Using Securities Markets for Financing & Investing Opportunities
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1 Chapter Nineteen Using Securities Markets for Financing & Investing Opportunities McGraw-Hill/Irwin Copyright 2010 by the McGraw-Hill Companies, Inc. All rights reserved.
2 WARREN BUFFETT Berkshire Hathaway With a net worth of $50 billion, Buffett was the richest person in the world in Got his big break when he gained control of Berkshire Hathaway. He invests in undervalued companies with strong management. Profile 19-2
3 The BASICS of SECURITIES MARKETS The Function of Securities Markets LG1 Securities markets are financial marketplaces for stocks and bonds and serve two primary functions: 1. Assist businesses in finding long-term funding to finance capital needs. 2. Provide private investors a place to buy and sell securities such as stocks and bonds. 19-3
4 TYPES of SECURITIES MARKETS Securities markets are divided into primary and secondary markets: - Primary markets handle the sale of new securities. - Secondary markets handle the trading of securities between investors with the proceeds of the sale going to the seller. Initial Public Offering (IPO) -- The first offering of a company s stock. The Function of Securities Markets LG1 19-4
5 INVESTMENT BANKERS and INSTITUTIONAL INVESTORS Investment Bankers -- Specialists who assist in the issue and sale of new securities. Institutional Investors -- Large organizations such as pension funds or mutual funds that invest their own funds or the funds of others. The Role of Investment Bankers LG1 19-5
6 STOCK EXCHANGES Stock Exchange -- An organization whose members can buy and sell securities on behalf of companies and individual investors. Over-the-Counter (OTC) Market -- Provides companies and investors with a means to trade stocks not listed on the national securities exchanges. NASDAQ -- A telecommunications network that links dealers across the nation so they can exchange securities. Stock Exchanges LG2 19-6
7 TOP STOCK EXCHANGES NYSE Euronext Stock Exchanges LG2 NASDAQ London Stock Exchange Tokyo Stock Exchange Deutsche Borse 19-7
8 The SECURITIES and EXCHANGE COMMISSION Securities Regulations and the SEC LG2 Securities and Exchange Commission (SEC) - - The federal agency responsible for regulating the various stock exchanges; created in 1934 through the Securities and Exchange Act. Prospectus -- A detailed registration statement that includes extensive economic and financial information that must be sent to prospective investors. 19-8
9 PROGRESS ASSESSMENT Progress Assessment What s the primary purpose of a stock exchange? Can you name the world s largest stock exchange? What does NASDAQ stand for? How does this exchange work? 19-9
10 WAGGING the DOG Making Ethical Decisions After 35 years at Laddie Come Home, you re ready to retire as CEO and your compensation package includes a bonus if the company s stock price reaches a certain amount. Another company would like to acquire the company at a price that exceeds the bonus level. If you encourage the board to sell the company, many jobs could be lost. What do you do? 19-10
11 The WIDE, WIDE WORLD of INVESTING Reaching Beyond Our Borders With apprehensions after the financial crisis of , why would we want to invest in less familiar global stocks? Analysts suggest investing money globally. From , markets in China and Brazil outperformed the U.S. Reviewing suggestions in the text are a good idea if you want to invest globally
12 LEARNING the LANGUAGE of STOCKS Learning the Language of Stocks LG3 Stocks -- Shares of ownership in a company. Stock Certificate -- Evidence of stock ownership. Dividends -- Part of a firm s profits that the firm may distribute to stockholders as either cash or additional shares
13 ADVANTAGES of ISSUING STOCKS Advantages & Disadvantages of Issuing Stock LG3 Stockholders are owners of a firm and never have to be repaid their investment. There s no legal obligation to pay dividends. Issuing stock can improve a firm s balance sheet since stock creates no debt
14 DISADVANTAGES of ISSUING STOCK Advantages & Disadvantages of Issuing Stock LG3 Stockholders have the right to vote for a company s board of directors. Issuing new shares of stock can alter the control of the firm. Dividends are paid from after-tax profits and are not tax deductible. The need to keep stockholders happy can affect management s decisions
15 TWO CLASSES of STOCK Issuing Shares of Common Stock LG3 Common Stock -- The most basic form; holders have the right to vote for the board of directors and share in the profits if dividends are approved. Preferred Stock -- Owners are given preference in the payment of company dividends before common stock dividends are distributed. Preferred stock can also be: - Callable - Convertible - Cumulative 19-15
16 PROGRESS ASSESSMENT Progress Assessment Name at least two advantages and disadvantages of issuing stock as a form of equity financing. What are the major differences between common stock and preferred stock? 19-16
