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CHAPTER 8
OVERVIEW OF EQUITY SECURITIES
Presenter
Venue
Date
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EXHIBIT 8-1 COUNTRY AND REGIONALCONTRIBUTIONS TO GLOBAL GDP AND EQUITY
MARKET CAPITALIZATION (2007)
Source: MacroMavens, IMF World Economic Outlook 2008 , Standard &Poor’s BMI Global Index weights.
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EXHIBIT 8-2 EQUITY MARKETS RANKED BY TOTALMARKET CAPITALIZATION AT THE END OF 2008
(BILLIONS OF U.S. DOLLARS)
Rank Name of Market
Total U.S. DollarMarket
Capitalization Total U.S. DollarTrading Volume
Number of ListedCompanies
1 NYSE Euronext (U.S.) $9,208.9 $33,638.9 3,011
2 Tokyo Stock Exchange Group $3,115.8 $5,607.3 2,390
3
NASDAQ OMX
$2,396.3
$36,446.5
2,952
4 NYSE Euronext (Europe) $2,101.7 $4,411.2 1,002
5 London Stock Exchange $1,868.2 $6,271.5 3,096
6 Shanghai Stock Exchange $1,425.4 $2,600.2 864
7 Hong Kong Exchanges $1,328.8 $1,629.8 1,261
8 Deutsche Börse $1,110.6 $4,678.8 832
9 TSX Group $1,033.4 $1,716.2 3,841
10 BME Spanish Exchanges $948.4 $2,410.7 3,576
Source: Adapted from the World Federation of Exchanges 2008 Report (seehttp://www.world-exchanges.org).
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EXHIBIT 8-3 REAL RETURNS ON GLOBAL EQUITYSECURITIES, BONDS, AND BILLS DURING 1900-2008
Source: E. Dimson, P. Marsh, and M. Staunton (2009)
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EXHIBIT 8-6 INTERNATIONAL COMPARISONS OFSTOCK OWNERSHIP IN SELECTED COUNTRIES:
2000 –2008
2000 2002 2004 2006 2008 Australia – Direct/Indirect 52% 50% 55% 46% 41% Canada – Shares/Funds 49 46 49 N/A N/A Germany – Shares/Funds 19 18 16 16 14 Hong Kong – Shares 22 20 24 N/A 22 New Zealand 24 N/A 23 26 N/A
South Korea –
Shares 7 8 8 7 N/A Switzerland – Shares/Funds 34 25 21 21 21 Sweden – Shares 22 23 22 20 18 U.K. – Shares/Funds 26 25 22 20 18 U.S. – Direct/Indirect N/A 50 49 N/A 45
Source: Adapted from the 2008 Australian Share Ownership Study conducted bythe Australian Securities Exchange (see http://www.asx.com.au). For Australiaand the United States, the data pertain to direct and indirect ownership in equitymarkets; for other countries, the data pertain to direct ownership in shares andshare funds. Data not available in specific years are shown as “N/A.”
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COMMON SHAREHOLDERS
• Share in the operatingperformance of the company.
Ownershipinterests
• Claim on assets after allliabilities have been paid.
Residualclaimants
• Voting rights on majorcorporate decisions.Governanceparticipants
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VOTING RIGHTS
Votingrights
Statutoryvoting
Cumulativevoting
Shareclasses
Vote by proxy
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EMBEDDED OPTIONS
Callablecommonshares Putable common
shares
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PREFERENCE SHARES (PREFERRED STOCK)
Rank above common stock for dividendpayments and liquidation claims
Shareholders do not share in the firm’soperating performance
Generally do not have voting rights
Dividends are fixed and typically higherthan common dividends
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DIVIDENDS ON PREFERENCE SHARES
Cumulative Noncumulative
Participating Nonparticipating
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POSSIBLE ADVANTAGES OF CONVERTIBLEPREFERENCE SHARES
Earn a higher dividend
Opportunity to share in profits
Benefit from a rise in the price of the commonshares
Price is less volatile than the common shareprice
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PRIVATE EQUITY SECURITIES
Equitysecurities
Private
Venturecapital
Leveragedbuyouts
Private
investment inpublic equityPublic
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INVESTING IN NONDOMESTIC EQUITYSECURITIES
• Buy and sell shares directly in foreignmarkets.
