Instructor Lecture PowerPoints

Instructor Lecture PowerPoints
Managing Finances Business Essentials, 8th Edition Ebert/Griffin Instructor Lecture PowerPoints PowerPoint Presentation prepared by Carol Vollmer Pope Alverno College Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 1

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall
L E A R N I N G O B J E C T I V E S After reading this chapter, you should be able to: Explain the concept of the time value of money and the principle of compound growth. Identify the opportunities offered by mutual funds and exchange-traded funds. Describe the role of securities markets, and identify the major stock exchanges and stock markets Explain how securities markets are regulated and tracked. In this chapter we will study managing finances. We will explain the concept of the time value of money and the principle of compound growth. We will identify the opportunities offered by mutual funds and exchange-traded funds. We will describe the role of securities markets, and identify the major stock exchanges and stock markets. We will explain how securities markets are regulated and tracked. Teaching Tips: Form a team with another student. In your teams, please select one of the learning objectives we just reviewed. Please prepare a brief introduction to the topic. We will share our answers with the class. Answers will vary. You can wait to comment on the answers until you have covered the material later in the chapter. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-2

L E A R N I N G O B J E C T I V E S (cont.)
After reading this chapter, you should be able to: Describe the risk-return relationship, and discuss the use of diversification and asset allocation for investments. Describe the various ways firms raise capital and identify the pros and cons of each method. Identify the reasons a company might make an initial public offering of its stock, and explain how stock value is determined. We will also describe the risk-return relationship, and discuss the use of diversification and asset allocation for investments. We will describe the various ways firms raise capital and identify the pros and cons of each method. We will identify the reasons a company might make an initial public offering of its stock, and explain how stock value is determined. Teaching Tips: In your student teams, please prepare a brief introduction to one of the learning objectives above. We will share our answers with the class. Answers will vary. You can wait to comment on the answers until you have covered the material later in the chapter. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-3 3

What’s in It for Me? By understanding the material in this chapter, you will understand the various ways individuals gather, either in person or, increasingly, online looking for ways to make their money work for them. This chapter will help you learn ways to make your money work for you Whether your goals are long- or short-term Whether you are motivated by profit or security Or simply because you enjoy the challenges inherent in investing What’s in it for you? By understanding this chapter’s discussion of managing finances, you’ll benefit in the following ways: You will understand the various ways individuals gather, either in person or, increasingly, online looking for ways to make their money work for them. This chapter will help you learn ways to make your money work for you: Whether your goals are long- or short-term Whether you are motivated by profit or security Or simply because you enjoy the challenges inherent in investing Teaching Tips: In your student teams, please discuss how you believe you will learn. Answers will vary. Your responses can wait until later in the class once the material has been covered. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-4

The Time Value of Money The time value of money is the most important concept in business finance While money is invested, it grows, earning interest or yielding some form of return This stems from the concept of compound growth Compounding interest paid to investors over given time periods It is important for us to understand the time value of money. This is perhaps the most important concept in business finance. Why? Because while money is invested, it grows, earning interest or yielding some form of return. This stems from another important concept: compound growth. This is the time value of money paid to investors over given time periods. Teaching Tips: In your student teams, imagine you have inherited $10,000 from your great aunt Susie who, unfortunately, just passed away. If you invest this amount, instead of spending it on a winter break trip to Australia, at 7% for one year, how much do you have at the end of the year? Then, if you continue to reinvest the principal and interest for another 4 years, how much will you have? And if you continue to invest the principal and interest at 7% for another 25 years, how much will you have? Why is this type of investment important? We will share our answers with the class. After 1 year we have $700 interest. Then we invest $10,700 at 7% for another 4 years, we have $14,025. If we keep reinvesting for another 25 years, we could have over $70,000. This material is from the text. Answers as to why this is important could be saving for retirement, growth wealth, etc. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-5

