S11: Equity Securities

Question 1

Equity Securities

Answer 1

Issued by a firm to raise money for projects, investors contribute money to firm in exchange for a % of ownership

Question 2

Bankruptcy

Answer 2

Inability to meet DEBT obligations, an all equity firm can’t go bankrupt

Question 3

Raising Capital

Answer 3

Often a mix of debt and equity, optimal mix depends on a firm’s financial position, stage of development, and market conditions

Question 4

Cost of Debt

Answer 4

Interest, coupons, yields

Question 5

Cost of Equity (Riskier)

Answer 5

Dividends (if paid), give up ownership, capital gains

Question 6

Common stock rights

Answer 6

Voting at firm’s annual meeting, dividends if paid, residual claim, preemptive rights

Question 7

Residual Claim

Answer 7

What remains after debt paid if liquidation occurs

Question 8

Preemptive Rights

Answer 8

Sometimes have ability to buy new stock first before it is offered to public, not common but beneficial for shareholders who don’t want their ownership to be diluted if more equity is raised

Question 9

Voting

Answer 9

Generally 1 share = 1 vote, thus large shareholders can exert significantly more influence

Question 10

Deal Class Share Structure (voting)

Answer 10

Some shares have more than 1 vote to protect founders’ power over the firm

Question 11

Straight Voting (voting)

Answer 11

Cast votes for each director

Question 12

Cumulative Voting (voting)

Answer 12

Cast all votes for one or few directors (may give more power to smaller voters, uncommon in US)

Question 13

Proxy (voting)

Answer 13

Submitting vote via ballot or a grant of authority to another individual to vote your share(s)

Question 14

Proxy Fight (voting)

Answer 14

Occurs when shareholders attempt to oust existing directors by soliciting proxies from other dissatisfied voters

Question 15

Staggered/Classified Boards (voting)

Answer 15

Occurs when firm only has some of their directors up for election at an annual meeting rather than all - unpopular with stakeholders bc it protects management

Question 16

Preferred Stock

Answer 16

Equity shares that pay cumulative dividends, no voting rights and may be callable, payed before common stock in liquidation events

Question 17

Cumulative Dividends

Answer 17

If dividends are skipped, payouts build and must be paid first before common stockholders receive any dividends

Question 18

Why are banks and financial institutions among the largest issuers of preferred stock?

Answer 18

It allows them to raise capital while maintaining legal capital requirements (e.g. debt to equity ratio)

Question 19

Equity Primary Markets

Answer 19

Firm raises money through the sale of stocks or bonds (such as an IPO)

Question 20

Equity Secondary Markets

Answer 20

Equity securities exchange hands among dealers, brokers, and investors (firm itself doesn’t make $)

Question 21

Dealers

Answer 21

Own inventories of securities and make $ through bid-ask spread. This is more risky than being a broker because they actually need to by the securities and can lose money if no one wants to by them

Question 22

Brokers

Answer 22

Match traders and transact on their client’s behalf. They make $ through commissions and fees from matching buyers and sellers.

Question 23

Broker-Dealers

Answer 23

Serve both roles as intermediary by matching buyers and sellers or trading from their own account

Question 24

Exchanges and Dealer Networks

Answer 24

Venues where trading of securities takes place

Question 25

Electronic Communication Networks (ECN)

Answer 25

Match buyers and sellers directly via electronic networks

Question 26

New York Stock Exchange (NYSE)

Answer 26

In person exchange with floor brokers and designated market

Question 27

Floor Broker

Answer 27

Receive requests from their clients to buy or sell a stock, then seek out a dealer on NYSE floor (DMM)

Question 28

Designated Market Maker (DMM)

Answer 28

Buy or sell shares, or can match them with another broker who has that stock

Question 29

National Association of Securities Dealers Automated Quotations (NASDAQ)

Answer 29

An electronic market of dealers only, they post their bid and ask prices and transact directly with one another by trading over the counter virtually

Question 30

Capital Market Efficiency

Answer 30

Stock prices vary through time as buyers and sellers of securities bid up prices of securities or sell out and reduce their price. Their actions are based on reactions to news info, practically immediately, after news comes to market

Question 31

Efficient Market Hypothesis

Answer 31

Idea that security prices reflect all available information - thus stock prices “effectively” reflect news and info

Question 32

High Frequency Traders (HFT)

Answer 32

Making thousands of transactions per second, like Citadel, need to be slowed down by speed bumps at times

Question 33

Speed Bump

Answer 33

Actual physical long wires between HFTs and trading network to slow them down

Question 34

Weak Form Market Efficiency

Answer 34

Security prices reflect all past and publicly known stock price info, looking forward analysis may be helpful

Question 35

Semi-Strong Form Market Efficiency

Answer 35

Security prices reflect everything in weak form as well as investor’s expectations about the future, insider info is useful but illegal

Question 36

Strong Form Market Efficiency

Answer 36

Security prices reflect everything before as well as private info

Question 37

Intrinsic Value of Stock

Answer 37

Price qual to the “true” value with all possible news already included