1. Copyright © 2003 by South-Western. All Rights Reserved. CHAPTER TWENTY FINANCING AND INVESTING THROUGH SECURITIES MARKETS Text by Profs. Gene Boone & David Kurtz Multimedia Presentation by Prof. Milton Pressley The University of New Orleans milton.pressley@uno.edu

2. Copyright © 2003 by South-Western. All Rights Reserved. Distinguish between the primary market for securities and the secondary market 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 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 Identify the five basic objectives of investors and the types of securities most likely to help them reach each objective LEARNING GOALS

3. Copyright © 2003 by South-Western. All Rights Reserved. Explain the process of buying or selling a security listed on an organized securities exchange 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 Describe the information included in stock, bond, and mutual fund quotations Explain the role of mutual funds in securities markets Explain the role of mutual funds in securities markets Evaluate the major features of regulations designed to protect investors Evaluate the major features of regulations designed to protect investors LEARNING GOALS

4. Copyright © 2003 by South-Western. All Rights Reserved. © PhotoDisc CHAPTER OVERVIEW Security: stock, bond, or money market instrument that represents an obligation of the issuer to provide the purchaser an expected or stated return on the investment Security: stock, bond, or money market instrument that represents an obligation of the issuer to provide the purchaser an expected or stated return on the investment

5. Copyright © 2003 by South-Western. All Rights Reserved. © PhotoDisc CHAPTER OVERVIEW Examines how securities are bought and sold in the primary and secondary markets Examines how securities are bought and sold in the primary and secondary markets Describes the characteristics of stocks, bonds, and money market instruments and how investors choose specific securities Describes the characteristics of stocks, bonds, and money market instruments and how investors choose specific securities Describes the role of organized securities exchanges Describes the role of organized securities exchanges Reviews the laws that regulate the securities markets and protect investors Reviews the laws that regulate the securities markets and protect investors

6. Copyright © 2003 by South-Western. All Rights Reserved. THE PRIMARY MARKET Primary market: market where new security issues are first sold to investors; the issuer receives the proceeds from the sale Primary market: market where new security issues are first sold to investors; the issuer receives the proceeds from the sale © PhotoDisc

7. Copyright © 2003 by South-Western. All Rights Reserved. Figure 20.1 Example of a Tombstone

8. Copyright © 2003 by South-Western. All Rights Reserved. Figure 20.2 An Example of the Services Provided by Investment Banking Firms

9. Copyright © 2003 by South-Western. All Rights Reserved. THE SECONDARY MARKET Secondary market: collection of financial markets where previously issued securities are traded among investors Secondary market: collection of financial markets where previously issued securities are traded among investors Examples: NY Stock Exchange and the NASDAQ Examples: NY Stock Exchange and the NASDAQ © PhotoDisc

10. Copyright © 2003 by South-Western. All Rights Reserved. SECURITIESSECURITIES Money market instrument: short-term debt security issued by corporations, financial institutions, and governments Money market instrument: short-term debt security issued by corporations, financial institutions, and governments By definition, all short-term money market instruments mature within one year from the date of issue 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 Examples include: U.S. Treasury Bills, commercial paper, repurchase agreements and bank Certificates of Deposit Money Market Instruments © PhotoDisc

11. Copyright © 2003 by South-Western. All Rights Reserved. SECURITIESSECURITIES Types of Bonds Types of Bonds Investors choose from among a variety of bonds Investors choose from among a variety of bonds Money Market Instruments Bonds © PhotoDisc

12. Copyright © 2003 by South-Western. All Rights Reserved. Figure 20.3 Types of Bonds and the Significant Features of Each

13. Copyright © 2003 by South-Western. All Rights Reserved. SECURITIESSECURITIES Types of Bonds Types of Bonds Secured bond: bond backed by a specific pledge of a company’s assets Secured bond: bond backed by a specific pledge of a company’s assets Money Market Instruments Bonds © PhotoDisc

14. Copyright © 2003 by South-Western. All Rights Reserved. © PhotoDisc SECURITIESSECURITIES Debenture: bond backed only by the reputation of the issuer rather than by a specific pledge of a company’s assets Debenture: bond backed only by the reputation of the issuer rather than by a specific pledge of a company’s assets Municipal bonds are those issued by governments Municipal bonds are those issued by governments Money Market Instruments Bonds

15. Copyright © 2003 by South-Western. All Rights Reserved. © PhotoDisc SECURITIESSECURITIES Two types of municipals: Two types of municipals: 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) 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) General obligation bond is a bond whose proceeds are used to pay for a non- revenue producing project (e.g., a fire station) Money Market Instruments Bonds