FIGURE 16.1 The Amount to Which an Initial $10,000 Investment Grows
Let’s look at the amount to which an initial $10,000 investment grows at different interest rates. Here it is obvious why an investor looks for the highest interest rate possible. Teaching Tips: In your student teams, please discuss what is happening with the current level of interest rates being paid in the economy. Answers will vary depending on the economy of the U.S. at the time of the question. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-6

The Rule of 72 The rule of 72 is an interesting concept. If we want to double our money, how many years will it take? Divide 72 by the interest rate you will receive. To know how long it will take to double your money, divide 72 by the number of years in which you want this to occur. Another interesting concept is the rule of 72. If we want to double our money, how many years will it take? Simply divide 72 by the interest rate you will receive. Also, if you want to know how long it will take to double your money, divide 72 by the number of years in which you want this to occur. Teaching Tips: In your student teams, please assume we will receive 8% interest. Also assume we want to double our money in 10 years. Please calculate how many years it will take to double our money. Also please calculate at what interest rate we need to invest if we want to double our money in 10 years. Please discuss what this concept tells us about investing. The answers are in the book. The answer to the first question is 8%. The answer to the second question is 10 years. This concept tells investors to look for the highest interest or return rate possible. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-7

Common Stock A stock is a portion of ownership in a company The ownership of the company is divided into small parts called shares These shares can be bought or sold to determine who owns what percent of the company The most common form of shares is called common stock Shares are purchased in the hope that they will increase in value Common stock is normally valued in two ways: Market value Book value What is stock? Stock is a portion of ownership in a company. The ownership of the company is divided into small parts called shares. These shares can be bought or sold, determining who owns what percent of the company. The most common form of shares is called common stock, which is valued in two ways: Market value Book value Teaching Tips: In your student teams, please choose either market or book value and prepare a brief description of the form of value and how it is calculated. We will share our responses with the class. Answers come from the text. Market value is the amount investors are willing to pay for the stock. Book value is obtained by dividing owners’ equity by the number of shares issued. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-8

Common Stock (cont.) Investment traits of common stock Most risky form of investment Offer high growth potential Also vary the most with changes in the stock market Dividends A payment made to shareholders on a per share basis from the company’s earnings. Let’s look at the investment traits of common stock. They are the most risky form of investment. They offer the highest growth potential. They also vary the most with changes in the stock market. Dividends are payments made to shareholders of a common stock on a per share basis from the company’s earnings. The amounts paid vary greatly depending on the company. Teaching Tips: In your student teams, please discuss what happened to the value of common stock and what level of dividends were paid to shareholders during the most recent economic crisis. Common stock values fell very sharply to new lows, and dividends were most likely eliminated. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-9

Mutual and Exchange Traded Funds
Mutual Funds and Exchange Traded Funds Alternatives to stock Easy to purchase with small sums of money Mutual funds Created by investment firms Pool cash investments into various investments to create a portfolio Grow in value across time and produce income Mutual Funds and Exchange Traded Funds are important alternatives to stock investments. They are easy to purchase with small sums of money. Mutual funds: Are created by investment firms. Pool cash investments of individuals and businesses into various investments to create a portfolio. Grow in value across time and produce income. Teaching Tips: In your student teams, please discuss your opinion of investing in mutual funds. Have you or anyone you know invested in these funds? What was the result? We will share our responses with the class. Answers will vary based on opinion and experience. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-10

