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Friday, September 26, 2008

Stock pricing book value

To clearly distinguish the market price of shares from the core ownership equity or shareholders' equity, the term 'book value' is often used since it focuses on the values that have been added and subtracted in the accounting books of a business (assets - liabilities). The term is also used to distinguish between the market price of any asset and its accounting value which depends more on historical cost and depreciation. It may be used interchangeably with carrying value. While it can be used to refer to the business' total equity, it is most often used:

  • as a 'per share' value': The balance sheet Equity value is divided by the number of shares outstanding at the date of the balance sheet (not the average o/s in the period).
  • as a 'diluted per share value': The Equity is bumped up by the exercise price of the options, warrants or preferred shares. Then it is divided by the number of shares that has been increased by those added.


  1. Book value is used in the financial ratio price/book. It is a valuation metric that sets the floor for stock prices under a worst-case scenario. When a business is liquidated, the book value is what may be left over for the owners after all the debts are paid. Paying only a price/book = 1 means the investor will get all his investment back. Shares of capital intensive industries trade at lower price/book ratios because they generate lower earnings per dollar of assets. Business depending on human capital will generate higher earnings per dollar of assets, so will trade at higher price/book ratios.
  2. Book value per share can be used to generate a measure of comprehensive earnings, when the opening and closing values are reconciled. BookValuePerShare, beginning of year - Dividends + ShareIssuePremium + Comprehensive EPS = BookValuePerShare, end of year.

Changes are caused by

  1. The sale of shares/units by the business increases the total book value. Book/sh will increase if the additional shares are issued at a price higher than the pre-existing book/sh.
  2. The purchase of its own shares by the business will decrease total book value. Book/sh will decrease if more is paid for them than was received when originally issued (pre-existing book/sh).
  3. Dividends paid out will decrease book value and book/sh.
  4. Comprehensive earnings/losses will increase/decrease book value and book/sh. Comprehensive earnings, in this case, includes net income from the Income Statement, foreign exchange translation changes to Balance Sheet items, accounting changes applied retroactively, and the opportunity cost of options exercised.

New share issues and dilution

The issue of more shares does not necessarily decrease the value of the current owner. While it is correct that when the number of shares is doubled the EPS will be cut in half, it is too simple to be the full story. It all depends on how much was paid for the new shares and what return the new capital earns once invested. See the discussion at stock dilution.

Net book value of long term assets

Book value is often used interchangeably with "net book value" or "carrying value", which is the original acquisition cost less accumulated depreciation, depletion or amortization.

Corporate book value

A company or corporation's book value, as an asset held by a separate economic entity, is the company or corporation's shareholders' equity, the acquisition cost of the shares, or the market value of the shares owned by the separate economic entity.

A corporation's book value is used in fundamental financial analysis to help determine whether the market value of corporate shares is above or below the book value of corporate shares. Neither market value nor book value is an unbiased estimate of a corporation's value. The corporation's bookkeeping or accounting records do not generally reflect the market value of assets and liabilities, and the market or trade value of the corporation's stock is subject to variations.

Net asset value

In the United Kingdom, the term net asset value may refer book value.

A mutual fund is an entity which primarily owns "financial assets" or capital assets such as bonds, stocks and commercial paper. The net asset value of a mutual fund is the market value of assets owned by the fund minus the fund's liabilities.This is similar to shareholders' equity, except the asset valuation is market-based rather than based on acquisition cost. In financial news reporting, the reported net asset value of a mutual fund is the net asset value of a single share in the fund. In the mutual fund's accounting records, the financial assets are recorded at acquisition cost. When assets are sold, the fund records a capital gain or capital loss.[citation needed]

Financial assets include stock shares and bonds owned by an individual or company. These may be reported on the individual or company balance sheet at cost or at market value.

Liability book value

"Discount on notes payable" is a contra-liability account which decreases the balance sheet valuation of the liability.

When a company sells (issues) bonds, this debt is a long-term liability on the company's balance sheet, recorded in the account Bonds Payable based on the contract amount. After the bonds are sold, the book value of Bonds Payable is increased or decreased to reflect the actual amount received in payment for the bonds. If the bonds sell for less than face value, the contra account Discount on Bonds Payable is debited for the difference between the amount of cash received and the face value of the bonds.

Depreciable, amortizable and depletable assets

Monthly or annual depreciation, amortization and depletion are used to reduce the book value of assets over time as they are "consumed" or used up in the process of obtaining revenue.These non-cash expenses are recorded in the accounting books after a trial balance is calculated to ensure that cash transactions have been recorded accurately. Depreciation is used to record the declining value of buildings and equipment over time. Land is not depreciated. Amortization is used to record the declining value of intangible assets such as patents. Depletion is used to record the consumption of natural resources.

Depreciation, amortization and depletion are recorded as expenses against a contra account. Contra accounts are used in bookkeeping to record asset and liability valuation changes. "Accumulated depreciation" is a contra-asset account used to record asset depreciation.

