Lecture 5 - Share Markets Flashcards
What are internally generated funds?
Cash reinvested in the firm; depreciation plus earnings not paid out as dividends.
What is the financial deficit?
The difference between the cash companies need and the amount generated internally.
How does a company make up a deficit?
Either borrow or issue new shares.
High debt ratios mean that more companies are likely to…
Fall into financial distress when a serious recession hits the economy.
What is treasury stock?
Stock that has been repurchased by the company and is held in its treasury.
The shares held by investors are said to be…
Issued and outstanding shares.
By contrast, treasury shares are said to be…
Issued but not outstanding.
What are issued shares?
Shares that have been issued by the company.
What are outstanding shares?
Shares that have been issued by the company and are held by investors.
What is authorised share capital?
Maximum number of shares that the company is permitted to issue without shareholder approval.
What is par value?
Value of security shown in the company’s account. It has little economic significance.
What is the additional paid in capital?
Difference between issue price and par value of stock. Also called capital surplus.
What are retained earnings?
Earnings not paid out as dividends. Profits that could be paid out as dividends are instead plowed back into the company (reinvested profits).
What are dividends?
Periodic cash distribution from the firm to the shareholders. It represents part of the return on the capital directly or indirectly lent to the company. They are not a liability until declared so cannot bankrupt a company - would not voluntarily bankrupt itself. They are paid out of after tax profits.
What is book value?
It is the value shown in the firm’s balance sheet. Book value records all the money that a firm has raised from its shareholders plus all the earnings that have been plowed back on their behalf. It is a backward looking measure and does not measure the value that shareholders place on those shares today. It is calculated as the difference between total assets and total liabilities. It does not capture the true value of a business.
What is market value?
This value is forward looking and depends on the future dividends that shareholders expect to receive. The market value represents the value of a company according to the stock market. It is the amount that investors are willing to pay for the shares of the firm. This depends on the earning power of todays assets and the expected profitability of future investments.
What is liquidation value?
Net proceeds that could be realised by selling the firm’s assets and paying off its creditors. The amount of cash per share a company could raise if it sold off all its assets in secondhand markets and paid off all its debts. It does not capture the value of a successful going concern.
The difference between a company’s actual value and its book or liquidation value is often attributed to its going concern value, which refers to what three factors?
Extra earning power - a company may have the ability to earn more than adequate rate of return on assets. In this case the value of those assets will be higher than their book value or secondhand value. Intangible assets - experience, expertise and knowledge are crucial assets and their values do not show up in stock prices.
Value of future investments - if investors believe a company will have the opportunity to make very profitable investments in the future, they will pay more for the company’s stock today.
What are the two features that determine a firms profits?
The earnings that can be generated by the firm’s tangible and intangible assets and the opportunities the firm has to invest in lucrative projects that will increase future earnings.
What is market capitalisation?
The total value of outstanding shares of stock. It can be calculated by multiplying a company’s outstanding shares by its current market price.
What is P/E ratio?
Ratio of stock price to earnings per share. It is the ratio of price per share to earnings per share.
What is dividend yield?
It is the forward dividend divided by previous close. It tells you how much dividend income you would receive for every $100 invested in the stock. It is like current yield of a bond. They both ignore prospective capital gains or losses.
Who owns a corporation?
A corporation is owned by its common stockholders. Some of the common stock is owned directly by individual investors but much of it is held by financial institutions such as mutual funds, pension funds and insurance companies. Stockholders are entitled to whatever profits are left over after the lenders have received their due. Usually the company pays out part of these profits as dividends and plows back the remainder into new investments. Shareholders hope that these investments will enable the company to earn higher profits and pay higher dividends in the future. Shareholders have ultimate control over how the company is run.
What do the board of directors do?
The board of directors have a duty to represent the shareholders’ interest. They appoint and oversee management and must vote to approve financial decisions including major capital investments, payment of dividends, share repurchase programs and new stock issues.
What is majority voting?
Voting system in which each director is voted on separately. Each director is voted separately, and stockholders cast one vote for each they own.
What is cumulative voting?
Voting system in which all votes that one shareholder is allowed to cast can be cast for one candidate for the board of directors. The directors are voted on jointly and stockholders can cast all their votes just for one candidate.
When might a supermajority vote be needed?
For a merger to be approved.
What is the difference between majority voting and cumulative voting?
Cumulative voting refers to the fact that a shareholder has votes that are equal to the number of shares multiplied by the number of positions the shareholders are voting for. Meanwhile, straight voting refers to the fact that a shareholder may only cast one vote per share that the shareholder has.
What are classified boards?
Allow only a third of directors come up for reelection each year, which makes it more difficult for a dissident group of shareholders to replace the board, leading to entrenched management. Staggered elections appear to protect management, deter proxy contests and reduce the degree to which CEO compensation is linked to firm performance.
What is proxy contest/fight?
Takeover attempt in which outsiders compete with existing management and directors for shareholders’ votes and control of the corporation.
Usually companies have how many classes of common stock?
One class of common stock and each share has one vote.
In some countries it is fairly common for firms to issue two classes of stock with different voting rights. What is good and bad about this?
It may be a good thing if controlling shareholders want to use their influence to improve profitability. However, if an idle or incompetent management has a large block of votes, it may use these votes to stay in control.
What is preferred stock?
Stock that takes priority over common stock. It promises a series of fixed payments to the investor and preferred dividends are paid in full and on time. It is legally an equity security. This is because payment of preferred dividends is within the discretion of the directors. Only obligation is that no dividends can be paid on the common stock until the preferred dividend has been paid. If the company goes out of business, the preferred stockholders get in queue after the debt holders but before the common stockholders.
What is net worth?
The sum of a company’s common equity and preferred stock.
What is common stock?
Ownership shares in a publicly held corporation. Limited liability - shareholders only lose their original investment in the event of failure.
Does preferred stock grant voting privileges?
Preferred stock rarely confers full voting privileges. This is an advantage to firms that want to raise new money without sharing control of the firm with the new shareholders. However, if there is any matter that affects their place in the queue, preferred stockholders usually get to vote on it.
When are common stock and preferred dividends paid?
They are paid from after tax income. This can be a serious deterrent to issuing preferred. If on corporation buy another’s stock, only 50% of the dividends it receives are taxed. This rule applies to dividends on both common and preferred stock, but it is most important for preferred, for which returns are dominated by dividends rather than capital gains.
What is floating rate preferred?
Preferred stock for which the dividend rate is linked to current market interest rates.
What is an initial public offering (IPO)?
First offering of stock to the general public.
What is the primary market?
Market for the sale of new securities by corporations.