Reasons for Investing Why should a person or business invest in the market? Stability and safety Money market mutual funds preserve capital and provide more current income Conservative capital growth Balanced funds stress preservation of capital and current income, as well as some growth Aggressive growth Aggressive growth funds seek maximum long-term growth Why should a person or business invest in the market? To achieve stability and safety for their investments. Money market mutual funds preserve capital and provide more current income. To achieve conservative capital growth for their investments. Balanced funds stress preservation of capital and provide current income as well as future growth. To achieve aggressive growth for their investments. Aggressive growth funds seek maximum long-term growth. Teaching Tips: In your student teams, please choose one of the three reasons for investing we have just discussed. Please discuss what kind of individual would invest using your chosen reason—for example, due to their age, income, etc.—or what type of business. Then discuss why that target market would choose your selected reason for investing. Answers will vary but should revolve around the discussion. Stability and safety: More likely people in retirement or nearing retirement, or people who are risk- averse. The same for companies whose investors fit that profile. Conservative capital growth: More likely those approaching retirement or who are risk-averse, or whose investors fit the same profile. Aggressive growth: More likely young investors who want to achieve the highest growth possible, those with lots of money who don’t worry about losing it but who do care about winning, and risk-tolerant people. The same for companies whose investors fit that profile. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-11

Exchange Traded Funds Exchange traded funds are a bundle of stocks and bonds that are in an index that tracks the overall movement of a market Unlike mutual funds, they can be traded like stocks Advantages of ETFs: Can be traded throughout the day like stocks Have lower operating costs than mutual funds Don’t require large amounts of investment Exchange traded funds, or ETFs, are a bundle of stocks and bonds that are in an index that tracks the overall movement of a market. Unlike mutual funds, they can be traded like stocks. Advantages of investing in ETFs are: They can be traded throughout the day like stocks. They have lower operating costs than mutual funds, and they don’t pass those costs on to investors as mutual funds do. They don’t require large amounts of investment. Teaching Tips: In your student teams, please discuss the difference between exchange traded funds and mutual funds. We will share our examples with the class. Answers should come from the material discussed above and from the elaboration from the text. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-12

Securities Markets Securities Represent secured, or financially valuable, claims on the part of investors Securities Markets Markets in which stocks and bonds are sold Stock Represents an ownership claim on the assets of a corporation Bond Represents a financial claim of money owed by a company to the bondholder Let’s examine the securities markets. Securities markets are the markets in which stocks and bonds are sold. Securities represent secured, or financially valuable, claims on the part of investors. Stock represents an ownership claim on the assets of a corporation. A bond represents a financial claim of money owed by a company to the bondholder. It is debt. Teaching Tips: In your student teams, please choose one of the four types of securities markets. Please prepare a brief description of your chosen market. Answers will be based on material reviewed above and from the text. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-13

Primary and Secondary Securities Markets
Primary Securities Markets The market in which new stocks and bonds (but not mutual funds) are bought and sold by firms and governments Secondary Securities Markets Where existing stocks and bonds are traded Securities and Exchange Commission (SEC) The government agency that regulates U.S. securities markets New securities must be approved by the SEC Let’s discuss the primary and secondary securities markets. The primary securities market is the market in which new stocks and bonds, but not mutual funds, are bought and sold by firms and governments. Secondary security markets are where existing stocks and bonds are traded. Both are regulated by the Securities and Exchange Commission or SEC, and new securities must be approved by the SEC. Teaching Tips: In your student teams, discuss the difference between the primary and secondary securities markets. We will share our answers with the class. The answer is in the above material. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-14

Primary and Secondary Securities Markets (cont.)
Investment banks help bring new securities to the market by: Advising companies on the timing and financial terms of new issues Underwriting—or buying—new securities, bearing some of the risks of issuing them Distributing new securities through banks and brokers to individual investors Investment banks help bring new securities to the market in three ways. First, by advising companies on the timing and financial terms of new issues. Second, by underwriting or buying new securities, bearing some of the risks of issuing them. Third, by distributing new securities through banks and brokers to individual investors. Teaching Tips: In your student teams, please choose one of the three ways investment banks help bring new securities to the market. Then please discuss how they accomplish this task. Answers should be based on the material discussed above. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-15

The Major Exchanges and Markets
New York Stock Exchange Global Stock Exchanges American Stock Exchange There are five major exchanges and markets. They include: The New York Stock Exchange, or NYSE The American Stock Exchange, or AMEX Regional stock exchanges Global stock exchanges around the world The NASDAQ, or National Association of Securities Dealers Automated Quotation System Let’s go learn more detail about each. Regional Stock Exchanges NASDAQ Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-16

