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

2. 1. Describe the role of securities markets. 2. Advantages & disadvantages of equity financing by issuing stock, and the differences between common and preferred stock. 3. Advantages & disadvantages of obtaining debt financing by issuing bonds, and identify types and features of bonds. 4. Explain investing in securities markets, setting & balancing investment objectives, and managing risks. 5. Analyze investment opportunities stocks, bonds, mutual funds, and exchange-traded funds (ETFs). 6. Describe market indicators like the Dow Jones Industrial Average, NASDAQ, and S&P 500. LEARNING GOALS Chapter Nineteen 19-2

3. 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

4. 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. Initial Public Offering (IPO) -- The first offering of a corporation’s stock, usually managed by an investment banker. The SECURITIES and EXCHANGE COMMISSION Securities Regulations and the SEC LG2 19-4

5. 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 19-5

6. Stock Exchange -- An organization whose members can buy and sell (exchange) securities on behalf of companies and individual investors. Over-the-Counter (OTC) Markets -- Provides smaller publically traded 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 EXCHANGES Stock Exchanges LG2 19-6

7. NYSE Euronext NASDAQ London Stock ExchangeLondon Stock Exchange Tokyo Stock Exchange Deutsche Borse TOP STOCK EXCHANGES LG2 Stock Exchanges 19-7

8. 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 19-8

9. 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 19-9

10. 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 LG3 Advantages & Disadvantages of Issuing Stock 19-10

11. 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 19-11

12. 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 SPLITS Stock Splits LG6 19-12

13. 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 19-13

14. 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 19-14

15. 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 Advantages & Disadvantages of Issuing Bonds 19-15

16. 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 19-16

17. 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 QUESTIONS Investing in Bonds LG7 19-17

18. BOND RATINGS Rating Moody’sS & PFitchDescription AaaAAA Highest Quality AaAA High Quality AAAUpper-Medium Grade BaaBBB Medium Grade BaBB Lower-Medium Grade BBBSpeculative CaaCCC, CCCCCPoor CaCDDDHighly Speculative CDDLowest Grade LG4 Advantages & Disadvantages of Issuing Bonds 19-18

19. 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.TD Ameritrade E*TradeScottrade BUYING SECURITIES How Investors Buy Securities LG5 19-19

20. 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 19-20

21. PERCENTAGE of HOUSEHOLDS OWNING MUTUAL FUNDS Source: Investment Company Institute Factbook. LG8 Investing in Mutual Funds & Exchange- Traded Funds 19-21

22. TOP FINANICIAL NEWS and RESEARCH SITES Yahoo Finance DailyFinance MSN Money Forbes Dow Jones & Co. LG6 Understanding Stock Quotations 19-22

23. 1. Investment risk 2. Yield 3. Duration 4. Liquidity 5. Tax consequences FIVE INVESTMENT CRITERIA Choosing the Right Investment Strategy LG5 19-23

24. AVERAGE ANNUAL RETURN of ASSET CLASSES (Since 1926) Source: Ibbotson Associates and Morningstar. LG5 Choosing the Right Investment Strategy 19-24 The greater the risk, the greater the rewards

25. COMPARING INVESTMENTS LG8 Understanding Mutual Fund Quotations 19-25

26. 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 DIVERSIFICATION Reducing Risk by Diversifying Investments LG5 19-26

27. 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 19-27

28. VARIETIES of ETFs Source: Schwab and E*Trade. LG8 Investing in Mutual Funds & Exchange- Traded Funds 19-28

29. INVESTING 101 Things to Do Before Making Your First Investment Source: Money, November 2010. LG5 Choosing the Right Investment Strategy Take an investing class. Join an investment club, or reputable web site like Motley Fool, not Motley Crue. Attend a conference (be very careful in selecting). Head to the library and pick up these books:  The Big Short The Big Short  The Intelligent Investor The Intelligent Investor  The Myth of the Rational Market The Myth of the Rational Market 19-29

30. 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 STOCKS LG6 Investing in Stocks 19-30

31. 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) 19-31

32. 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 19-32

33. Bulls: Investors who believe stock prices are going to rise. PERCEPTIONS of the MARKET “Animal Spirits” Investing in Stocks Bears: Investors who expect stock prices to decline. LG6 19-33 Bull markets are all alike, but every bear market is bad in its own way. Stock market is usually the messenger of the problem, but not always. Lack of confidence

34. BEAR MARKET DECLINES in the S&P 500 Source: Stock Traders Almanac 2011. LG6 Investing in Stocks 19-34

35. 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 2000s LG9 Riding the Market’s Roller Coaster 19-35

36. Program Trading -- Giving instructions to computers to automatically sell if the price of a stock dips to a certain point to avoid potential losses. ‾High Frequency Trading increases potential for greater volatility. 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 19-36

37. Buying Stock on Margin -- Borrowing some of the stock’s purchase cost from the brokerage firm. BUYING STOCK on MARGIN Buying 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 19-37

38. Wall Street – Issued exotic securities; −Securitization (Selling mortgages or contracts for upfront payment (lead to bankruptcies of Enron ‘01 & Continental Illinois ‘84) −Bond rating agencies gave AAA rating to MBS Paid excessive compensation based on bonuses Investment banks got the SEC to relax capital requirements. Main Street – Americans borrowed beyond their means; Banks grew fast by giving favorable loans to homebuilders Homeowners took out equity loans ARM mortgage rates fueled Housing market bubble WHO’S at FAULT for the ECONOMIC CRISIS? Source: Fortune Magazine, www.fortune.com, accessed July 2011.www.fortune.com LG9 Riding the Market’s Roller Coaster 19-38

39. Washington Gramm-Leach-Billey Act allowed commercial & investment banks to combined Fed kept interest rates low in a bid to boost economy Community Reinvestment Act required lending to people with bad credit. FNMA (Fannie Mae) & FHLMC (Freddie Mac) expanded significantly, buying ~ 90% of home mortgages WHO’S at FAULT for the ECONOMIC CRISIS? Source: Fortune Magazine, www.fortune.com, accessed July 2011.www.fortune.com LG9 Riding the Market’s Roller Coaster 19-39

40. 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. 19- 40

41. 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) 19-41

42. What’s the primary purpose of a securities exchange? What does NASDAQ stand for? How does this exchange work? PROGRESS ASSESSMENT Progress Assessment 19-42

43. 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 ASSESSMENT Progress Assessment 19-43

44. 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 ASSESSMENT Progress Assessment 19-44

45. What is the key advantage of investing through online brokers? What is the key disadvantage? What is the primary purpose of diversifying investments? PROGRESS ASSESSMENT Progress Assessment 19-45

46. 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 ASSESSMENT Progress Assessment 19-46

47. 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 ASSESSMENT Progress Assessment 19-47