finance_handout for prelim

8/9/2019 Finance_Handout for Prelim

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FINA100 Basic Business FinanceThe Stock Market

The Stock Market

1. There are many ways to increase capitalization of a firma. The most popular are debt financing and equity financing.

2. Key Terms

a. Capitali. The long term funds of a firm

b. Debt capitali. All long term borrowing incurred by a firm

c. Equity Capitali. The long term funds provided by the firms owners, the

stockholders

Can be obtained internallyo Instead of paying stockholders dividend, the

company retains it to be used (retainedearnings)

Can also be obtained externallyo Sell common or preferred stock

3. Concepts and Key Characteristics of Stocksa. When a new corporation is organized, its charter must indicate

the maximum number of shares of stock it can issueb. Authorized Capital

i. The number of shares of common stock that a firmscorporate charter allows it to issue

ii. The firm cannot sell more shares than the charterauthorizes without obtaining approval through ashareholder vote

iii. The Board of Directors, with the approval of thestockholders and the SEC may amend the CorporationsCharter to increase its authorized capital.

c. Issued sharesi. The number of shares that have been put into circulationii. The sum of outstanding shares and treasury stock

d. Outstanding sharesi. The number of shares held by the public other than the

corporation itselfe. Treasury stock

i. This refers to reacquired sharesii. Treasury stock can be re-issued to the public without

obtaining shareholders approvalf. Stock can either be common or preferred.

4. Common Stocka. Corporations issue at least one class of common stock in the

form of shares

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b. Sometimes common stockholders are called residual ownersbecause they receive what is left after all other claims on thefirms income and assets have been satisfied

5. Features of Common Stocka. Stock ownership

i. Privately Owned Stock : all common stock of a firm isowned by a single individual.

ii. Closely Owned Stock : all common stock of a firm is ownedby a small group of investors.

iii. Public Owned Stock : common stock of a firm is owned by abroad group of unrelated individuals or institutionalinvestors.

b. Par Valuei. Stated Value: are bookkeeping items only and bear no

relationship to the original price of the common stock.ii. Book Value : tangible net asset value per share

If a corporation is to be liquidated, this is the amounta stockholder is supposed to receive for each sharehe owns.

iii. Current Market Value : the price which someone is willing topay for each share

If the shares are listed on an exchange, this is thelast trading price of the share.

c. Pre-emptive Rightsi. Permits the current shareholders, if they so choose, to

maintain their proportionate share of ownership in thecorporation by buying additional shares before selling tothe public.

ii. Prevents the dilution of ownership

Dilution of Ownershipo results in the dilution of earnings because each

present shareholder has a claim on a smallerpart of the firms earnings than previous

d. Voting Rightsi. Each share of common stock entitles its holder to one vote

in the election of directors and on special issues.ii. Two methods of voting:

Statutory votingo A stockholder may vote for every directorship a

maximum number of votes equal to thenumber of shares he or she owns.

o Example

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If 5 directors are to be elected, a holderof 100 shares may cast 100 votes foreach of 5 positions to be filled.

Cumulative votingo A stockholder may spread his total votes

among the number of positions to be filled inany manner

o Example:

A holder with 100 shares may cast allhis/her 500 votes for one candidate (or

200 for one candidate and 300 foranother).

iii. When stockholders cannot attend the annual meeting tovote they may assign a proxy statement transferring theirvotes to another party.

e. Dividendsi. Dividends are declared out of the unrestricted retained

earnings (or accumulated profits) of the companyii. The Board of Directors of a corporation decides whether

dividends will be declared or not.iii. Stockholders cannot demand that dividends be paid even if

the company is profitable.iv. Three types of dividends:

Cash dividendso Paid to stockholder in cash

Stock dividendso Stockholders are given additional shares of the

company as dividends.

Property dividendso Although rarely done, the Board of Directors

may also payout dividends in the form of

assets.6. Issuing Common Stocks

a. When a firm wishes to sell its stock in the primary market it hasthree alternatives

i. Public offering

It offers its shares for sale to the general public.

