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Flashcards in Stock Basics Deck (146):
1

Define Stock.

A stock is a type of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earnings.

2

Define corporation.

A corporation is a legal entity that is separate and distinct from its owners. Corporations enjoy most of the rights and responsibilities that an individual possesses; that is, a corporation has the right to enter into contracts, loan and borrow money, sue and be sued, hire employees, own assets and pay taxes. It is often referred to as a "legal person."

3

Define Limited Liability.

Limited liability is a type of liability that does not exceed the amount invested in a partnership or limited liability company. The limited liability feature is one of the biggest advantages of investing in publicly listed companies. While a shareholder can participate wholly in the growth of a company, his or her liability is restricted to the amount of the investment in the company, even if it subsequently goes bankrupt and has remaining debt obligations.

4

Define Common Stock.

Common stock is a security that represents ownership in a corporation. Holders of common stock exercise control by electing a board of directors and voting on corporate policy. Common stockholders are on the bottom of the priority ladder for ownership structure; in the event of liquidation, common shareholders have rights to a company's assets only after bondholders, preferred shareholders and other debtholders are paid in full.

5

Define Preferred Stock.

A preferred stock is a class of ownership in a corporation that has a higher claim on its assets and earnings than common stock. Preferred shares generally have a dividend that must be paid out before dividends to common shareholders, and the shares usually do not carry voting rights.

6

Define the main difference between Preferred Stock and Common Stock.

There are two main types of stock: common and preferred. Common stock usually entitles the owner to vote at shareholders' meetings and to receive dividends. Preferred stock generally does not have voting rights, but has a higher claim on assets and earnings than the common shares. For example, owners of preferred stock receive dividends beforecommon shareholders and have priority in the event that a company goes bankrupt and is liquidated.

7


Define “Shares”.

Shares are units of ownership interest in a corporation or financial asset that provide for an equal distribution in any profits, if any are declared, in the form of dividends. The two main types of shares are common shares and preferred shares. Physical paper stock certificates have been replaced with electronic recording of stock shares, just as mutual fund shares are recorded electronically

8

Define “Shareholder”.

A shareholder is any person, company or other institution that owns at least one share of a company’s stock. Because shareholders are a company's owners, they reap the benefits of the company's successes in the form of increased stock valuation. If the company does poorly, however, shareholders can lose money if the price of its stock declines.

9

Define “Stock Market”.

The stock market is the market in which shares of publicly held companies are issued and traded either through exchanges or over-the-counter markets. Also known as the equity market, the stock market is one of the most vital components of a free-market economy, as it provides companies with access to capital in exchange for giving investors a slice of ownership in the company. The stock market makes it possible to grow small initial sums of money into large ones, and to become wealthy without taking the risk of starting a business or making the sacrifices that often accompany a high-paying career.

10

Define “Dividend”.

A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders. Dividends can be issued as cash payments, as shares of stock, or other property.

11

Define Asset.

An asset is a resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit. Assets are reported on a company's balance sheet, and they are bought or created to increase the value of a firm or benefit the firm's operations. An asset can be thought of as something that in the future can generate cash flow, reduce expenses, improve sales, regardless of whether it's a company's manufacturing equipment or a patent on a particular technology.

12

Assets can be broadly categorized into what?

Assets can be broadly categorized into short-term (or current) assets, fixed assets, financial investments and intangible assets.

13

Define current assets.

Current assets are short-term economic resources that are expected to be converted into cash within one year. Current assets include cash and cash equivalents, accounts receivable, inventory, and various prepaid expenses. While cash is easy to value, accountants periodically reassess the recoverability of inventory and accounts receivable. If there is persuasive evidence that collectability of accounts receivable is impaired or that inventory becomes obsolete, companies may write off these assets.

14

Define Fixed assets.

Fixed assets are long-term resources, such as plants, equipment and buildings. An adjustment for aging of fixed assets is made based on periodic charges called depreciation, which may or may not reflect the loss of earning power of a fixed asset. Generally accepted accounting principles (GAAP) allow depreciation under two broad methods: the straight-line method assumes that a fixed asset loses its value in proportion to its useful life, while the accelerated method assumes that the asset loses its value faster in its first years of use.

15

Define Financial Assets.

Financial assets represent investments in the assets and securities of other institutions. Financial assets include stocks, sovereign and corporate bonds, preferred equity, and other hybrid securities. Financial assets are valued depending on how the investment is categorized and the motive behind it.

16

Define Intangible assets.

Intangible assets are economic resources that have no physical presence. They include patents, trademarks, copyrights and goodwill. Accounting for intangible assets differs depending on the type of asset, and they can be either amortized or tested for impairment each year.

17

Define Earnings.

