Chapter 6 Flashcards
Corporation
A legal form of business that provides owners (shareholders) with protection from losing more than their investment if the business fails.
run by boards of directors who appoint officers, such as the CEO, the CFO, and the COO.
Limited liability
The legal provision that shields owners (shareholders) of a corporation from losing more than they have invested in the firm.
Dividend
A payment that a corporation makes to stockholders, typically on a quarterly basis
Preferred Stock
Holders of preferred stock receive fixed dividends set when the stock is first issued
Common stock
Holders of common stock receive dividends that may fluctuate with the profitability of the firm
Preferred vs Common Stock
- If the company suspends its dividend temporarily and then decides to reinstate it, the company must pay the dividends promised to preferred stockholders before paying holders of common stock.
- If a corporation declares bankruptcy, creditors and bondholders are paid first, followed by holders of preferred stock. Common stockholders are paid only if there are any funds left after preferred stockholders are paid
the firm’s Market Capitalization
is the total market value of a firm’s common and preferred stock
Stock exchange
A physical location where stocks are bought and sold face-to-face on a trading floor.
ex. NYSE
Over-the-counter market
A market in which financial securities are bought and sold by dealers linked by computer.
ex. NASDAQ
Publicly traded company
A corporation that sells stock in the U.S. stock market; only 5,100 of the 5 million U.S. corporations are publicly traded companies.
Stock indexes
-Are averages of stock prices
- Measures overall performance of the stock market
ex. the Dow Jones Industrial Average, S&P 500, and NASDAQ
Composite Average
(move broadly together)
Stock Market Influence/
Affect of change
Economists believe that fluctuations in stock prices can affect the economy by affecting the spending of
households and firms. Large corporations use the stock market as an important source of funds for
expansion. When stock prices rise, so does household wealth, which affects consumer spending. Perhaps
the most important consequence of fluctuations in stock prices may be their effect on the expectations of
consumers and firms. Stock market fluctuations can heighten uncertainty and lead households and firms
to postpone their spending.
Stock Price Determination
The price of any financial asset is equal to the present value (PV) of the payments (cash flows) to be received from owning it.
‘required rate of return’.
To discount cash flows from a stock investment we use a rate that represents investors’ expected return on alternative investments of comparable risk to the stock of the company under consideration.
Required return on equities, rE:
The expected return necessary to compensate for the risk of investing in stocks.
-From the viewpoint of firms, rE is the rate of return they need to pay to attract investors, so it is called the equity cost of capital.
