Chapter 19

Using
Securities
Markets for
Financing and
Investing
Opportunities

McGraw-Hill/Irwin Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter
Nineteen
LEARNING GOALS

1. Describe the role of securities markets and of

investment bankers.

2. Identify the stock exchanges where securities are

traded.

3. Compare the advantages and disadvantages of

equity financing by issuing stock, and detail the
differences between common and preferred stock.

4. Compare the advantages and disadvantages of

obtaining debt financing by issuing bonds, and
identify the classes and features of bonds.
19-2
Chapter
Nineteen
LEARNING GOALS

5. Explain how to invest in securities markets and set

investment objectives such as long-term growth,
income, cash, and protection from inflation.
6. Analyze the opportunities stocks offer as
investments.
7. Analyze the opportunities bonds offer as investments.
8. Explain the investment opportunities in mutual funds
and exchange-traded funds (ETFs).
9. Describe how indicators like the Dow Jones Industrial
Average affect the market.
19-3
Profile
MARIA BARTIROMO
CNBC

Emmy Award-winning
journalist, Bartiromos analysis
of day-to-day Wall Street has
made her the face of investing.
Started as an overnight
producer for CNN before
moving to CNBC.
Shes lead anchor at two of
CNBCs biggest shows, has
written several books and
numerous columns.
19-4
Chapter
Nineteen
NAME that COMPANY

When the price of their stock rises to a certain

level, many companies will split the stock in
order to make the stock appear more
affordable. However, this company run by
Americas most successful investor has never
split its stock even when the price of the
companys stock reached $150,000 a share
(thats right $150,000 for one share.)

Name that company!

19-5
The Function
of Securities
Markets
The BASICS of
LG1 SECURITIES MARKETS

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.

19-6
The Function
of Securities
Markets
TYPES of
LG1 SECURITIES MARKETS

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 corporations stock.

19-7
The Role of
Investment
Bankers
INVESTMENT BANKERS
LG1 and INSTITUTIONAL INVESTORS

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.

19-8
Stock
Exchanges STOCK EXCHANGES
LG2

Stock Exchange -- An organization whose

members can buy and sell (exchange) 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 electronically.

19-9
Stock
Exchanges TOP STOCK EXCHANGES
LG2

NYSE Euronext

NASDAQ

London Stock
Exchange

Tokyo Stock Exchange

Deutsche Borse

19-10
 A PLACE for
SMALL COMPANIES to CALL HOME
(Spotlight on Small Business)

Since the recent financial crisis, small businesses

have found it difficult to secure financing from
banks.

David Weild wants a new stock exchange where

small companies can raise needed capital.

Though this is a new idea in the U.S., China

established ChiNext which is designed for start-
up companies.

19-11
Securities
Regulations
and the SEC
The SECURITIES and
LG2 EXCHANGE COMMISSION

Securities and Exchange Commission (SEC)

-- The federal agency responsible for regulating the
various stock exchanges; created in 1934 through the
Securities and Exchange Act.

Prospectus -- A condensed version of economic

and financial information that a company must file
with the SEC before issuing stock; the prospectus
must be sent to prospective investors.

19-12
Progress
Assessment PROGRESS ASSESSMENT

Whats the primary purpose of a securities

exchange?

What does NASDAQ stand for? How does this

exchange work?

19-13
How Businesses
Raise Capital by
Selling Stock
LEARNING the
LG3 LANGUAGE of STOCKS

Stocks -- Shares of
ownership in a company.

Stock Certificate --
Evidence of stock ownership.

Dividends -- Part of a firms

profits that the firm may
distribute to stockholders as
either cash or additional
shares.
19-14
Advantages &
Disadvantages
of Issuing Stock ADVANTAGES of
LG3 ISSUING STOCK

Stockholders are owners of

a firm and never have to be
repaid their investment.

Theres no legal obligation to

pay dividends.

Issuing stock can improve a

firms balance sheet since
stock creates no debt.

19-15
Advantages &
Disadvantages
of Issuing Stock DISADVANTAGES of
LG3 ISSUING STOCK

Stockholders have the right to vote for a

companys 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

managements decisions.
19-16
Issuing Shares
of Common and

TWO CLASSES of STOCK

Preferred Stock

LG3

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

19-17
Progress
Assessment PROGRESS ASSESSMENT

Name at least two advantages and

disadvantages of a companys issuing stock as a
form of equity financing.

What are the major differences between common

stock and preferred stock?

19-18
Learning the
Language of
Bonds
LEARNING the
LG4 LANGUAGE of BONDS

Bond -- A corporate certificate indicating that an

investor has lent money to a firm (or a government).

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.

19-19
Advantages &
Disadvantages
of Issuing Bonds ADVANTAGES of
LG4 ISSUING BONDS

Bondholders are creditors, not owners of the firm

and cant 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.

