The Handbook of Financial Instruments

Chapter 4 Common Stock

Frank J. Fabozzi, Ph.D., CFA

Adjunct Professor of Finance School of Management Yale University

Frank J. Jones, Ph.D.

Chief Investment Officer The Guardian Life Insurance Company of America

Robert R. Johnson, Ph.D., CFA

Senior Vice President Association for Investment Management and Research

In this chapter we will discuss the investment characteristics of common stock, explain the markets where common stock is traded, the arrangements made for the trading of common stock by retail (i.e., individual) and institutional investors, and review common stock portfolio strategies.

COMMON STOCK VERSUS PREFERRED STOCK

Common stocks are also called equity securities. Equity securities represent an ownership interest in a corporation. Holders of equity securities are entitled to the earnings of the corporation when those earnings are distributed in the form of dividends ; they are also entitled to a pro rata share of the remaining equity in case of liquidation.

Common stock is only one type of equity security. Another type is preferred stock. The key distinction between the two forms of equity securities is the degree to which their holders may participate in any distribution of earnings and capital and the priority given to each class in the distribution of earnings. Typically, preferred stockholders are entitled to a fixed dividend, which they receive before common stockholders may receive any dividends. Therefore, we refer to preferred stock as a senior corporate ...