Earnings typically refer to after-tax net income. Earnings are the main determinant of share price, because earnings and the circumstances relating to them can indicate whether the business will be profitable and successful in the long run. Earnings are perhaps the single most studied number in a company's financial statements, because they show a company's profitability compared to analyst estimates and company guidance.

18

What are the measures and uses of Earnings?

There are many different measures and uses of earnings. Some analysts like to calculate earnings before taxes. This is referred to as pre-tax income, earnings before taxes, or EBT. Some analysts like to see earnings before interest and taxes. This is referred to as earnings before interest and taxes, or EBIT. Still other analysts, mainly in industries with a high level of fixed assets, prefer to see earnings before interest, taxes, depreciation and amortization, also known as EBITDA. All three measures provide varying degrees of profitability.

19

What’s the key difference between amortization and depreciation?

The key difference between amortization and depreciation is that amortization charges off the cost of an intangible asset, while depreciation does so for a tangible asset.

20

Define Earnings Per Share. (similar to P/E)

Earnings per share is a commonly cited ratio used to show the company's profitability on a per-share basis. It is also commonly used in relative valuation measures such as the price-to-earnings ratio. The price-to-earnings ratio, calculated as price divided by earnings per share, is primarily used to find relative values for the earnings of companies in the same industry. A company with a high price compared to the earnings it makes is considered overvalued. Likewise, a company with a low price compared to the earnings it makes is undervalued.

21

Define Earnings Manipulation.

While earnings may appear to be the holy grail of performance measures, they can still be manipulated. Some companies intentionally manipulate earnings higher. These companies are said to have a poor or weak quality of earnings. Earnings per share can also be manipulated higher, even when earnings are down, with share buybacks. Companies do this by repurchasing shares with retained earnings or debt.

22

Define Equity.

The value of an asset less the value of all liabilities on that asset.
Equity = Assets - Liabilities

23

Define Private Equity.

A stock or any other security representing an ownership interest. This may be in a private company (not publicly traded), in which case it is called private equity.

24

Define Shareholders’ equity.

On a company's balance sheet, the amount of the funds contributed by the owners (the stockholders) plus the retained earnings (or losses). Also referred to as shareholders' equity.

25

Define Equity in the context of margin trading.

In the context of margin trading, the value of securities in a margin account minus what has been borrowed from the brokerage.

26

Define Real Property Value.

In the context of real estate, the difference between the current fair market value of the property and the amount the owner still owes on the mortgage. It is the amount that the owner would receive after selling a property and paying off the mortgage. Also referred to as “real property value.”

27

Define equity in the context of investment strategies.

In terms of investment strategies, equity (stocks) is one of the principal asset classes. The other two are fixed-income (bonds) and cash/cash-equivalents. These are used in asset allocation planning to structure a desired risk and return profile for an investor's portfolio.

28

Define Ownership Equity.

When a business goes bankrupt and has to liquidate, the amount of money remaining (if any) after the business repays its creditors. This is most often called “ownership equity” but is also referred to as risk capital or “liable capital.”

29

Define equity in terms of general finance.

The term's meaning depends very much on the context. In finance in general, you can think of equity as one’s ownership in any asset after all debts associated with that asset are paid off.

30

In spite of what seems like substantial differences, these variants of equity all share what common thread?

Yet, in spite of what seems like substantial differences, these variants of equity all share the common thread that equity is the value of an asset after deducting the value of liabilities. One could determine the equity of a business by determining its value (factoring in any owned land, buildings, capital goods, inventory and earnings) and deducting liabilities (including debts and overhead).

31

Define Brand Equity.

Through years of advertising and development of a customer base, a company’s brand itself can come to bear an inherent value. This concept is often referred to as “brand equity,” which measures the value of a brand relative to a generic or store brand version of a product.

32

Define Street Name.

A street name is when securities are held in the name of a broker or other nominee, as opposed to being held in the customer's name. Securities are sometimes held in street name because it makes transferring the securities easier. Securities held in street name remain in the broker's custody instead of having to be transferred to the customer and registered in the customer's name. Most securities today are held in street name, although it is possible for securities to be held in the customer's name.

33

Define Stock Record.

An electronic system that helps brokerage firms keep track of the positions, location and ownership of the securities it is holding. The stock record displays the names of the real and beneficial owners as well as the names of the securities and must be updated any time a trade is executed. Since today's brokerage firms hold shares in street name for investors, meticulous bookkeeping is necessary for keeping track of the actual owners of the securities.

34

Define Board of Directors.

Elected to act as, representatives of the stockholders to establish corporate management related policies and to make decisions on major company issues. Every public company must have a board of directors. Some private and nonprofit companies have a board of directors as well.

35

In a Board of Directors, what is an Inside Director?