Directinvestment
• Global depository receipts (GDR)• American depository receipts (ADR)• Global registered share (GRS)
• Basket of listed depository receipts(BLDR)
Depository
receipts(DR)
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EXHIBIT 8-16 SUMMARY OF THE MAIN FEATURES OF AMERICAN DEPOSITORY RECEIPTS
Level I
(Unlisted)
Level II
(Listed)
Level III
(Listed)
Rule 144A
(Unlisted)Objectives Develop and
broaden U.S.investor base withexisting shares
Develop and broaden U.S.investor base withexisting shares
Develop and broaden U.S.investor base withexisting/newshares
Access qualifiedinstitutional buyers (QIBs)
Raising capital onU.S. markets?
No No Yes, through public offerings
Yes, through private placements
to QIBsSEC registration Form F-6 Form F-6 Forms F-1 and F-
6 None
Trading Over the counter(OTC)
NYSE, NASDAQ, orAMEX
NYSE, NASDAQ, orAMEX
Private offerings,resales, andtrading throughautomatedlinkages such as
PORTALListing fees Low High High Low
Size and earningsrequirements
None Yes Yes None
Source: Adapted from Boubakri, Cosset, and Samet (2008): Table 1.
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RETURN CHARACTERISTICS OF EQUITYSECURITIES
Dividendincome
Price change (capitalgain)
Foreign exchangegains or losses
Reinvesteddividends
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EXHIBIT 8-17 IMPACT OF REINVESTED DIVIDENDS ONCUMULATIVE REAL RETURNS IN THE U.S. EQUITY MARKET:
1900 –2008
Source: Dimson, Marsh, and Staunton (2009).
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METHODS FOR ESTIMATING RISK ANDRETURN
Historical data
• Average rate of return• Standard deviation
Probability distribution ofpossible returns
• Expected return• Standard deviation
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PREFERENCE SHARES ARE LESS RISKY THANCOMMON SHARES
Knownliquidation
value
Priorityclaim onincome
Fixeddividend
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EMBEDDED OPTIONS AND RISK
Higher risk:
• Callable
• Nonputable
• Noncumulative
Lower risk:
• Noncallable
• Putable• Cumulative
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WHY ISSUE EQUITY?
Raise capital
Finance revenue-generating activities
Ensure goingconcern status
Increase liquidity
Mergers andacquisitions
Stock-basedcompensation
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GOALS FOR MANAGING EQUITY
Increasebook
value
Maximize
marketvalue
• Increase net income• Retain more earnings• Issue shares
• Manage investors’
expectations
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ACCOUNTING RETURN ON EQUITY (ROE)
Financial Year Ending
31 Dec 2008 31 Dec 2007 31 Dec 2006
Pfizer
Net income $8,104,000 $8,144,000 $19,337,000
Total stockholders’ equity $57,556,000 $65,010,000 $71,358,000
%2.132/)000,010,65$000,556,57($
000,104,8$ROE
%9.112/)000,358,71$000,010,65($
000,144,8$ROE
2/BVEBVE
NIROE
2008
2007
1
t t
t
t
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MARKET VALUE, BOOK VALUE, ANDPRICE-TO-BOOK RATIO
PfizerMarket price $16.97Total shares outstanding 6,750,000Total shareholders’ equity $57,556,000Total market value of equity $114,547,500
Market value of equity = Market price per share × Shares outstandingMarket value of equity = US$16.97 × 6,750,000 = US$114,547,500
Book value of equity per share = Total shareholders’ equity/Shares
outstandingBook value of equity per share = US$57,556,000/6,750,000 = US$8.53
Price-to-book ratio = Market price per share/Book value of equity per sharePrice-to-book ratio = US$16.97/US$8.53 = 1.99
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THE COST OF EQUITY
Companywants to raiseequity capital
Company notcontractuallyobligated toshareholders
What is
the costof equity?
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INVESTOR’S REQUIRED RATE OF
RETURN
Investor’s minimum required rate of
returnCost of
equity
Estimate with pricing models:
dividend discount model (DDM),capital asset pricing model (CAPM),
etc.
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SUMMARY
• Types of equity securities• Importance and relative performance of equity securities
• Ownership characteristics and voting rights
• Investing in nondomestic equities
• Risk and return characteristics
• Market value and book value
• Cost of equity, (accounting) return on equity, and investor’s
required return