Sample general journal entry for depreciation

  • Depreciation expenses: building... debit = $150, under expenses in retained earnings
  • Accumulated depreciation: building... credit = $150, under assets

The balance sheet valuation for an asset is the asset's cost basis minus accumulated depreciation. Similar bookkeeping transactions are used to record amortization and depletion.

Asset book value

An asset's initial book value is its actual cash value or its acquisition cost. Cash assets are recorded or "booked" at actual cash value. Assets such as buildings, land and equipment are valued based on their acquisition cost, which includes the actual cash cost of the asset plus certain costs tied to the purchase of the asset, such as broker fees. Not all purchased items are recorded as assets; incidental supplies are recorded as expenses. Some assets might be recorded as current expenses for tax purposes. An example of this is assets purchased and expensed under Section 179 of the US tax code.

Book value

In accounting, book value or carrying value is the value of an asset or according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset. A company's book value is its total assets minus intangible assets and liabilities. In the United Kingdom, the term net asset value may refer to the book value of a company.

Calculating EPS

The EPS formula does not include preferred dividends for categories outside of continued operations and net income. Earnings per share for continuing operations and net income are more complicated in that any preferred dividends are removed from net income before calculating EPS. Remember that preferred stock rights have precedence over common stock. If preferred dividends total $100,000, then that is money not available to distribute to each share of common stock.

Earnings Per Share (Basic Formula)
\mbox{Earnings Per Share}=\frac{\mbox{Profit}}{\mbox{Weighted Average Common Shares}}

Earnings Per Share (Net Income Formula)
\mbox{Earnings Per Share}=\frac{\mbox{Net Income}}{\mbox{Weighted Average Common Shares}}

Earnings Per Share (Continuing Operations Formula)
\mbox{Earnings Per Share}=\frac{\mbox{Income from Continuing Operations}}{\mbox{Weighted Average Common Shares}}

Note: Only preferred dividends actually declared in the current year are subtracted. The exception is when preferred shares are cumulative, in which case annual dividends are deducted regardless of whether they have been declared or not. Dividends in arrears are not relevant when calculating EPS

Earnings per share

Earnings per share (EPS) are the earnings returned on the initial investment amount.

In the US, the Financial Accounting Standards Board (FASB) requires companies' income statements to report EPS for each of the major categories of the income statement: continuing operations, discontinued operations, extraordinary items, and net income.

S&P 500

In 1982 the dividend yield on the S&P 500 Index reached 6.7%. Over the following 16 years, the dividend yield declined to just a percentage value of 1.4% during 1998, because stock prices increased faster than dividend payments from earnings, and public company earnings increased slower than stock prices. During the 20th century, the highest growth rates for earnings and dividends over any 30-year period were 6.3% annually for dividends, and 7.8% for earnings. As of 2008, the average dividend yield is around 2%

Dow Industrials

The dividend yield of the Dow Jones Industrial Average, which is obtained from the annual dividends of all 30 companies in the average divided by their cumulative stock price, has also been considered to be an important indicator of the strength of the U.S. stock market. Historically, the Dow Jones dividend yield has fluctuated between 3.2% (during market highs, for example in 1929) and around 8.0% (during typical market lows). The highest ever Dow Jones dividend yield occurred during the stock market collapse of 1932, when it exceeded 15%.

With the decreased emphasis on dividends since the mid-1990s, the Dow Jones dividend yield has fallen well below its historical low-water mark of 3.2% and reached as low as 1.4% during the stock market peak of 2000


Historically, a higher dividend yield has been considered to be desirable among investors. A high dividend yield can be considered to be evidence that a stock is under priced or that the company has fallen on hard times and future dividends will not be as high as previous ones. Similarly a low dividend yield can be considered evidence that the stock is overpriced or that future dividends might be higher.

Dividend yield fell out of favor somewhat during the 1990s because of an increasing emphasis on price appreciation over dividends as the main form of return on investments.

The importance of the dividend yield in determining investment strength is still a debated topic. The persistent historic low in the Dow Jones dividend yield during the early 21st century is considered by some bearish investors as indicative that the market is still overvalued.

Common share dividend yield

Unlike preferred stock, there is no stipulated dividend for common stock. Instead, dividends paid to holders of common stock are set by management, usually in relation to the company's earnings. There is no guarantee that future dividends will match past dividends or even be paid at all. Due to the difficulty in accurately forecasting future dividends, the most commonly-cited figure for dividend yield is the current yield which is calculated using the following formula:

\mbox{Current Dividend Yield}=\frac{\mbox{Most Recent Full-Year Dividend}}{\mbox{Current Share Price}}

For example, take a company which paid dividends totaling $1 last year and whose shares currently sell for $20. Its dividend yield would be calculated as follows: \begin{array}{lcl}  \mbox{Current Dividend Yield} & = & \frac{\mbox{Most Recent Full-Year Dividend}}{\mbox{Current Share Price}}     \\         & = & \frac{$1}{$20} \\         & = & 0.05 \\         & = & 5% \\ \end{array}

Rather than use last year's dividend, some try to estimate what the next year's dividend will be and use this as the basis of a future dividend yield. Such a scheme is used for the calculation of the FTSE UK Dividend+ Index. It should be noted that estimates of future dividend yields are by definition uncertain.