An inside director is a member who has the interest of major shareholders, officers, and employees in mind and whose expertise in their business and their market adds value to the board. They’re not compensated for their position on the board, as it is seen as a responsibility of their job with the company. These inside members can be C-level executives, major shareholders, or stakeholders like union representatives.

36

In a Board of Directors, what is an ‘outside’ board director?

Independent or ‘outside’ board directors are not involved in the inner workings of the company and bring experience from working in with other businesses. These member are reimbursed, and usually get additional pay for attending meetings. Ideally, this position provides more of an objective view what goals need to be met and how to fairly settle disputes.

37

Touch on the balance between inside and outside directors.

Too many insiders serving as directors will mean that the board will tend to make decisions more beneficial to management but possibly not to the company as a whole, and too many independent directors may mean management will be left out of the decision-making process and may cause good managers to leave in frustration. Because of these concerns, striking a balance on the types of members on any board is important for their success.

38

What is the Board of Directors structure in some countries in the EU and Asia?

Structure differs slightly in some countries in the E.U., and in Asia where the governance of a company is split into two tiers: an executive board, and an supervisory board. The executive board is made up of insiders elected by employees and shareholders and is headed by the CEO or managing officer. This board is in charge of the daily business operations of the company. The Supervisory board is chaired by someone other than the presiding officer of the executive board, and concerns itself with issues closer to what a board of directors would deal with in the U.S.

39

How are board of directors elected?

While members of the board of directors are elected by shareholders, those put up for nomination are decided by a nomination committee. When executives within the corporation participated in the nomination process, they ended up nominating candidates who were less likely to aggressively monitor the managers of the corporation. In 2002 the NYSE and NASDAQ required the committee to consist of independent directors, so as to ensure the fiduciary duties of the board of directors would be fulfilled. In some cases, depending on the structure set up for the board of directors and the laws in the state, in the case of the death of a director or their resignation. Ideally, the terms of directors are staggered, so not all directors are up for election during the same year.

40

How are board of directors removed?

Removal by resolution in a general meeting is challenging because most bylaws allow for a director to be given a copy of the proposal, and then respond to it in the meeting, increasing the possibility of an unpleasant split. Even then, most director’s contracts include a disincentive for firing, a golden parachute clause that requires the corporation to pay the director a bonus upon being let go.

41

Give an example of the history of Board of Directors.

An 1811 act put into law in the state of New York is generally considered to be the first instance of codifying the pre-existing practice of having elected directors serve a supervisory role of a corporation's management.

42

Define dividend rate and dividend yield.

The dividend rate may be quoted in terms of the dollar amount each share receives (dividends per share, or DPS), or It can also be quoted in terms of a percent of the current market price, which is referred to as the dividend yield.

43

Define Exchange-Traded Fund (ETF)

An ETF, or exchange traded fund, is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. Unlike mutual funds, an ETF trades like a common stock on a stock exchange. ETFs experience price changes throughout the day as they are bought and sold. ETFs typically have higher daily liquidity and lower fees than mutual fund shares, making them an attractive alternative for individual investors. Because it trades like a stock, an ETF does not have its net asset value (NAV) calculated once at the end of every day like a mutual fund does.

44

What are arguments for issuing dividends?

The bird-in-hand argument for dividend policy claims that investors are less certain of receiving future growth and capital gains from the reinvested retained earnings than they are of receiving current (and therefore certain) dividend payments. The main argument is that investors place a higher value on a dollar of current dividends that they are certain to receive than on a dollar of expected capital gains, even if they are theoretically equivalent.

45

What are the four dividend payout policies?

Stable dividend policy
Target payout ratio
Constant payout ratio
Residual dividend model

46

Define Stable Dividend Policy.

Stable dividend policy: Even if corporate earnings are in flux, stable dividend policy focuses on maintaining a steady dividend payout.

47

Define the dividend method of Target Payout Ratio.

Target payout ratio: A stable dividend policy could target a long-run dividend-to-earnings ratio. The goal is to pay a stated percentage of earnings, but the share payout is given in a nominal dollar amount that adjusts to its target at the earnings baseline changes.

Expected dividend = (previous dividend) + [(expected increase in EPS) x (target payout ratio) x (adjustment factor)]

where: adjustment factor = (1 / # of years over which the adjustment in dividends will take place)

48

Define a Target Payout Ratio.

A target payout ratio is a measure of what size a company's dividends should be. Firms generally determine their target payout ratio through a stable dividend policy tied to long-run, sustainable earnings. They are usually reluctant to increase dividends unless a reversal is not expected in the near future.

Target Payout Ratio = (dividends per share / earnings per share)

49

What are the following steps to determine the residual dividend model?

