Chapter Nineteen Using Securities Markets for Financing Investing

* Chapter Nineteen * Using Securities Markets for Financing & Investing Opportunities Mc. Graw-Hill/Irwin Copyright © 2010 by the Mc. Graw-Hill Companies, Inc. All rights reserved.

The BASICS of SECURITIES MARKETS *The Function of Securities Markets LG 1 * • 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 -2

*The Function TYPES of SECURITIES MARKETS of Securities Markets * LG 1 • 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. 19 -3

INVESTMENT BANKERS and INSTITUTIONAL INVESTORS *The Role of Investment Bankers LG 1 * • 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. 19 -4

STOCK EXCHANGES *Stock Exchanges http: //www. youtube. com/watch? v=reiru 4 Du 9 a. I * LG 2 • 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. 19 -5

TOP STOCK EXCHANGES *Stock Exchanges LG 2 * • NYSE Euronext • NASDAQ • London Stock Exchange • Tokyo Stock Exchange • Deutsche Borse 19 -6

The SECURITIES and EXCHANGE COMMISSION *Securities Regulations and the SEC * LG 2 • Securities and Exchange Commission (SEC) -The federal agency responsible for regulating the various stock exchanges; created in 1934 through the Securities and Exchange Act. http: //www. sec. gov/ • Prospectus -- A detailed registration statement that includes extensive economic and financial information that must be sent to prospective investors. 19 -7

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 -8

LEARNING the LANGUAGE of STOCKS * Learning the Language of Stocks LG 3 * • 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. 19 -9

ADVANTAGES of ISSUING STOCKS * Advantages & Disadvantages of Issuing Stock LG 3 * • 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. 19 -10

DISADVANTAGES of ISSUING STOCK * Advantages & Disadvantages of Issuing Stock LG 3 * • 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. 19 -11

* TWO CLASSES of STOCK Issuing Shares of Common Stock * LG 3 • 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 -12

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 -13

LEARNING the LANGUAGE of BONDS *Learning the Language of Bonds LG 4 * • 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. 19 -14

ADVANTAGES of ISSUING BONDS * Advantages & Disadvantages of Issuing Bonds * LG 4 • 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 -15

DISADVANTAGES of ISSUING BONDS * Advantages & Disadvantages of Issuing Bonds LG 4 * • 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. 19 -16

* BOND RATINGS Advantages & Disadvantages of Issuing Bonds http: //www. youtube. com/watch? v=q 3 RPe. Bt. I 6 Yc LG 4 * Rating 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 -17

DIFFERENT CLASSES of CORPORATE BONDS *Different Classes of Bonds LG 4 * • 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). 19 -18

SPECIAL FEATURES in BOND ISSUES *Special Bond Features * LG 4 • 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. 19 -19

PROGRESS ASSESSMENT * 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? 19 -20

BUYING SECURITIES *How Investors Buy Securities LG 5 * • Stockbroker -- A registered representative who works as a market intermediary to buy and sell securities for clients. • Online trading services, such as TD Ameritrade, E*Trade, and Scottrade, offer securities trading services online to buy and sell stocks and bonds. 19 -21

FIVE INVESTMENT CRITERIA * Choosing the Right Investment Strategy http: //www. youtube. com/watch? v=r. Irt. QC-p. Hk. Y LG 5 * 1. Investment risk 2. Yield 3. Duration 4. Liquidity 5. Tax consequences 19 -22

AVERAGE ANNUAL RETURN of ASSET CLASSES (1926 -2007) Investment * LG 5 * 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. Choosing the Right Investment Strategy 19 -23

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 -24

BEAR MARKET DECLINES in the S&P 500 Time Period % Drop in Prices 2007 -2009 52. 5% 2000 -2002 51% 1973 -1974 48. 2% 1968 -1970 36. 1% 1987 -1988 33. 5% Source: Stock Traders Almanac 2009. *Investing in Stocks LG 6 * 19 -25

SELECTING STOCKS *Investing in Stocks LG 6 * • 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 -26

STOCK SPLITS * Stock Splits LG 6 * • 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. 19 -27

BUYING STOCK on MARGIN * Buying Stock on Margin * LG 6 • 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. • If a broker issues a margin call, the investor has to come up with money to cover losses. 19 -28

TOP FINANICIAL NEWS and RESEARCH SITES *Understanding Stock Quotations LG 6 * • Yahoo Finance • AOL Money and Finance • MSN Money • Forbes • Dow Jones & Co. Source: Entrepreneur Magazine, March 2009. 19 -29

* IMPORTANT BOND QUESTIONS Investing in Bonds * LG 7 • 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. 19 -30

* INVESTING in MUTUAL FUNDS and EXCHANGE-TRADED FUNDS Investing in Mutual Funds & Exchange. Traded Funds * LG 8 • 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. 19 -31

COMPARING INVESTMENTS * Investing in Mutual Funds & Exchange. Traded Funds LG 8 * 19 -32

PROGRESS ASSESSMENT * Progress Assessment * • What’s a stock split? Why do companies sometimes split their stock? • What does buying stock on margin mean? • What are mutual funds? • What’s the key benefit to investors in investing in a mutual fund? 19 -33

KEY STOCK MARKET INDICATORS * Understanding Stock Market Indicators * LG 9 • 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. 19 -34

Original 12 Dow Stocks (1896) • American Cotton Oil • Laclede Gas Light Co. • American Sugar Refining Co. • National Lead • American Tobacco • North American Co. • Chicago Gas • Tennessee Coal, Iron, & Railroad Co. • Distilling & Cattle Feeding Co. • U. S. Leather • General Electric Co. 19 -35 • U. S. Rubber Co.

WHO’S at FAULT for the ECONOMIC CRISIS? * Investing Challenges in the 21 st Century Market * LG 2 • 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. Source: Fortune Magazine, www. fortune. com. 19 -36