The Major Exchanges and Markets (cont.)
The New York Stock Exchange For many people, “the stock market” means the New York Stock Exchange (NYSE) The American Stock Exchange (AMEX) The second-largest floor-based U.S. exchange is also located in New York City Regional Stock Exchanges Seven regional stock exchanges were organized to serve investors in places other than New York Global Stock Exchanges The value of shares listed on foreign exchanges continues to grow The New York Stock Exchange, or NYSE, equals the “stock market” for many people. The American Stock Exchange, or AMEX, is the second-largest floor-based U.S. exchange and is also located in New York City. Regional Stock Exchanges exist in seven different locations, and were organized to serve investors in places other than New York. Global Stock Exchanges are the value of shares listed on foreign exchanges. These exchanges continue to grow. Teaching Tips: In your teams, please make a list of different global stock exchanges. Where are they located? We will compare our lists as a class. See the next slide. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-17

TABLE 16.1 Selected Global Stock Exchanges and Markets
Table 16.2 shows a list of selected global stock exchanges and markets. Teaching Tips: How many did we list in our discussion? Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-18

The Major Exchanges and Markets (cont.)
National Association of Securities Dealers Automated Quotation (NASDAQ) system The world’s oldest electronic stock market Orders are gathered and executed on a computer network Electronic communication networks have allowed for: Cross-border ownership International consolidation of markets Another important market is the National Association of Securities Dealers Automated Quotation System, more commonly known as NASDAQ. This is the world’s oldest electronic stock market. Orders are gathered and executed on a computer network. Electronic communications networks have allowed for: Cross-border ownership International consolidation of markets Teaching Tips: In your student teams, please discuss how the Internet and electronic communication networks have impacted the major exchanges and markets. Answers will vary. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-19

Individual Investor Trading
Stock Brokers Earn commissions by executing buy-and-sell orders from nonexchange members Discount Brokers Offer lower fees to investors than do full-service stock brokers Full-Service Brokers Offer full services to investors who do not have the time to manage their own portfolios Online Trading Conditions favoring online trading Convenient access to the Internet Fast, no-nonsense transactions Opportunity for self-directed investors to manage their own investments while paying low fees for trading Ownership records have been helped by book-entry ownership Individual investor trading can be accomplished through a number of different ways. First, stock brokers can buy and sell stocks. They earn commissions by executing buy-and-sell orders from nonexchange members. Discount brokers offer lower fees to investors than do full-service brokers. Full-service brokers offer full services to investors who do not have the time to manage their own portfolios. Conditions favoring online trading including the following: Convenient access to the Internet Fast, no-nonsense transactions The opportunity for self-directed investors to manage their own investments while paying low fees for trading Ownership records can be controlled through book-entry ownership. Teaching Tips: In your student teams, discuss which type of broker or trading you would feel most comfortable engaging in. We will share our answers with the class. Answers will vary. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-20

Dow Jones Industrial Average
Market Indexes Dow Jones Industrial Average The S&P 500 The NASDAQ Composite Let’s look at the major market indexes: The Dow Jones Industrial Average The S&P 500 The NASDAQ Composite The Russell 2000 Index-matching ETFs The Russell 2000 Index-matching FTFs Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-21

Market Indexes (cont.) The Dow Jones Industrial Average (DJIA) The most widely cited U.S. market index Measures the performance of financial markets by focusing on 30 blue-chip companies as reflectors of economic health The S&P 500 Composite Index Consists of 500 stocks, including 400 industrial firms, 40 utilities, 40 financial institutions, and 20 transportation companies The Dow Jones Industrial Average is the most widely cited U.S. market index. It measures the performance of financial markets by focusing on 30 blue-chip companies as reflectors of economic health. The S&P 500 Composite Index consists of 500 stocks, including 400 industrial firms, 40 utilities, 40 financial institutions, and 20 transportation companies. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-22