Initial Public Offeringo the first public sale of a firms stock

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ii. Rights offering

new shares are sold to the existing stockholdersiii. Private placement

the firm sells new securities directly to an investor orgroup of investors

iv. Stock optionb. All securities are initially issued in the primary market

i. Primary market

Financial market in which securities are initiallyissued

The only market in which the issuer is directlyinvolved in the transaction.

ii. Secondary market

financial market in which pre-owned securities (thosethat are not new issues) are traded

7. Classification of Common Stocka. Class A

i. reserved for Filipino investorsb. Class B

i. open to both foreign investors and Filipino investorsc. Both classes have the same privileges and rights; receive the

same amount of dividends.8. Preferred Stock

a. Another type of equity security is the preferred stockb. It is called as such because it is senior to or has preference over

common stock as to dividends and claims on assets of thecompany in the event of liquidation.

9. Features of Preferred Stocka. Voting rights

i. Preferred stocks does not usually carry voting rights (toelect members of the Board of Directors)

ii. However, holders of preferred stock are still entitled tovote on certain issues affecting the company such as:

Amendment of the Articles of Incorporation

Adoption and amendment of the by-laws

Increase or decrease of capital stock

Incurring, creating or increasing bond indebtedness Merger or consolidation of the corporation with

another corporation or corporations

Sale, lease, exchange, mortgage pledge or otherdisposition of all or substantially all of the companysproperties.

Investment of corporate funds in anothercorporation, and

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Dissolution of the corporationb. Dividends

i. Preferred stockholder are prescribed a fixed periodicdividend which is set at a fixed rate of its par value.

c. Restrictive Covenants

i. Aimed at ensuring the firms continued existence andregular payment of the dividend.

10. Types of Preferred Stocka. Participating preferred stockb. Cumulative/non-cumulative preferred stockc. Callable preferred stock

i. Premium

usually higher than the actual priced. Convertible preferred stock

i. Conversion Value = conversion ratio x stock price11. Advantages of a Stock Market

a. Most accessible marketb. Ready marketc. Liquidity of the marketd. Operates in full public view

12. Players in the Stock Marketa. Investors are the ones who buy and sell but they are not the only

players in the stock market.b. The players are:

i. Stockbrokersii. Stock exchangeiii. Transfer agent

iv. Clearing house Securities Clearing Corporation of the Philippines

(SCCP)o Assumes the role of settlement coordinator and

risk manager for broker transactionso Administrator of the trade guaranty fund

o Clearing and settlement agency for depository

eligible trades in the exchange.v. Philippine Central Depository (established in March 1995)

Provides the securities settlement system for both

debt and equity instruments of the Exchange. It provides a computerized book-entry-settlement

system which paved the way for the safe andefficient scrip less trading.

vi. Listed company

A corporation that offers and lists its shares in thestock exchange is called a listed company or issuer

This listed company is also known as the publiclyowned company

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13. Where Can You Buy or Sell Stocksa. Stock marketb. Stock exchangec. Trading floor

14. How Can You Buy or Sell Stocks

a. Choose a stockbrokeri. Should be a member in good standing at the PSE

b. Open a brokerage accounti. This account allows the client to perform stock transactions

anytimeii. Relatively easy to open

c. Place order with your brokeri. After opening the account, a trader will be assigned to buy

and sell securities at the PSEd. Settle your transactione. Buying and selling transactions are settled by book-entry

f. The account is credited when buying shares, and debited in thecase of selling shares

15. How Can You Make Money in the Stock Marketa. Dividendsb. Capital gains

i. Results from the capital appreciation or an increase in themarket value of the stock you own

c. Combination of dividend income and the capital appreciationmade constitutes the total return

d. Nominal Rate of Returni. Nominal Rate of Return = capital appreciation + dividend

incomePurchase price of the stocks

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