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Part 6

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  1. Part 6 Managing Financial Resources

  2. Chapter 18 Financing and Investing through Securities Markets

  3. Chapter Objectives • Distinguish between the primary market for securities and the secondary market. • Compare money market instruments, bonds, and common stock, and explain why particular investors might prefer each type of security. • Identify the five basic objectives of investors and the types of securities most likely to help them reach each objective. • Explain the process of buying or selling a security listed on an organized securities exchange. • Describe the information included in stock, bond, and mutual fund quotations. • Explain the role of mutual funds in securities markets. • Evaluate the major features of regulations designed to protect investors.

  4. The Primary Market • Security—stock, bond, or money market instrument that represents an obligation on the part of the issuer. • Primary Market—market where new security issues are first sold to investors; the issuer receives the proceeds from the sale. • Initial Public Offering (IPO)

  5. IPOExample of a Tombstone

  6. The Secondary Market • Secondary Market—financial markets where previously issued securities are traded among investors. • Examples: NY Stock Exchange and the NASDAQ

  7. Securities • Money Market Instruments—short-term debt securities issued by corporations, financial institutions such as banks, and governments. • By definition, all short-term money market instruments mature within one year from the date of issue • Examples include: U.S. Treasury Bills, commercial paper, repurchase agreements and bank Certificates of Deposit

  8. Securities • Bonds • Investors choose from among a variety of bonds

  9. Securities • Types of Bonds • Secured Bond—bond backed by specific pledge of a company’s assets. • Debenture—bond backed by the reputation of the issuer rather than by a specific pledge of a company’s assets.

  10. Securities • Types of Bonds • Government Bonds issued by U.S. Treasury • Municipal Bonds are those issued by governments • Revenue bond is a bond whose proceeds are to be used to pay for a project that will produce revenue (e.g., a toll bridge) • General obligation bond is a bond whose proceeds are used to pay for a non-revenue producing project (e.g., a fire station)

  11. Securities • Quality Ratings for Bonds • Two factors determine a bond’s price: risk and interest rate • Bonds vary considerably in terms of risk as shown on the next slide

  12. Moody’s and Standard & Poor’s Bond Ratings

  13. Securities • Retiring Bonds • Bonds mature on a specific date • Borrowers must have the necessary funds available to pay the principal at that time • Call Provision

  14. Securities • Stock • Common Stock • Share of ownership in a company. • Common stock owners can vote on major company decisions • They expect to receive cash dividends and to benefit from capital gains. (Often no dividends are issued.)

  15. Securities • Stock • Preferred Stock • Stock whose holders receive preference in the payment of dividends • Seldom confers voting rights • Dividends are fixed

  16. Securities • Stock • Convertible Securities • Bonds or stock that contains a conversion feature • Gives the holder the right to exchange their securities for a fixed number of shares of common stock

  17. Securities Purchasers • The general types of investors who buy securities include institutions and individuals • Institutions invest their own funds or those held in trust for others • Individual investors still play a vital role . . . over half of all Americans now own stock

  18. Securities Purchasers • Investment Motivations • Primary Investment Objectives by Type of Security

  19. Securities Purchasers • Taxes and Investing • Interest received from bonds, and dividends received from stocks, are considered ordinary income which is taxed at the investor’s marginal tax rate • Profits made from the sale of securities owned for over a year are taxed at the capital gains rate • Other, special tax rules apply for investment income

  20. Securities Exchanges • Stock Exchange—centralized marketplace where primarily common stock are traded. • Stock exchanges are secondary markets, selling securities which have already been issued by firms and sold in the primary market

  21. Securities Exchanges • The New York Stock Exchange • NYSE (Big Board)—the largest, and probably the most famous, stock market in the world • Also one of the oldest, having been founded in 1792

  22. Securities Exchanges • The NASDAQ Stock Market • NASDAQ stock market—second-largest stock market in U.S., trading stock issues of firms that are typically smaller, less well-known than those on the NSYE • Unlike trading on the NSYE, which takes place face-to-face or the trading floor, trading on the NASDAQ takes place on an electronic network • World’s largest Intranet