17 LEARNING the LANGUAGE of BONDS Learning the Language of Bonds LG4 Bond -- A corporate certificate indicating that an investor has lent money to a firm. The principal is the face value of the bond. Interest -- The payment the bond issuer makes to the bondholders to compensate them for the use of their money
18 ADVANTAGES of ISSUING BONDS Advantages & Disadvantages of Issuing Bonds LG4 Bondholders are creditors, not owners of the firm and can t vote on corporate matters. Bond interest is tax deductible. Bonds are a temporary source of funding and are eventually repaid. Bonds can be repaid before the maturity date if they contain a call provision
19 DISADVANTAGES of ISSUING BONDS Advantages & Disadvantages of Issuing Bonds LG4 Bonds increase debt and can affect the market s perception of the firm. Paying interest on bonds is a legal obligation. If interest isn t paid, bondholders can take legal action. The face value of the bond must be repaid on the maturity date
20 BOND RATINGS Rating Advantages & Disadvantages of Issuing Bonds LG4 Moody s Standard & Poor s Description Aaa AAA Highest Quality Aa AA High Quality A A Upper-Medium Grade Baa BBB Medium Grade Ba BB Lower-Medium Grade B B Speculative Caa CCC, CC Poor Ca C Highly Speculative C D Lowest Grade 19-20
21 DIFFERENT CLASSES of CORPORATE BONDS Different Classes of Bonds LG4 Corporations can issue two classes of bonds: 1. Unsecured bonds (debenture bonds): not backed by specific collateral. 2. Secured bonds: backed by collateral (land or equipment)
22 SPECIAL FEATURES in BOND ISSUES Special Bond Features LG4 Sinking Fund -- Reserve account set up to ensure that enough money will be available to repay bondholders on the maturity date. Callable bonds permit bond issuers to pay off the principal before the maturity date. Convertible bonds allow bondholders to convert their bonds into shares of common stock
23 PROGRESS ASSESSMENT Why are bonds considered a form of debt financing? What does it mean if a firm issues a 9% bond due in 2025? Explain the difference between an unsecured and secured bond. Why are convertible bonds attractive to investors? Progress Assessment 19-23
24 BUYING SECURITIES Stockbroker -- A registered representative who works as a market intermediary to buy and sell securities for clients. Online trading services, such as TD Ameritrade, ETrade, and Scottrade, offer securities trading services online to buy and sell stocks and bonds. How Investors Buy Securities LG
25 PRIMARY INVESTMENT SERVICES CONSUMERS NEED Major Services Consumers Seek from Financial Advisers LG5 Savings and investing advice Help with 401k plans Retirement planning Tax planning Estate planning Education expense planning Source: Investment Company Institute
26 FIVE INVESTMENT CRITERIA 1. Investment risk Choosing the Right Investment Strategy LG5 2. Yield 3. Duration 4. Liquidity 5. Tax consequences 19-26
27 AVERAGE ANNUAL RETURN of ASSET CLASSES ( ) Choosing the Right Investment Strategy LG5 Investment Return Small company stocks 12.2% Large company stocks 9.5% Corporate bonds 6.0% Long-term government bonds 5.8% Treasury bills 4.1% Source: Ibbotson Associates and Morningstar
28 PROGRESS ASSESSMENT Progress Assessment What s the key advantage of investing through online brokers? What s the key disadvantage? What s the primary purpose of diversifying investments? 19-28
29 PERCEPTIONS of the MARKET Investing in Stocks LG6 Bulls: Investors who believe stock prices are going to rise. Bears: Investors who expect stock prices to decline
30 BEAR MARKET DECLINES in the S&P 500 Investing in Stocks LG6 Time Period % Drop in Prices % % % % % Source: Stock Traders Almanac
31 SELECTING STOCKS Investing in Stocks LG6 Capital Gains -- The positive difference between the price at which you bought a stock and what you sell it for. Investors can also choose stocks according to their strategy: - Blue-chip stocks - Growth stocks - Income stocks - Penny stocks 19-31
32 STOCK SPLITS Stock Splits LG6 Stock Splits -- An action by a company that gives stockholders two or more shares of additional stock for every share that s outstanding. Splits cause no change in the firm s ownership structure and no change in the investment s value. Firms can never be forced to spilt their stocks
33 BUYING STOCK on MARGIN Buying Stock on Margin -- Borrowing some of the stock s purchase cost from the brokerage firm. Margin is the portion of the stock s purchase price that the investor must pay with their own money. Buying Stock on Margin LG6 If a broker issues a margin call, the investor has to come up with money to cover losses
34 UNDERSTANDING STOCK QUOTATIONS Understanding Stock Quotations LG
35 TOP FINANICIAL NEWS and RESEARCH SITES Understanding Stock Quotations LG6 Yahoo Finance AOL Money and Finance MSN Money Forbes Dow Jones & Co. Source: Entrepreneur Magazine, March
