Chapter 13 - The Stock Market

Question 1

Equity/stocks/shares riskier than bonds?

Answer 1

Much riskier than bonds because dividends and prices are not guaranteed. Also no maturity date.

Question 2

Stocks residual claimant

Answer 2

In a default they get what’s left after all other creditors have been paid off

Question 3

equity vs. debt who is senior?

Answer 3

Debt is senior to equity

Question 4

Bull and bear market

Answer 4

Bull market: increase in stock prices

Bear market: decrease in stock prices

Question 5

Types of stocks (2)

Answer 5

Common stock: gives right to vote

Preferred stock: pays fixed dividend, price is stable, no voting rights, have higher seniority than common stock

Question 6

Stocks vs. bonds: trade off between control rights and cash

Answer 6

Stocks: high control rights, low cash flow (uncertain, volatile)
Bonds: low control rights, high cash flow (stable)

Question 7

Stocks vs. bonds: taxation

Answer 7

Equity funding is more costly than debt funding. ROI from bonds is tax-deductible dividends are not.

Question 8

Authorized shares

Answer 8

Maximum number of shares the company can issue during its lifetime.
-decided at the time the firm files registration statement. It can be changed but needs shareholder’s vote-

Question 9

Outstanding shares (2)

Answer 9

of shares company issued

1. Restricted shares: only available in private companies as salaries/bonuses
2. Float: freely bought and sold with no restrictions

Question 10

Secondary stocks market (2)

Answer 10

1. Organized exchanges: NYSE, LSE. Specific trading location, works like an auction market.
2. OTC markets: NASDAQ. All electronic. Dealers/makers stand ready to make a market. Inventory of stocks with set price of buying/selling. Earn different of buy/sell price + commission

Question 11

Organized exchanges (2)

Answer 11

Market orders: executed immediately at market price
Limit orders: buy/sell stock at specific price or better. Certain conditions have to be met for firms to be listed - more liquid and prestige -

Question 12

Stock market indexes (2)

Answer 12

Used to monitor the behavior of a group of stocks to observe the overall market
E.g. Dow Jones, NASDAQ, Dikkei - Price weighted index
E.g. S&P 500 - value weighted index

Question 13

Gordon growth model

Answer 13

Assumes dividend grows at constant rate, g

Question 14

Price earnings valuation

Answer 14

How much the market is willing to pay for $1 of earnings from the firms

Question 15

High price earnings (2) means:

Answer 15

1. Earnings are expected to rise compared to low PE companies
2. Company is low risk. The market pays a premium for its earnings,

High PE= growth/glamor stocks. Low PE= value stocks