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Using Securities Markets for Financing and Investing Opportunit ies Chapter 19 Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
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Page 1: Chap019

Using Securities

Markets for Financing and

Investing Opportunities

Chapter 19

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Page 2: Chap019

1. Describe the role of securities markets and of investment bankers.

2. Identify the stock exchanges where securities are traded.

3. Compare the advantages and disadvantages of equity financing by issuing stock, and detail the differences between common and preferred stock.

4. Compare the advantages and disadvantages of obtaining debt financing by issuing bonds, and identify the classes and features of bonds.

LEARNING GOALSChapter Nineteen

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5. Explain how to invest in securities markets and set investment objectives such as long-term growth, income, cash, and protection from inflation.

6. Analyze the opportunities stocks offer as investments.

7. Analyze the opportunities bonds offer as investments.

8. Explain the investment opportunities in mutual funds and exchange-traded funds (ETFs).

9. Describe how indicators like the Dow Jones Industrial Average affect the market.

LEARNING GOALSChapter Nineteen

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• Emmy Award-winning journalist, Bartiromo’s analysis of day-to-day Wall Street has made her the face of investing.

• Started as an overnight producer for CNN before moving to CNBC.

• She’s lead anchor at two of CNBC’s biggest shows, has written several books and numerous columns.

MARIA BARTIROMOCNBC

Profile

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NAME that COMPANYChapter Nineteen

When the price of their stock rises to a certain level, many companies will split the stock in order to make the stock appear more affordable. However, this company run by America’s most successful investor has never split its stock even when the price of the company’s stock reached $150,000 a share (that’s right $150,000 for one share.)

Name that company!

19-5

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• 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

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• 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 corporation’s stock.

TYPES of SECURITIES MARKETSLG1

The Function of Securities Markets

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• Investment Bankers -- Specialists who assist in the issue and sale of new securities.

INVESTMENT BANKERS and INSTITUTIONAL INVESTORS

The Role of Investment Bankers

LG1

• Institutional Investors -- Large organizations such as pension funds or mutual funds that invest their own funds or the funds of others.

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• Stock Exchange -- An organization whose members can buy and sell (exchange) 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 electronically.

STOCK EXCHANGESStock Exchanges

LG2

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• NYSE Euronext

• NASDAQ

• London Stock Exchange

• Tokyo Stock Exchange

• Deutsche Borse

TOP STOCK EXCHANGESLG2

Stock Exchanges

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• Since the recent financial crisis, small businesses have found it difficult to secure financing from banks.

• David Weild wants a new stock exchange where small companies can raise needed capital.

• Though this is a new idea in the U.S., China established ChiNext which is designed for start-up companies.

A PLACE for SMALL COMPANIES to CALL HOME

(Spotlight on Small Business)

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• 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 condensed version of economic and financial information that a company must file with the SEC before issuing stock; the prospectus must be sent to prospective investors.

The SECURITIES and EXCHANGE COMMISSION

Securities Regulations and the SEC

LG2

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• What’s the primary purpose of a securities exchange?

• What does NASDAQ stand for? How does this exchange work?

PROGRESS ASSESSMENTProgress Assessment

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• 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

How Businesses Raise Capital by Selling Stock

LG3

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• 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.

ADVANTAGES of ISSUING STOCK

Advantages & Disadvantages of Issuing Stock

LG3

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• 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 STOCKLG3

Advantages & Disadvantages of Issuing Stock

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• 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

TWO CLASSES of STOCK

Issuing Shares of Common and Preferred Stock

LG3

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• Name at least two advantages and disadvantages of a company’s issuing stock as a form of equity financing.

• What are the major differences between common stock and preferred stock?

PROGRESS ASSESSMENTProgress Assessment

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

LEARNING the LANGUAGE of BONDS

Learning the Language of Bonds

• 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.