1) Identify the optimal capital budget allocation, or what proportion of the budget comes from equity vs. debt financing
2) Determine the amount of equity needed to finance that capital budget for a given capital structure.
3) Meet equity requirements to the maximum extent possible with retained earnings.
4) Pay dividends with the "residual" earnings that are available after the needs of the optimal capital budget are supported. The residual dividend policy implies that dividends are paid out of leftover earnings.

50

Define the dividend method of Constant Payout Ratio.

Constant payout ratio: A company pays out a specific percentage of its earnings each year as dividends, and the amount of those dividends therefore vary directly with earnings.

51

Define the dividend method of Residual Dividend Model.

Residual dividend model: Dividends are based on earnings less funds the firm retains to finance the equity portion of its capital budget and any residual profits are then paid out to shareholders.

52

Define Residual Dividend.

A residual dividend is a dividend policy company management uses to fund capital expenditures with available earnings before paying dividends to shareholders, and this policy creates more volatility in the dollar amount of dividends paid to investors each year. The first priority is to use earnings to cash flow capital expenditures, and dividends are paid with any remaining earnings generated by the firm.

53

Define Bankruptcy.

Bankruptcy is a legal proceeding involving a person or business that is unable to repay outstanding debts.

54

Define the Bankruptcy process.

The bankruptcy process begins with a petition filed by the debtor, which is most common, or on behalf of creditors, which is less common. All of the debtor's assets are measured and evaluated, and the assets may be used to repay a portion of outstanding debt.

55

Bankruptcy filings in the United States fall under one of several chapters of the Bankruptcy Code: Define Chapter 7.

Chapter 7, which involves liquidation of assets

56

Bankruptcy filings in the United States fall under one of several chapters of the Bankruptcy Code: Define Chapter 11.

Chapter 11, which deals with company or individual reorganizations

57

Bankruptcy filings in the United States fall under one of several chapters of the Bankruptcy Code: Define Chapter 13.

Chapter 13, which is debt repayment with lowered debt covenants or payment plans.

58

Define “Liquidation”.

In finance and economics, liquidation is an event that usually occurs when a company is insolvent, meaning it cannot pay its obligations as and when they come due. The company’s operations are brought to an end, and its assets are divvied up among creditors and shareholders, according to the priority of their claims.

59

In Trading, define “Liquidating a Position”.

Liquidation can also refer to the act of exiting a securities position. In the simplest terms, this means selling the position for cash.

60

Define “Partnership”

A partnership is an arrangement in which two or more individuals share the profits and liabilities of a business venture.

61

What are some various arrangements of partnerships?

Various arrangements are possible: all partners might share liabilities and profits equally, or some partners may have limited liability. Not every partner is necessarily involved in the management and day-to-day operations of the venture.

62

What are the four types of Partnerships?

General Partnership (GP)
Limited Partnership (LP).
Limited Liability Partnership (LLP)
Limited Liability Limited Partnership (LLLP)

63

Define General Partnership (GP).

In a general partnership (GP), all parties share the legal and financial liability of the partnership equally.

64

Define Limited Liability Partnership (LLP).

Limited liability partnerships (LLP) are a common structure for professional firms, such as accounting, law and architecture firms. This arrangement limits partners' personal liability, so that, for example, if one partner is sued for malpractice, other partners' individual assets are not at risk as a result.

65

Define Limited Partnership (LP).

Limited partnerships (LP) are a hybrid of general partnerships and limited liability partnerships. At least one partner must be a general partner, with full personal liability for the partnership's debts, while at least one partner's liability must be limited to the amount she's invested in the partnership.

66


Define Limited Liability Limited Partnership (LLLP).

A fourth variety, limited liability limited partnerships (LLLP), are new and relatively uncommon. They are limited partnerships that provide a greater shield from liability for general partners.

67

Define “Debt Financing”.

Debt financing occurs when a firm raises money for working capital or capital expenditures by selling bonds, bills or notes to individuals and/or institutional investors. In return for lending the money, the individuals or institutions become creditors and receive a promise the principal and interest on the debt will be repaid.

68

Why would someone choose debt financing over equity financing?

Debt financing can be difficult to obtain, but for many companies, it provides funding at lower rates than equity financing, especially in periods of historically low interest rates. Another perk to debt financing is the interest on debt is tax deductible. Still, adding too much debt can increase the cost of capital, which reduces the present value of the company.

69

Define “Covenants”.

In addition to paying interest, debt financing often requires the borrower to adhere to certain rules regarding financial performance. These rules are referred to as covenants.

70

Define Interest Rates on Debt Financing.

Some investors in debt are only interested in principal protection, while others want a return in the form of interest.

71

Define how the rate interest is determined in Debt Financing.

The rate of interest is determined by market rates and the creditworthiness of the borrower.

72

In Debt Financing, what does higher rates of interest imply?

