RSM230 Final Exam.docx

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Rotman Commerce
Fotini Tolias

RSM230 NOTES FINAL EXAM LECTURE #1 EQUITIES Stock Markets are Volatile Another work for equities is stocks traded on the stock market Volatile means that it moves around a lot Huge drop between 2011-2012 markets were ignoring problems in the euro market and as the year progressed, there was more and more talk about Greece needing a bailout important because they are "first in line"/indicators Investment Performance Historically stocks have the highest historic return and the greatest risk Excess return = equities (stocks) treasury (bonds) Volatility standard deviation in returns (measure of riskiness) stocks more volatile than bonds What's the outlook for the stock market? Stock prices rise when corporate earnings are expected to increase Earnings expectations rise when the economy is getting stronger so investors watch all new economic data US stocks are rising now because investors believe that the US economy is strengthening European market uncertainty (Greece, Spain, and euro zone generally have introduced a lot of volatility in the market) What are stocks (shares)? Stocks claim on the residual income produced by a company after all expenses and taxes are paid Represent part ownership of the firm and are (generally) accompanied by voting rights which afford the owner some measure of control over the organization Companies will sell claims on their future income (stocks) in order to raise capital for large investments; Initial and Seasoned Equity offerings (IPOs & SEOs) "equity" means ownership o Net income have two choices: either to (a) retain all of it to reinvest in the firm; or (b) pay dividends to shareholders Features of Common Equity Limited liability o Most traded companies are corporations: Inc, Ltd, PLC o Shareholder is only at risk for the initial shareholder's capital (i.e. stops at corporate level) Separate legal existence o Can sue and be sued (signing authority; officers of the company) o Corporation taxes Companies can be: o Public ease of exchanging ownership (private: limited transfer rights) o Listed on an exchange to make exchange of ownership (trading) easier o Accessing public markets brings in securities legislation whether the stock is listed or not Shareholder Rights Canadian Business Corporations Act 24-3 defines the rights of shareholders when there is one class of shares as: o A) the right to vote at any meeting of the shareholders of the corporation The right to vote confers the right to choose the board of directors which in turn chooses management and determines control of the company o B) to receive any dividend declared by the corporation Dividends have to be declared by the Board of Directors and shareholders cannot force payment When a company pays a dividend, this is a negative signal to investors because it indicates that the company no longer needs to reinvest in their own firms (i.e. stagnant or decreasing growth) o C) to receive the remaining property of the corporation on dissolution (bankruptcy) When bankrupt, creditors (bondholders) and banks get paid first; common shareholders are last to get paid (residual right) Multiple Classes of Shares These thee rights can be assigned to different classes of shares: o Preference (preferred) shares limited voting rights when dividends are not paid Preferential right to a dividend (rank above common shareholders) Cumulative or non-cumulative Limited voting rights when dividends are in arrears Have par value of $25 Only created by banks and utilities EXAMPLE: preferred shares (class C) No voting rights unless dividends in arrears for two years, after which each share gets one vote A dividend of $0.30/share every quarter when declared by the board of directors Payment of $25 par value before any payments to class A and B shares on wind up of company o Non-voting or limited voting common shares EXAMPLE: non-voting shares (class A) No voting rights as long as dividend payments are made A $0.05 dividend in addition to any dividend paid to class B shares Equal share with class B shares in residual receipts on wind up of the company o Regular common shares EXAMPLE: regular shares (class B) Full voting rights No dividends if dividends on class C shares are in arrears Equal share with class A shares in residual receipts on wind up on the company Summary of examples: o Full assignment of voting rights (B votes as long as dividends paid, then gradually A and then C shares get voting rights) o Full assignment of dividend rights (C has preference to the dividends, then A gets a premium over B due to the lack of voting rights) o Full assignment of wind up rights (C has first claim to its par value, then A&B share equally in residual) Note A&C have no par value to the shares as they get the residual The rights of any class of shareholders depend on the articles of incorporation and the terms under which the shares are issued (stated on the prospectus) Tax Treatment of Cash Flows from Firms Interest o Tax deductible as a business expense by payer o Fully taxed as ordinary income for recipient o Income Tax Act (CRA) treats interest as an expense for corporations and income for individuals Dividends o Paid out of after tax income: bears the corporate income tax rate o Not taxable for corporate recipients o Personal recipient receives a dividend tax credit as partial compensation for corporate income tax already paid Capital gains o 50% fully taxable o Losses can be carried back against previous gains or carried forward indefinitely Notes on Preferred Shares Part of shareholder's equity Dividends declared by BoD and paid out of after tax income Have many of the same features as debt contracts Key features: preferred shares may have: o Cumulative dividends (if company doesn't pay dividend in one quarter, pays both quarters' dividends next time) o A fixed or floating dividend o Voting rights if dividends in arrears o Ability to convert into common shares o A purchase fund (to redeem shares) o A maturity date similar to bonds (term preferreds) o A retraction feature that allows you to sell them at par on specific dates to get cash (hard) or common shares (soft retraction) Canadian Equities Shares in Canada are traded on the TSX, located downtown Now it is a completely electronic exchange with approximately 4000 companies traded TSX Minimum Listing Requirements Initial listing o 300 shareholders o 1,000,000 shares o $4,000,000 market value ($10 million for technology) o Sponsorship (investment dealer) o Industry specific criteria (net tangible assets; working capital; profits) Weaker subsequent requirements: o Annual filing (financial statements within 140 days of year end/prior notification of material change) TSX Venture and Senior Market Market Structure Historically, stock markets were "private clubs" to which a membership "seats" were needed to participate in trading o TSX was "demutualized" in 2003 and became a listed company on the TSX Stock exchanges now compete with each other for listings and order flow To trade stocks, the public must access the market either via a market intermediary (broker) or directly through a discount brokerage service Market Makers Markets makers were required to trade (buy and sell) shares in specific stocks to create liquidity Held an inventory of shares which they adjusted by changing the prices they were willing to buy (bid) and sell (offer or ask) at (just like any retailer) Difference is called the bid-ask spread and represents how expensive it is to trade o Cost is frequently over-looked by investors o Spread enables them to capture profits which offsets risks they face by agreeing to be everyone's counter-party o Spread is in addition to brokerage charges Basic Types of Stock Market Orders Market order an order to buy or sell at the market price o There may not be enough available so price may be volatile Limit order order to buy or sell at a particular price o Order is entered into the limit order book and ends up as a bid or offer Day order good only for the day All or none the entire order must be executed or none at all Stop loss/buy an order to sell (from long) or buy (from short) if the price drops below a certain amount Types of Accounts Cash accounts only hold positions that are long, i.e. holdings purchased with cash
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