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Rob's e2000 Notes

👨‍🏫 Outline

Formulas for this lecture can be found in my paper formula sheets and online formula sheet.

Overview

  • Introduction: Stocks vs. Bonds
  • Long-run Returns vs. Short-run Volatility
  • The Primary Market
    • Finance Jargon: Shares Outstanding, Float, etc.
    • Market Cap Categories
    • The IPO Process
  • The Secondary Market
    • Types of Exchanges

Intro to Stocks

Are Dividends a Thing of the Past?

Stocks vs. Bonds

BondsStocks
IOUOwnership share
Coupon paymentDividend
Position in event
of liquidation		Residual claimant

Long-term Returns on Stocks vs. Bonds

S&P 500 Index Over the Past Five Years

Share Types: Authorized, Outstanding, Float, etc.

  • Authorized shares
    • Largest number of shares a firm can issue
    • Set in the articles of incorporation when the company is formed
    • Can only be changed by a vote of the shareholders
    • Issued shares
      • Shares outstanding
        • Restricted shares (shares given to insiders as part of their compensation; require special permission before being transacted)
        • Float
      • Treasury stock
    • Unissued shares

Authorized shares = issued shares + unissued shares

Issued shares = shares outstanding + treasury stock

A series of concentric circles showing the different types of shares

Share Types Example

Before Firm Buys Back 100 Million Shares

• Authorized shares1 Billion
 • Issued shares500 Million
  • Shares outstanding500 Million
   • Restricted shares100 Million
   • Float400 Million
(IPO)
  • Treasury stock-
 • Unissued shares500 Million

Effect of buying back shares

After Firm Buys Back 100 Million Shares

• Authorized shares1 Billion
 • Issued shares500 Million
  • Shares outstanding400 Million
   • Restricted shares100 Million
   • Float300 Million
(IPO)
  • Treasury stock100 million
 • Unissued shares500 Million

Market Capitalization

market cap=shares outstanding×price per share\text{market cap} = \text{shares outstanding} × \text{price per share}

Example:

  • 1 Billion shares outstanding
  • Share price = $10
Market cap=$10×1 Billion=$10 Billion\begin{aligned} \text{Market cap} &= \$10 × 1 \text{ Billion} \\ &= \$10 \text{ Billion} \end{aligned}

Meta (Facebook) Share Statistics

On 10/31/23

  • 9.1 billion Class A and Class B shares authorized
  • 2.69 billion shares outstanding
  • 45 million restricted shares
  • 2.24 billion share float
Market cap=2.69B×$301.27=$810.4Billion\begin{aligned} \text{Market cap} &= 2.69 B × \$301.27 \\ &= \$810.4 \text{Billion} \end{aligned}

Market Cap Categories

Mega Cap

>$200  Billion>\$200 \;\text{Billion}

  • Slower growth—lower risk
  • Wal-Mart, Microsoft, Exxon Mobil, Alphabet, Apple (more examples)
  • Considered Blue Chip
Large Cap

$10  Billion−$200  Billion\$10 \;\text{Billion} - \$200 \;\text{Billion}

  • GE, Ford, IBM, Citigroup, Shell Oil
  • Considered Blue Chip
Mid Cap

$2  Billion−$10  Billion\$2 \;\text{Billion} - \$10 \;\text{Billion}

  • Growth stocks
  • Wendy’s, JetBlue, Spotify, Lyft, Alcoa
Small Cap

$300  Million−$2  Billion\$300 \;\text{Million} - \$2 \;\text{Billion}

  • Relatively young companies
  • Higher growth potential; higher risk
  • Coursera, Rocket Pharmaceuticals, Ethan Allen, Supernus Pharmaceuticals
Micro Cap

$50  Million−$300  Million\$50 \;\text{Million} - \$300 \;\text{Million}

  • Very small companies, with highly illiquid, speculative shares (illiquid = can be hard to sell your shares because so few buyers.)
  • Mostly regional companies or companies most people haven’t heard of.
  • Nautilus, Culp, Inc., NRx Pharmaceuticals, Lantern Pharma

Initial Public Offerings (Primary Market)

Benefits vs. Costs of Going Public

  • Benefits

    • Increased access to capital markets
    • Founders can “cash in”

  • Costs

    • Loss of control (Example: Jobs and Wozniak at Apple)
    • Exposure of sensitive information (SOX)
    • Investor relations efforts

The Initial Public Offering

  • Initial Public Offering (IPO)
    • First offering of stock to Public
  • Underwriting
    • Role of the syndicate

Top Underwriters, 2021 (by value of deals)

Top Underwriters, 2021 (by Fees Collected)

How Do Firms Choose an Underwriter

  • The contract
  • The spread
  • The Rep

Steps in an IPO: The Role of the Lead Underwriter

  • Valuing the company
  • Determining the offering price of shares
    • “Building the book” via road shows
  • Filing the necessary paperwork
    • Filing the prospectus

Types of Underwriting Contracts

  • Firm commitment contract: issuance to distribution and sale
    • Safest but most expensive for the issuer
    • Underwriter’s profit is the “spread”
  • Best efforts contract
  • All-or-none contract

Costs Involved in an IPO

  • Legal and administrative costs
  • Spread (or underwriting commission)
  • Underpricing

Spreads on Selected Issues

Costs of Raising Capital

Exchanges (Secondary Market)

Different Types of Markets

  • Direct search
    • Buyers and sellers seek each other
  • Brokered markets
    • Brokers search out buyers and sellers
  • Dealer markets
    • Dealers have inventories of assets from which they buy and sell
  • Auction markets
    • Traders converge at one place to trade

New York Stock Exchange (NYSE)

  • Acquired by Intercontinental Exchange (ICE) in 2013
  • Around 2,800 companies listed
  • “Open outcry” auction market, which is quickly - evolving into an electronic market
    • “Hybrid market”—orders can be handled electronically, - or by floor brokers (as of January 24, 2007) 80%+ of - trades now handled electronically
    • Diminished role of specialists
  • $24T in total market capitalization
  • Avg. daily volume 3.2B shares
  • Formerly: 1,366 “seats”, conferring the right to - trade on the exchange
  • Now: NYSE sells 1-year licenses to trade on the - exchange
  • Lists the largest, most established companies: - ExxonMobil, General Electric, Wal-Mart, Disney
  • The largest U.S. stock exchange as measured by the value of the stocks listed on the exchange
  • Automatic electronic trading runs side-by-side with traditional broker/specialist system
    • SuperDot : Electronic order-routing system
    • DirectPlus: Fully automated execution for small orders
    • Specialists: Handle large orders and maintain orderly trading

NASDAQ

Founded in 1971
Electronic exchange
Has always been “screen-based”
3,300 companies listed
$19T in total market capitalization
Avg. daily volume around 2B shares
High tech and innovative firms: Microsoft, Intel, Cisco, JetBlue

  • Originally, NASDAQ was primarily a dealer market with a price quotation system
  • Today, NASDAQ’s Market Center offers a sophisticated electronic trading platform with automatic trade execution
  • Large orders may still be negotiated through brokers and dealers

Types of Exchanges

  • Physical “Floor” Exchanges
    • NYSE
    • AMEX
  • Electronic Exchanges
    • NASDAQ
    • London Stock Exchange
  • Electronic Communication Networks (ECNs)
    • A more automated, efficient kind of electronic exchange
    • No market makers

Open Outcry: The Platform for 200 Years

How Long Before It’s a Museum?

The New “Trading Floor”