Higher rates of interest imply a greater degree of default and therefore a higher level of risk. Higher interest rates help to compensate the borrower for the increased risk. On the other side of a high-yield investment is a high-risk borrower.

73

Define how to measure debt financing.

One metric analysts use to measure and compare how much of a company's capital is being financed with debt financing is the debt-to-equity (D/E) ratio. For example, if total debt is $2 billion and total stockholders' equity is $10 billion, the D/E ratio is one to five, or 20%. This means for every $1 of debt financing, there is $5 of equity. In general, a low D/E ratio is preferable to a high one, though certain industries have a higher tolerance for debt than others. Both debt and equity can be found on the balance sheet.

74

Define Equity Financing.

Equity financing is the process of raising capital through the sale of shares in an enterprise. Equity financing essentially refers to the sale of an ownership interest to raise funds for business purposes.

75


In Equity Financing, who are typically the first investors?

Angel Investors
Venture Capitalists

76

In Equity Financing, what do AI & VCs generally prefer?

inclined to favor convertible preferred shares rather than common equity in exchange for funding new companies, since the former have greater upside potential and some downside protection.

77

In Equity Financing, what happens when a company has grown large enough?

Once the company has grown large enough to consider going public, it may consider selling common equity to institutional and retail investors.

78

In Equity Financing, once gone public, what can a company do if it needs additional capital?

Later on, if it needs additional capital, the company may go in for secondary equity financings such as a rights offering or an offering of equity units that includes warrants as a “sweetener.”

79

In Equity Financing, the equity-financing process is governed by regulation imposed by a local or national security authority in most jurisdictions. What is generally done to protect unsuspecting investors from unscrupulous operators?

An equity financing is therefore generally accompanied by an offering memorandum or prospectus, which contains a great deal of information that should help the investor make an informed decision about the merits of the financing.

80

What does the investor’s appetite for equity financing depend on?

Investor appetite for equity financings depends significantly on the state of financial markets in general and equity markets in particular. While a steady pace of equity financings is seen as a sign of investor confidence, a torrent of financings may indicate excessive optimism and a looming market top.

81

Define Initial Public Offering (IPO).

An initial public offering (IPO) is the first time that the stock of a private company is offered to the public. IPOs are often issued by smaller, younger companies seeking capital to expand, but they can also be done by large privately owned companies looking to become publicly traded.

82

In an IPO, the issuer obtains assistance from where? What kind of assistance?

In an IPO, the issuer obtains the assistance of an underwriting firm, which helps determine what type of security to issue, the best offering price, the amount of shares to be issued and the time to bring it to market.

83

An IPO is also referred to as a public offering. When a company initiates the IPO process, a very specific set of events occurs. The chosen underwriters facilitate all of these steps. STEP 1.

An external IPO team is formed, consisting of an underwriter, lawyers, certified public accountants (CPAs) and Securities and Exchange Commission (SEC) experts.

84

An IPO is also referred to as a public offering. When a company initiates the IPO process, a very specific set of events occurs. The chosen underwriters facilitate all of these steps. STEP 2.

Information regarding the company is compiled, including financial performance and expected future operations. This becomes part of the company prospectus, which is circulated for review.

85

An IPO is also referred to as a public offering. When a company initiates the IPO process, a very specific set of events occurs. The chosen underwriters facilitate all of these steps. STEP 3.

The financial statements are submitted for official audit.

86

An IPO is also referred to as a public offering. When a company initiates the IPO process, a very specific set of events occurs. The chosen underwriters facilitate all of these steps. STEP 4.

The company files its prospectus with the SEC and sets a date for the offering.

87

What are the risks of investing in an IPO?


IPOs can be a risky investment. For the individual investor, it is tough to predict what the stock will do on its initial day of trading and in the near future because there is often little historical data to use to analyze the company. Also, most IPOs are for companies that are going through a transitory growth period, which means that they are subject to additional uncertainty regarding their future values.

88

Define Absolute Priority.

An absolute priority is a rule that stipulates the order of payment - creditors before shareholders - in the event of liquidation. The absolute priority rule is used in bankruptcies to decide what portion of payment will be received by which participants. Debts to creditors will be paid first and shareholders (partial owners) divide what remains.

89

Define ‘Appreciation’.

Appreciation is an increase in the value of an asset over time. The increase can occur for a number of reasons, including increased demand or weakening supply, or as a result of changes in inflation or interest rates. This is the opposite of depreciation, which is a decrease over time.

90

What is an example of assets appreciating?

While appreciation of assets in accounting is less frequent, assets such as trademarks may see an upward value revision due to increased brand recognition.

91

Define Capital Appreciation.

capital appreciation refers to an increase in the value of financial assets such as stocks, which can occur for reasons such as improved financial performance of the company.