Market Indexes (cont.) NASDAQ Composite Index All NASDAQ-listed companies are included in the index, for a total of more than 3,300 firms (both domestic and foreign) The Russell 2000 A specialty index that measures the smallest companies based on market capitalization Index matching ETFs Includes countless other specialty indexes The NASDAQ Composite Index includes 3,300 firms, both domestic and foreign. The Russell 2000 is a specialty index that measures the smallest companies based on market capitalization. Index matching ETFs are countless other specialty indexes. Teaching Tips: In your student teams, choose one of the five major market indexes and prepare a brief description. We will share our description with the class. Answers should be based on the information from the last two slides plus additional information from the text. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-23

FIGURE 16.2 Bull and Bear Markets
Figure 16.2 shows the movement of the stock market as depicted by the Dow Jones Average, the S&P 500, and the NASDAQ Composite Index. From this we can see that there have been times of growth and times of decline. Times of growth in the market lasting more than 12 months are called a bull market. Times of decline with negative investor sentiment are called a bear market. Teaching Tips: In your student groups, please discuss the current economic situation in terms of the performance of the stock market. We will share our discussion with the class. Answers will vary depending on the timing of this chapter presentation, but at the end of 2008, the economy was in a recession and it was definitely a bear market, with shares of the Dow falling to the low 8,000s. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-24

The Risk Return Relationship
Each type of investment has a risk return relationship There are three main types of returns: Dividends Price appreciation Total return Let’s talk about the risk return relationship. Every investment has one. There are three main types of returns. They are: Dividends paid to shareholders from profits Price appreciation of the stock, which results in a capital gain Total return, which is the sum of the dividends, interest and capital gain from the stock Total return needs to be examined from the perspective of the initial investment. This can be achieved through the following formula: Total return as a percent of original investment = Total dividend and interest + capital gain/original investment amount x 100. Teaching Tips: In your student teams, please discuss one of the three main types of returns. In your discussion, please make a list of any stocks you might know of that provide the type of return your team chose. Also prepare a brief description of the type of return. We will share our examples with the class. Answers should include student experiences and also include material just discussed. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-25

FIGURE 16.3 Uncertainty About Financial Returns on Investments
Figure 16.3 graphs uncertainty about financial returns on investments. This graph shows how the size of the financial return amount that must be offered to induce investment into this type of investment grows with the level of future certainty of returns. Teaching Tips: In your student teams, please review this figure and prepare a brief description of your understanding of this concept. We will share our descriptions with the class. Descriptions should include the discussion presented in the figure and the text, as well as the points made in this slide. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-26

Reducing Risk With Diversification and Asset Allocation
Buying several different kinds of investments so the risk of loss is reduced by spreading the total investment across more stocks Asset Allocation The proportion—the relative amounts—of funds invested in (or allocated to) each of the investment alternatives Performance Differences for Different Portfolios A portfolio is the combination of all the investments— stocks, bonds, real estate, and mutual funds Portfolios have different investment objectives, and can be managed through asset allocation Let’s discuss reducing risk with diversification and asset allocation. Diversification includes buying several different kinds of investments, rather than just one, so that the risk of loss is reduced by spreading the total investment across more stocks. Asset allocation is the proportion, or the relative amounts, of funds invested in or allocated to each of the investment alternatives. Let’s also discuss an investment portfolio. A portfolio is the combination of all the investments—stocks, bonds, real estate, and mutual funds—that an individual or a corporation makes. Portfolios have different investment objectives. These objectives can be managed through asset allocation. Teaching Tips: In your student teams, please prepare a sample investment portfolio, either for yourselves or for a corporation. Be sure to define the investment objectives for your portfolio. We will share our answers with the class. Answers will vary depending on what the investment objectives are for each portfolio suggested. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-27

