BUS110 Chapter 19 - Securities Market

*

*Chapter Nineteen

Using Securities

Markets for Financing and

Investing Opportunities

Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

*

*

• 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.

The BASICS of SECURITIES MARKETS

The Function of Securities Markets

LG1

19-2

19-3

Equity (Stocks)• Preferred or

Common• Investment never has

to be repaid• Not legally obligated

to pay dividends

Debt (Bonds)• Secured or Unsecured• Must be repaid on

maturity date• Interest must be paid

whenever specified

Debt vs. Equity Financing

*

*

• 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.

LEARNING the LANGUAGE of STOCKS

Learning the Language of Stocks

LG3

19-4

19-5

Capital - $ - Markets

• Primary Markets – Initial Public Offerings (IPO's)

• Secondary Markets

*

*

• Stockholders are owners of a firm and never have to be repaid their investment.

• There’s no legal obligation to pay dividends.

• Issuing a stock can improve a firm’s balance sheet since stock creates no debt.

ADVANTAGES of ISSUING STOCKS

Advantages & Disadvantages of Issuing Stock

LG3

19-6

*

*

• 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.

DISADVANTAGES of ISSUING STOCKS

Advantages & Disadvantages of Issuing Stock

LG3

19-7

*

*

• Common Stock -- The most basic form

• right to vote for the board of directors • share in the profits if dividends are approved.

• Preferred Stock – • Owners given preference in payment of company

dividends

TWO CLASSES of STOCKIssuing Shares of Common Stock

LG3

19-8

19-9

Organized Securities Exchanges

• New York Stock Exchange (NYSE)

• American Stock Exchange (AMEX)

• Over-the-Counter (OTC)

• NASDAQ

*

*

• Bond -- A corporate certificate indicating that an investor has lent money to a firm.

LEARNING the LANGUAGE of BONDS

Learning the Language of Bonds

LG4

• 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.

19-10

*

*

• 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.

ADVANTAGES of ISSUING BONDS

Advantages & Disadvantages of Issuing Bonds

LG4

19-11

*

*

• 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.

DISADVANTAGES of ISSUING BONDS

Advantages & Disadvantages of Issuing Bonds

LG4

19-12

*

*

• Corporations can issue two classes of bonds:

1. Unsecured bonds (debenture bonds): not backed by specific collateral.

DIFFERENT CLASSES of CORPORATE BONDS

Different Classes of Bonds

LG4

2. Secured bonds: backed by collateral (land or equipment).

19-13

*

*

1. Investment risk

2. Yield

3. Duration

4. Liquidity

5. Tax consequences

FIVE INVESTMENT CRITERIAChoosing the Right Investment Strategy

LG5

19-14

KEY CONSIDERATION

• Diversification!

*

*

• 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

SELECTING STOCKSInvesting in Stocks

LG6

19-16

*

*

• 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 investment’s value.

• Firms can never be forced to spilt their stocks.

STOCK SPLITS Stock Splits

LG6

19-17

19-18

How Stock Splits Work100 shares of 100 shares of

ABC stock ABC stock selling at selling at

$80$80

100 shares @ 100 shares @ $40$40

100 shares @ 100 shares @ $40$40

100 shares 100 shares @ $45@ $45

100 shares 100 shares @ $45@ $45

2 for 12 for 1 Stock Split Stock Split

DeclaredDeclared

Lower Price Lower Price increases increases DemandDemand

Increased Increased demand demand

increases priceincreases price

How Much Profit Has Been How Much Profit Has Been Made?Made?

*

*

• 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 and EXCHANGE-TRADED FUNDS

LG8

Investing in Mutual Funds & Exchange-Traded Funds

19-19

19-20

Original 12 Dow Stocks (1896)

• American Cotton Oil

• American Sugar Refining Co.

• American Tobacco

• Chicago Gas

• Distilling & Cattle Feeding Co.

• General Electric Co.

• Laclede Gas Light Co.

• National Lead

• North American Co.

• Tennessee Coal, Iron, & Railroad Co.

• U.S. Leather

• U.S. Rubber Co.

Current DJIA 30

19-21

DJIA 30