16. Copyright © 2003 by South-Western. All Rights Reserved. SECURITIESSECURITIES Quality Ratings for Bonds Quality Ratings for Bonds Two factors determine a bond’s price: risk and interest rate Two factors determine a bond’s price: risk and interest rate Bonds vary considerably in terms of risk as shown on the next slide Bonds vary considerably in terms of risk as shown on the next slide Money Market Instruments Bonds © PhotoDisc

17. Copyright © 2003 by South-Western. All Rights Reserved.

18. SECURITIESSECURITIES Retiring Bonds Retiring Bonds Bonds mature on a specific date Bonds mature on a specific date Borrowers must have the necessary funds available to pay the principal at that time Borrowers must have the necessary funds available to pay the principal at that time Money Market Instruments Bonds © PhotoDisc

19. Copyright © 2003 by South-Western. All Rights Reserved. © PhotoDisc SECURITIESSECURITIES Common stock: share of ownership in a company Common stock: share of ownership in a company Common stock owners can vote on major company decisions Common stock owners can vote on major company decisions They expect to receive cash dividends and to benefit from capital gains They expect to receive cash dividends and to benefit from capital gains Money Market Instruments Bonds Stocks

20. Copyright © 2003 by South-Western. All Rights Reserved. Figure 20.4 Relationship between Earnings and Stock Prices for Johnson & Johnson

21. Copyright © 2003 by South-Western. All Rights Reserved. © PhotoDisc SECURITIESSECURITIES Preferred stock: Stock whose holders receive preference in the payment of dividends Preferred stock: Stock whose holders receive preference in the payment of dividends Seldom confers voting rights Seldom confers voting rights Dividends are fixed Dividends are fixed Money Market Instruments Bonds Stocks

22. Copyright © 2003 by South-Western. All Rights Reserved. SECURITIESSECURITIES Convertible securities: bonds or stock that contains a conversion feature 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 Gives the holder the right to exchange their securities for a fixed number of shares of common stock Money Market Instruments Bonds Stocks © PhotoDisc

23. Copyright © 2003 by South-Western. All Rights Reserved. SECURITIES PURCHASERS The general types of investors who buy securities include institutions and individuals The general types of investors who buy securities include institutions and individuals Institutions invest their own funds or those held in trust for others Institutions invest their own funds or those held in trust for others They account for around two-thirds of all trading volume They account for around two-thirds of all trading volume Individual investors still play a vital role... over half of all Americans now own stock Individual investors still play a vital role... over half of all Americans now own stock © PhotoDisc

24. Copyright © 2003 by South-Western. All Rights Reserved. Investment Motivations

25. Copyright © 2003 by South-Western. All Rights Reserved. Investment Motivations Nothing provides more potential for growth in capital over long periods of time than common stock Nothing provides more potential for growth in capital over long periods of time than common stock $1000 invested in common stocks vs. bonds over a recent 25 year period would have grown to approximately $217,000 vs. $90,000 respectively $1000 invested in common stocks vs. bonds over a recent 25 year period would have grown to approximately $217,000 vs. $90,000 respectively Growth in Capital © PhotoDisc

26. Copyright © 2003 by South-Western. All Rights Reserved. The interest received on bonds is fixed for the life of the bond The interest received on bonds is fixed for the life of the bond Interest on money market instruments can increase over time (but can also decrease) Interest on money market instruments can increase over time (but can also decrease) Common stock has a typically risen at a rate exceeding of that of inflation Common stock has a typically risen at a rate exceeding of that of inflation Recent events have shown, however, that there are no guarantees of high stock returns Recent events have shown, however, that there are no guarantees of high stock returns Investment Motivations Growth in Capital Stability of Principal © PhotoDisc

27. Copyright © 2003 by South-Western. All Rights Reserved. A measure of the speed at which assets can be converted into cash A measure of the speed at which assets can be converted into cash CDs have short maturities, stable prices and offer the highest amount of liquidity for money market instruments CDs have short maturities, stable prices and offer the highest amount of liquidity for money market instruments Investment Motivations Growth in Capital Stability of Principal © PhotoDisc Liquidity

28. Copyright © 2003 by South-Western. All Rights Reserved. Historically bonds have provided the highest current income of any security Historically bonds have provided the highest current income of any security Higher than money market interest rates or the dividends paid on common stocks Higher than money market interest rates or the dividends paid on common stocks Investment Motivations Growth in Capital Stability of Principal Current Income © PhotoDisc Liquidity

29. Copyright © 2003 by South-Western. All Rights Reserved. The interest received on bonds is fixed for the life of the bond The interest received on bonds is fixed for the life of the bond Interest on money market instruments can increase over time (but can also decrease) Interest on money market instruments can increase over time (but can also decrease) Common stock has a typically risen at a rate exceeding of that of inflation Common stock has a typically risen at a rate exceeding of that of inflation Recent events have shown, however, that there are no guarantees of high stock returns Recent events have shown, however, that there are no guarantees of high stock returns Investment Motivations Growth in Capital Stability of Principal Current Income Growth in Income © PhotoDisc Liquidity

