Chapter 4 EQUITY MARKETS

Public Equity  When firms go public, they issue stocks in the primary markets in exchange for cash.. In exchange for a lower dividend, convertible preferred stock can be converted to

Chapter 4 – EQUITY MARKETS

Reading & References

 Chapter 10, 11, and 12: Madura (2013), Financial Markets and Institutions South-Western Cengage Learning.

 Chapter 10: Kidwell et al (2012), Financial Institutions, Markets and

Money John Wiley & Sons.

 Chapter 13: Mishkin and Eakins (2012), Financial Markets and Institutions Pearson.

 Chapter 13 and 14: Fabozzi (2010), Foundations of Financial Markets and Institutions 4E.

 Types of equity and equity markets

 Primary vs secondary markets

 Organized vs OTC markets

 The role of equity markets

 Market Participations

 The major stock market indicators

 Group discussion on Vietnam Stock Markets

4.1 Overview of Equity Markets

4.1.1 Private Equity

 Private equity is a business that is privately held and

the owners cannot sell their shares to the public.

 Private equity consists of investors and funds that make

investments directly into private firms or conduct

buyouts of public firms that result in a delisting of

public equity.

 Some business owners hope to go public so that:

 They can obtain financing to support the firm’s

growth

 They can “cash out” by selling their original equity

investment to others.

4

4.1 Overview of Equity Markets

4.1.2 Public Equity

 When firms go public, they issue stocks in the

primary markets in exchange for cash.

 Going public has two effects on the firm.

 It changes the firm’s ownership structure by

increasing the number of owners

 It changes the firm’s capital structure by increasing

the equity investment in the firm.

 Stock markets are like other financial markets in that

they link the surplus units (that have excess funds)

4.1 Overview of Equity Markets

4.1.3 Joint Stock Company

 Joint stock company is a form of organization which is

capable of mobilizing larger amount of capital with provision

of limited liability for owners and affording professional

management to conduct its business

4.1 Overview of Equity Markets

4.1.4 What are stocks?

 At some point, just about every firm needs to raise

money.

 In each case, they have two choices:

 Borrow the money, or

 Raise it from investors by selling them a stake

(issuing shares of stock) in the firm.

 Stock is ownership in a publicly traded company.

 Stock is a claim on the company’s assets and

earnings.

 When you own a share of stock, you are a part owner in the

company with a claim (however small it may be) on every

asset and every penny in earnings

 Individual stock buyers rarely think like owners, and it’s not

as if they actually have a say in how things are done

Nevertheless, it’s that ownership structure that gives a stock

4.1 Overview of Equity Markets

4.1.4 What are stocks?

4.2 Types of Stock

4.2.1 Common Stock

 Common stock is the fundamental ownership claim in a

public or private corporation

 Dividends are discretionary and are thus not guaranteed.

 Common stockholders have the lowest priority claim in the

event of bankruptcy (i.e., a residual claim).

 Limited liability implies that common stockholders can lose

no more than their original investment

 Common stockholders control the firm’s activities indirectly

by exercising their voting rights in the election of the board of

directors

4.2 Types of Stock 4.2.2 Preferred Stock

 Preferred stock represents an equity interest in a firm that usually

does not allow for significant voting rights

 Preferred shareholders share the ownership of the firm with

common shareholders and are therefore compensated only when earnings have been generated

 A cumulative provision on most preferred stock prevents dividends from being paid on common stock until all preferred stock

dividends have been paid

 Because the dividends on preferred stock can be omitted, a firm

assumes less risk when issuing it than when issuing bonds

 Dividends are not tax-deductible for the firm, making preferred

4.2 Types of Stock

4.2.3 Convertible Preferred Stock

 Dividends for preferred shareholders do not grow at the

same rate In bad times, preferred shareholders are

guaranteed, but in good times, they do not benefit from

increased dividends or share price.

 Convertible preferred stock provides a solution to this the trade-off In exchange for a lower dividend, convertible

preferred stock can be converted to common shares at a

certain price (the conversion ratio) The conversion ratio is set by the firm before the stock is issued.

4.3 Equity Markets

 A stock market or equity market is a public entity for the

trading of company stock (shares) and derivatives at an agreed price

13

Source:

Titman at al (2011),

Financial Management

4.3.1 Market Participants

 Broker-Dealers

 Clearing Agencies

 Credit Rating Agencies

 Electronic Communications Networks

4.3.2 Structures of Equity Markets

15

4.3.3.1 Primary Markets & Secondary Markets

 A primary market issues new stocks on an exchange Companies,

governments and other groups obtain financing through debt or

equity based securities, are facilitated by underwriting groups,

which consist of investment banks that will set a beginning price

range for a given security and then oversee its sale directly to

investors.