19-20
Advantages &
Disadvantages
of Issuing Bonds DISADVANTAGES of
LG4 ISSUING BONDS

Bonds increase debt and can affect the markets

perception of the firm.

Paying interest on bonds is a legal obligation.

If interest isnt paid, bondholders can take legal

action.

The face value of the bond must be repaid on

the maturity date.

19-21
Advantages &

BOND RATINGS
Disadvantages
of Issuing Bonds

LG4

Rating

Moodys S&P Fitch Description

Aaa AAA AAA Highest Quality
Aa AA AA High Quality
A A A Upper-Medium Grade
Baa BBB BBB Medium Grade
Ba BB BB Lower-Medium Grade
B B B Speculative
Caa CCC, CC CCC Poor
Ca C DDD Highly Speculative
C D D Lowest Grade

19-22
Different
Classes of
Bonds
DIFFERENT CLASSES of
LG4 CORPORATE BONDS

Corporations can issue two classes of bonds:

1. Unsecured bonds
(debenture bonds):
not backed by
specific collateral.

2. Secured bonds:
backed by
collateral (land or
equipment).

19-23
Special Bond
Features SPECIAL FEATURES in
LG4 BOND ISSUES

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.

19-24
Progress
Assessment PROGRESS ASSESSMENT

Why are bonds considered a form of debt

financing?

What does it mean if a firm issues a 9%

debenture bond due in 2025?

Explain the difference between an unsecured and

secured bond.

Why are convertible bonds attractive to investors?

19-25
How
Investors Buy
Securities
BUYING SECURITIES
LG5

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.
19-26
 MONEY GOING UP in SMOKE
(Making Ethical Decisions)

You recently received news that your Uncle Alex

passed away after a long battle with lung cancer
caused by smoking. He left you $25,000 in his
will, saying you were his favorite nephew.

Your friend Jack recommends that you buy stock

in a well-known multinational firm thats primary
product is tobacco.

Will you invest your inheritance in a company that

markets tobacco?
19-27
Choosing the
Right Investment
Strategy FIVE INVESTMENT CRITERIA
LG5

1. Investment risk

2. Yield

3. Duration

4. Liquidity

5. Tax consequences

19-28
Choosing the
Right Investment
Strategy INVESTING 101
Things to Do Before Making Your First Investment
LG5

Take an investing class.

Attend a conference.

Head to the library and pick up these books:

- The Big Short
- The Intelligent Investor
- The Myth of the Rational Market

Source: Money, November 2010.

19-29
Choosing the
Right Investment
Strategy
AVERAGE ANNUAL RETURN of
LG5 ASSET CLASSES (Since 1926)

Source: Ibbotson Associates and Morningstar.

19-30
Reducing Risk
by Diversifying
Investments DIVERSIFICATION
LG5

Diversification -- Buying several different types of

investments to spread the risk of investing.

If diversifying, an investor may put:

- 25% of his/her money into U.S. growth stocks
- 25% in government bonds
- 25% in dividend-paying stocks
- 10% in an international mutual fund
- The rest in a savings account

19-31
 The SUN NEVER SETS on
STOCK OPPORTUNITIES
(Reaching Beyond Our Borders)

Suggestions for building your financial future:

- Invest in global companies you know and that have
solid performance records.
- Invest in global stocks listed on U.S. exchanges.
- Contact U.S. brokers about American Depository
Receipts (ADRs).
- Invest in global mutual funds that focus on specific
countries or regions.
- Use extreme caution if investing in unstable
countries!
19-32
Reducing Risk
by Diversifying
Investments PRIMARY INVESTMENT SERVICES
LG5 CONSUMERS NEED

Savings and investing advice

Help with 401k plans
Retirement planning
Tax planning
Estate planning
Education expense planning

Source: Investment Company Institute.

19-33
Progress
Assessment PROGRESS ASSESSMENT

What is the key advantage of investing through

online brokers? What is the key disadvantage?

What is the primary purpose of diversifying

investments?

19-34
Investing in
Stocks PERCEPTIONS of the MARKET
LG6

Bulls: Investors who

believe stock prices
are going to rise.

Bears: Investors who

expect stock prices to
decline.

19-35
Investing in
Stocks BEAR MARKET DECLINES
LG6 in the S&P 500

Source: Stock Traders Almanac 2011.

19-36
Investing in
Stocks SELECTING STOCKS
LG6

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

19-37
Stock Splits
STOCK SPLITS
LG6

Stock Splits -- An action by a company that gives

stockholders two or more shares of additional stock
for every share that they own.

Splits cause no change in the firms ownership

structure and no change in the investments
value.

Firms can never be forced to spilt their stocks.

