Chapter 14 Flashcards
Why do corporations issue common stock? (5)
to raise money for startup costs/expansion/business activities; don’t have to repay money a stockholder pays for stock; investors can sell shares to another investor; dividends not mandatory but corporations distribute 30-70% of earnings to stockholders; common stockholders have voting rights
Define private corporation.
stock held by a few people and not traded openly on stock markets
Define public corporation.
stock held widely and traded openly on stock markets
Corporations must accommodate stockholders by (4)
holding annual meetings; allowing stockholders to elect a board of directors and approve major policy changes; allowing for pre-emptive rights; distributing quarterly and annual reports
Investors can make money in what two ways?
income from dividends in the form of cash or additional stock; dollar appreciation of stock value
What happens when a corporation splits its stock? (3)
shares owned by existing stockholders are increased into a larger number of shares; price per share is reduced by proportionate amount; total value unchanged
The ex-dividend date is set
two business days before the record date
What is the record date?
cut-off date established by a company in order to determine which shareholders are eligible to receive a dividend or distribution
What is the payable date?
date that any declared stock dividends are due to be paid out
Give four examples of the dates for common shareholders.
May 14 (eligible for dividend); May 17 (ex-dividend date); May 19 (record date); June 10 (payable date)
What is the ex-dividend date?
the day the stock starts trading without the value of its next dividend payment
What is preferred stock?
a “middle” investment representing a “callable”
ownership position between common stock and
corporate bonds
What is the biggest difference between common and preferred stock?
preferred stockholders receives cash dividends before common stockholders are paid any cash dividends
Why would an investor choose preferred stock over common stock?
preferred stock is a more predictable source of income because you own the stock and know the rate of return
Which stock has higher dividends, common stock or preferred stock?
preferred stock
Describe cumulative preferred stock.
Unpaid cash dividends accumulate and must be paid before cash dividends are paid to the common stockholders
Describe convertible preferred stock.
Can be traded for shares of common stock in the same company
If a company goes bankrupt, what is the order of payments?
taxing authorities at all levels; secured creditors; unsecured bond holders; preferred stock holders; common stock holders
Give two examples of blue-chip stock.
AT&T; Coke
Give two examples of cyclical stock.
GM, Whirlpool
Give two examples of defensive stock.
P&G; Kimberly Clark
Give two examples of growth stock.
Target; Netflix
Give two examples of income stock.
McDonald’s; IBM
Give two examples of large cap stock.
Apple; Dow Chemical
Give two examples of mid cap stock.
Ulta; Best Buy
Give two examples of small cap stock.
Bankrate; Fossil
Give an example of micro cap stock.
PC Connection
Give two examples of penny stock.
Avon; Groupon
Give three examples of stock advisory services.
Standard and Poor’s reports; Value Line; Morningstar
What is the formula for rate of return?
(ending value of investment - beginning value of investment) / beginning value of investment * 100
What six categories of information does the federal government require companies to disclose to the public?
earnings; assets; liabilities; products; services; management qualifications
Define earnings per share (EPS).
corporation’s after-tax earnings divided by the number of outstanding shares of a common stock
Define price-earnings (P/E) ratio.
price of one share of stock divided by the earnings per share of stock over the last 12 months.
Dividend payout =
(annual dividend amount) / EPS
Dividend yield =
(annual dividend amount) / price per share
Total return =
total dividends + capital gain
Annualized holding period yield =
(total return / original investment) * (1/N), where N = number of years investment is held
What is beta?
measure of volatility
A beta value of 1 indicates
that a stock’s risk is equal to the market’s risk
A beta value of 2 indicates
that a stock’s risk is twice that of the market
What is the formula for book value?
(assets - liabilities) / shares outstanding
Book value equals
net worth per share
If a share costs more than the book value,
the stock may be overpriced
What is the formula for market-to-book ratio?
(market value per share) / (book value per share)
A low market-to-book value indicates
undervalued stock
A high market-to-book value indicates
overvalued stock
What are the two main investment theories?
active; passive
What is the active investment theory?
doing research to determine which stock or sector will outperform the market, using fundamental analysis and technical analysis
What is the passive investment theory?
believe few can predict future, so instead, diversify very well
What is fundamental analysis?
based on the assumption that a stock’s intrinsic/real value is determined by the company’s future earnings
Give an example of a fundamentalist.
Warren Buffet
Warren Buffet considers what aspects of a company, in the context of fundamental analysis?
financial strength of the company; type of industry; new-product development; economic growth of the overall economy
What is technical analysis?
based on the assumption that a stock’s value is based on the forces of supply and demand in the stock market as a whole
What do chartists do?
plot past price movements and other market averages to observe trends they use to predict a stock’s future value
The efficient market theory falls into which of the two investment theories?
passive
What are the main points of the efficient market theory?
based on assumption that stock price movements are purely random; stock’s current market price reflects true value; impossible for investor to systematically outperform average for stock market as a whole over time; be well diversified
What percent of U.S. mutual fund managers beat the S&P 500 index fund in 2010?
32%
What percent of U.S. mutual fund managers beat the S&P 500 index fund over an annualized 15 year period?
17%
What percent of U.S. mutual fund managers beat the S&P 500 index fund every year for the past five years??
<1%
Which investment strategy has the highest average annual total returns?
buy and hold strategy
Define primary market.
market in which an investor purchases financial securities through investment bank (or other representative) from issuer of those securities
Define investment bank.
firm that assists corporations in raising funds, usually by helping to sell new security issues
When does an IPO occur?
when corporation sells stock to the general public for the first time
Define secondary market.
market for existing financial securities that are currently traded among investors through brokers
Give two examples of secondary markets.
NYSE, NASDAQ
Define security exchanges.
Marketplace where member brokers who represent investors meet to buy and sell securities
Most over-the-counter securities are traded on
NASDAQ
How many stocks does NASDAQ have?
3,100
Define market order.
request to buy or sell stock at the current market value when executed
Define limit order.
request to buy or sell a stock at a specific price or better
Define stop (loss) order.
request to sell a stock at the next available opportunity after its market price reaches a specified amount
What is dollar cost averaging?
buy equal dollar amount of stock at equal time periods (i.e. $3,000 worth of XOM every quarter)
What is direct investment?
buy stock from corporation
What is the dividend re-investment plan?
reinvest cash dividends to buy additional shares of stock
Give four examples of long-term investing techniques.
buy and hold; dollar cost averaging; direct investment; dividend re-investment plan
Give four examples of short-term investing techniques.
day trading; buying stock on margin; selling short; trading in options (call option, put option)
Define buying stock on margin.
borrowing up to 50% of stock purchase to have more shares
Define selling short.
borrowing stock to make profits when stock prices are falling
Define trading in options.
right to buy (call) or sell (put) at predetermined price during specified time period
Give an example of a call option.
$20 stock with $23 exercise price and $1 fee — make profit once stock rises above $24
Give an example of a put option.
$20 stock with a $16 exercise price and $1 fee — make profit once stock falls below $!5
