CHAPTER 16: SECURITIES AND INVESTMENTS
I. Securities Markets
Stocks and bonds are referred to as securities because they represent secured claims on the part of investors.
Shares of stock represent ownership, whereas bonds represent financial liability for money owed to bondholders
by a company or the government. Stocks and bonds are sold in securities markets.
A. Primary and Secondary Securities Markets
Newly issued stocks and bonds are bought and sold in primary securities markets. To bring a new security to
market, the issuing firm must get approval from the Securities and Exchange Commission (SEC) —the government
agency that regulates U.S. securities markets. Investment banks issue and resell new securities, as well as create
the distribution networks for selling the securities. Existing stocks and bonds are actively traded in secondary
securities markets.
II. Stocks
A stock is a portion of the ownership of a corporation. The company’s total ownership is divided into small parts,
called shares, that can be bought and sold to determine how much of the company (how many shares of stock) is
owned by each investor.
A. Common Stock
A share of common stock is the most basic form of ownership in a company. Individuals and other companies
purchase a firm’s common stock in the hope that it will increase in value, provide dividend income, and because
each common share has a vote on major issues that are brought before the shareholders.
A dividend is a payment to shareholders, on a per-share basis, out of the company’s earnings. Par value is the face
value of a share of stock at the time of its original issue. Market value is the current share price in the stock
market.
Book value of common stock is stockholders’ equity divided by the number of outstanding shares.
1. Investment Traits of Common Stock. Growth prospects in various industries change from time to time. Blue chip
stocks are stocks of well-established firms that consistently provide investors with secure income from dividend
payouts.
a. The “Old” Economy Versus the “New”: What’s a “Blue Chip” Now? Because the very nature of the stock market
is continuously changing, the future performance of any stock is often unpredictable. Some “newcomers” in the
market are referred to as blue chips, though their financial performance is very different from traditional blue-chip
companies.
B. Preferred Stock
Preferred stock is usually issued with a stated par value; dividends are expressed as a percentage of par value.
Preferred stocks are less risky because they have first rights to dividends.
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C. Investor Preferences
Investors invest for different reasons. Some prefer capital gains, which are the earnings from buying and selling a
share of stock. Some prefer dividends. Some prefer market appreciation, which is the change in market value for a
share of stock at two points in time.
D. Stock Exchanges
A stock exchange is an organization of individuals that provides an institutional setting in which stock can be
bought or sold. Exchange members purchase “seats” that allow them to make trades. Seats may be bought or sold.
1. The Trading Floor. Each exchange governs the places and times when trading occurs. Trading is allowed only on
the trading floor.
2. Stock Brokers. Stock Brokers receive and execute orders from non-exchange members and earn commissions as
a result.
a. Discount Brokers. These brokers are fast and low-cost, providing no advice or sales consultations.
b. Online Trading. This is possible via convenient access to the Internet; this is ideal for self-directed investors.
c. Full-Service Brokers. Consulting advice and financial planning are provided here.
3. The Major Exchanges and Markets. The two major exchanges in the United States are the New York Stock
Exchange and American Stock Exchange.
a. The New York Stock Exchange (NYSE). More than half of all shares traded are done so on the NYSE; firms must
meet certain requirements to be listed on the NYSE.
b. The American Stock Exchange. AMEX accounts for 2 percent of all shares traded on U.S. exchanges;
requirements for listing are less stringent than those of the NYSE.
c. Regional Stock Exchanges. Seven regional stock exchanges serve investors outside of New York. Many firms list
their stocks regionally as well as on one of the national exchanges.
d. Global Stock Exchanges. The value of shares listed on foreign exchanges continues to grow
e. Over-the-Counter Market. The OTC has no trading floor. The privilege of trading in the OTC market is granted by
federal regulators and by the NASD.
f. The Nasdaq Market. Nasdaq is a telecommunications system that broadcasts trading information on an intranet
to 350,000 terminals. Nasdaq is an electronics network that can replace trading floors of traditional exchanges.
g. Steps Toward a Global Stock Market. Analysts expect separate stock markets in various regions will be being
driven together by the rise of the global shareholder and the thousands of new companies that need access to
stock markets for raising capital.
E. Fantasy Stock Markets
Such markets allow investors or potential investors to try their hands at various investment strategies; fantasy
stock markets are fun, educational, and challenging.
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III. Bonds
A bond is an IOU—a promise by the issuer to pay the buyer a certain amount of money by a specified future date,
usually with interest paid at regular intervals. The U.S. government, municipalities, and corporations supply the
U.S. bond market. Some publications rate bond quality according to default risk, which is the likelihood that
promised payments will be deferred or even missed.
A. U.S. Government Bonds The federal government issues a variety of government bonds, including T-bills,
Treasury notes, and Treasury bonds, in order to finance its debt. Government agencies also issue bonds. Because
they are backed by the federal government, government bonds are the safest investment available.
B. Municipal Bonds
State and local governments issue municipal bonds to finance schools, transportation systems, and other projects.