Financing the Business
Secured loans for equipment Businesses usually need some financing to start operations Secured loans provide capital for such loans With a secured loan, the borrower needs to guarantee repayment The loan needs to be secured by pledging the asset as collateral to the lender If the borrower defaults and doesn’t pay the loan, the lender can claim the equipment in lieu of payment Now we will discuss financing the business. Most businesses usually need some type of financing in order to start operations. Commercial lending institutions will offer secured loans to most businesses. The borrower needs to guarantee repayment of a secured loan. In order for the loan to be secured, the borrower must pledge the asset being purchased, such as a new piece of equipment, to the lender. This is called collateral. If the borrower defaults and doesn’t pay the loan, the lender can claim the equipment or asset in lieu of payment. Teaching Tips: In your student teams, make a list of three items for which a new business might need a secured loan. We will share our examples with the class. Answers should include items that are tangible and can be classified as an asset. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-28

Financing the Business (cont.)
Principal and Interest Rates Loan Principal is the amount of money that is owed on a loan Interest is also paid at an annual percentage rate (APR) agreed to by the commercial lender and the borrower Interest is a fee paid by the borrower to the lender for the use of the loan principal In addition to pledging an asset, businesses will pay back the loan over a specified amount of time, which is agreed upon with their lender. There are two parts to the loan repayment: The first is the loan principal, or the amount of money that is owed on the loan. The second is the interest, which is a fee paid by the borrower to the lender for the use of the loan principal. Interest is charged and paid at an annual percentage rate, or APR, that is agreed to by the commercial lender and the borrower. Teaching Tips: In your student teams, thinking about the items you just presented as examples for a secured business loan a few minutes ago, please discuss what you believe the appropriate rate of interest, or APR, should be for the loan. One of your team members can take the role of the lender and the other the role of the borrower. We will share our examples with the class. Answers will vary, but the discussion should include some reference to the prime rate or lending rate for a basis point for the loan. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-29

Working Capital and Unsecured Loans from Banks
Firms need cash to operate their businesses Working capital = Current assets – current liabilities If working capital is positive for the firm, they are able to cover operating expenses If the result of this equation is negative, the firm may need to borrow funds in the short term to pay operating expenses Unsecured loans from banks can be obtained without pledging collateral Firms need a good credit rating to obtain this type of loan They may be required to keep a portion of the loan balance—called a compensating balance—in a separate, non-interest-bearing account with the bank Let’s discuss working capital. Firms need cash to run their businesses and pay for everyday operating expenses. Working capital should cover these expenses. Working capital = Current assets – current liabilities If the result of this equation is positive, the working capital is positive, and the firm is able to cover operating expenses. If the result of this equation is negative, the firm may need to borrow funds in the short term to pay operating expenses. Unsecured loans from banks can be obtained without pledging collateral. Firms will need a good credit rating and good relationship with a commercial lender to obtain this type of loan. The firm may be required to keep a portion of the loan balance—called a compensating balance—in a separate, non-interest-bearing account with the lending bank. Teaching Tips: In your student teams, please list the type of information a commercial lender might need in order to offer an unsecured loan to a business. We will share our examples with the class. Answers will vary. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-30

Angel Investors and Venture Capital
Once a business is started, it may need additional capital Angel investors provide what is called venture capital Usually wealthy individuals or corporations that seek to invest in a new business Require a sizeable return (up to 50% ownership of the company) in exchange for their investment In general, firms turn toward angel investors and venture capital when they are too new to have established credit with a commercial bank Let’s discuss angel investors and venture capital. Once a business is started, it may need additional capital. Angel investors are a source for this type of investment. They: Are usually wealthy individuals or corporations that seek to invest in a new business. Require a sizeable return, perhaps up to 50% ownership of the company, in exchange for their investment. Provide what is called venture capital. In general, firms turn toward angel investors and venture capital when they are too new to have established credit with a commercial bank. Teaching Tips: In your student teams, please make a list of three examples of firms that might seek angel investors and venture capital. We will share our examples with the class. Answers will vary, but should address the issue that the firm is new and does not have established credit with a commercial bank. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-31

