Contemporary business, 12 by kurts CB12ech18

Chapter 18 Financing and Investing Through Securities s al o G Markets ng i n r Explain the process of buying or a Le Distinguish between the primary and secondary securities markets Compare money market instruments, bonds, and common stock, including their benefits Identify the objectives of investors and the types of securities that best correspond to each Describe the characteristics of the major stock exchanges selling a security and the information included in stock and bond quotations and stock indexes Discuss the role of mutual funds and exchange-traded funds in the securities market Evaluate the major features of regulations and laws designed to protect investors Securities Financial instrument such as stocks and bonds PRIMARY VERSUS SECONDARY MARKETS Primary market Market in which new security issues are first sold to investors; issuers receive the proceeds from the sale • Stock offering gives investors the opportunity to purchase ownership shares in a firm and to participate in its future growth, in exchange for providing current capital • Initial public offering (IPO) The first sale of a company’s stock to the general public • Securities are sold on the open market and through investment bankers • U.S Treasury accepts both competitive and noncompetitive bids for its securities • Investment bankers Financial specialists who handle the sales of most corporate and municipal securities • Underwriting Process of purchasing an issue from a firm or government and then reselling the issue to investors • Investment bankers underwrite stock and bond issues at a discount, which is their compensation for their services Secondary market Market in which existing security issues are bought and sold by investors • Examples: New York Stock Exchange, Nasdaq • On a typical day, more than $50 billion worth of stock is traded on NYSE TYPES OF SECURITIES Money Market Instruments Money market instruments Short-term debt securities issued by corporations, financial institutions, and governments • Generally low-risk securities and are purchased by investors when they have surplus cash Bonds • Through bonds firms obtain long-term debt capital • Claims of bondholders are satisfied before those of stockholders in cases of bankruptcy Types of Bonds • Government bonds Bonds sold by the U.S Treasury • Backed by the full faith and credit of the U.S government • Municipal bonds Bonds issued by state or local governments • Revenue bond—proceeds are to be used to pay for a project that will produce revenue, such as a toll road or bridge • General obligation bond—proceeds are to be used to pay for a project that will not produce any revenue, such as a new state police post • Can be sold only by governmental units that have the power to levy taxes • Interest payments are exempt from federal income tax • Secured bond Corporate bond backed by a specific pledge of company assets • Debentures Corporate bonds backed only by the issuing firm’s financial reputation • Mortgage pass-through security Backed by a self-liquidating pool of mortgage loans purchased from lenders Quality Ratings for Bonds • Two factors determine the price of a bond: its risk and its interest rate • Bond rating A rating of a bond’s level of risk Quality Ratings for Bonds • Two factors determine the price of a bond: its risk and its interest rate • Bond rating A rating of a bond’s level of risk • Higher interest rates bring higher bond prices • Market interest rates also influences bond prices Retiring Bonds • Firms must have necessary funds to pay bonds at maturity • Some firms issue serial bonds, an issue of bonds that mature at different rates • Call provision Allows the issuer to redeem the bond before its maturity at a prespecified price Stock Common stock Shares of ownership in a corporation • Holders of common stock vote on major company decisions • In exchange for their investment, they receive dividends and/or benefits of increased stock price • Risk loss of investment if company fails • Book value Company assets – company liabilities No of outstanding shares of common stock • Market value Price at which a stock is currently selling Preferred Stock Preferred stock Stock whose holders have priority over common stockholders in the payment of dividends but usually have no voting rights • Pays fixed dividend regardless of company performance • Many investors consider it more like a bond than a common stock Convertible Securities • Feature of bond or preferred stock that gives the holder the right to exchange the bond or preferred stock for a fixed number of shares of common stock • Convertible bonds pay a lower interest rate than those without a conversion feature SECURITIES EXCHANGES Stock exchanges Financial market where stocks are traded • Exist throughout the world, and most countries have at least one New York Stock Exchange • One of