Direct equity claims – represents ownership interests and include common stock as well as other instruments that can be used to purchase common stock – warrants options
Indirect equity – can be acquired through placing funds in investment companies such as mutual funds. Company pools the resources of many investors and invests them in common stock.
Creditor claims –
Preferred stock- A class of ownership in a corporation that has a higher claim on the assets and earnings than common stock. Preferred stock generally has a dividend that must be paid out before dividends to common stockholders and the shares usually do not have voting rights.
Factors you must consider in investing risk and safety principal current income vs capital appreciation liquidity short term vs long term orientation taxes ease of mgmt retirement and real estate planning
defined benefit plan – specifies the amount of the retirement benefit based on income and years of service defined contributuion plan – requires an employee to make contributions of each paycheck into a retirement fund
rate or return = (ending value – beginning value) + income / beginning value
risk tax risk – people who put money into an ira think they will be taxed less because of less income
operating risk – volatility of operating earnings and given the cyclical nature of the economy and the stability of the industry this is a risk that can be measured financial risk – occurs when a firm uses too much financial leverage( high debt ratio) and risks BK
3 compnonents make up required return from an investment the real rate of return anticipated inflation factor risk premium real rate of return – is the return investors require for allowing others to use their money for a given period of time. The annual percentage return realized on an investment, which is adjusted for changes in prices due to inflation or other external effects.
Anticipated rate of inflation + real rate of return = required return on an investment which is the risk free rate because you are not taking into account the risk involved
Risk premium - The return in excess of the risk-free rate of return that an investment is expected to yield. An asset's risk premium is a form of compensation for investors who tolerate the extra risk
Capital asset pricing model – incorporates all the factors we have previously discussed but has a slightly different way of looking at the risk premium. Risk is dived into company risk and market risk. Beta measures the risk of a secutiy realative to the market
Beta represents systematic risk cant be diversified into portfolios of stocks
2nd factor associated with calculating risk is the risk premium allocated into the stock market. Called equity risk. Expected return of the stock – expected risk free rate U.S govt sec
required rate of return = Risk free rate + Beta ( Equity Risk Premium)
market- way of exchanging assets, usually cash for something of value
efefficient market – when price respond quickly to new info when each successive trade is made at a price close to the proceeding price can take on more security and assets without changing the price significantly
liquidity – measure of the speed with which an asset can be converted into cash at its fair market value
secondary markets – stock market, markets for exisiting assets that currently traded between investors create prices and allow for liquidity
primary markets are designed by the flow of funds between the market particiapants. Buy their assets directly from the source of the asset. Alow corps and govt to raise needed funds for capital expansion
Underwriting process investment banker acts like the middle man in process of raising funds and usually takes the risk for underwriting securities underwriting is the guarantee an IB gives the selling firm to purchase sec at a fixed price.