LG4

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• 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

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• 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 BONDSLG4

Advantages & Disadvantages of Issuing Bonds

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BOND RATINGS

Rating

Moody’s S & P Fitch Description

Aaa AAA AAA Highest Quality

Aa AA AA High Quality

A A A Upper-Medium Grade

Baa BBB BBB Medium Grade

Ba BB BB Lower-Medium Grade

B B B Speculative

Caa CCC, CC CCC Poor

Ca C DDD Highly Speculative

C D D Lowest Grade

LG4

Advantages & Disadvantages of Issuing Bonds

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• Corporations can issue two classes of bonds:

DIFFERENT CLASSES of CORPORATE BONDS

Different Classes of Bonds

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

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

LG4

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• 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.

SPECIAL FEATURES in BOND ISSUES

Special Bond Features

LG4

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• Why are bonds considered a form of debt financing?

• What does it mean if a firm issues a 9% debenture bond due in 2025?

• Explain the difference between an unsecured and secured bond.

• Why are convertible bonds attractive to investors?

PROGRESS ASSESSMENTProgress Assessment

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• 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.

BUYING SECURITIESHow Investors Buy Securities

LG5

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• You recently received news that your Uncle Alex passed away after a long battle with lung cancer caused by smoking. He left you $25,000 in his will, saying you were his favorite nephew.

• Your friend Jack recommends that you buy stock in a well-known multinational firm that’s primary product is tobacco.

• Will you invest your inheritance in a company that markets tobacco?

MONEY GOING UP in SMOKE(Making Ethical Decisions)

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1. Investment risk

2. Yield

3. Duration

4. Liquidity

5. Tax consequences

FIVE INVESTMENT CRITERIAChoosing the Right Investment Strategy

LG5

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INVESTING 101Things to Do Before Making Your First Investment

Source: Money, November 2010.

LG5

Choosing the Right Investment Strategy

• Take an investing class.

• Attend a conference.

• Head to the library and pick up these books:

- The Big Short

- The Intelligent Investor

- The Myth of the Rational Market

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AVERAGE ANNUAL RETURN of ASSET CLASSES (Since 1926)

Source: Ibbotson Associates and Morningstar.

LG5

Choosing the Right Investment Strategy

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• Diversification -- Buying several different types of investments to spread the risk of investing.

• If diversifying, an investor may put: - 25% of his/her money into U.S. growth stocks

- 25% in government bonds

- 25% in dividend-paying stocks

- 10% in an international mutual fund

- The rest in a savings account

DIVERSIFICATIONReducing Risk by Diversifying Investments

LG5

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• Suggestions for building your financial future:

- Invest in global companies you know and that have solid performance records.

- Invest in global stocks listed on U.S. exchanges.

- Contact U.S. brokers about American Depository Receipts (ADRs).

- Invest in global mutual funds that focus on specific countries or regions.

- Use extreme caution if investing in unstable countries!

The SUN NEVER SETS on STOCK OPPORTUNITIES

(Reaching Beyond Our Borders)

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PRIMARY INVESTMENT SERVICES CONSUMERS NEED

• Savings and investing advice

• Help with 401k plans

• Retirement planning

• Tax planning

• Estate planning

• Education expense planning

Source: Investment Company Institute.

LG5

Reducing Risk by Diversifying Investments

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• What is the key advantage of investing through online brokers? What is the key disadvantage?

• What is the primary purpose of diversifying investments?

PROGRESS ASSESSMENTProgress Assessment

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• Bulls: Investors who believe stock prices are going to rise.

PERCEPTIONS of the MARKETInvesting in Stocks

• Bears: Investors who expect stock prices to decline.

LG6

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BEAR MARKET DECLINES in the S&P 500

Source: Stock Traders Almanac 2011.

LG6

Investing in Stocks

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• 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 STOCKSLG6

Investing in Stocks

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• Stock Splits -- An action by a company that gives stockholders two or more shares of additional stock for every share that they own.

• 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.

STOCK SPLITSStock Splits

LG6

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• Buying Stock on Margin -- Borrowing some of the stock’s purchase cost from the brokerage firm.

BUYING STOCK on MARGINBuying Stock on Margin

• 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.