92

Define Currency Appreciation.

Another type of appreciation is currency appreciation. The value of a country's currency can appreciate or depreciate over time in relation to other currencies.

93

What is the main difference between appreciation vs depreciation.

Certain assets are given to appreciation, while other assets tend to depreciate over time. As a general rule, assets that have a finite useful life depreciate rather than appreciate.

94

Why do companies issue different classes of stock?

The most common reason for this is the company wanting the voting power to remain with a certain group; therefore, different classes of shares are given different voting rights. For example, one class of shares would be held by a select group who are given ten votes per share while a second class would be issued to the majority of investors who are given one vote per share.

95

Define Class A Shares.

Class A shares refers to a classification of common stock that is accompanied by more voting rights than Class B shares, usually given to a company's management team.

96

Why do companies issue class A Shares?

Class A shares are used to provide a company's management team with voting power in a volatile public market. Since these types of shares carry a higher amount of votes per share, it helps keep control of the company in the hands of senior management, C-level executives and the board of directors.

97

Define Class B Shares.

Class B shares are a classification of common stock that may be accompanied by more or fewer voting rights than Class A shares.

98

What should you watch out for with Class A and B shares?

Although Class A shares are often thought to carry more voting rights than Class B shares, this is not always the case: Companies will often try to disguise the disadvantages associated with owning shares with fewer voting rights by naming those shares "Class A" and those with more voting rights "Class B."

99

Define Primary Market.

A primary market issues new securities on an exchange for companies, governments and other groups to obtain financing through debt-based or equity-based securities.

100

Define Secondary Market.

The secondary market is where investors buy and sell securities they already own. It is what most people typically think of as the "stock market," though stocks are also sold on the primary market when they are first issued.

101

Give two examples of secondary markets.

The national exchanges, such as the New York Stock Exchange (NYSE) and the NASDAQ, are secondary markets.

102

The New York Stock Exchange - History

The most prestigious exchange in the world is the New York Stock Exchange (NYSE). The "Big Board" was founded over 200 years ago in 1792 with the signing of the Buttonwood Agreement by 24 New York City stockbrokers and merchants. Currently the NYSE, with stocks like General Electric, McDonald's, Citigroup, Coca-Cola, Gillette and Wal-mart, is the market of choice for the largest companies in America.

103

The New York Stock Exchange - Size

The New York Stock Exchange (NYSE) is a stock exchange based in New York City that is considered the largest equities-based exchange in the world, based on total market capitalization of its listed securities.

104

The New York Stock Exchange – Mergers

Formerly run as a private organization, the NYSE became a public entity in 2005 following the acquisition of electronic trading exchange Archipelago. The parent company of the New York Stock Exchange is now called NYSE Euronext, following a merger with the European exchange in 2007; the NYSE Euronext was acquired by Intercontinental Exchange.

105

In the New York Stock Exchange, what is a specialist?

A specialist is a member of a stock exchange who acts as the market maker to facilitate the trading of a given stock. The specialist holds an inventory of the stock, posts the bid and ask prices, manages limit orders and executes trades.

106

In the NYSE, what is the specialist’s role?

If there is a large shift in demand on the buy or sell side, the specialist steps in and sells off his own inventory as a way to manage large movements and to meet the demand until the gap between supply and demand narrows.

107

What is an ‘Auction Market’?

An auction market is a market in which buyers enter competitive bids, and sellers enter competitive offers at the same time. The price at which a stock is traded represents the highest price that a buyer is willing to pay and the lowest price that a seller is willing to sell.

108

Define Double Auction Markets

An auction market is also referred to as a double auction market. It allows buyers and sellers to submit prices they deem acceptable to a list. When a match between a buyer’s price and a seller’s asking price is made, the trade proceeds at that price. Trades without matches will not be executed.

109

Define Treasury Auctions

The U.S. Treasury holds auctions in order to finance certain government financial activities. The auction is open to the public as well as to various larger investment entities. Bids are submitted electronically and are divided into competing and non-competing bids, depending on the person or entity who places the recorded bid.

110

What is the Nasdaq?

A global electronic marketplace for buying and selling securities, as well as the benchmark index for U.S. technology stocks.

111

What is the history of the Nasdaq?

Nasdaq was created by the National Association of Securities Dealers (NASD) to enable investors to trade securities on a computerized, speedy and transparent system, and commenced operations on February 8, 1971.

112

What is the Nasdaq composite?

The term “Nasdaq” is also used to refer to the Nasdaq Composite, an index of more than 3,000 stocks listed on the Nasdaq exchange that includes the world’s foremost technology and biotech giants such as Apple, Google, Microsoft, Oracle, Amazon, Intel and Amgen.

113

What is Nasdaq OMX?