Investors do not pay taxes on interest received.
C. Corporate Bonds
Corporate bonds issued by U.S. companies are a large source of financing, often involving more money than
government and municipal bonds combined. Longer-term corporate bonds are somewhat riskier than shorter-term
bonds. Good sources to help investors evaluate risk are Standard & Poor’s and Moody’s.
1. Interest Payment: Registered and Bearer Bonds. Registered bonds register the names of holders with the
company, which mails out the checks; bearer (coupon) bonds require bondholders to clip coupons from
certificates and send them to the issuer to receive payment.
2. Secured Bonds. With secured bonds, issuers can reduce risk to holders by pledging assets in case of default.
These bonds are usually backed by mortgages or other assets.
3. Unsecured Bonds: Debentures. Debentures are unsecured bonds that have an inferior claim on corporate
assets. Holders do have claims against property not otherwise pledged in the company’s other bonds, though no
specific property is pledged as security.
IV. Mutual Funds
Mutual funds pool investments from individuals and organizations to purchase a portfolio of stocks, bonds, and
short-term securities. No-load funds do not charge investors sales commissions when shares are bought or sold;
load funds charge investors commissions ranging from 2 to 8 percent.
A. Reasons for Investing
Mutual funds are flexible in their investment goals.
1. Stability and Safety. Funds stressing safety include money market mutual funds and other funds that preserve
the fund holders’ capital and reliably pay current income.
2. Conservative Capital Growth. Preservation of capital and current income, alongside some capital appreciation,
can be gained through balanced funds.
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3. Aggressive Growth. Aggressive growth funds seek maximum long-term capital growth; they sacrifice current
income and safety by investing in stocks of new and sometimes troubled companies, firms developing new
products and technologies, and other high-risk securities.
V. Diversification and Asset Allocation
A. The Risk-Return Relationship
Each type of investment has a risk-return relationship, which reflects the notion that safer investments tend to
offer lower returns, and riskier investments tend to offer higher returns.
B. Diversification
Through diversification, investors buy several kinds of investments rather than one kind; this strategy reduces
investor risk by “not having all eggs in one basket.”
C. Asset Allocation
Asset allocation is the proportion of funds invested in each of the investment alternatives.
VI. Buying and Selling Securities
The buying and selling of securities includes deciding your investment objectives, selecting a broker, opening an
account, and placing an order.
A. Financial Information Services
1. Stock Quotations. Daily NYSE transactions are reported in numerous sources. Stock prices are stated as dollars
per share. Cash dividends and dividend yield, price/earnings ratio, the current price of the stock divided by the
firm’s current annual earnings per share, number of shares, high, low, close, and net change are ngenerally shown.
2. Bond Quotations. These quotations contain the same type of information as stock quotations, as well as the year
of maturity.
3. Mutual Fund Quotations. In these quotations, each fund’s objective is reported; each fund’s recent and longterm performance is ranked against other funds with similar objectives. The fund’s net asset value (NAV) is the
current market value of one share.
4. Market Indexes. Market indexes summarize trends. Bull markets are periods of increasing stock prices; bear
markets are periods of decreasing stock prices.
a. The Dow. The Dow Jones Industrial Average is the sum of market prices for 30 of the largest industrial stocks
listed on the NYSE.
b. The S&P 500. Standard & Poor’s Composite Index consists of 500 stocks; the S&P is a broader market measure.
c. The Nasdaq Composite. All Nasdaq companies are included, which makes this index more critical than others
according to some analysts.
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B. Placing Orders
A market order signals a broker to buy or sell a security at the current market price.
A limit order authorizes the purchase of a stock if its price is less than or equal to a specified amount. A stop order
authorizes the broker to sell if a stock price falls to a certain level. Round lots are 100 shares of a stock; odd lots
are fractions of round lots.
C. Financing Purchases
1. Margin Trading. Buying on margin allows the buyer to put down a portion of the stock’s price while borrowing
the balance from the broker.
2. Short Sales. In a short sale, the buyer borrows a security from the broker, sells it, and restores an equal number
of shares of the issue to the brokerage at a later date, along with a fee. A falling stock price yields a profit for the
buyer.
VII. Securities Market Regulation
A. NASD and Securities Regulation
The National Association of Securities Dealers (NASD) is the largest private-sector securities-regulation
organization in the world; every broker/dealer in the United States who conducts securities business with the
public is required by law to be a member of the NASD.
B. NYSE Self-Regulation
The New York Stock Exchange has established circuit breakers, which reduce excessive market volatility, limit mass
or panic selling, and promote investor confidence as trading is suspend for preset lengths of time with preset drops
in the stock market in a single day.
C. The Securities and Exchange Commission (SEC)
The SEC oversees many phases in the security issuance process to protect investors and to maintain functioning
markets. A detailed prospectus is filed by the firm with the SEC to protect investors from fraudulent issues.
1. Insider Trading. Insider trading is the use of special knowledge about a firm for profit.
2. Blue-Sky Laws. Blue-sky laws require that securities be registered with state officials.
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