LG6

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UNDERSTANDING STOCK QUOTATIONS

Understanding Stock Quotations

LG6

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TOP FINANICIAL NEWS and RESEARCH SITES

• Yahoo Finance

• DailyFinance

• MSN Money

• Forbes

• Dow Jones & Co.

LG6

Understanding Stock Quotations

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• 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 are high-risk and have high default rates.

IMPORTANT BOND QUESTIONSInvesting in Bonds

LG7

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UNDERSTANDING BONDQUOTATIONS

Understanding Bond Quotations

LG7

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• 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 are traded more like individual stocks than mutual funds.

INVESTING in MUTUAL FUNDS and EXCHANGE-TRADED FUNDS

Investing in Mutual Funds & Exchange-Traded Funds

LG8

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WHAT MUTUAL FUNDS CAN LEARN FROM KaChing

Source: Fast Company, March 2010.

LG8

Investing in Mutual Funds & Exchange-Traded Funds

1. Reform the ratings system

2. Give information for free

3. Cut out useless fees

4. Be transparent

5. Share insights

19-45

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PERCENTAGE of HOUSEHOLDS OWNING MUTUAL FUNDS

Source: Investment Company Institute Factbook.

LG8

Investing in Mutual Funds & Exchange-Traded Funds

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VARIETIES of ETFs

Source: Schwab and E*Trade.

LG8

Investing in Mutual Funds & Exchange-Traded Funds

19-47

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UNDERSTANDING MUTUAL FUND QUOTATIONSLG8

Understanding Mutual Fund Quotations

19-48

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COMPARING INVESTMENTSLG8

Understanding Mutual Fund Quotations

19-49

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• What is a stock split? Why do companies sometimes split their stock?

• What does buying stock on margin mean?

• What are mutual funds and ETFs?

• What is the key benefit to investors in investing in a mutual fund or ETF?

PROGRESS ASSESSMENTProgress Assessment

19-50

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• 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.

KEY STOCK MARKET INDICATORS

Understanding Stock Market Indicators

LG9

19-51

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• The stock market has its shares of ups and downs:

MARKET TURMOIL

- October 29, 1929 - Black Tuesday; the market lost 13% of its value.

- October 19, 1987 - The market suffered its worst one-day drop when it lost 22% of its value.

- October 27, 1997 - Fears of an economic crisis in Asia cause widespread panic and losses.

LG9

Riding the Market’s Roller Coaster

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• The market collapsed into a deep decline in 2000-2002 when the dot-com bubble burst.

- Investors lost $7 trillion in market value.

• Starting in 2008, 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 re-energize the economy.

TURMOIL in the 2000sLG9

Riding the Market’s Roller Coaster

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The WALL STREET of NOW

Source: Bloomberg Businessweek, September 6, 2010.

LG9

Riding the Market’s Roller Coaster

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• Program Trading -- Giving instructions to computers to automatically sell if the price of a stock dips to a certain point to avoid potential losses.

• Analysts believe program trading caused the turmoil in 1987.

• The exchanges created mechanisms to restrict program trading.

The UPS and DOWNS of the MARKET

Riding the Market’s Roller Coaster

LG9

19-55

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• Wall Street - Issued exotic securities; paid excessive compensation based on bonuses; and investment banks got the SEC to relax capital requirements.

• 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.

WHO’S at FAULT for the ECONOMIC CRISIS?

Source: Fortune Magazine, www.fortune.com, accessed July 2011.

LG9

Riding the Market’s Roller Coaster

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• Congress passed the Dodd-Frank Financial Reform and Consumer Protection Act into law on July 21, 2010.

• Gives the government power to seize and shutter large financial institutions on the verge of collapse in an effort to prevent further bailouts.

• Formed an independent consumer protection agency housed within the Federal Reserve, protecting borrowers against a host of financial abuses ranging from payday loans to mortgages and credit cards.

CLEANING UP the STREET(Legal Briefcase)

19-57

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• 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 ASSESSMENTProgress Assessment

19-58