In 2007, it combined with the Scandinavian exchange group OMX to become the Nasdaq OMX group, which is the largest exchange company globally, powering 1 in 10 of the world’s securities transactions.

114

How does the Nasdaq operate?

Headquartered in New York, Nasdaq OMX operates 26 markets – primarily equities, and also including options, fixed income, derivatives and commodities – as well as three clearinghouses and five central securities depositories in the U.S. and Europe.

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How is the Nasdaq listed?

It is listed on the Nasdaq under the symbol NDAQ and has been part of the S&P 500 since 2008.

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How do ‘Over-The-Counter – OTC’ exchanges relate to Formal Exchanges?

Over-the-counter (OTC) is a security traded in some context other than on a formal exchange such as the New York Stock Exchange (NYSE), Toronto Stock Exchange or the NYSE MKT, formerly known as the American Stock Exchange (AMEX).

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What is ‘Over-The-Counter – OTC’


The phrase "over-the-counter" can be used to refer to stocks that trade via a dealer network as opposed to on a centralized exchange. It also refers to debt securities and other financial instruments, such as derivatives, which are traded through a dealer network.

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Explain securities on OTC Networks.

Stocks are usually traded OTC because the company is small and cannot meet exchange listing requirements. Also known as unlisted stock, these securities are traded by broker-dealers who negotiate directly with one another over computer networks and by phone.

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What is ‘Market Maker’

A market maker is a broker-dealer firm that assumes the risk of holding a certain number of shares of a particular security in order to facilitate the trading of that security.

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What is a ‘Bid’

A bid is an offer made by an investor, a trader or a dealer to buy a security, commodity or currency. It stipulates both the price the potential buyer is willing to pay and the quantity to be purchased at that price. Bid also refers to the price at which a market maker is willing to buy; unlike a retail buyer, a market maker also displays an ask price.

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What is a ‘Ask’

Ask is the price a seller is willing to accept for a security, which is often referred to as the offer price. Along with the price, the ask quote might also stipulate the amount of the security available to be sold at that price. Bid is the price a buyer is willing to pay for a security, and the ask will always be higher than the bid.

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What is a ‘Spread’

The spread between the bid and the ask is an indicator of supply and demand for the financial instrument in question. The more interest that investors have, the tighter the spread.

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In finance, there are 5 ways the term spread is used:

Bid-Ask Spread
Spread Trade
Option-adjusted Spread
Z-Spread

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Bid-Ask Spread

The bid-ask spread is also known as the bid-offer spread and buy-sell. Their equivalents use slashes instead of dashes. For securities like futures contracts, options, currency pairs, and stocks, the bid-offer spread is the difference between the prices given for an immediate order – the ask – and an immediate sale – the bid. One of the uses of the bid-ask spread is to measure the liquidity of the market and the size of the transaction cost of the stock.

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Spread Trade

The spread trade is also called the relative value trade. Spread trades are the act of purchasing one security and selling another related security as a unit. Usually, spread trades are done with options or futures contracts. These trades are executed to produce an overall net trade with a positive value called the spread.

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Yield Spread

The yield spread is also called the credit spread. The yield spread shows the difference between the quoted rates of return between two different investment vehicles. These vehicles usually differ regarding credit quality. Some analysts refer to the yield spread as the “yield spread of X over Y”. This is usually the yearly percentage return on investment of one financial instrument minus the annual percentage return on investment of another.

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Option-adjusted Spread

To discount a security’s price and match it to the current market price, the yield spread must be added to a benchmark yield curve. This adjusted price is called option-adjusted spread. This is usually used for mortgage-backed securities (MBS), bonds, interest rate derivatives, and options. For securities with cash flows that are separate from future interest rate movements, the option-adjusted spread becomes the same as the Z-spread.

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Z-Spread


The Z-spread is also called the Z SPRD, yield curve spread, and zero-volatility spread. The Z-spread is used for mortgage-backed securities. It is the spread that results from zero-coupon Treasury yield curves which are needed for discounting pre-determined cash flow schedule to reach its current market price. This kind of spread is also used in credit default swaps (CDS) to measure credit spread.

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What is the ‘American Stock Exchange – AMEX’

The American Stock Exchange (AMEX) is the third-largest stock exchange by trading volume in the United States. In 2008, it was acquired by the NYSE Euronext and became the NYSE Amex Equities in 2009. The AMEX is located in New York City and handles about 10% of all securities traded in the United States.

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History of AMEX


The American Stock Exchange has roots all the way back to the late 18th century. With the investment trading market still in its infancy, brokers gathered at coffeehouses and on the street to exchange securities.