30. Copyright © 2003 by South-Western. All Rights Reserved. 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 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 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 Other, special tax rules apply for investment income

31. Copyright © 2003 by South-Western. All Rights Reserved. SECURITIES EXCHANGES Stock exchange (stock market): centralized marketplace where primarily common stocks are traded Stock exchange (stock market): centralized marketplace where primarily common stocks are traded Stock exchanges are secondary markets, selling securities which have already been issued by firms and sold in the primary market Stock exchanges are secondary markets, selling securities which have already been issued by firms and sold in the primary market © PhotoDisc

32. Copyright © 2003 by South-Western. All Rights Reserved. The New York Stock Exchange New York Stock Exchange (Big Board or NSYE): the largest, and probably the most famous, stock market in the world New York Stock Exchange (Big Board or NSYE): the largest, and probably the most famous, stock market in the world Also one of the oldest, having been founded in 1792 Also one of the oldest, having been founded in 1792 26,000 stock issues representing most of the largest, best known companies in the U.S., with a total market value in excess of $5 trillion, are traded on the NSYE 26,000 stock issues representing most of the largest, best known companies in the U.S., with a total market value in excess of $5 trillion, are traded on the NSYE © PhotoDisc

33. Copyright © 2003 by South-Western. All Rights Reserved. The NASDAQ Stock Market NASDAQ stock market: second- largest stock market in U.S., trading almost 5000 stock issues of firms that are typically smaller, less well-known than those on the NSYE NASDAQ stock market: second- largest stock market in U.S., trading almost 5000 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 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 © PhotoDisc

34. Copyright © 2003 by South-Western. All Rights Reserved. Other U.S. Securities Markets American Stock Exchange (AMEX): focuses on stocks of smaller firms as well as other financial instruments such as options 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 Several regional stock exchanges also operate in the United States including the Chicago, Pacific (San Francisco) Boston, Cincinnati, and Philadelphia exchanges © PhotoDisc

35. Copyright © 2003 by South-Western. All Rights Reserved. Foreign Stock Exchanges Virtually all developed, and many developing, countries have stock exchanges Virtually all developed, and many developing, countries have stock exchanges Examples include Bombay, Helsinki, Hong Kong, Mexico City, and Toronto Examples include Bombay, Helsinki, Hong Kong, Mexico City, and Toronto © PhotoDisc

36. Copyright © 2003 by South-Western. All Rights Reserved. The Fourth Market 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 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 Island.com and Instinet, have become quite visible in recent years Electronic Communications Networks (ECNs): such as Island.com and Instinet, have become quite visible in recent years © PhotoDisc

37. Copyright © 2003 by South-Western. All Rights Reserved. BUYING AND SELLING SECURITIES Brokerage firm: financial intermediary who buys and sells securities for individual and institutional investors Brokerage firm: financial intermediary who buys and sells securities for individual and institutional investors Examples: A.G. Edwards, Quick and Rilley, and Salomon Smith Barney Examples: A.G. Edwards, Quick and Rilley, and Salomon Smith Barney

38. Copyright © 2003 by South-Western. All Rights Reserved. BUYING AND SELLING SECURITIES Placing an Order A market order instructs a brokerage firm to obtain the highest price – if the investor is is selling – or the lowest price – if the investor is buying – possible A market order instructs a brokerage firm to obtain the highest price – if the investor is is selling – or the lowest price – if the investor is buying – possible

39. Copyright © 2003 by South-Western. All Rights Reserved. BUYING AND SELLING SECURITIES Placing an Order 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 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

40. Copyright © 2003 by South-Western. All Rights Reserved. BUYING AND SELLING SECURITIES Placing an Order Costs of Trading When investors buy or sell securities through a brokerage firm, they pay a fee When investors buy or sell securities through a brokerage firm, they pay a fee These costs vary widely among brokerage firms These costs vary widely among brokerage firms

41. Copyright © 2003 by South-Western. All Rights Reserved. BUYING AND SELLING SECURITIES Placing an Order Costs of Trading A full-service firm charges higher fees, but provides a large number of services and offers investment advice A full-service firm charges higher fees, but provides a large number of services and offers investment advice

42. Copyright © 2003 by South-Western. All Rights Reserved. BUYING AND SELLING SECURITIES Placing an Order Costs of Trading A discount firm charges lower fees, but offers less advice and fewer services A discount firm charges lower fees, but offers less advice and fewer services

43. Copyright © 2003 by South-Western. All Rights Reserved. Figure 20.5 Investment Services Provided by Discount Broker Charles Schwab

44. Copyright © 2003 by South-Western. All Rights Reserved. BUYING AND SELLING SECURITIES Placing an Order Costs of Trading Direct Investing A growing number of corporations offer investors a direct way of purchasing stock through dividend reinvestment plans (DRIPs) 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 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

