Chapter 18

Financing and Investing Through Securities

Markets
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Distinguish between the primary
1 and secondary securities markets.
Compare money market
2 instruments, bonds, and common
stock, including their benefits.
3 Identify the objectives of investors
and the types of securities that
best correspond to each.
4 Describe the characteristics of the
major stock exchanges.
5 Explain the process of buying or
selling a security and the
information included in stock and
bond quotations and stock
indexes.
6 Discuss the role of mutual funds
and exchange-traded funds in the
securities market.
7 Evaluate the major
features of regulations
and laws designed to
protect investors.
Securities Financial instrument such as stocks and bonds.

PRIMARY VERSUS SECONDARY

MARKETS
Primary market Market in which new security issues are first sold to investors; 
issuers receive the proceeds from the sale.
• Initial public offering (IPO) The first sale of a company’s stock to the general 
public.
•  Investment bankers Financial specialists who handle the sales of most 
corporate and municipal securities.
• Underwriting Process of purchasing an issue from a firm or government and 
then reselling the issue to investors. 
Secondary market Market in which existing security issues are 
bought and sold by investors.
• Examples: New York Stock Exchange, Nasdaq
TYPES OF SECURITIES
Money Market Instruments
Money market instruments Short­term debt securities issued 
by corporations, financial institutions, and governments.
• Generally low­risk securities and are purchased by investors 
when they have surplus cash.
Bonds
• Through bonds firms obtain long­term debt capital. 
• Claims of bondholders are satisfied before those of stockholders in cases of 
bankruptcy.
Quality Ratings for Bonds
• Two factors determine the price of a bond: its risk and its interest rate.
• Bond rating A rating of a bond’s level of risk.
• Higher interest rates bring higher bond prices.
• Market interest rates also influences bond prices.
Retiring Bonds
• Firms must have necessary funds to pay bonds at maturity.
• Some firms issue serial bonds, an issue of bonds that mature at different rates.
• Call provision Allows the issuer to redeem the bond before its maturity at a 
prespecified price.
Stock
Common stock Shares of ownership in a corporation.
• Holders of common stock vote on major company 
decisions.
• In exchange for their investment, they receive
dividends and/or benefits of increased stock price.
Preferred stock Stock whose holders have priority over 
common stockholders in the payment of dividends but 
usually have no voting rights.
Convertible Securities
• Feature of bond or preferred stock that gives the holder the right to exchange the 
bond or preferred stock for a fixed number of shares of common stock.
• Convertible bonds pay a lower interest rate than those without a conversion 
feature.
SECURITIES PURCHASERS
• Institutional investors An organization that invests its own funds or those it 
holds in trust for others.
• Individual purchasers, many of who own shares through mutual funds or 
employer’s retirement funds.
Investment Motivations
Taxes and Investing
• Interest from government and corporate bonds is income taxed at the investor’s 
marginal tax rate.
• Dividends are taxed at a lower rate.
• Profits from stock sales are taxed as capital gains. 
• Tax considerations are an important factor in investment decisions.
SECURITIES EXCHANGES
Stock exchanges Financial market where stocks are traded.
• Exist throughout the world, and most countries have at least one.
New York Stock Exchange
• Lists more than 3,000 common and preferred stocks with market value of more 
than $13 trillion. 
• World’s largest, as measured by total value of stock traded.
The Nasdaq Stock Market
• A computerized communications network that links member investment firms.
• World’s largest intranet.
• Lists approximately 5,000 stocks.
Other U.S. Stock Markets
• American Stock Exchange, or AMEX, in New York.
• Daily trading volume around 60 million shares.
• Regional stock exchanges include Chicago, Pacific (San Francisco), Boston, 
Cincinnati, and Philadelphia Stock Exchanges.
Foreign Stock Markets
• Most countries have at least one stock exchange.
• One of largest outside U.S. is the London Stock Exchange.
• Lists 2,900 companies.
• Handles two­thirds of all cross­border trading worldwide.
ECNs and the Future of Stock Markets
• Electronic communications networks (ECNs) Fourth market 
in which buyers and sellers meet trade directly with one another.
BUYING AND SELLING SECURITIES
Brokerage firm Financial intermediary that buys and sells securities for 
individual and institutional investors.
• Examples: A. G. Edwards, Raymond James, Morgan Stanley, and 
Wachovia Securities.
Placing an Order
• Investor initiates purchase by contacting brokerage firm.
• Market order Instructs the brokerage firm to obtain the highest price possible, 
if the investor is selling, or the lowest price possible, if the investor is buying. 
• Limit order Instructs the brokerage firm not to pay more than a specified price 
for a stock, if the investor is buying, or not to accept less than a specified 
price, if the investor is selling.
Stock Indexes
• Examples include the Dow Jones Industrial Average, Standard & Poor’s 500, 
and the Nasdaq Composite indexes.
• Dow Jones Industrial Average, started in 1884, has served as a general measure 
of overall stock prices and a reflection of the economy.
• Only original remaining member is General Electric.
MUTUAL FUNDS AND EXCHANGE-
TRADED FUNDS
Mutual fund Financial institution that pools money from purchases of its shares 
and uses the money to acquire diversified portfolios of securities consistent 
with the fund’s investment objectives.
Mutual Funds
• Investors become part owners of large number of securities, lessening individual 
risk.
• Total mutual fund assets exceed $8 trillion. 
• 55 million American households own mutual fund shares.
Exchange-Traded Funds
• Raises funds by selling shares to investors and then uses those funds to purchase 
a portfolio of securities. 
• Sells a fixed number of shares to investors in what is effectively an initial public 
offering. 
• Then ETF shares trade on stock exchanges much like shares of individual 
companies. 
• Almost 200 ETFs with total assets of around $250 billion.
• Two main appeals:
• Shareholders are charged little or nothing for annual operating expenses. 
• Can be more tax efficient because they don’t generate a lot of taxable capital 
gains.
LEGAL AND ETHICAL ISSUES IN
SECURITIES TRADING
Government Regulation of the Securities
Market
• SEC requires registration of all new public issues of corporate securities.
Full and fair disclosure Requirement that investors should be told all relevant 
information by stock or bond issuers so they can make informed decisions.
Insider trading Use of material, nonpublic information to make investor profits.
Industry Self-Regulation
• Rules of conduct established and updated by the National Association of 
Securities Dealers
• Markets use surveillance for spotting possible violations of trading rules or 
securities laws.
• NYSE uses Stock Watch to flag unusual price and volume activity.