Answers to Chapter 8
Questions:
1. This is because stock market movements are sometimes seen as predictors of economic activity in a country. This
2. While common stockholders can potentially receive unlimited dividend payments if the firm is highly profitable,
they have no special or guaranteed dividend rights. The payment and size of dividends is determined by the board of
3. Common stockholders have the lowest priority claim on a corporation’s assets in the event of bankruptcy. That is,
4. Dual-class firms are corporations in which two classes of common stock are outstanding with differential voting
rights assigned to each class in various ways. For example, inferior voting rights have been assigned by i) limiting
5. Nonparticipating preferred stock means that the preferred stock dividend is fixed regardless of any increase or
decrease in the issuing firm’s profits. In contrast, participating preferred stock means that actual dividends paid in
6. Cumulative preferred stock means that any missed dividend payments go into arrears and must be made up
7. In a public sale of stock, once the issuing firm and the investment bank have agreed on the details of the stock
After submission of the registration statement, the SEC has 20 days to request additional information or changes
to the registration statement. It generally takes about 20 days for the SEC to declare whether or not a registration
Once the SEC is satisfied with the registration statement, it registers the issue. At this point, the issuer (along with
The period of time between the company’s filing of the registration statement with the SEC and the selling of
shares is referred to as the “quiet period.” Historically, the issuing company could send no written communication
to the public during the quiet period other than information regarding the normal course of business. Once a
8. The two major U.S. stock markets are the NYSE Euronext and the NASDAQ system. Prior to its acquisition by
the NYSE in 2008, the American Stock Exchange (AMEX) was a third major stock exchange. Figures 8-6 and 8-7
9. A market order is an order for the broker and the designated market maker (DMM) to transact at the best price
available when the order reaches the post. The floor or commission broker will go to the post and conduct the
trade. A limit order is an order to transact only at a specified price (the limit price). When a floor or commission
10. As a result of the potential for increased volatility created by program trading, in 1990 the New York Stock
11. As a result of the flash crash, circuit breakers, termed in this case limit up-limit down (LULD) rules, were
instituted for individual stocks. Figure 8-12 shows the rules put in place in 2013. Phase I began in April 2013 for
12. Flash trading is a controversial practice in which, for a fee, traders are allowed to see incoming buy or sell
orders milliseconds earlier than general market traders. With this very slight advance notice of market orders, these
Naked access trading allows some traders and others to rapidly buy and sell stocks directly on exchanges using a
broker’s computer code without exchanges or regulators always knowing who is making the trades. The firms,
Dark pools of liquidity are trading networks that provide liquidity but that do not display trades on order books. This
is useful for traders such as institutional traders who wish to buy and sell large numbers of shares without revealing
Critics contend that activities such as flash trading, naked access, and dark pool trading create a market in which
certain traders can unfairly exploit others. The Wall Street Reform and Consumer Protection Act of 2010 gave the
Commodity Futures Trading Commission (CFTC) expanded powers to investigate and prosecute disruptive trading
13. The Dow Jones Industrial Average (the DJIA or the Dow) is the most widely reported stock market index. The
DJIA, first established in 1896, is an index based on the values of 30 large (in terms of sales and total assets)
In 1966, the NYSE established the NYSE Composite Index to provide a comprehensive measure of the
performance of the overall NYSE market. The index consists of all common stocks listed on the NYSE. In
Standard & Poor’s established the S&P 500 index (a value-weighted index) consisting of the stocks of 500 of the
largest U.S. corporations listed on the NYSE and the NASDAQ. The NYSE stocks included in the S&P 500 index
account for over 80 percent of the total market value of all stocks listed on the NYSE. Thus, movements in the
The Wilshire 5000 index was created in 1974 (when computers made the daily computation of such a large index
possible) to track the value of the entire stock market. It is the broadest stock market index and possibly the most
accurate reflection of the overall stock market. The Wilshire 5000 index contains virtually every stock that meets
14. In a price-weighted index the stock prices of the companies in the indexes are added together and divided by an
adjusted value, (or divisor). Dow indexes are price-weighted averages. The divisor was set at 30 in 1928, but due to
In a value-weighted index the current market values (stock price x number of shares outstanding) of all stocks in the
index are added together and divided by their value on a base date. Any changes in the stocks included in the index
15. Households are the single largest holders of corporate stock (holding 39.5 percent of all corporate stock
outstanding in 2013). Mutual funds and foreign investors are also prominent in the stock markets (holding 19.6
As a result of the tremendous increase in stock values in the 1990s, most individuals in the United States either
directly own corporate stock or indirectly own stock via investments in mutual funds and pension funds. Figure
Table 8–5 reports characteristics of adult investors in the stock markets, in April 2008 and 2013. Note that in every
category, percentages have dropped over this period. Older investors are the most active. In 2013, sixty-one percent
of individuals 50 to 64 years old are invested, compared to just 27 percent of those 18 to 29 years old. These
16. Figure 8-15 shows the relation between stock market movements and economic cycles in the U.S. Notice some
recessionary periods were indeed, preceded by a decline in stock market index values; other recessionary periods