Dividend yield

The dividend yield on a company stock is the company's annual dividend payments divided by its market cap, or the dividend per share divided by the price per share. It is often expressed as a percentage.

Preferred share dividend yield

Dividend payments on preferred shares are stipulated by the prospectus. The company will typically refer to a preferred share by its initial name which is the yield on its original price — for example, a 6% preferred share. However, the price of preferred shares varies according to the market so the yield based on the current price fluctuates. Owners of preferred shares calculate multiple yields to reflect the different possible outcomes over the life of the security.

  • current yield is the $Dividend / Pfd share current price.
  • Since the share may be purchased at a lower (higher) cost than its final redemption value, holding it to maturity will result in a capital gain (loss). The annualized rate of gain is calculated using the Present value of a dollar calculation. ('PV' is the current stock price. 'FV' is the redemption value. 'n' is the number of years to redemption. Solve for the interest rate 'r'.) The yield to maturity is the sum of this annualized gain (loss) and the current yield.
  • There are other possible yields discussed at Yield to maturity.



We want to find out the value of Pn as  n \rightarrow \infty , where

P_n = \sum_{t=1}^{n}  D\times \frac{(1+g)^t}{(1+k)^t} = D\times \sum_{t=1}^{n} \frac{(1+g)^t}{(1+k)^t}  = D\times \sum_{t=1}^{n} \left(\frac{1+g}{1+k}\right)^t


 a = \frac{1+g}{1+k} .


P_n = D\times \sum_{t=1}^{n} a^t .


 1-a^{(n+1)} = (1-a) \times (1 + a + a^2 + ... + a^n) = (1-a) \times (1 + \sum_{t=1}^{n} a^t) ,

we get

 \frac{1-a^{(n+1)}}{1-a} - 1 = \sum_{t=1}^{n} a^t .


P_n = D \times \left[ \frac{1-a^{(n+1)}}{1-a} - 1 \right] .

If g < k, then a <> and

 a^{(n+1)} \rightarrow 0 as  n \rightarrow \infty .

Thus, we get

P_\infty = D \times \left( \frac{1}{1-a} - 1 \right) = D \times \left( \frac{a}{1-a} \right) = D \times \left(\frac{1+g}{1+k}\right) / \left[ 1 - \left(\frac{1+g}{1+k}\right) \right] = D \times \left( \frac{1+g}{k-g} \right) .

Problems with the model

Problems with the model

a) The model requires one perpetual growth rate

But for many growth stocks, the current growth rate can vary with the cost of capital significantly year by year. In this case this model should not be used.

b) If the stock does not currently pay a dividend, like many growth stocks, more general versions of the discounted dividend model must be used to value the stock. One common technique is to assume that the Miller-Modigliani hypothesis of dividend irrelevance is true, and therefore replace the stocks's dividend D with E earnings per share.

But this has the effect of double counting the earnings. The model's equation recognizes the trade off between paying dividends and the growth realized by reinvested earnings. It incorporates both factors. By replacing the (lack of) dividend with earnings, and multiplying by the growth from those earnings, you double count.

c) Gordon's model is sensitive if k is close to g. For example, if

  • dividend = $1.00
  • cost of capital = 8%

Say the

  • growth rate = 1% - 2%

So the price of the stock

  • assuming 1% growth= $14.43 = 1.00(1.01/.07)
  • assuming 2% growth= $17.00 = 1.00(1.02/.06)

The difference determined in valuation is relatively small.

Now say the

  • growth rate = 6% - 7%

So the price of the stock

  • assuming 6% growth= $53 = 1.00(1.06/.02)
  • assuming 7% growth= $107 = 1.00(1.07/.01)

The difference determined in valuation is large.

Gordon model

Gordon growth model is a variant of the Discounted cash flow model, a method for valuing a stock or business. Often used to provide difficult-to-resolve valuation issues for litigation, tax planning, and business transactions that are currently off market. It is named after Myron Gordon, who was a professor at the University of Toronto.

It assumes that the company issues a dividend that has a current value of D that grows at a constant rate g. It also assumes that the required rate of return for the stock remains constant at k which is equal to the cost of equity for that company. It involves summing the infinite series which gives the value of price current P.

 P= \sum_{t=1}^{\infty}  D\times\frac{(1+g)^t}{(1+k)^t}.
Summing the infinite series we get,

P = D\times\frac{1+g}{k-g}, In practice this P is then adjusted by various factors e.g. the size of the company.
k=\frac{D\times\left(1+g\right)}{P}+g, k denotes expected return = yield + expected growth.

It is common to use the next value of D given by D1 = D0(1 + g), thus the Gordon's model can be stated as [1]

P_0 = \frac{D_1}{k-g}.

