Personal Finance

Chapter 14 part 1
Canaday
Stocks
• There are different types of stock.
• But when people discuss stocks and don’t specify they almost
certainly are referring to what is known as common stock.
• There is a type of stock called preferred stock which we will discuss
later. Preferred stock is not better than common stock. It is different.
And if someone is talking about investing in stocks they are very likely
talking about investing in common stock.
Stocks
• Stocks are a type of equity financing. If a company is looking to raise
funds it can do it through debt or equity. When a company issues
stock, the company gets funds and the people who buy it get some
ownership in the company.
• Note that when we look at well known stock markets we are looking
at a secondary and not a primary market. People are buying and
selling ownership in companies from each other and the companies
are not getting additional sources of funds nor are they giving out
additional ownership claims. The ownership claims are just changing
hands from one party to another.
Common Stock
• With common stock, if a company goes bankrupt, the common
stockholders do not receive their money until the creditors,
bondholders, and preferred shareholders have received their respective
share. This makes common stock riskier than debt or preferred shares.
The upside to common shares is they usually outperform bonds and
preferred shares in the long run. Many companies issue all three types
of securities. 
Common Stock
• The first-ever common stock was established in 1602 by the Dutch
East India Company and introduced on the Amsterdam Stock
Exchange. Larger US-based stocks are traded on a public exchange,
such as the New York Stock Exchange (NYSE) or NASDAQ. As of
2019, the former has 2800 stocks listed on its bourses, while the latter
has 3300 stocks listed. NYSE had a market capitalization of $28.5
trillion in June 2018, making it the biggest stock exchange in the
world by market cap.
Common Stock
• There are also several international exchanges for foreign stocks, such
as the London Stock Exchange and the Tokyo Stock Exchange.
Companies that are smaller in size and unable to meet an exchange’s
listing requirements are considered unlisted. These unlisted stocks are
traded Over-The-Counter which means they don’t trade at a physical
location like the NYSE.
• Some very large companies don’t trade on physical exchanges. Apple
and Tesla stock are listed on NASDAQ (the largest OTC network).
Common Stock
• For a company to issue stock, it must begin by having an initial public
offering (IPO). An IPO is a great way for a company, seeking
additional capital, to expand. To begin the IPO process, a company
must work with an underwriting investment banking firm, which helps
determine both the type and pricing of the stock.
• After the IPO phase is completed, the general public is allowed to
purchase the new stock on the secondary market.
Common Stock- Shareholder rights
• The main sources of shareholder rights are legislation in the
company’s incorporation, corporate charter, and governance
documents. Therefore, the rights of shareholders can vary
from one jurisdiction to another and from one corporation
to another.
Common Stock- Shareholder rights
• Nevertheless, there are a few shareholder rights that are
almost uniform for every corporation. First, the right of
shareholders to claim a portion of the company’s profits. The
shareholders usually receive a portion of profits through 
dividends. In addition, in case of a company’s liquidation,
holders of common stock own rights to the company’s
assets. However, since common shareholders are at the
bottom of the priority ladder, it is very unlikely that they
would receive a high degree of compensation in the event of
liquidation.
Common Stock- Shareholder rights
• Moreover, common shareholders can participate in
important corporate decisions through voting. They can
participate in the election of the board of directors and vote
on different corporate matters such as corporate objectives,
policies, and stock splits.
• Stockholders may vote in person at the corporation’s annual meeting
or by proxy. A proxy is a legal form that lists the issues to be decided
at a stockholders’ meeting and requests that stockholders transfer their
voting rights to some individual or individuals.
• Note that there are some classes of common stock without
voting rights (see later).
Common Stock- Classification
• There is no unified classification of common stock. However,
some companies may issue two classes of common stock. In
most cases, a company will issue one class of voting shares
and another class of non-voting (or with less voting power)
shares. The main rationale for using dual classification is to
preserve control over the company.
• Despite the difference in voting rights, different classes
usually enjoy the same rights to the company’s profits.