  23. Securities Exchanges • Other U.S. Stock Markets • American Stock Exchange (AMEX)— focuses on stocks of smaller firms as well as other financial instruments such as options • Several regional stock exchanges also operate in the United States including the Chicago, Pacific (San Francisco) Boston, Cincinnati, and Philadelphia exchanges

  24. Securities Exchanges • Foreign Stock Markets • Virtually all developed, and many developing, countries have stock exchanges • Examples include Bombay, Helsinki, Hong Kong, Mexico City, Paris, and Toronto

  25. Securities Exchanges • Direct Trading and ECNs • Fourth market—direct trading of exchange-listed stocks off the floor of the NSYE, or outside the network, in case of NASDAQ-listed stocks • Electronic Communications Networks (ECNs)—such as Instinet, have become quite visible in recent years

  26. Buying and Selling Securities • Brokerage Firm—financial intermediary that buys and sells securities for individual and institutional investors.

  27. Buying and Selling Securities • Placing an Order • A market order instructs a brokerage firm to obtain the highest price possible – if the investor is selling – or the lowest price possible – if the investor is buying • A limit order instructs the brokerage firm not to pay more than a specified price for stock if the investor is buying, or accept less than a specified price if the investor is selling

  28. Costs of Trading • When investors buy or sell securities through a brokerage firm, they pay a fee • These costs vary widely among brokerage firms • A full-service firm charges higher fees, but provides a large number of services and offers investment advice • A discount firm charges lower fees, but offers less advice and fewer services

  29. Costs of Trading • Direct Investing • A growing number of corporations offer investors a direct way of purchasing stock through dividend reinvestment plans (DRIPs) • With DRIPs, the company uses the dividends paid on shares owned by an investor to buy additional shares of the company stock -- bypassing brokers -- and their fees • Another form of direct investing is the stock purchase program

  30. Costs of Trading • Reading the Financial News • Current financial news may be found in most daily newspapers, numerous websites, and many television and radio programs

  31. How to Read Stock Quote Tables

  32. How to Read Bond Quote Tables

  33. Stock Indexes • Stock indexes reflect the general activity of the stock market • The most common indices include the Dow Jones Average (Dow), the Standard & Poor’s 500, and the NASDAQ composite • Foreign indices include the DAX (Germany), the FT-100 or “Footsie” (London), and the Nikkei (Tokyo)

  34. Mutual Funds • Mutual Fund—financial institution that pools investment money from purchases of its shares and uses the money to acquire diversified portfolios of securities consistent with the fund’s investment objective. • Investors who buy shares of a mutual fund become part owners of a large number of securities, thereby lessening their individual risk

  35. Distribution of Mutual Fund Assets by Type of Fund

  36. How to Read Mutual Fund Tables

  37. Legal and Ethical Issues in Securities • Examples of unethical trading practices include brokers urging investors to buy high-risk investments or “churning” accounts (excessive trading) just to generate higher commissions • Examples of illegal trading practices include brokers theft from a client’s portfolio and giving false or misleading information to investors

  38. Legal and Ethical Issues in Securities • Government Regulation of the Securities Markets • Full and Fair Disclosure—requirement that investors should be told all relevant information by issuers so the can make informed decisions. • Prospectus—document that gives a detailed description of a company issuing securities

  39. Legal and Ethical Issues in Securities • Government Regulation of the Securities Markets • Insider Training—the use of material non-public information to make an investment profit • Example: someone using non-public information about a pending merger, or a major oil discovery, to profit in the stock market at the expense of ordinary investors • Regulation FD

  40. Legal and Ethical Issues in Securities • Industry Self-Regulation • Professional Rules of Conduct—rules of conduct for members of the National Association of Securities Dealers that try to ensure that brokers perform their basic functions honestly and fairly, under constant supervision • Market Surveillance—techniques used by all securities markets to spot possible violations of trading rules or securities laws