Note that the model assumes that the earnings growth is constant for perpetuity. In practice a very high growth rate cannot be sustained for a long time. Often it is assumed that the high growth rate can be sustained for only a limited number of years. After that only a sustainable growth rate will be experienced. This corresponds to the terminal case of the Discounted cash flow model. Gordon's model is thus applicable to the terminal case.


Over-the-counter (OTC) trading is to trade financial instruments such as stocks, bonds, commodities or derivatives directly between two parties. It is contrasted with exchange trading, which occurs via corporate-owned facilities constructed for the purpose of trading (i.e., exchanges), such as futures exchanges or stock exchanges.

OTC-traded stocks

In the U.S., over-the-counter trading in stocks is carried out by market makers that make markets in OTCBB and Pink Sheets securities using inter-dealer quotation services such as Pink Quote (operated by Pink OTC Markets) and the OTC Bulletin Board (OTCBB). OTC stocks are not listed or traded on any stock exchange. Although stocks quoted on the OTCBB must comply with SEC reporting requirements, other OTC stocks, such as those stocks categorized as Pink Sheets securities, have no reporting requirements, while those stocks categorized as OTCQX have met alternative disclosure guidelines through Pink OTC Markets.

The OTC market presents investment opportunities for informed investors, but also has a high degree of risk. Many OTC issuers are small companies with limited operating histories or are economically distressed. Investments in legitimate OTC companies can often lead to the complete loss of the investment. Investors should avoid the OTC market unless they can afford a complete loss of their investment. Investors should never purchase any security without first evaluating the fundamentals of the company and carefully reviewing the financial statements, management background and other data. Investors who purchase securities based on a "hot tip" or the advice of chat room touts may often be disappointed.

OTC market statistics

Data provided by Pink Sheets:

  • Securities quoted exclusively on Pink Sheets - 5,019
  • Securities dually quoted on Pink Sheets and OTCBB - 3,445
  • Securities quoted exclusively on OTCBB - 130

Total OTC securities - 5,149

Friday, August 15, 2008

Approximate valuation approaches

Average growth approximation: Assuming that two stocks have the same earnings growth, the one with a lower P/E is a better value. The P/E method is perhaps the most commonly used valuation method in the stock brokerage industry. By using comparison firms, a target price/earnings (or P/E) ratio is selected for the company, and then the future earnings of the company are estimated. The valuation's fair price is simply estimated earnings times target P/E. This model is essentially the same model as Gordon's model, if k-g is estimated as the dividend payout ratio (D/E) divided by the target P/E ratio.

Constant growth approximation: The Gordon model or Gordon's growth is the best known of a class of discounted dividend models. It assumes that dividends will increase at a constant growth rate (less than the discount rate) forever. The valuation is given by the formula:

P = D\cdot\sum_{i=1}^{\infty}\left(\frac{1+g}{1+k}\right)^{i} = D\cdot\frac{1+g}{k-g}

and the following table defines each symbol:

Symbol Meaning Units
\ P \ estimated stock price $ or € or £
\ D \ last dividend paid $ or € or £
\ k \ discount rate %
\ g the growth rate of the dividends %

Fundamental criteria (fair value)

he most theoretically sound stock valuation method, called income valuation or the discounted cash flow (DCF) method, involves discounting of the profits (dividends, earnings, or cash flows) the stock will bring to the stockholder in the foreseeable future, and a final value on disposition. The discounted rate normally includes a risk premium which is commonly based on the capital asset pricing model.

Stock valuation

here are several methods used to value companies and their stocks. They attempt to give an estimate of their fair value, by using fundamental economic criteria. This theoretical valuation has to be perfected with market criteria, as the final purpose is to determine potential market prices.

Wednesday, July 16, 2008


The future of stock exchanges

The future of stock trading appears to be electronic, as competition is continually growing between the remaining traditional New York Stock Exchange specialist system against the relatively new, all Electronic Communications Networks, or ECNs. ECNs point to their speedy execution of large block trades, while specialist system proponents cite the role of specialists in maintaining orderly markets, especially under extraordinary conditions or for special types of orders.

The ECNs contend that an array of special interests profit at the expense of investors in even the most mundane exchange-directed trades. Machine-based systems, they argue, are much more efficient, because they speed up the execution mechanism and eliminate the need to deal with an intermediary.

Historically, the 'market' (which, as noted, encompasses the totality of stock trading on all exchanges) has been slow to respond to technological innovation. Conversion to all-electronic trading could erode/eliminate the trading profits of floor specialists and the NYSE's "upstairs traders."

William Lupien, founder of the Instinet trading system and the OptiMark system, has been quoted as saying "I'd definitely say the ECNs are winning... Things happen awfully fast once you reach the tipping point. We're now at the tipping point."

Congress mandated the establishment of a national market system of multiple exchanges in 1975. Since then, ECNs have been developing rapidly.