36 IMPORTANT BOND QUESTIONS First-time bond investors generally ask two questions: - Do you have to hold a bond until the maturity date? - How can I assess the investment risk of a particular bond issue? Junk Bonds -- Bonds that have a high risk and high default rates. Investing in Bonds LG
37 INVESTING in MUTUAL FUNDS and EXCHANGE-TRADED FUNDS Mutual Fund -- An organization the buys stocks and bonds and then sells shares in those securities to the public. The fund pools investors money and buys stocks according to the fund s purpose. Exchange-Traded Fund (ETF) -- Collections of stocks and bonds that are traded on securities exchanges but themselves are traded more like stocks than mutual funds. Investing in Mutual Funds & Exchange- Traded Funds LG
38 PERCENTAGE of HOUSEHOLDS OWNING MUTUAL FUNDS Investing in Mutual Funds & Exchange- Traded Funds LG8 Year % of Households % % % % % Source: Investment Company Institute
39 THREE VARIETIES of ETFs Investing in Mutual Funds & Exchange- Traded Funds LG8 ETF Description Traditional Most common; include large U.S. stocks, small U.S. stocks, international stocks, or investment-grade bonds. Niche Focus on an individual sector like healthcare, high-yield bonds, or a single country. Exotic Invest in unusual, more volatile sectors such as commodities like gold and concepts like clean technology. Source: Schwab and ETrade
40 UNDERSTANDING MUTUAL FUND QUOTATIONS Investing in Mutual Funds & Exchange- Traded Funds LG
41 INVESTING with INTEGRITY Thinking Green A number of socially responsible investment funds (SRIs) are prospering. SRIs invest only in companies with exceptional environmental, social and governance practices. SRIs are good investments for long-term investors - they re lower risk than alternative investments
42 GROWTH of SOCIALLY RESPONSIBLE INVESTING Investing in Mutual Funds & Exchange- Traded Funds LG8 Year Number of SRIs Total Net Assets $10 Billion $90 Billion $170 Billion $210 Billion $260 Billion Source: Charles Schwab on Investing
43 COMPARING INVESTMENTS Investing in Mutual Funds & Exchange- Traded Funds LG
44 PROGRESS ASSESSMENT What s a stock split? Why do companies sometimes split their stock? Progress Assessment What does buying stock on margin mean? What are mutual funds and ETFs? What s the key benefit to investors in investing in a mutual fund or ETF? 19-44
45 KEY STOCK MARKET INDICATORS Understanding Stock Market Indicators LG9 Dow Jones Industrial Average -- The average cost of 30 selected industrial stocks. Critics say the 30-company Dow is too small a sample and suggest following the S&P 500. S&P 500 tracks the performance of 400 industrial, 40 financial, 40 public utility, and 20 transportation stocks
46 MARKET TURMOIL The stock market has its shares of ups and downs: - October 29, Black Tuesday; the market lost 13% of its value. - October 19, The market suffered its worst one-day drop when it lost 22% of its value. - October 27, Fears of an economic crisis in Asia cause widespread panic and losses. Investing Challenges in the 21 st Century Market LG
47 TURMOIL in the 2000s The market collapsed into a deep decline in with the dot-com bubble burst. - Investors lost $7 trillion in market value. In , the collapse of the real estate market sent financial markets into panic. - The U.S. government made significant investments in private banks and offered a large stimulus package to reenergize the economy. Investing Challenges in the 21 st Century Market LG
48 WHO S at FAULT for the ECONOMIC CRISIS? Wall Street - Issued exotic securities; paid excessive compensation based on bonuses; and investment banks got the SEC to relax capital requirement. Main Street - Americans lived beyond their means; lenders gave favorable loans to homebuilders; greedy homeowners took out equity loans; and teaser mortgage rates let people live large. Washington - Gramm-Leach-Billey Act allowed commercial and investment banks to partner; housing interest rates were kept low; and Community Reinvestment Act forced lending to people with bad credit. Investing Challenges in the 21 st Century Market LG2 Source: Fortune Magazine,
49 GAMBLING with INVESTORS SECURITY Legal Briefcase Fannie Mae bought huge numbers of mortgages and bundled them into securities they sold. Loans were riskier and more complex. Borrowers didn t fully understand and unqualified borrowers were granted loans they couldn t afford. As borrowers defaulted on loans, real estate prices fell. Financial institutions were left with loans that wouldn t be repaid
50 PROGRESS ASSESSMENT What does the Dow Jones Industrial Average measure? Why is it important? Why do the 30 companies comprising the Dow change periodically? Explain program trading and the problems it can create. Progress Assessment 19-50
Using Securities Markets for Financing and Investing Opportunities
Chapter 19 Using Securities Markets for Financing and Investing Opportunities McGraw-Hill/Irwin Copyright 2014 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Nineteen NAME that COMPANY
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