Sale of Corporate Bonds
Corporations can raise capital by selling corporate bonds A corporate bond is a formal pledge (IOU) obligating the issuer to pay interest periodically and repay the principal at maturity (a preset future date) to the lender The government also offers municipal bonds Corporations can also raise capital by selling corporate bonds. A corporate bond is a formal pledge, or IOU, obligating the issuer to pay interest periodically and repay the principal at maturity (which is a preset future date) to the lender. The government also offers bonds, called municipal bonds. Teaching Tips: In your student teams, please give an example of the type of company that might issue a corporate bond. Answers will vary. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-32

Characteristics of Corporate Bonds
A bondholder has no claim to corporate ownership Each new bond has a bond indenture Sets forth the borrower’s obligations and the financial returns for lenders An important point for a bond is its maturity date Date by which the company must repay the face value (or par value) of the bond to the lender Bond default A bond is in default when it fails to make payment to the lender If this occurs, the bondholders can file a bondholders’ claim If the company cannot pay back its debt, it may declare bankruptcy, which gives the company relief from repaying some or all of its debts Let’s examine the characteristics of corporate bonds. A bondholder has no claim to corporate ownership or to receive dividends. Each new bond has a bond indenture. This legal document sets forth the borrower’s obligations. It also sets the financial return rate for lenders. An important point for a bond is its maturity date. This is the date by which the company must repay the face value, or what is also called par value, of the bond to the lender. A corporation can default on a bond it has issued. A bond is in default when it fails to make payment to the lender. If this occurs, the bondholders can file a bondholders’ claim. If the company cannot pay back its debt, it may declare bankruptcy, which gives the company relief from repaying some or all of its debts. Teaching Tips: In your student teams, please prepare a brief summary of issues that are important when issuing or buying a corporate bond. Be sure to list the differences between issuing and purchasing the bond. We will share our summaries with the class. Answers will vary but should refer to the information just discussed above. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-33

TABLE 16.2 Bond Rating Systems
There are two key bond rating systems: Moody’s Standard & Poor’s You will see from Table 16.2 that there are different bond rating systems used by each firm. The typology may be different; however, both rating systems use the same levels, which include: High grades Medium grades or investment grades Speculative Poor grades Teaching Tips: In your student teams, please discuss why bonds might fall into the different rating levels. Why is it important for investors to know about a bond’s rating? We will share our answers with the class. Answers will vary but should address the risk factors involved with lower-grade bonds. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-34

Becoming a Public Corporation
Initial Public Offerings (IPOs) are a significant form of funding for corporations IPOs are the first sale of a company’s stock to the general public Going public means selling off part of the company Means giving up control of some of the company Large investors can become corporate raiders A company goes public when it offers its shares of stock for sale to the public. This is called an Initial Public Offering, or IPO. When a company goes public, it means selling off part of the company and giving up some of the control of the company. When one individual or firm holds a majority share of the stock, these large investors can become corporate raiders. Corporate raiders are investors who decide to try to take over the management of the company. Teaching Tips: In your student teams, please think of some examples of companies who have had large initial public offerings, or IPOs. We will share our examples with the class. Answers will vary but could include the example of Google, Inc., from the text. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-35

