Stock • Prof.

Darko Vuković

markets • E-mail: [email protected]

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 Common Stock

• Common stock, or equities, is the fundamental ownership claim

in a public or private corporation.
1. discretionary dividend payments,
2. residual claim status,
3. limited liability, and
4. voting rights.

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 • The Dow Jones Industrial Average
[DJIA], the NYSE Composite Index,
the S&P Composite Index, the
NASDAQ Composite Index, and the
Stock Wilshire 5000 Index.
• The Dow Jones Industrial Average:
Market • 1896 as an index of 12 industrial
stocks. In 1928, the Dow was
Listings expanded to include the values of
30 large (in terms of sales and total
assets) corporations selected by the
editors of The Wall Street Journal.

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Listing of stocks traded on the
New York Stock annual
Exchange
dividend per dollar paid for the stock
0.0191, or 1.91%.

How much stock purchasers must pay per dollar of earnings

the firm generates for each share.

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PWA

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 Price-Weighted
Average

• Consider the data in Table 2.3 for a hypothetical two-stock version of the Dow
Jones Average. Let’s compare the changes in the value of the portfolio holding
one share of each firm and the price weighted index.
6 • Stock ABC starts at $25 a share and increases to $30. Stock XYZ starts at $100 but
falls to $90.
• Portfolio Initial value = $25 + $100 = $125
Final value = $30 + $90 = $120
Percentage change in portfolio value = −5/125 = −.04 = −4%
• Index: Initial index value = (25 + 100)/2 = 62.5
Final index value = (30 + 90)/2 = 60
Percentage change in index = −2.5/62.5 = −.04 = −4%
Companies
included in
the Dow
Jones
Industrial
Average:
1928 and
2021

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 Stock Market Indexes

• In 1966, the NYSE established the NYSE Composite Index to provide a

comprehensive measure of the performance of the overall NYSE
market.
(stocks are divided into four subgroups: industrial, transportation, utility,
and financial companies)
• The Standard & Poor’s 500 Index
• The NASDAQ Composite Index.
Established in 1971, the NASDAQ Composite Index (a value-weighted index
of 2500 stocks) consists of three categories of NASDAQ companies:
industrials, banks, and insurance companies.
• The Wilshire 5000 Index (more than 3500 traded stocks).

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 The Standard & Poor’s 500 Index

• Market value–weighted index: The S&P 500 is computed by

calculating the total market value of the 500 firms in the index and
the total market value of those firms on the previous day of trading.
• Example: The final value of all outstanding stock in our two-stock
universe is $690 million. The initial value was $600 million.
• Therefore, if the initial level of a market value–weighted index of
stocks ABC and XYZ were set equal to an arbitrarily chosen starting
value such as 100, the index value at year-end would be
100 × (690/600) = 115.
The increase in the index would reflect the 15% return earned on a
portfolio consisting of those two stocks held in proportion to
outstanding market values. 10
Foreign and International Stock Market Indexes
- Morgan Stanley Capital International-

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 Dividends

• The payment and size of dividends are

determined by the board of directors of
the issuing firm.
• A corporation does not default if it misses
a dividend payment to common
stockholders.
• Taxed twice.
• The return to a stockholder over a period
t - 1 to t can be written as:

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 • Return on investment in stock consisting of cash
dividends and capital gains / losses.
The expected return in the investment period
The internal (HPR) is calculated as:
summation expected dividends E (D1) and the
value of anticipated price appreciation (E (P1) - P0) divided by
the current price (P0) wherein:
stock P1 expected price at end of year
P0 current price
E(D1) + (E(P1)- P0)
Expected (HPR)= --------------------------
(P0)
 • Under Capital Assets Pricing Model (CAPM),
rate of return that investors can expect from
securities is
(k): rf + β [ E(rm) - rf ]
Market
capitalization β - coefficient measures of market (systemic) risk
rf - risk-free rate
rate(k) E(rm) - the expected rate of return on the market
portfolio
(k) is usually called the market capitalization rate
(required rate of return, because investor
demands return of any other investment that
carries the same risk)
 The intrinsic value of stock

• The internal value of stock or the intrinsic value (V0) is

defined as the present value of all cash amounts to be paid
to the owner of stock.
(Including dividends and revenues from the sale of stock,
discounted at an appropriate interest rate corrected for risk
k)

E(D1) + E(P1)
V0= -------------------
1+k
 Common stockholders have the lowest
priority claim on a corporation’s assets
in the event of bankruptcy—they have
a residual claim.

