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 |  Money and Capital Markets: Financial Institutions and Instruments in a Global Marketplace, 8/e Peter Rose,
Texas A & M University
Corporate Stock
Chapter SummaryThe market for corporate stock is the most widely followed of all securities markets, with
millions of shares changing hands each day.
- Most stock trades involve not the creation of new funds—the raising of new capital—
but rather the exchange of existing shares for money. Thus, most stock trading takes
place in the secondary market, not the primary (or new issue) market.
- Trading in equity shares reveals a close correlation with economic conditions. Advancing
stock prices appear to be a leading indicator, forecasting the growth of the economy, in part because business investment spending appears to be influenced by what is happening
to stock prices.
- Corporate stock today can be divided into two major types: common stock and preferred
stock. Common stock represents a residual claim against the assets of the issuing firm,
entitling the owner to share in the net earnings of the firm when it is profitable and to
share in the net market value of the company’s assets if it is liquidated. Preferred stock
carries a stated annual dividend expressed as a percent of the stock’s par value.
- Households—individuals and families—are the dominant holders of corporate stock,
followed by pension funds and mutual funds.
- Stock prices are positively related to the expected stream of dividends paid by the firm
that issued the stock and negatively related to the discount rate associated with that
stream of dividends (measuring equity risk).
- The market for corporate equity shares normally is divided into two main parts—the organized
exchanges (such as the New York Stock Exchange) and the over-the-counter
market. Trading on the exchanges is governed by regulations and formal procedures to
promote competition and to contribute toward improved liquidity of equity shares. The
over-the-counter (OTC) market is much less formal than the organized exchanges and
generally involves broker-to-broker or dealer-to-dealer transactions on behalf of stock
buyers and sellers.
- Other branches of the stock market have become important in recent years. These include
a third market, in which exchange-listed stocks are traded over the counter; and a
private equity market, where new businesses, privately held companies and partnerships,
troubled firms, and even larger publicly traded companies can find financing for
their long-term equity needs. The private equity market is involved in selling shares off
the major exchanges with trading taking place between stock issuers and limited partnerships,
venture capital companies, and other specialized investors.
- Rapid growth has occurred in the closely related market of stock options—an agreement
between two parties granting one party the right, but not the obligation, to purchase an
asset from or sell an asset to the other party at a set price. Both put (or selling) options
and call (or buying) options are designed to manage the risk of fluctuating security
prices.
- The stock market has become global in scope, rising from a series of national markets
due to advances in the technology of information and funds transfer. Today the sun
never sets on equity trading around the globe in an efficient marketplace.
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2003 McGraw-Hill Higher Education