One example of improved efficiency of ECNs is the prevention of front running, by which manual Wall Street traders use knowledge of a customer's incoming order to place their own orders so as to benefit from the perceived change to market direction that the introduction of a large order will cause. By executing large trades at lightning speed without manual intervention, ECNs make impossible this illegal practice, for which several NYSE floor brokers were investigated and severely fined in recent years. Under the specialist system, when the market sees a large trade in a name, other buyers are immediately able to look to see how big the trader is in the name, and make inferences about why s/he is selling or buying. All traders who are quick enough are able to use that information to anticipate price movements.

ECNs have changed ordinary stock transaction processing (like brokerage services before them) into a commodity-type business. ECNs could regulate the fairness of initial public offerings (IPOs), oversee Hambrecht's OpenIPO process, or measure the effectiveness of securities research and use transaction fees to subsidize small- and mid-cap research efforts.

Some, however, believe the answer will be some combination of the best of technology and "upstairs trading" — in other words, a hybrid model.

Trading 25,000 shares of General Electric stock (recent quote: $34.76; recent volume: 44,760,300) would be a relatively simple e-commerce transaction; trading 100 shares of Berkshire Hathaway Class A stock (recent quote: $139,700.00; recent volume: 850) may never be. The choice of system should be clear (but always that of the trader), based on the characteristics of the security to be traded.

Even with ECNs forming an important part of a national market system, opportunities presumably remain to profit from the spread between the bid and offer price. That is especially true for investment managers that direct huge trading volume, and own a stake in an ECN or specialist firm. For example, in its individual stock-brokerage accounts, "Fidelity Investments runs 29% of its undesignated orders in NYSE-listed stocks, and 37% of its undesignated market orders through the Boston Stock Exchange, where an affiliate controls a specialist post."

Fidelity says these arrangements are governed by a separate brokerage "order-flow management" team, which seeks to obtain the best possible execution for customers, and that its execution is highly rated.

Other types of exchanges

In the 19th century, exchanges were opened to trade forward contracts on commodities. Exchange traded forward contracts are called futures contracts. These commodity exchanges later started offering future contracts on other products, such as interest rates and shares, as well as options contracts. They are now generally known as futures exchanges.


Stock exchanges originated as mutual organizations, owned by its member stock brokers. There has been a recent trend for stock exchanges to demutualize, where the members sell their shares in an initial public offering. In this way the mutual organization becomes a corporation, with shares that are listed on a stock exchange. Examples are Australian Securities Exchange (1998), Euronext (merged with New York Stock Exchange), NASDAQ (2002), the New York Stock Exchange (2005), Bolsas y Mercados Españoles, and the São Paulo Stock Exchange (2007).

Listing requirements

Listing requirements are the set of conditions imposed by a given stock exchange upon companies that want to be listed on that exchange. Such conditions sometimes include minimum number of shares outstanding, minimum market capitalization, and minimum annual income.

Requirements by stock exchange

Companies have to meet the requirements of the exchange in order to have their stocks and shares listed and traded there, but requirements vary by stock exchange:

  • London Stock Exchange: The main market of the London Stock Exchange has requirements for a minimum market capitalization (£700,000), three years of audited financial statements, minimum public float (25 per cent) and sufficient working capital for at least 12 months from the date of listing.
  • NASDAQ Stock Exchange: To be listed on the NASDAQ a company must have issued at least 1.25 million shares of stock worth at least $70 million and must have earned more than $11 million over the last three years.
  • New York Stock Exchange: To be listed on the New York Stock Exchange (NYSE), for example, a company must have issued at least a million shares of stock worth $100 million and must have earned more than $10 million over the last three years.
  • Bombay Stock Exchange: Bombay Stock Exchange (BSE) has requirements for a minimum market capitalization of Rs.250 Million and minimum public float equivalent to Rs.100 Million.

The main stock exchanges

Major stock exchanges

Major stock exchanges

Twenty Major Stock Exchanges In The World: Market Capitalization & Year-to-date Turnover at the end of October 2007
Region ↓ Stock Exchange ↓ Market Value
(trillions of US dollars) ↓ Total Share Turnover
(trillions of US dollars) ↓
Africa Johannesburg Securities Exchange $0.940 $0.349
Americas NASDAQ $4.39 $12.4
Americas São Paulo Stock Exchange $1.40 $0.476
Americas Toronto Stock Exchange $2.29 $1.36
Americas/Europe NYSE Euronext $20.7 $28.7
Asia-Pacific Australian Securities Exchange $1.453 $1.003
South Asia Bombay Stock Exchange $1.61 $0.263
Asia-Pacific Hong Kong Stock Exchange $2.97 $1.70
Asia-Pacific Korea Exchange $1.26 $1.66
South Asia National Stock Exchange of India $1.46 $0.564
Asia-Pacific Shanghai Stock Exchange $3.02 $3.56
Asia-Pacific Shenzhen Stock Exchange $0.741 $1.86
Asia-Pacific Tokyo Stock Exchange $4.63 $5.45
Europe Frankfurt Stock Exchange (Deutsche Börse) $2.12 $3.64
Europe London Stock Exchange $4.21 $9.14
Europe Madrid Stock Exchange (Bolsas y Mercados Españoles) $1.83 $2.49
Europe Milan Stock Exchange (Borsa Italiana) $1.13 $1.98
Europe Moscow Interbank Currency Exchange (MICEX) $0.9652 $0.4882
Europe Nordic Stock Exchange Group OMX1 $1.38 $1.60
Europe Swiss Exchange $1.33 $1.58

