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ch4 - Chapter 4Valuing Stocks ECO389 Spring 2010 1...

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Chapter 4–Valuing Stocks ECO389, Spring 2010 1 Introduction Usually, firms issue shares of common stock to the public when they need to raise money. They typically engage investment banking firms such as Goldman Sachs to help them market these share. 1. Common Stock (stock or share): Ownership shares in a publicly held corpora- tion. –The shareholder is entitled to his/her portion of the company’s assets after all debt is paid. –Debt has priority over stock (equity). –Preferred stocks: the stockholders are the owners of the company. They have limited rights in company’s operation since those stockholders can claim divi- dend before common stockholders. Some companies will give fixed amount of dividend to preferred stockholders. –Debt owners/Preferred stockholders/Common stockholders (risk level–from lowest to highest) 1
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2. Financial Markets: Sales of new stock by the firm are said to occur in the primary market . –Primary market: Market for the sale of new securities by corporations. (two types) 1. Initial Public Offering (IPO): First offering of stock to the general public. A company that has been privately owned sells stock to the public for the first time. Some IPOs are very popular with investors. For example, Google search has been predicted to reach a market price at 20 billion to 30 billion dollars. 2. Seasoned Offerings: (established firms that already have issued stock to the public also may decide to raise money from time to time by issuing additional shares.) Sales of new shares by such firms are also primary market issues and are called seasoned offerings . (When a firm issues new shares to the public, the previous owners share their ownership of the company with additional shareholders. In this sense, issuing new shares is like having new partners buy into the firm.) 3. Compared with bonds, shares of stock can be risky investments. If the price of a stock keeps dropping, investors would lose most of their investments. Therefore, no investors will tie with a particular company forever. Thus, we have the financial markets. On the market, large companies can arrange for their stocks to be listed on a stock exchange, which allows investors to trade existing stocks among themselves. –Secondary Market: Market in which previously issued securities are traded among investors. (those markets are exchanges, which are markets for second- hand stocks.) –Conclusion: a. Financial markets provide a source of financing for businesses and gov- ernments; a financial investment opportunity for individual and institutional investors. b. The initial, funds-raising sale of securities, usually with an investment banker, is in the primary market; subsequent trading between investors for liq- uidity, financial investing, and portfolio rebalancing is in the secondary market.
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