 Initial public offering (IPO) versus “seasoned” new issue IPO

-Common stock shares of a company being sold for the first time.

 Issue facilitated by investment dealers.

 Specialists in advice, design, and sales.

 Intermediaries between issuer and investor.

 Initial Public Offering (IPO)

 First public sale of a company’s stock.

 Requires the Securities and Exchange Commission (SEC)

approval.

 Three Choices to Market Securities in Primary Market

 Public offering: an offering to sell to the investing public a set

number of shares of a firm’s stock at a specified price

 Rights offering: an offering of a new issue of stock to existing

stockholders, who may purchase new shares in proportion to their

current ownership

 Private Placement: an offering of a company's securities that is

not registered with SEC and is not offered to the public at large

17

4.3.3.1 Primary Markets & Secondary Markets

 Secondary Market: the market in which securities are traded

after they have been issued.

 Role of Secondary Markets

 Provides liquidity to security purchasers

 Provides continuous pricing mechanism

 The U.S has three major stock markets:

 The New York Stock Exchange Euronext (NYSE Euronext).

 The National Association of Securities Dealers Automated

Quotation (NASDAQ).

 The American Stock Exchange (AMEX).

4.3.3.1 Primary Markets & Secondary Markets

4.3.3.2 Organized Exchanges & the-Counter Markets

Over- Each organized exchange has a trading floor where floor

traders execute transactions in the secondary market for their clients

 New York Stock Exchange (NYSE) is by far the largest with two broad types of members

 Floor brokers are either commission brokers or independent brokers

 Specialists can match orders of buyers and sellers

 Listing Requirements - minimum number of shares

outstanding and a minimum level of earnings, cash flow, and revenue over a recent period

19

4.3.3.2 Organized Exchanges & the-Counter Markets

 OTC Bulletin Board - lists stocks that have a price below $1 per

share, which are sometimes referred to as penny stocks.

 Pink Sheets - The OTC market has where even smaller stocks are

4.3.5 Stock Market Indexes

 A stock market index is the composite value of a group of

secondary market-traded stocks

 Stock market indexes are frequently used to monitor the

behavior of a groups of stocks

 Benchmarks to evaluate performance of professional money

managers

 To create and monitor an index fund

 To measure market rates of return in economic studies

 For predicting future market movements by technicians

 As a substitute for the market portfolio of risky assets when

calculating the systematic risk of an asset

21

4.3.5 Stock Market Indexes

 Provide a composite report of market behavior on a given day

 Dow Jones Industrial Average (DJIA)

 Composed of 30 “blue-chip” stocks

 Price weighted

 S&P 500 Composite Index

 Composed of 500 “large” firm stocks

 Market value weighted

 Nikkei 225 Average

 Price weighted index of 225 actively-traded stocks on the

Tokyo Stock Exchange

4.3.6 Main Types of Orders

23

Limit Orders

• Order specifies the

buy or sell price

• Time specifications

for order may vary:

Instantaneous “fill or

kill”, part of a day, a

full day, several

4.3.7 Other concepts

a Short Sales of Stock

 Sell overpriced stock that you don’t own and

purchase it back later (hopefully at a lower price).

 Borrow the stock from another investor (through

your broker).

 Can only be made on an uptick trade.

 Must pay any dividends to lender.

 Margin requirements apply.

4.3.7 Other concepts

c Reading a Stock Table

 Ticker Symbol – the alphabetic name that identifies the stock.

 Price - current stock price

 Open - current day’s opening price

 Close - the last trading price from the previous day

 Net Change - the net change from the previous day

 Day’s Range - the current day’s price range

 52-Week Hi and Low - the highest and lowest prices at which a stock has traded

over the past year

 Trading Volume - the total number of shares traded for the day

 Market Capitalization - the market value of the company

 Dividend Per Share - annual dividend payment per share.

Reading a Stock Table (cont’ed)

27

Source:

Titman at al (2011),

Financial Management

GROUP DISCUSSION Vietnam Stock Markets

- Organizational structure of the market

 Financial oversight framework

 Law and Regulations (find the details on the E-learning)

 VN-Index performance (from July 2000 – July 2016)

 Market Trading (Time, Trading system, Trading priorities,

Daily Price limit, Types of order, Settlement cycle)

 Reading a Stock Table:

http://dautucophieu.net/Huong-dan-cach-xem-Bang-gia-Chung-khoan-p78.html