* * Chapter Nineteen Using Securities Markets for Financing & Investing Opportunities Copyright ©...

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*Chapter Nineteen

Using Securities

Markets for Financing & Investing

Opportunities

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

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• With a net worth of $50 billion, Buffett was the richest person in the world in 2008.

• Got his big break when he gained control of Berkshire Hathaway.

• He invests in undervalued companies with strong management.

WARREN BUFFETTBerkshire Hathaway

Profile

19-2

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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

19-3

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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 company’s stock.

TYPES of SECURITIES MARKETSThe Function of Securities Markets

LG1

19-4

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• 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.

INVESTMENT BANKERS and INSTITUTIONAL INVESTORS

The Role of Investment Bankers

LG1

19-5

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• 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 EXCHANGESStock Exchanges

LG2

19-6

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• NYSE Euronext

• NASDAQ

• London Stock Exchange

• Tokyo Stock Exchange

• Deutsche Borse

TOP STOCK EXCHANGESStock Exchanges

LG2

19-7

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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 detailed registration statement that includes extensive economic and financial information that must be sent to prospective investors.

The SECURITIES and EXCHANGE COMMISSION

Securities Regulations and the SEC

LG2

19-8

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• 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?

PROGRESS ASSESSMENTProgress Assessment

19-9

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• 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?

WAGGING the DOGMaking Ethical Decisions

19-10

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• With apprehensions after the financial crisis of 2008-2009, why would we want to invest in less familiar global stocks?

• Analysts suggest investing money globally. From 2003-2008, markets in China and Brazil outperformed the U.S.

• Reviewing suggestions in the text are a good idea if you want to invest globally.

The WIDE, WIDE WORLD of INVESTING

Reaching Beyond Our Borders

19-11

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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

Learning the Language of Stocks

LG3

19-12

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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 STOCKS

Advantages & Disadvantages of Issuing Stock

LG3

19-13

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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 STOCK

Advantages & Disadvantages of Issuing Stock

LG3

19-14

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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 STOCKIssuing Shares of Common Stock

LG3

19-15

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• 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

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• 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.

19-17

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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

19-18

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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 BONDS


LG4

19-19

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*BOND RATINGS


LG4

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

19-20

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• 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).

19-21

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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

19-22

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• 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?


19-23

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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

19-24

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*PRIMARY INVESTMENT SERVICES

CONSUMERS NEEDLG5

• Savings and investing advice

• Help with 401k plans

• Retirement planning

• Tax planning

• Estate planning

• Education expense planning

Source: Investment Company Institute.

Major Services Consumers Seek from Financial Advisers

19-25

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1. Investment risk

2. Yield

3. Duration

4. Liquidity

5. Tax consequences

FIVE INVESTMENT CRITERIAChoosing the Right Investment Strategy

LG5

19-26

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*AVERAGE ANNUAL RETURN of

ASSET CLASSES (1926-2007)LG5

Choosing the Right Investment Strategy

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. 19-27

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• 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

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

PERCEPTIONS of the MARKETInvesting in Stocks

LG6

• Bears: Investors who expect stock prices to decline.

19-29

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*BEAR MARKET DECLINES

in the S&P 500LG6

Time Period % Drop in Prices

2007-2009 52.5%

2000-2002 51%

1973-1974 48.2%

1968-1970 36.1%

1987-1988 33.5%

Investing in Stocks

Source: Stock Traders Almanac 2009. 19-30

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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 STOCKSInvesting in Stocks

LG6

19-31

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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’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.

STOCK SPLITS Stock Splits

LG6

19-32

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

BUYING STOCK on MARGIN Buying Stock on Margin

LG6

• 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.

19-33

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*UNDERSTANDING STOCK

QUOTATIONS

Understanding Stock Quotations

LG6

19-34

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*TOP FINANICIAL NEWS and

RESEARCH SITESLG6

• Yahoo Finance

• AOL Money and Finance

• MSN Money

• Forbes

• Dow Jones & Co.

Source: Entrepreneur Magazine, March 2009.

Understanding Stock Quotations

19-35

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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 have a high risk and high default rates.

IMPORTANT BOND QUESTIONSInvesting in Bonds

LG7

19-36

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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 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

19-37

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*PERCENTAGE of HOUSEHOLDS

OWNING MUTUAL FUNDSLG8

Source: Investment Company Institute.


Year % of Households

1980 5%

1990 24%

2000 43%

2005 42%

2009 44%

19-38

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*THREE VARIETIES of ETFs

LG8

Source: Schwab and E*Trade.


ETF Description

TraditionalMost common; include large U.S. stocks, small U.S. stocks, international stocks, or investment-grade bonds.

NicheFocus on an individual sector like healthcare, high-yield bonds, or a single country.

ExoticInvest in unusual, more volatile sectors such as commodities like gold and concepts like clean technology.

19-39

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*UNDERSTANDING

MUTUAL FUND QUOTATIONSLG8


19-40

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• A number of socially responsible investment funds (SRIs) are prospering.

INVESTING with INTEGRITYThinking Green

• 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.

19-41

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*GROWTH of SOCIALLY

RESPONSIBLE INVESTINGLG8

Source: Charles Schwab on Investing.


Year Number of SRIs Total Net Assets

1995 50 $10 Billion

1997 130 $90 Billion

2001 175 $170 Billion

2004 200 $210 Billion

2007 250 $260 Billion

19-42

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*COMPARING INVESTMENTS

LG8


19-43

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• What’s a stock split? Why do companies sometimes split their stock?

• 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

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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

19-45

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

MARKET TURMOILInvesting Challenges in the 21st Century Market

LG9

- 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.

19-46

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

- Investors lost $7 trillion in market value.

• In 2008-2009, 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 2000sInvesting Challenges in the 21st Century Market

LG9

19-47

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• 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.

WHO’S at FAULT for the ECONOMIC CRISIS?

LG2

Investing Challenges in the 21st Century Market

Source: Fortune Magazine, www.fortune.com. 19-48

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• 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.

GAMBLING with INVESTORS’ SECURITY

Legal Briefcase *

19-49

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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.


19-50

* * Chapter Nineteen Using Securities Markets for Financing & Investing Opportunities Copyright ©...

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