Residual First firm’s employees, bond holders,

the government (taxes), and preferred
Claim stockholders.

The bankruptcy of Washington Mutual

Bank in 2008.

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 • limited liability
• sole proprietorship
• unlimited” liability
Limited Liability • The typical voting rights
arrangement is to assign one vote
and Voting per share of common stock.
• Dual-class firms, in which two
Rights classes of common stock are
outstanding, with different voting
and/or dividend rights assigned to
each class.
• Proxy Votes
• Preemptive Rights

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 • Preferred stock is a hybrid security that
has characteristics of both a bond (fixed
periodic payment) and a common stock
(ownership interest).
• Missed without fear of bankruptcy
proceedings.

Preferred • Preferred stockholders generally do not

have voting rights in the firm.

Stock • Nonparticipating preferred stock means

that the preferred stock dividend is fixed
regardless of any increase or decrease in
the issuing firm’s profits.
• Cumulative preferred stock means that
any missed dividend payments go into
arrears and must be made up before any
common stock dividends can be paid.

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 Primary Stock Markets
• First or new issues of stocks.
• In USA Morgan Stanley or Bank of America Merrill Lynch.
• Commitment underwriting: gross proceeds and the net
proceeds (called the underwriter’s spread ).
• Initial public offerings (IPOs)
• Best efforts underwriting basis.

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syndicate

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 Dividend discount model
• Dividends represent future cash flows that
should be reduced to present value
The general form of common shares valuation
model based on discounted dividends:
∞
Divt
V =∑
(1 + k )
t
t =1

• In order to use this model in reality, it is

necessary to introduce some additional
assumptions about future growth dividend.
Dividend Assumptions about the growth of dividends:

discount Model of zero growth - comes down to evaluation of

preference of the stock

model Model of constant growth

Multiphase model of growth

 Evaluation of stock’s preference - zero
growth model
In this model of a constant rate of growth is equal to zero.

Therefore, the term is :

• Ie. can be expressed through the dividend discount

model:
D1
V0= -------------------
k
 Model of constant growth

According to this model it is assumed that the dividend have a stable growth rate
(g).

Example:
If the growth rate (g) is 0.05, and if the last dividend is
3, 81 USD, expected future dividends are:

D0=3,81
1. D1=D0(1+g) = 3,81 x 1,05 = 4,00
2. D2=D0(1+g)2 = 3,81 x 1,052 = 4,20
3. D3=D0(1+g)3 = 3,81 x 1,053 = 4,41
 Model of constant growth
• The model can be expressed as:

D1 (1+ g) D1 (1+ g)2 D1 (1+ g)3

V0= ---------------- + --------------- + ------------ + ....
1+k (1 + k) 2 (1 + k) 3

Div0 (1 + g ) Div0 (1 + g ) Div1

t
∞
or: =V ∑ = =
(1 + k )
t
t =1 k−g k−g
 Characteristics • Constant growth model is valid only when g is less
of the model of than k.

constant If dividends are expected to grow continuously at

growth a rate that is higher than k, the value of stock
would be unlimited. This is only viable in the short
term.
 Model of constant growth implies that the value of
Characteristics stock is growing:
of the model of
- When the expected dividend per share
constant increase.
growth - When the market capitalization rate decrease
(k)
- When the expected growth rate dividend
increase (g).
 Secondary Stock Markets
• The New York Stock Exchange

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Purchase of a Stock on the NYSE

A market order (buy or sell orders that are to be executed immediately

at current market prices)

A limit order (A limit buy order may instruct the broker to buy some number of
shares if and when they may be obtained at or below a stipulated
price.
Conversely, a limit sell instructs the broker to sell if and when the stock price rises
above a specified limit). 29
 Weak Form Market Efficiency
(current stock prices reflect all
historic price and volume
information about a company).

Semi strong Form Market Efficiency

Market (public information arrives about a
company, it is immediately
Efficiency impounded into its stock price).

Strong Form Market Efficiency

(Insider information).

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 Do managers really
attempt to maximize
Separation of
Ownership firm value?
and
Management

Agency problem!

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Carl Icahn’s Proxy Fight with Yahoo!

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 • Essential of investments, 40
Literature – 48; 56 - 69.

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