Common Stock- Dividends
• Dividends are paid out of profits and must be approved by
the board of Directors.
• If the company is not making profits it wouldn’t be able to
pay dividends. Additionally, companies in a period of high
growth and investment often may not pay out a dividend.
Their boards of directors think retaining the earnings to fuel
future growth are more important for the future of the
company than paying it out to the stockholders.
Common Stock- Dividends
• Dividends are paid out of profits and must be approved by
the board of Directors.
• If the company is not making profits it wouldn’t be able to
pay dividends. Additionally, companies in a period of high
growth and investment often may not pay out a dividend.
Their boards of directors think retaining the earnings to fuel
future growth are more important for the future of the
company than paying it out to the stockholders.
Common Stock- Dividends
• Dividends are typically paid out in terms of cash and
sometimes in terms of additional stock.
• The record date is the date on which a stockholder must be registered
on the corporation’s books in order to receive dividend payments.
When a stock is traded around the record date, the company must
determine whether the buyer or the seller is entitled to the dividend. To
solve this problem, this rule is followed: Dividends remain with the
stock until two business days before the record date.
Common Stock- Dividends
• On the second day before the record date, the stock begins selling ex-
dividend. The term ex-dividend describes a situation when a stock
trades “without dividend,” and the seller—not the buyer—is entitled to
a declared dividend payment.
Common Stock- Dividends
Common Stock- Dividends
• For example, Chevron declared a quarterly dividend of $0.72 per share
to stockholders who owned its stock on Wednesday, May 19. The
stock went ex-dividend on Monday, May 17, two business days before
the May 19 date. A stockholder who purchased the stock on Monday,
May 17, or after was not entitled to this quarterly dividend payment.
Chevron made the actual dividend payment on June 10 to stockholders
who owned the stock on the record date.
• Investors are generally very conscious of the date on which a stock
goes ex-dividend, and the dollar value of the stock may go down by
the value of the quarterly dividend.
Example: profit/loss from owning stock

• The increase in the value of the stock between purchase and sale is
called a capital gain. If the value fell over this time it is a capital loss.
Stock splits
• Sometimes stocks split. A stock split is a procedure in which the
shares of stock owned by existing stockholders are divided into a
larger number of shares. In a 2-to-1 stock split everyone’s shares will
double. In a 3-to-1 everyone’s will triple. This doesn’t mean the
value of your stock doubles in a 2-to-1 split as the market price will
likely fall in half.
• Why do stocks split? Management simply may have a range they want
the prices to trade in.
Preferred Stock
• Preferred stock is a form of stock which may have any
combination of features not possessed by common stock
 including properties of both an equity and a debt instrument,
and is generally considered a hybrid instrument. Preferred
stocks are senior (i.e., higher ranking) to common stock, but
subordinate to bonds in terms of claim (or rights to their share of
the assets of the company).
Preferred Stock
• Unlike common stockholders, preferred stockholders have limited
rights which usually does not include voting. Preferred stock combines
features of debt, in that it pays fixed dividends, and equity, in that it
has the potential to appreciate in price. This appeals to investors
seeking stability in potential future cash flows.
Preferred Stock
• Preferred stock, like common stock, is equity financing that does
not have to be repaid. And dividends on preferred stock, as on
common stock, may be omitted by action of the board of directors.
To make preferred stock issues more attractive, some corporations
may offer two additional features.
Preferred Stock
• One way preferred stockholders can protect themselves against
omitted dividends is to purchase cumulative preferred stock.
Cumulative preferred stock is stock whose unpaid dividends
accumulate and must be paid before cash dividends are paid to
common stockholders. If a corporation does not pay dividends to the
cumulative preferred stockholders during one dividend period, the
amount of the missed dividends must be paid before common stock
holders are paid dividends.
Preferred Stock
• Convertible preferred stock can be exchanged, at the stockholder’s
option, for a specified number of shares of common stock. The
conversion feature provides the investor with the added safety of
preferred stock and the possibility of greater speculative gain through
conversion to common stock.