19-38
Buying Stock
on Margin BUYING STOCK on MARGIN
LG6

Buying Stock on Margin -- Borrowing some of the

stocks purchase cost from the brokerage firm.

Margin is the portion of the

stocks 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.
19-39
Understanding
Stock
Quotations
UNDERSTANDING STOCK
LG6 QUOTATIONS

19-40
Understanding
Stock TOP FINANICIAL NEWS and
Quotations
LG6 RESEARCH SITES

Yahoo Finance
DailyFinance
MSN Money
Forbes
Dow Jones & Co.

19-41
Investing in
Bonds IMPORTANT BOND QUESTIONS
LG7

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 are high-risk and have

high default rates.

19-42
Understanding
Bond
Quotations
UNDERSTANDING BOND
LG7 QUOTATIONS

19-43
Investing in

INVESTING in MUTUAL FUNDS

Mutual Funds &
Exchange-Traded
Funds
LG8 and EXCHANGE-TRADED FUNDS

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 funds purpose.

Exchange-Traded Fund (ETF) -- Collections of

stocks and bonds that are traded on securities
exchanges, but are traded more like individual stocks
than mutual funds.

19-44
Investing in
Mutual Funds &
Exchange-Traded WHAT MUTUAL FUNDS CAN
LEARN FROM KaChing
Funds
LG8

1. Reform the ratings

system

2. Give information for

free

3. Cut out useless fees

4. Be transparent

5. Share insights
Source: Fast Company, March 2010.
19-45
Investing in
Mutual Funds &
Exchange-Traded PERCENTAGE of HOUSEHOLDS
OWNING MUTUAL FUNDS
Funds
LG8

Source: Investment Company Institute Factbook.

19-46
Investing in
Mutual Funds &
Exchange-Traded
Funds VARIETIES of ETFs
LG8

Source: Schwab and E*Trade.

19-47
Understanding
Mutual Fund
Quotations
UNDERSTANDING
LG8 MUTUAL FUND QUOTATIONS

19-48
Understanding
Mutual Fund
Quotations
COMPARING INVESTMENTS
LG8

19-49
Progress
Assessment PROGRESS ASSESSMENT

What is a stock split? Why do companies

sometimes split their stock?

What does buying stock on margin mean?

What are mutual funds and ETFs?

What is the key benefit to investors in investing in

a mutual fund or ETF?

19-50
Understanding
Stock Market
Indicators
KEY STOCK MARKET
LG9 INDICATORS

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.

19-51
Riding the
Markets Roller
Coaster MARKET TURMOIL
LG9

The stock market has its shares of ups and

downs:
- October 29, 1929 - Black
Tuesday; the market lost 13%
of its value.
- October 19, 1987 - The market
suffered its worst one-day drop
when it lost 22% of its value.
- October 27, 1997 - Fears of an
economic crisis in Asia cause
widespread panic and losses.

19-52
Riding the
Markets Roller
Coaster TURMOIL in the 2000s
LG9

The market collapsed into a deep decline in

2000-2002 when the dot-com bubble burst.
- Investors lost $7 trillion in market value.

Starting in 2008, the collapse of the real estate

market sent financial markets into panic.
- The U.S. government made significant investments in
private banks and offered a large stimulus package to re-
energize the economy.

19-53
Riding the
Markets Roller
Coaster
The WALL STREET of NOW
LG9

Source: Bloomberg Businessweek, September 6, 2010.

19-54
Riding the
Markets Roller
Coaster
The UPS and DOWNS
LG9 of the MARKET

Program Trading -- Giving instructions to

computers to automatically sell if the price of a stock
dips to a certain point to avoid potential losses.

Analysts believe program trading caused the

turmoil in 1987.

The exchanges created mechanisms to restrict

program trading.

19-55
Riding the
Markets Roller
Coaster
WHOS at FAULT for the
LG9 ECONOMIC CRISIS?
Wall Street - Issued exotic securities; paid excessive
compensation based on bonuses; and investment banks got
the SEC to relax capital requirements.

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.
Source: Fortune Magazine, www.fortune.com, accessed July 2011.
19-56
 CLEANING UP the STREET
(Legal Briefcase)

Congress passed the Dodd-Frank Financial Reform

and Consumer Protection Act into law on July 21,
2010.
Gives the government power to seize and shutter
large financial institutions on the verge of collapse in
an effort to prevent further bailouts.
Formed an independent consumer protection agency
housed within the Federal Reserve, protecting
borrowers against a host of financial abuses ranging
from payday loans to mortgages and credit cards.

19-57
Progress
Assessment PROGRESS ASSESSMENT

What does the Dow Jones Industrial Average

measure? Why is it important?

Why do the 30 companies comprising the Dow

change periodically?

Explain program trading and the problems it can

create.

19-58