Note 1: includes the Copenhagen, Helsinki, Iceland, Stockholm, Tallinn, Riga and Vilnius Stock Exchanges
Note 2: latest data available is at the end of June 2007
Note 3: latest data available is at the end of September 2007

* Sources: World Federation of Exchanges - Statistics/Monthly
* Remarks: There are 2 pending major mergers: NASDAQ with OMX; and London Stock Exchange with Milan Stock Exchange

Major stock exchanges

Major stock exchanges

Twenty Major Stock Exchanges In The World: Market Capitalization & Year-to-date Turnover at the end of October 2007
Region ↓ Stock Exchange ↓ Market Value
(trillions of US dollars) ↓ Total Share Turnover
(trillions of US dollars) ↓
Africa Johannesburg Securities Exchange $0.940 $0.349
Americas NASDAQ $4.39 $12.4
Americas São Paulo Stock Exchange $1.40 $0.476
Americas Toronto Stock Exchange $2.29 $1.36
Americas/Europe NYSE Euronext $20.7 $28.7
Asia-Pacific Australian Securities Exchange $1.453 $1.003
South Asia Bombay Stock Exchange $1.61 $0.263
Asia-Pacific Hong Kong Stock Exchange $2.97 $1.70
Asia-Pacific Korea Exchange $1.26 $1.66
South Asia National Stock Exchange of India $1.46 $0.564
Asia-Pacific Shanghai Stock Exchange $3.02 $3.56
Asia-Pacific Shenzhen Stock Exchange $0.741 $1.86
Asia-Pacific Tokyo Stock Exchange $4.63 $5.45
Europe Frankfurt Stock Exchange (Deutsche Börse) $2.12 $3.64
Europe London Stock Exchange $4.21 $9.14
Europe Madrid Stock Exchange (Bolsas y Mercados Españoles) $1.83 $2.49
Europe Milan Stock Exchange (Borsa Italiana) $1.13 $1.98
Europe Moscow Interbank Currency Exchange (MICEX) $0.9652 $0.4882
Europe Nordic Stock Exchange Group OMX1 $1.38 $1.60
Europe Swiss Exchange $1.33 $1.58

Note 1: includes the Copenhagen, Helsinki, Iceland, Stockholm, Tallinn, Riga and Vilnius Stock Exchanges
Note 2: latest data available is at the end of June 2007
Note 3: latest data available is at the end of September 2007

* Sources: World Federation of Exchanges - Statistics/Monthly
* Remarks: There are 2 pending major mergers: NASDAQ with OMX; and London Stock Exchange with Milan Stock Exchange

The role of stock exchanges

Stock exchanges have multiple roles in the economy, this may include the following:

Raising capital for businesses

The Stock Exchange provides companies with the facility to raise capital for expansion through selling shares to the investing public.[2]

Mobilizing savings for investment

When people draw their savings and invest in shares, it leads to a more rational allocation of resources because funds, which could have been consumed, or kept in idle deposits with banks, are mobilized and redirected to promote business activity with benefits for several economic sectors such as agriculture, commerce and industry, resulting in a stronger economic growth and higher productivity levels and firms.

Facilitating company growth

Companies view acquisitions as an opportunity to expand product lines, increase distribution channels, hedge against volatility, increase its market share, or acquire other necessary business assets. A takeover bid or a merger agreement through the stock market is one of the simplest and most common ways for a company to grow by acquisition or fusion.

Redistribution of wealth

Stocks exchanges do not exist to redistribute wealth. However, both casual and professional stock investors, through dividends and stock price increases that may result in capital gains, will share in the wealth of profitable businesses.

Corporate governance

By having a wide and varied scope of owners, companies generally tend to improve on their management standards and efficiency in order to satisfy the demands of these shareholders and the more stringent rules for public corporations imposed by public stock exchanges and the government. Consequently, it is alleged that public companies (companies that are owned by shareholders who are members of the general public and trade shares on public exchanges) tend to have better management records than privately-held companies (those companies where shares are not publicly traded, often owned by the company founders and/or their families and heirs, or otherwise by a small group of investors). However, some well-documented cases are known where it is alleged that there has been considerable slippage in corporate governance on the part of some public companies (Pets.com (2000), Enron Corporation (2001), One.Tel (2001), [[Sunbeam Products|Sunbeam]] (2001), Webvan (2001), Adelphia (2002), MCI WorldCom (2002), or Parmalat (2003), are among the most widely scrutinized by the media).

