Financial Markets Book Financial Markets For The Rest Of Us
An Easy Guide To Money, Bonds, Futures, Stocks, Options, And Mutual Funds
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by Robert Hashemian

Page 193

changing it for two $10 bills (two bills for one), or four $5 bills. You end up with more bills but the entire value of your money is still $20. You may also change two $50 bills for five $20 bills. You would have $100 to begin with and you would still end up with $100.

The same principle applies to stock splits. It is a zero sum gain. (Sorry to rain on your parade). Many splits are 2 for 1 but other permutations also exist such as 3 for 1, 4 for 1, 5 for 1, 5 for 2, 3 for 2, etc. For simplicity I'll assume a 2 for 1 split for the discussion that follows, but just be aware that other types of splits are also possible.

A 2 for 1 stock split yields twice as many shares but at the same time the value of each share is cut in half, leaving the market value of the stock the same as before. Suppose you own 100 shares of Ford at $50 per share and a 2 for 1 stock split is declared. After the split, you would end up with 200 shares of Ford at $25 per share, assuming that the share price is still $50 at split time. You would continue to have the same percentage of ownership in the company since every shareholder now has twice as many shares. You don't double your money overnight like some investors may think, but you double your shares. Stock splits are usually approved by the board of directors, followed by receiving the shareholders' approval, before going into affect.

Let's get back to the original question of why - in many cases (especially recently) - the stock price jumps when a split is declared for that stock. The reason is more psychological than anything else. A stock split carries the benefit of reducing the stock price per share, thereby allowing more investors to buy the stock. This possible demand not only causes a hike for the stock price but also has the effect of making the shares more liquid (easier to buy and sell). That is the technical reason for the stock price increases during splits. But lately many investors regard the post-split stock price as cheap and just drive

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Copyright and Disclaimer
Book Chapters
Table of Contents Copyright and Disclaimer Foreword Money
Bonds Futures Stocks Options
Mutual Funds Retirement Final Words Appendix A

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