Stock Valuation Stock valuation Prices of stocks vary in value due to many factors Why do prices of stocks vary? The price of a stock depends on the demand for and supply of a specific company’s stock The corporation may want the stock to be valued in a specific price range Stock split: If the price of a company’s stock gets too high, it can restore it to its original range by paying a special dividend in shares of stock to its shareholders Let’s discuss how stocks are valued. Stock valuation means that the prices of stocks vary in value due to many factors. Why do prices of stocks vary? The price of a stock can depend on the demand for and supply of a specific company’s stock. The corporation may want the stock to be valued in a specific price range, say between $20 and $50 per share. If the price of a company’s stock gets too high, the company can restore it to its original range by paying a special dividend in shares of stock to its shareholders. This is called a stock split. Teaching Tips: In your student teams, please discuss why stock prices vary. You will also want to consider what occurred with stock prices during the stock market plunge in late We will share our answers with the class. Answers will vary, but should include the reasons listed above, especially the demand for and supply of a company’s stock. Stocks fell in part due to a lowered demand for many corporations’ stock due to poor performance by the companies in the economic downturn. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-36

TABLE 16.3 Financial Comparison of Coca-Cola and PepsiCo
In reviewing price variations of a stock, Table 16.3 compares the recent prices of both Coca-Cola and PepsiCo. It also looks at the earnings per share for each stock, as well as the dividend yield. Teaching Tips: In your student teams, please discuss the differences between these two stocks. We will share our discussion with the class. Answers should focus on the example from the text. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-37

TABLE 16.4 Corporation Sizes Based on Capitalization
Market capitalization is a way of examining the size of firms in an industry. As we can see from Table 16.4, firms are categorized by capitalization into four categories: Micro-cap Small-cap Mid-cap Large-cap Teaching Tips: In your student teams, please discuss the reasons for capitalization categories. We will discuss our answers with the class. Answers should reflect back to the information in the text. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-38

Pros and Cons of Debt Financing
Long-term borrowing from sources outside the company Major source of funding Long-term loans are attractive: Speed of availability due to limited parties involved No public disclosure required Debt financing is the long-term borrowing of funds from sources outside the company. This is a major source of funding for firms. Long-term loans are attractive for a corporation for two reasons: Their speed of availability due to the fact that there are a limited number of parties involved. No public disclosure is required, unlike with corporate bonds. Teaching Tips: In your student teams, please discuss why debt financing might be attractive to a corporation. We will share our answers with the class. Answers will vary, and should reflect the reasoning just covered. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-39

Pros and Cons of Equity Financing
Looking inside the company for funding sources The expense of common stock Paying dividends to shareholders is more expensive than paying interest on corporate bonds Retained earnings as a source of capital Means smaller dividends to shareholders Means no interest paid on debt Equity financing means looking inside the company for funding sources. One main reason why corporations may not want to use this form of financing is because it is more expensive to pay dividends to shareholders than to pay interest on corporate bonds. A company can use retained earnings as a source of capital. This will mean smaller dividends are paid to shareholders, and it also means there is no interest paid on outside debt. Teaching Tips: In your student teams, please discuss the reasons a company may decide to finance itself from equity. We will share our answers with the class. Answers should focus on the reasons stated earlier in this slide. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-40

Key Terms corporate raiders debt financing default discount brokers diversification dividends electronic communication networks equity financing exchange traded funds face value full-service brokers initial public offering interest investment banks loan principal aggressive growth funds Amex angel investors asset allocation balanced funds bear market bond indenture bondholders’ claim bond rating systems bonds book entry ownership book value bull market collateral common stock compound growth corporate bond There are many key terms that we learned in this chapter. Teaching Tips: Please form teams of two students. Each team will be assigned a number of terms. Your team should write an appropriate sentence using the key terms assigned to your group, which we will share with the class. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-41

Key Terms (cont.) shares stock stock brokers stock split time value of money unsecured loan venture capital working capital market capitalization market value maturity date money market mutual funds mutual funds NASDAQ NYSE online trading par value portfolio risk return relationship rule of 72 secured loan securities securities market (primary and secondary) There are many key terms that we learned in this chapter. Teaching Tips: Please form teams of two students. Each team will be assigned a number of terms. Your team should write an appropriate sentence using the key terms assigned to your group, which we will share with the class. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-42

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 16-43 43 43

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