Creating investment opportunities for small investors

As opposed to other businesses that require huge capital outlay, investing in shares is open to both the large and small stock investors because a person buys the number of shares they can afford. Therefore the Stock Exchange provides the opportunity for small investors to own shares of the same companies as large investors.

Government capital-raising for development projects

Governments at various levels may decide to borrow money in order to finance infrastructure projects such as sewage and water treatment works or housing estates by selling another category of securities known as bonds. These bonds can be raised through the Stock Exchange whereby members of the public buy them, thus loaning money to the government. The issuance of such bonds can obviate the need to directly tax the citizens in order to finance development, although by securing such bonds with the full faith and credit of the government instead of with collateral, the result is that the government must tax the citizens or otherwise raise additional funds to make any regular coupon payments and refund the principal when the bonds mature.

Barometer of the economy

At the stock exchange, share prices rise and fall depending, largely, on market forces. Share prices tend to rise or remain stable when companies and the economy in general show signs of stability and growth. An economic recession, depression, or financial crisis could eventually lead to a stock market crash. Therefore the movement of share prices and in general of the stock indexes can be an indicator of the general trend in the economy.

History of stock exchanges

In 11th century France the courtiers de change were concerned with managing and regulating the debts of agricultural communities on behalf of the banks. As these men also traded in debts, they could be called the first brokers.

Some stories suggest that the origins of the term "bourse" come from the Latin bursa meaning a bag because, in 13th century Bruges, the sign of a purse (or perhaps three purses), hung on the front of the house where merchants met.

House Ter Beurze in Bruges
House Ter Beurze in Bruges

However, it is more likely that in the late 13th century commodity traders in Bruges gathered inside the house of a man called Van der Burse, and in 1309 they institutionalized this until now informal meeting and became the "Bruges Bourse". The idea spread quickly around Flanders and neighbouring counties and "Bourses" soon opened in Ghent and Amsterdam.

The house of the Beurze family on Vlamingstraat Bruges was the site of the worlds first stock Exchange, circa 1415. The term Bourse is believed to have derived from the family name Beurze.

In the middle of the 13th century, Venetian bankers began to trade in government securities. In 1351, the Venetian Government outlawed spreading rumors intended to lower the price of government funds. There were people in Pisa, Verona, Genoa and Florence who also began trading in government securities during the 14th century. This was only possible because these were independent city states ruled by a council of influential citizens, not by a duke.

The Dutch later started joint stock companies, which let shareholders invest in business ventures and get a share of their profits - or losses. In 1602, the Dutch East India Company issued the first shares on the Amsterdam Stock Exchange. It was the first company to issue stocks and bonds. In 1688, the trading of stocks began on a stock exchange in London.

Stock exchange

A stock exchange, share market or bourse is a corporation or mutual organization which provides "trading" facilities for stock brokers and traders, to trade stocks and other securities. Stock exchanges also provide facilities for the issue and redemption of securities as well as other financial instruments and capital events including the payment of income and dividends. The securities traded on a stock exchange include: shares issued by companies, unit trusts and other pooled investment products and bonds. To be able to trade a security on a certain stock exchange, it has to be listed there. Usually there is a central location at least for recordkeeping, but trade is less and less linked to such a physical place, as modern markets are electronic networks, which gives them advantages of speed and cost of transactions. Trade on an exchange is by members only. The initial offering of stocks and bonds to investors is by definition done in the primary market and subsequent trading is done in the secondary market. A stock exchange is often the most important component of a stock market. Supply and demand in stock markets is driven by various factors which, as in all free markets, affect the price of stocks (see stock valuation).

There is usually no compulsion to issue stock via the stock exchange itself, nor must stock be subsequently traded on the exchange. Such trading is said to be off exchange or over-the-counter. This is the usual way that bonds are traded. Increasingly, stock exchanges are part of a global market for securities.

Floor broker

A floor broker is a member of an exchange who is an employee of a member firm and executes orders, as agent, on the floor of the exchange for clients. The floor broker receives an order via teletype machine from his firm's trading department and then proceeds to the appropriate trading post on the exchange floor. There he joins other brokers and the specialist in the security being bought or sold and executes the trade at the best competitive price available. On completion of the transaction the customer is notified through his registered representative back at the firm and the trade is printed on the consolidated ticker tape which is displayed electronically around the country. A floor broker should not be confused with a Floor Trader who trades as a principal for his or her own account, rather than as a broker.

floor trader

A floor trader is a member of a stock or commodities exchange who trades on the floor of that exchange for his or her own account. The floor trader must abide by trading rules similar to those of the exchange specialists who trade on behalf of others. The term should not be confused with Floor broker. Floor Traders are occasionally referred to as Registered Competitive Traders, Individual Liquidity Providers or locals.

A Floor Trader checking market prices

Market maker

A market maker is a firm who quotes both a buy and a sell price in a financial instrument or commodity, hoping to make a profit on the turn or the bid/offer spread.

