Equity Securities Overview

Definition and Characteristics

• Equity securities represent ownership in a company.
• Holders of equity securities (stockholders) enjoy residual rights to a company's assets and earnings.
• Common stock is the most basic form of equity.
• Preferred stock has preference over common stock in dividends and liquidation, but lacks voting rights.
• Stock ownership is measured in shares.
• Equity securities allow investors to share in a company's growth and profitability.
• They are traded on exchanges or over-the-counter.

Types of Equity Securities

• Common Stock:

  • Represents basic company ownership.
  • Holders have voting rights.
  • Dividends are paid after preferred stock dividends.
  • Holders face the most risk but have the potential for greatest reward.

• Preferred Stock:

  • Represents preferred, but subordinate, company ownership.
  • Holders receive fixed dividends.
  • Holders usually have no voting rights, except under specific conditions.
  • Dividends are paid before common stock dividends.
  • Generally offers less growth potential and lower risk than common stock.

Market Mechanisms for Equity Securities

• Exchanges (e.g., NYSE, NASDAQ): Organized marketplaces for listed securities trading.
• Over-the-counter (OTC) market: Dealers and brokers trade securities outside exchanges, often smaller companies; electronic platforms are expanding.
• Brokerage firms: Connect buyers and sellers for investor transactions.
• Market makers: Supply liquidity by quoting bid and ask prices for securities.

Valuation of Equity Securities

• Intrinsic value: Estimated true worth based on future prospects and risk.
• Market value: Current trading price of a security.
• Discounted cash flow (DCF) analysis: Estimates intrinsic value by discounting future cash flows.
• Relative valuation: Valuates a company by comparing it to similar companies.
• Fundamental analysis: Assesses intrinsic value through financial statement and other company information.
• Technical analysis: Uses historical price and volume data to predict future price movements.

Key factors affecting equity prices

• Company performance (earnings, revenue, growth) strongly affects stock prices.
• Market sentiment (investor confidence, market conditions) influences prices.
• Economic outlook (economic conditions, inflation, interest rates) impact stock markets.
• Political factors (events, policy changes) affect investor confidence.
• Industry trends influence the value of companies.
• Global events affect markets widely.
• Management quality: Tied to investor confidence in future and stability.

Risks Associated with Equity Securities

• Market risk: Stock price declines due to broad market downturns.
• Company-specific risk: Stock price decline due to a company's performance or other factors.
• Interest rate risk: Potential stock price decrease due to rising interest rates.
• Inflation risk: Stock prices may not keep pace with inflation.
• Liquidity risk: Difficulty selling a stock quickly at a desired price.
• Credit risk (some preferred stocks): Risk of issuer defaulting on financial obligations.

Legal and Regulatory Considerations

• Securities laws and regulations: Govern equity security issuance and trading to protect investors.
• Reporting requirements: Companies must disclose financial information to investors.
• Financial statement analysis: Investors should review financial statements before investment decisions.

Other Considerations

• Dividends: Periodic payments from companies to shareholders.
• Stock splits: Increase the number of outstanding shares.
• Stock options: Rights to buy shares at a future date.
• Share buy-backs: Companies buy back their own shares.
• Capital gains: Profits from selling shares at higher prices.
• Capital losses: Losses from selling shares at lower prices.

This quiz covers the definition, characteristics, and types of equity securities, including common and preferred stock. Learn about ownership rights, dividends, and the different risks associated with equity investment. Test your knowledge on how equity securities function and their role in the financial markets.