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The Curbstone Brokers History

Traders in the streets became known as curbstone broker and specialized in trading the stocks of small and emerging companies. Many newly created businesses focused on industries such as railroads, oil and textiles often traded first through the curbstone brokers. In the 19th century, curbside trading was largely disorganized. In 1908, the New York Curb Market Agency was established to create a framework of rules and regulations surrounding trading practices.

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The New York Curb Exchange

In 1929, the New York Curb Market became the New York Curb Exchange. It adopted an additional set of rules and standards to govern its practices and expanded its trading floor to accommodate the additional volume. In the 1950s, a growing number of new and emerging businesses traded their stocks on the New York Curb Exchange as the value of listed companies jumped from $12 billion in 1950 to $23 billion in 1960.

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1953 Milestone for the American Stock Exchange

In 1953, the New York Curb Exchange officially changed its name to the American Stock Exchange. It became known as an exchange where new products were developed and traded.

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1975 Milestone for the American Stock Exchange

In 1975, the AMEX launched its options market and began delivering educational materials discussing the risks and rewards of this new product.

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1993 Milestone for the American Stock Exchange

In 1993, the American Stock Exchange introduced the first ever exchange-traded fund (ETF), the Standard & Poor's Depository Receipts (SPDR) focused on investing in the Standard & Poor's (S&P) 500 Index.

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2008 Milestone for the American Stock Exchange

In 2008, the AMEX joined the NYSE family of exchanges and enhanced its position in trading equities, options, ETFs and closed-end funds.

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NASD

The National Association of Securities Dealers (NASD) was the self-regulatory organization of the securities industry responsible for the operation and regulation of the NASDAQ stock market and over-the-counter markets. It also administrated exams for investment professionals, such as the Series 7 exam. The NASD was charged with watching over the NASDAQ’s market operations; however, in 2007, it was merged with the Financial Industry Regulatory Authority (FINRA).

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Small Cap

Small cap is a term used to classify companies with a relatively small market capitalization.

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Advantages of investing in small-cap stocks

One of the biggest advantages of investing in small-cap stocks is the opportunity to beat institutional investors. Because mutual funds have restrictions that limit them from buying large portions of any one issuer's outstanding shares, some mutual funds would not be able to give the small cap a meaningful position in the fund. To overcome these limitations, the fund would usually have to file with the SEC, which means tipping its hand and inflating the previously attractive price.

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There are two main advantages in investing in small cap stocks, what’s first?

As a general rule, small-cap companies offer investors more room for growth but also confer greater risk and volatility than large-cap companies, which have market capitalization of $10 billion or greater. With large-cap companies, such as General Electric and Boeing, the most aggressive growth tends to be in the rear-view mirror, and as a result, such companies offer investors stability more than big returns that crush the market.

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There are two main advantages in investing in small cap stocks, what’s second?

Historically, small-cap stocks have outperformed large-cap stocks. Having said that, whether smaller or larger companies perform better varies over time based on the broader economic climate. For example, large-cap companies dominated during the tech bubble of the 1990s, as investors gravitated toward large-cap tech stocks such as Microsoft, Cisco and AOL Time Warner. After the bubble burst in March 2000, small-cap companies became the better performers until 2002, as many of the large-caps that had enjoyed immense success during the 1990s hemorrhaged value amid the crash.

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Mid-cap stock advantage

Investors wanting the best of both worlds might consider mid-cap companies, which have market capitalizations between $2 billion and $10 billion. Historically, these companies have offered more stability than small-cap companies yet confer more growth potential than large-cap companies.

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What is the ‘London Stock Exchange – LSE’

The primary stock exchange in the U.K. and the largest in Europe. Originated in 1773, the regional exchanges were merged in 1973 to form the Stock Exchange of Great Britain and Ireland, later renamed the London Stock Exchange (LSE). The Financial Times Stock Exchange (FTSE) 100 Share Index, or "Footsie", is the dominant index, containing 100 of the top blue chips on the LSE.

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What is the ‘Over-The-Counter Bulletin Board – OTCBB’

The over-the-counter bulletin board (OTCBB) is an electronic trading service provided by the National Association of Securities Dealers (NASD) that offers traders and investors up-to-the-minute quotes, last-sale prices and volume information for equity securities traded over the counter (OTC).

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How does a company get listed in the OTCBB?

All companies listed on this exchange must file current financial statements with the Securities and Exchange Commission (SEC) or a regulator. Different from listings on the Nasdaq and New York Stock Exchange (NYSE), there are no listing requirements for companies listing stocks on the OTCBB.

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Penny Stocks


A penny stock typically trades outside of the major market exchanges at a relatively low price and has a small market capitalization. These stocks are generally considered highly speculative and high risk because of their lack of liquidity, large bid-ask spreads, small capitalization and limited following and disclosure. They often trade over-the-counter through the OTC Bulletin Board (OTCBB) and pink sheets.