7- 1 Market Efficiency and Long-term Financing 7- 2 A $1 Investment in Different Types of Portfolios: 1926-1996 (Fig. 12.4) Index ($) Small Company Stocks $4,495.99 $1,370.95 Large Company Stocks $33.73 Long-Term Government Bonds $13.54 $8.85 Treasury Bills Inflation Year-End
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Small Company Stocks
Large Company Stocks
Long-Term Government Bonds
In an Efficient Capital Market prices reflect all relevant information. You cannot consistently earn excess or ‘abnormal’ profits.
Does this mean prices remain always the same and won’t move?
Random Walk - Security prices change randomly, with no predictable trends or patterns.
Technical Analysts - Investors who attempt to identify over- or undervalued stocks by searching for patterns in past prices.
Head and Shoulders Triple Tops
Fundamental Analysts - Analysts who attempt to find under- or overvalued securities by analyzing fundamental information, such as earnings, asset values, and business prospects.
Efficient market reaction
Days relativeto announcement day
Efficient market reaction: The price instantaneously adjusts to and fully reflects new information; there is no tendency for subsequent increases and decreases.Delayed reaction:The price partially adjusts to the new information; 8 days elapse before the price completely reflects the new informationOverreaction:The price over-adjusts to the new information; it “overshoots” the new price and subsequently corrects.
Debt and Equity
Assume 3 directors to be elected and you own 20 shares
Straight Voting: Directors are elected one at a time
You may cast all your votes for each member of the BOD
20 shares = 20 votes
Cumulative Voting: Directors are elected all at once
You may cast all your votes for one member of the BOD
# votes = # shares × # directors to be elected:
(20 shares) × (4 directors to be elected) = 60 votes
For cumulative voting if N directors are to be elected, it takes 1/(N+1) percent of the stock + 1 share to assure a deciding vote for one director
25% of the shares + 1 share will guarantee you one deciding vote for 1 director
Internally generated funds
New Equity Sales
Nine of the 10 biggest first-day gains by IPOs were Internet stocks
Issuer Offering Date % Change
theglobe.com 11/12/98 474
MarketWatch.com 1/15/99 471
Broadcast.com 7/16/98 249
EarthWeb 11/10/98 247
Ticketmaster Online 12/2/98 243
uBid 12/3/98 220
Secure Computing 11/17/95 202
Artificial Life 12/17/98 176
eBay 9/24/98 163
Yahoo! 4/12/96 154
Source: The Wall Street Journal January, 1999
IPO's rise in value on first day of issue by an average of15%
In 1980, when Apple Computer went public, shares were offered at $22 per share and jumped to $36.
Boston Chicken stock was offered at $20 per share and jumped to $49 on the first day of trading.
Should you invest in each IPO given the average 15% return on an IPO during the first day?
Seasoned Equity Offering
On average stock prices fall. Why?
- Management may know firm is overvalued
- Management may know future earnings of the firm are
going to be poor
- Issuing equity may imply the firm has too much debt or too little equity
- High issue costs
- Downward sloping demand curves
An issue of common stock to existing shareholders.
Example: April 8, 1994, Revco to raise $217 Million
Stockholders of record as of 6/13/94 will receive 0.305
transferable right for each share of stock
Subscription price of $14 per share
Rights to expire 7/7/94
Proceeds used to facilitate acquisition of Hook-SupeRx, Inc.
The Individual Shareholder
DOTCOM Corporation Rights Offer
Design Corp. gives existing shareholders the opportunity to
buy 1 additional share at $15 per share for 3 rights owned.
1 share includes 1 right. Current Share price=$30
- What is the ex-rights share price?0
- What is the value of a right before the offering?
- What is the value of a right after the offering?