In foreign exchange trading, where most deals are conducted Over-the-Counter and are, therefore, completely virtual, the market maker sells to and buys from its clients. Hence, the client's loss and the spread is the market-maker firm's profit, which gets thus compensated for the effort of providing liquidity in a competitive market. This extra liquidity reduces transaction costs and therefore facilitates trades for the clients, who would otherwise have to accept a worse price or even not be able to trade at all. Most foreign exchange trading firms are market makers and so are many banks, although not in all currency markets.

Most stock exchanges operate on a matched bargain or order driven basis. In such a system there are no designated or official market makers, but market makers nevertheless exist. When a buyer's bid meets a seller's offer or vice versa, the stock exchange's matching system will decide that a deal has been executed.

In the United States, the New York Stock Exchange (NYSE) and American Stock Exchange (AMEX), among others, have a single exchange member, known as the "specialist," who acts as the official market maker for a given security. In return for a) providing a required amount of liquidity to the security's market, b) taking the other side of trades when there are short-term buy-and-sell-side imbalances in customer orders, and c) attempting to prevent excess volatility, the specialist is granted various informational and trade execution advantages.

Other U.S. exchanges, most prominently the NASDAQ Stock Exchange, employ several competing official market makers in a security. These market makers are required to maintain two-sided markets during exchange hours and are obligated to buy and sell at their displayed bids and offers. They typically do not receive the trading advantages a specialist does, but they do get some, such as the ability to naked short a stock, i.e., selling it without borrowing it. In most situations, only official market makers are permitted to engage in naked shorting.

On the London Stock Exchange (LSE) there are official market makers for many securities (but not for shares in the largest and most heavily traded companies, which instead use an automated system called TradElect). Some of the LSE's member firms take on the obligation of always making a two way price in each of the stocks in which they make markets. It is their prices which are displayed on the Stock Exchange Automated Quotation system, and it is with them that ordinary stockbrokers generally have to deal when buying or selling stock on behalf of their clients.

Proponents of the official market making system claim market makers add to the liquidity and depth of the market by taking a short or long position for a time, thus assuming some risk, in return for hopefully making a small profit. On the LSE one can always buy and sell stock: each stock always has at least two market makers and they are obliged to deal.

This contrasts with some of the smaller order driven markets. On the Johannesburg Securities Exchange, for example, it can be very difficult to determine at what price one would be able to buy or sell even a small block of any of the many illiquid stocks because there are often no buyers or sellers on the order board. However, there is no doubting the liquidity of the big order driven markets in the U.S.

Unofficial market makers are free to operate on order driven markets or, indeed, on the LSE. They do not have the obligation to always be making a two way price but they do not have the advantage that everyone must deal with them either.

Tuesday, July 8, 2008

Accounting for treasury stock

On the balance sheet, treasury stock is listed under shareholder equity as a negative number.

One way of accounting for treasury stock is with the cost method. In this method, the paid-in capital account is reduced in the balance sheet when the treasury stock is bought. When the treasury stock is sold back on the open market, the paid-in capital is either debited or credited if it is sold for more or less than the initial cost respectively.

Another common way for accounting for treasury stock is the par value method. In the par value method, when the stock is purchased back from the market, the books will reflect the action as a retirement of the shares. Therefore, common stock is debited and treasury stock is credited. However, when the treasury stock is resold back to the market the entry in the books will be the same as the cost method.

In either method, any transaction involving treasury stock cannot increase the amount of retained earnings. If the treasury stock is sold for more than cost, then the paid-in capital treasury stock is the account that is increased not retained earnings. In auditing financial statements, it is a common practice to check for this error to detect possible attempts to "cook the books".

Buying back shares


If efficient market theory is correct, a company buying back its stock should have no effect at all on its stock price. If the market fairly prices a company's shares at $50/share, and the company buys back 100 shares for $5000, it now has $5000 less cash but there are 100 fewer shares outstanding; the net effect should be that the value per share is unchanged. However, buying back shares does improve certain per-share ratios, such as price/earnings (earnings per share is increased due to fewer shares outstanding), but that is only because valuing a company's shares according to those ratios is not accurate when a company is holding a lot of cash. If a company's shares are underpriced, then a company can benefit its other shareholders by buying back shares. If a company's shares are overpriced, then a company is actually hurting its remaining shareholders by buying back stock.


One other reason for a company to buy back its own stock is to reward holders of stock options. Option holders are hurt by dividend payments, since, typically, they are not eligible to receive them. A share buyback program may increase the value of remaining shares (if the buyback is executed when shares are underpriced); if so, option holders benefit. A dividend payment short term always decreases the value of shares after the payment, so, on the day shares go ex-dividend, option holders always lose. Finally, if the sellers into a corporate buyback are actually the option holders themselves, they may directly benefit from temporarily unrealistically favorable pricing.

After buyback

The company can either retire the shares (however, retired shares are not listed as treasury stock on the company's financial statements) or hold the shares for later resale. Buying back stocks reduces the number of outstanding shares. To see this, note that accompanying the decrease in the number of shares outstanding is a reduction in company assets, in particular, cash assets, which are used to buy back shares.