👨‍🏫 Outline

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

Bonds	Stocks
IOU	Ownership share
Coupon payment	Dividend
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

Share Types Example

Before Firm Buys Back 100 Million Shares

• Authorized shares	1 Billion
• Issued shares	500 Million
• Shares outstanding	500 Million
• Restricted shares	100 Million
• Float	400 Million (IPO)
• Treasury stock	-
• Unissued shares	500 Million

Effect of buying back shares

After Firm Buys Back 100 Million Shares

• Authorized shares	1 Billion
• Issued shares	500 Million
• Shares outstanding	400 Million
• Restricted shares	100 Million
• Float	300 Million (IPO)
• Treasury stock	100 million
• Unissued shares	500 Million

Market Capitalization

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

Example:

• 1 Billion shares outstanding
• Share price = $10

$$\begin{aligned} \text{Market cap} &= \$10 × 1 \text{ Billion} \\ &= \$10 \text{ Billion} \end{aligned}$$

A free list of the largest companies by market cap can be found at companiesmarketcap.com. You can filter by countries or industries that are of interest to you.

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

$$\begin{aligned} \text{Market cap} &= 2.69 B × \$301.27 \\ &= \$810.4 \text{Billion} \end{aligned}$$

Market Cap Categories

Mega Cap	$>\$200 \;\text{Billion}$ Slower growth—lower risk Wal-Mart, Microsoft, Exxon Mobil, Alphabet, Apple (more examples) Considered Blue Chip
Large Cap	$\$10 \;\text{Billion} - \$200 \;\text{Billion}$ GE, Ford, IBM, Citigroup, Shell Oil Considered Blue Chip
Mid Cap	$\$2 \;\text{Billion} - \$10 \;\text{Billion}$ Growth stocks Wendy’s, JetBlue, Spotify, Lyft, Alcoa
Small Cap	$\$300 \;\text{Million} - \$2 \;\text{Billion}$ Relatively young companies Higher growth potential; higher risk Coursera, Rocket Pharmaceuticals, Ethan Allen, Supernus Pharmaceuticals
Micro Cap	$\$50 \;\text{Million} - \$300 \;\text{Million}$ 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”