Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc. CHAPTER 19 Understanding Securities and Investments

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Learning Objectives Explain the difference between primary and secondary securities markets. Discuss the value of common stock and preferred stock to shareholders and describe the secondary market for each type of security. Distinguish among various types of bonds in terms of their issuers, safety, and retirement. Describe the investment opportunities offered by mutual funds and commodities. Explain the process by which securities are bought and sold. Explain how security markets are regulated.

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Securities Primary securities market sale and purchase of newly issued stocks or bonds offered by firms and governments Secondary securities market sale & purchase of previously issued stocks & bonds Investment bankers financial specialists who issue new securities

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Characteristics of Common Stocks Market value current price of a share the secondary securities market Capital gains profits from the sale of an asset (i.e.: Stocks) Book value shareholders’ equity divided by the number of shares of common stock outstanding of limited usefulness in evaluating investments

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Investment Traits of Common Stocks Investment Traits risky securities dividends may not be paid in unprofitable years have high growth potential Blue Chip Stocks Stocks of well-established, financially sound firms

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Preferred Stock Issued with a stated par value Dividends paid based on a percentage of par value Value of the stock can rise or fall with the fortunes of the company Less risky than common stock Limited growth potential due to the fixed dividend Cumulative preferred stock deferred dividend payments must be paid before any dividends are paid to common stock holders

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Stock Exchanges Voluntary organization of individuals formed to provide an institutional setting where members can buy and sell stock for themselves and their clients in accordance with the rules of the exchange to become a member a firm must purchase seats only members (or their representatives) are allowed to trade on the exchange all trading must go through members of the exchange

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Brokers Individuals licensed to buy and sell securities for customers in the secondary market Full-service brokerage for a reasonable fee, offers a variety of services including buying, selling, and investment advice Discount brokerage for a reduced fee, buys and sells securities, but has limited service offerings

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Capitalization The dollar value (market value) of stocks listed on a stock exchange Can be determined by calculating and totalling the market value of each stock on the exchange Capitalization changes daily as stock prices fluctuate

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc The Over-the-Counter Market (OTC) Many securities are not listed on a stock exchange OTC markets consist of numerous dealers who trade among themselves for smaller firms and those not listed on exchanges Also trade all fixed-income securities, which includes bonds and debentures

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Bonds Bond a written promise that the borrower (firm) will pay the lender (investor) at a stated future date, the principal plus a stated rate of interest Bonds differ from one another in terms of maturity (payment date), tax status, potential yield (interest rate) Several companies rate the quality of various bonds

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Bond Ratings

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Corporate Bonds Secured assets are pledged as security for the bond Unsecured (debentures) these bonds are not backed by any security only sold by financially strong corporations that carry lower risk for investors Bearer (coupon) bonds holders clip coupons from the bond to receive interest payments: anyone with the coupon can redeem it Registered Bonds Certificates are only of value to registered holders

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Retiring Bonds Callable bonds may be called at anytime, or after a certain minimum period of time, for a specified fee Sinking fund provision the company must put money into a special bank account each year, such that at the time of maturity, there is sufficient money to retire the bonds Serial bond redemption rates are staggered so that the bond is paid off gradually over time Convertible option of receiving common stock in lieu of cash

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Mutual Funds A company pools the resources of many investors and uses funds to purchase various types of financial securities (a portfolio) Different funds have different goals (stability, growth, etc.) and different levels of risk Investments are professionally managed No-load fund investors are not charged a sales commission when they buy into or sell out of a fund

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Commodities Futures contract agreement to purchase specific amounts of a commodity at a certain price on a set date in the future Risky investment with many variables Commodities market a market in which futures contracts are traded Investors can buy on “margin,” with a minimal amount as a down payment

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Stock Options Call option the purchased right to buy a particular stock at a certain price until a specified date Put option the purchased right to sell a particular stock at a certain price until a specified date Daily prices of put and call options appear in the financial press

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Reading Bond Quotations Company Name Coupon (interest rate %) Maturity Date (April 8, 2022) Price (Last transaction price = $138.50) Yield (Annual interest Market price) Change(Closing price up $1.11 from previous day)

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Reading Stock Quotations Stock Sales (Total number of shares traded) Close (Last price paid at close of trading) High (Highest price paid per share for the day was $29.15) Low (Lowest price paid per share for the day was $28.50) Change (Difference between today’s price and previous day’s. A.40 decrease)

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Reading the Market Market indexes summarize trends in the stock market and specific industries Dow Jones Industrial Average Standard & Poor’s Composite Index NYSE Index TSE 300, Tokyo Index Bear market: a period of falling stock prices Bull market: a period of rising stock prices

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Buying and Selling Stocks Market order order to buy/sell a security at the current market price Limit order an order to buy a security but only if its price is less than, or equal to, a certain level Stop order order to sell a security if its price falls below a level Round lot the purchase or sale of shares in units of 100 Odd lot the purchase or sale of shares in units of other than 100

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Margin Trading The investor makes a down payment on a portion of the price with the rest financed by the broker The broker borrows the amount from the bank, secured by stock The broker charges the investor a higher rate of interest than he/she pays the bank Investors can pay off the financing when they sell the stock, hopefully at a profit Margin trading is very risky %

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Short Sale An investor sells shares from the broker without paying for them The investor is “borrowing” the shares from the broker for a period of time In order to return the borrowed shares, the investor must purchase the equal number of shares later and return them to the broker Profit or loss is based on the spread between the selling price and the purchasing price

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc Securities Regulations Brokers are licensed and securities are registered Blue-sky law laws regulating how firms back up securities Prospectus a detailed registration statement about a new stock Insider trading illegal activity of using special (inside) knowledge about a firm to make a profit