
company to raise new finance, the shares are
offered to current shareholders first in proportion
to the number of shares that they own.
Shareholders can transfer their rights to a third
party.
14
Q
A rights issue
A
- The new shares are usually offered at a discount
to the existing price to encourage take-up of the
issue. - Example
A “one-for-two” issue, the existing stockholders
(shareholders) are offered one new share for every
two shares that they already hold. If the shares are
currently valued at 100 pence each, then the new
share maybe priced at 70 pence, the stockholder
must decide whether to take up his rights or sell
them to a third party.
15
Q
a rights issue 3
A
- If the stockholder takes up his right then he
retains the same proportion of ownership of
the company as prior to the issue, but the
price of his shares will fall after the rights
issue:
(100 + 100 + 70)/3 = 90 pence - The stockholder also can sell his right to a
third party for up to 20 pence (90 pence – 70
pence).
16
Q
Have a try
A
- A company is offering a “one-for-seven” rights
issue. The current market price of a share of this company is 120 pence per share, the new
share is priced at 80 pence per share. If the shareholders take up the rights, how much will be the market price of a share after the rights
issue?
17
Q
Have a try solution
A
- A “one-for-seven” issue, the existing
stockholders are offered one new share for
every seven shares that they already hold. - Share price after the rights issue
= (120*7 + 80)/8 = 115 pence
18
Q
Returns
A
- Return on an investment comes in two forms:
a) Income
i.e. dividends in the case of shares or
coupons in the case of bonds
b) Capital gain / loss
based on change in price
19
Q
Arithmetic Return (R)
A
This is for one period:
R=(Pt+1 - Pt + D)/Pt
R= Arithmetic Return
Pt+1= Closing share price
Pt = Opening share price
D = Dividends
20
Q
Arithmetic Return (R)
A
Date Price Dividend R (1
year)
1/Jan/1996 100p - -
31/Dec/1996 120p 10p 30.0%
31/Dec/1997 130p 10p 16.7%
31/Dec/1998 140p 10p 15.4%
31/Dec/1999 167p 10p 26.4%
E.g. R1996 = (120p – 100p + 10p)/100p = 30%
21
Q
Risks and Returns (without dividends)
A
- FTSE100 index (2010 – credit crunch was finally
gone) - Over last year, up by 9.2%
- Over last 3 years, down by 14.2%
- Over last 5 years, up by 2.5%
- Over last 10 years, down by 10.6%
(while UK house prices are up 98%)
Indication of market volatility (or riskiness)
22
Q
Risks and returns (with dividends)
A
- When dividends are included
- Over last year, total return is +13.0%
(versus 9.2% capital gain) - Over last three years, total return is -3.5%
(versus 14.2% capital loss) - Over last five years, total return is +23.3%
(versus 2.5% capital gain) - Over last ten years, total return is +25.9%
(versus 10.6% capital loss)
23
Q
Share valuation
A
- Based on the dividend discount model (DDM),
the current price (present value) of a share is
present value of all future dividends. - What if the dividends payments
- have a zero growth rate (constant dividends)
- have a constant growth rate
- have differential growth rates
- Define g is the dividends growth rate, R is the
required rate of return of the stock, P0 is the
share’s current market price.
24
Q
Share valuation
A
- Limitations of dividend discount model
- R must be greater than g.
- Cannot be applied on no dividend firm.
- A lack of consideration of growth opportunity.
