1. * * Chapter Nineteen Using Securities Markets for Financing & Investing Opportunities Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

2. * * 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 19-2

3. * * Securities markets are divided into primary and secondary markets:  Primary markets handle the sale of new securities.  Secondary markets handle the trading of securities between investors with the proceeds of the sale going to the seller. Initial Public Offering (IPO) -- The first offering of a company’s stock. TYPES of SECURITIES MARKETS The Function of Securities Markets LG1 19-3

4. * * Investment Bankers -- Specialists who assist in the issue and sale of new securities. Institutional Investors -- Large organizations such as pension funds or mutual funds that invest their own funds or the funds of others. INVESTMENT BANKERS and INSTITUTIONAL INVESTORS The Role of Investment Bankers LG1 19-4

5. * * Stock Exchange -- An organization whose members can buy and sell securities on behalf of companies and individual investors. Over-the-Counter (OTC) Market -- Provides 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. STOCK EXCHANGES http://www.youtube.com/watch?v=reiru4Du9aI Stock Exchanges LG2 19-5

6. * * NYSE Euronext NASDAQ London Stock Exchange Tokyo Stock Exchange Deutsche Borse TOP STOCK EXCHANGES Stock Exchanges LG2 19-6

7. * * Securities and Exchange Commission (SEC) - - The federal agency responsible for regulating the various stock exchanges; created in 1934 through the Securities and Exchange Act. http://www.sec.gov/http://www.sec.gov/ Prospectus -- A detailed registration statement that includes extensive economic and financial information that must be sent to prospective investors. The SECURITIES and EXCHANGE COMMISSION Securities Regulations and the SEC LG2 19-7

8. * * What’s the primary purpose of a stock exchange? Can you name the world’s largest stock exchange? What does NASDAQ stand for? How does this exchange work? PROGRESS ASSESSMENT Progress Assessment 19-8

9. * * 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 Learning the Language of Stocks LG3 19-9

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

11. * * 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 Advantages & Disadvantages of Issuing Stock LG3 19-11

12. * * 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 Stock LG3 19-12

13. * * Name at least two advantages and disadvantages of issuing stock as a form of equity financing. What are the major differences between common stock and preferred stock? PROGRESS ASSESSMENT Progress Assessment 19-13

14. * * Bond -- A corporate certificate indicating that an investor has lent money to a firm. LEARNING the LANGUAGE of BONDS Learning the Language of Bonds LG4 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. 19-14

15. * * 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 19-15

16. * * 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 Advantages & Disadvantages of Issuing Bonds LG4 19-16

17. * * BOND RATINGS http://www.youtube.com/watch?v=q3RPeBtI6Yc Advantages & Disadvantages of Issuing Bonds LG4 Rating Moody’sStandard & Poor’sDescription AaaAAAHighest Quality AaAAHigh Quality AAUpper-Medium Grade BaaBBBMedium Grade BaBBLower-Medium Grade BBSpeculative CaaCCC, CCPoor CaCHighly Speculative CDLowest Grade 19-17

18. * * Corporations can issue two classes of bonds: 1. Unsecured bonds (debenture bonds): not backed by specific collateral. DIFFERENT CLASSES of CORPORATE BONDS Different Classes of Bonds LG4 2. Secured bonds: backed by collateral (land or equipment). 19-18

19. * * Sinking Fund -- Reserve account set up to ensure that enough money will be available to repay bondholders on the maturity date. Callable bonds permit bond issuers to pay off the principal before the maturity date. Convertible bonds allow bondholders to convert their bonds into shares of common stock. SPECIAL FEATURES in BOND ISSUES Special Bond Features LG4 19-19

20. * * Why are bonds considered a form of debt financing? What does it mean if a firm issues a 9% bond due in 2025? Explain the difference between an unsecured and secured bond. Why are convertible bonds attractive to investors? PROGRESS ASSESSMENT Progress Assessment 19-20

21. * * 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 19-21

22. * * 1. Investment risk 2. Yield 3. Duration 4. Liquidity 5. Tax consequences FIVE INVESTMENT CRITERIA http://www.youtube.com/watch?v=rIrtQC-pHkY Choosing the Right Investment Strategy LG5 19-22

23. * * AVERAGE ANNUAL RETURN of ASSET CLASSES (1926-2007) LG5 Choosing the Right Investment Strategy InvestmentReturn Small company stocks12.2% Large company stocks9.5% Corporate bonds6.0% Long-term government bonds5.8% Treasury bills4.1% Source: Ibbotson Associates and Morningstar. 19-23

24. * * What’s the key advantage of investing through online brokers? What’s the key disadvantage? What’s the primary purpose of diversifying investments? PROGRESS ASSESSMENT Progress Assessment 19-24

25. * * BEAR MARKET DECLINES in the S&P 500 LG6 Time Period% Drop in Prices 2007-200952.5% 2000-200251% 1973-197448.2% 1968-197036.1% 1987-198833.5% Investing in Stocks Source: Stock Traders Almanac 2009. 19-25

26. * * 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 Investing in Stocks LG6 19-26

27. * * Stock Splits -- An action by a company that gives stockholders two or more shares of additional stock for every share that’s outstanding. 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 19-27

28. * * Buying Stock on Margin -- Borrowing some of the stock’s purchase cost from the brokerage firm. BUYING STOCK on MARGIN Buying Stock on Margin LG6 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. 19-28

29. * * TOP FINANICIAL NEWS and RESEARCH SITES LG6 Yahoo Finance AOL Money and Finance MSN Money Forbes Dow Jones & Co. Source: Entrepreneur Magazine, March 2009. Understanding Stock Quotations 19-29

30. * * 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 have a high risk and high default rates. IMPORTANT BOND QUESTIONS Investing in Bonds LG7 19-30

31. * * 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 themselves are traded more like stocks than mutual funds. INVESTING in MUTUAL FUNDS and EXCHANGE-TRADED FUNDS LG8 Investing in Mutual Funds & Exchange- Traded Funds 19-31

32. * * COMPARING INVESTMENTS LG8 Investing in Mutual Funds & Exchange- Traded Funds 19-32

33. * * What’s a stock split? Why do companies sometimes split their stock? What does buying stock on margin mean? What are mutual funds? What’s the key benefit to investors in investing in a mutual fund? PROGRESS ASSESSMENT Progress Assessment 19-33

34. * * 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 19-34

35. 19-35 Original 12 Dow Stocks (1896) American Cotton Oil American Sugar Refining Co. American Tobacco Chicago Gas Distilling & Cattle Feeding Co. General Electric Co. Laclede Gas Light Co. National Lead North American Co. Tennessee Coal, Iron, & Railroad Co. U.S. Leather U.S. Rubber Co.

36. * * Wall Street - Issued exotic securities; paid excessive compensation based on bonuses; and investment banks got the SEC to relax capital requirement. Main Street - Americans lived beyond their means; lenders gave favorable loans to homebuilders; greedy homeowners took out equity loans; and teaser mortgage rates let people live large. Washington - Gramm-Leach-Billey Act allowed commercial and investment banks to partner; housing interest rates were kept low; and Community Reinvestment Act forced lending to people with bad credit. WHO’S at FAULT for the ECONOMIC CRISIS? LG2 Investing Challenges in the 21 st Century Market Source: Fortune Magazine, www.fortune.com.www.fortune.com 19-36