45. Copyright © 2003 by South-Western. All Rights Reserved. BUYING AND SELLING SECURITIES Placing an Order Costs of Trading Direct Investing Another form of direct investing is the stock purchase program Another form of direct investing is the stock purchase program Over 100 companies allow first-time investors to buy shares directly from the company, again avoiding brokerage fees Over 100 companies allow first-time investors to buy shares directly from the company, again avoiding brokerage fees

46. Copyright © 2003 by South-Western. All Rights Reserved. BUYING AND SELLING SECURITIES Placing an Order Costs of Trading Direct Investing Reading the Financial News Current financial news may be found in most daily newspapers, numerous websites, and many television and radio programs Current financial news may be found in most daily newspapers, numerous websites, and many television and radio programs

47. Copyright © 2003 by South-Western. All Rights Reserved. BUYING AND SELLING SECURITIES Placing an Order Stock Quotations Costs of Trading Direct Investing Reading the Financial News To understand how to read the stock tables found in newspapers, you must understand how to interpret the symbols in the various columns as explained in figure 20.6 on the next slide To understand how to read the stock tables found in newspapers, you must understand how to interpret the symbols in the various columns as explained in figure 20.6 on the next slide

48. Copyright © 2003 by South-Western. All Rights Reserved. Figure 20.6 How to Read Stock Quote Tables

49. Copyright © 2003 by South-Western. All Rights Reserved. BUYING AND SELLING SECURITIES Placing an Order Stock Quotations Bond Quotations Bond Quotations Costs of Trading Direct Investing Reading the Financial News Bond quotations are explained in Figure 20.7 on the next slide... Bond quotations are explained in Figure 20.7 on the next slide...

50. Copyright © 2003 by South-Western. All Rights Reserved. Figure 20.7 How to Read Bond Quote Tables

51. Copyright © 2003 by South-Western. All Rights Reserved. STOCK INDEXES Stock indexes reflect the general activity of the stock market 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 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) Foreign indices include the DAX (Germany), the FT-100 or “Footsie” (London), and the Nikkei (Tokyo) © PhotoDisc

52. Copyright © 2003 by South-Western. All Rights Reserved. MUTUAL FUNDS Mutual fund: financial institution that pools investment money from purchasers of its shares and uses it to acquire diversified portfolios of securities consistent with its investment objectives Mutual fund: financial institution that pools investment money from purchasers of its shares and uses it to acquire diversified portfolios of securities consistent with its investment objectives Investors who buy shares of a mutual fund become part owners of a large number of securities, thereby lessening their individual risk Investors who buy shares of a mutual fund become part owners of a large number of securities, thereby lessening their individual risk © PhotoDisc

53. Copyright © 2003 by South-Western. All Rights Reserved. Figure 20.8 Mutual Funds – Active Participants in Firms in Which They Invest

54. Copyright © 2003 by South-Western. All Rights Reserved. Figure 20.9 Breakdown of Mutual Fund Assets by Type

55. Copyright © 2003 by South-Western. All Rights Reserved. Figure 20.10 How to Read Mutual Fund Tables

56. Copyright © 2003 by South-Western. All Rights Reserved. LEGAL AND ETHICAL ISSUES IN SECURITIES TRADING 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 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 Examples of illegal trading practices include brokers theft from a client’s portfolio and giving false or misleading information to investors © PhotoDisc

57. Copyright © 2003 by South-Western. All Rights Reserved. Government Regulation of the Securities Markets Prospectus: document that gives a detailed description of a company issuing securities Prospectus: document that gives a detailed description of a company issuing securities Full and fair disclosure: regulatory philosophy that investors should be told all relevant information so they can make informed decisions Full and fair disclosure: regulatory philosophy that investors should be told all relevant information so they can make informed decisions © PhotoDisc

58. Copyright © 2003 by South-Western. All Rights Reserved. Government Regulation of the Securities Markets Insider training: the use of material non-public information to make an investment profit 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 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 © PhotoDisc

59. Copyright © 2003 by South-Western. All Rights Reserved. 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 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 Market Surveillance: techniques used by all securities markets to spot possible violations of trading rules or securities laws © PhotoDisc

60. Copyright © 2003 by South-Western. All Rights Reserved. WHAT’S AHEAD Contemporary Business concludes with two appendices Contemporary Business concludes with two appendices Appendix A discusses the concept of risk, the alternative ways of dealing with risk, and the various kinds of insurance Appendix A discusses the concept of risk, the alternative ways of dealing with risk, and the various kinds of insurance Appendix B outlines the key points of business law, including contract law, the uniform commercial code, and the law of agency Appendix B outlines the key points of business law, including contract law, the uniform commercial code, and the law of agency © PhotoDisc