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Risk Cash flows do not match EXPECTATION.

• Is a company with roller-coaster like sales figure a risky company?

• Why are Pharmaceutical companies so big?• What kind of company is GE like? Why?• Why do most people can't sleep tight after

loosing money in the casino/stock while some can?

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Independent or Correlated Risks

        - stand-alone risk (project risk)      - firm risk      - diversified portfolio risk      - market risk

Special Topic II

Stock

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#1 Goal of Firm: MAXIMIZE SHAREHOLDER WEALTH

• Some questions:• Is this true in every economy?

Why CEOs invest in money loosing projecting?

• Why do companies almost always defend against hostile takeover?

5

The Anatomy of Stocks

• Firms issue shares of stock when they need to raise long-term financial capital– usually for investment spending

• A share of stock represents equity in a corporation and entitles the owner to a share of the corporation’s profits

• Stock may be preferred stock or common stock

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Preferred Stock

• Owners of preferred stock receive a fixed dividend to which they are entitled before owners of common stock receive anything– similar to the interest payment that a

bondholder receives– dividends must only be paid to preferred

stockholders if the firm earns a profit (unlike interest which must always be paid)

– dividend payments are not tax-deductible (unlike interest payments)

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Common Stock

• Common stockholders receive a variable dividend after the preferred stockholders have been paid and retained earnings have been set aside– retained earnings are profits not distributed to

stockholders and are usually used to fund investment projects

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The Anatomy of Stocks

• All companies that issue publicly traded shares of stock are regulated by the Securities and Exchange Commission (SEC)– the SEC has broad disclosure requirements to

protect investors • the financial condition of the corporation• information about key personnel• any changes that would be important to

stockholders

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The Stock Markets

• When most people think about the stock market, they think about Wall Street

• Virtual vs. Physical

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The Stock Markets

• The expanded use of computers to execute trades has accommodated the greater volume of trading and has facilitated an increase in program trading by institutional investors– allows institutional investors to pre-program

computers to buy or sell a large basket of stocks

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The New York Stock Exchange

• The New York Stock Exchange (NYSE) is the world’s largest market for trading securities– about 2,800 companies including more than

470 non-U.S. companies

• For a stock to be listed, the corporation must apply to the exchange and meet several criteria dealing with the size and number of shareholders

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The New York Stock Exchange

• The NYSE is a highly-visible auction-type market where members (acting as agents for others) buy and sell shares of stock– each member has purchased a seat on the

exchange• the price of a seat is determined by supply and

demand

– the benefits of membership include direct participation in stock trading and charging commissions to customers for trading stocks

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The New York Stock Exchange

• Each firm whose stock is listed is assigned to a single post where a specialist in that stock manages the auction process– members of the NYSE bring all large buy and

sell orders to the floor– orders are then funneled to the appropriate

post– the forces of supply and demand determine

stock prices

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The New York Stock Exchange

• When a new price is reached, a clerk records the information and sends it out over the ticker– provides a constant stream of stock symbols

and prices• each symbol consist of 3 or fewer letters and

represents the stock of a particular corporation

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Other Exchanges

• The American Stock Exchange– over 660 corporations

• Regional exchanges that primarily trade stocks listed on the NYSE are located in Boston, Chicago, San Francisco, and Philadelphia

• Many foreign countries also have stock exchanges

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The Over-the-Counter Market

• The over-the-counter market is composed of thousands of securities dealers located all over the country– transactions are executed over the telephone

or via computer– dealers buy and sell securities at publicly

quoted prices– market is regulated by the National

Association of Securities Dealers (NASD)

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The Over-the-Counter Market

• About 3,000 of the companies whose stocks are traded over the counter are also members of the National Association of Securities Dealers Automated Quotation System (NASDAQ)– the world’s first electronic stock market– stocks are traded on an advanced computer

system that provides immediate information about prices and the number of shares traded

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Stock Market Indexes

• The Dow Jones Industrial Average (the Dow) measures movements in the stock prices of the 30 largest companies in the U.S.– oldest index in use today (introduced in 1896)– an unweighted average of the sum of the daily

closing prices (adjusted to take account of the effects of stock splits and stock dividends)

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Stock Market Indexes

• The Standard & Poor’s 500 (S&P 500) is a weighted index of prices of 500 broad-based corporations– weighted by their relative values