world’s oldest, founded in 1792 • Lists more than 3,000 common and preferred stocks with market value of more than $13 trillion • World’s largest, as measured by total value of stock traded • Trading takes place face-to-face on trade floor • Only members are allowed to trade on the floor The Nasdaq Stock Market • A computerized communications network that links member investment firms • World’s largest intranet • Lists approximately 5,000 stocks Other U.S Stock Markets • American Stock Exchange, or AMEX, in New York • Daily trading volume around 60 million shares • Regional stock exchanges include Chicago, Pacific (San Francisco), Boston, Cincinnati, and Philadelphia Stock Exchanges Foreign Stock Markets • Most countries have at least one stock exchange • One of largest outside U.S is the London Stock Exchange • Lists 2,900 companies • Handles two-thirds of all cross-border trading worldwide ECNs and the Future of Stock Markets • Electronic communications networks (ECNs) Fourth market opening up to smaller, individual investors • Buyers and sellers meet trade directly with one another in a virtual stock market BUYING AND SELLING SECURITIES Brokerage firm Financial intermediary that buys and sells securities for individual and institutional investors • Examples: A G Edwards, Raymond James, Morgan Stanley, and Wachovia Securities Placing an Order • Investor initiates purchase by contacting brokerage firm • Market order Instructs the brokerage firm to obtain the highest price possible, if the investor is selling, or the lowest price possible, if the investor is buying • Limit order Instructs the brokerage firm not to pay more than a specified price for a stock, if the investor is buying, or not to accept less than a specified price, if the investor is selling Stock Indexes • Examples include the Dow Jones Industrial Average, Standard & Poor’s 500, and the Nasdaq Composite indexes • Dow Jones Industrial Average, started in 1884, has served as a general measure of overall stock prices and a reflection of the economy • Only original remaining member is General Electric MUTUAL FUNDS AND EXCHANGETRADED FUNDS Mutual fund Financial institution that pools money from purchases of its shares and uses the money to acquire diversified portfolios of securities consistent with the fund’s investment objectives Mutual Funds • Investors become part owners of large number of securities, lessening individual risk • Total mutual fund assets exceed $8 trillion • 55 million American households own mutual fund shares Exchange-Traded Funds • Raises funds by selling shares to investors and then uses those funds to purchase a portfolio of securities • Sells a fixed number of shares to investors in what is effectively an initial public offering • Then ETF shares trade on stock exchanges much like shares of individual companies • Almost 200 ETFs with total assets of around $250 billion • Two main appeals: • Shareholders are charged little or nothing for annual operating expenses • Can be more tax efficient because they don’t generate a lot of taxable capital gains LEGAL AND ETHICAL ISSUES IN SECURITIES TRADING Government Regulation of the Securities Market • Mostly by the federal government, primarily the Securities and Exchange Commission • SEC requires registration of all new public issues of corporate securities Full and fair disclosure Requirement that investors should be told all relevant information by stock or bond issuers so they can make informed decisions Insider trading Use of material, nonpublic information to make investor profits • Regulation FD Requires firms to share information with all investors at the same time • Public corporations must file several reports annually Industry Self-Regulation Professional Rules of Conduct • Rules of conduct established and updated by the National Association of Securities Dealers • Ensure that brokers perform their basic functions honestly and fairly, under constant supervision Market Surveillance • Techniques for spotting possible violations of trading rules or securities laws • NYSE uses Stock Watch to flag unusual price and volume activity • Market participants keep detailed records about transactions Perfection is not just for the movies Self-regulation means that Professional Rules of Conduct should always be followed ... Types of Bonds • Government bonds Bonds sold by the U.S Treasury • Backed by the full faith and credit of the U.S government • Municipal bonds Bonds issued by state or local governments • Revenue... instruments Short-term debt securities issued by corporations, financial institutions, and governments • Generally low-risk securities and are purchased by investors when they have surplus cash Bonds... post • Can be sold only by governmental units that have the power to levy taxes • Interest payments are exempt from federal income tax • Secured bond Corporate bond backed by a specific pledge of