CHAPTER 19
Using Securities
Markets for
Financing &
Investing
Opportunities
McGraw-Hill/Irwin
Copyright © 2015 by the McGraw-Hill Companies, Inc. All rights reserved.
LEARNING OBJECTIVES
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
LEARNING OBJECTIVES
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
MELODY HOBSON
Ariel Investments
• Hobson started as an intern at
Ariel Investments after
graduating from Princeton in
1991.
• Now, as president of the
company, she oversees more
than $9 billion in assets.
• Preaches patience in investing.
• Ariel Investments focuses on
stocks and equity funds that
should perform in the long term.
19-4
NAME that COMPANY
If someone had bought 100 shares in this company
when it was first available to the public in 1965,
it would have cost $2,250. If they held on to the
stock, the number of shares they’d have today
would be 74,360 (after 12 stock splits) with a
value of approximately $7.4 million.
Name that company!
19-5
The BASICS of
SECURITIES MARKETS
LO 19-1
• 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
TYPES of
SECURITIES MARKETS
LO 19-1
• 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 corporation’s stock.
19-7
INVESTMENT BANKERS
and INSTITUTIONAL INVESTORS
LO 19-1
• 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
LO 19-1
• 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
TOP STOCK EXCHANGES
LO 19-1
• NYSE Euronext
• NASDAQ
• London Stock
Exchange
• Tokyo Stock Exchange
• Deutsche Borse
19-10
GIVING SMALL BUSINESS
a JUMP on FUNDING
• The goal of the JOBS Act is to ease small
business financing problems.
• The SEC adopted new rules, including:
- Raised from 500 to 2,000 the number of shareholders
a company could have before it must register its stock
with the SEC.
- Allows equity crowdfunding through brokers or portals.
- Expanded the abilities of private companies to raise
capital through limited stock offerings.
19-11
The SECURITIES and
EXCHANGE COMMISSION
LO 19-2
• 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
TEST PREP
• What is the primary purpose of a securities
exchange?
• What does NASDAQ stand for? How does this
exchange work?
19-13
LEARNING the
LANGUAGE of STOCKS
LO 19-3
• 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.
19-14
ADVANTAGES of
ISSUING STOCK
LO 19-3
• Stockholders are owners
of a firm and never have to
be repaid their investment.
• There is no legal obligation
to pay dividends.
• Issuing stock can improve
a firm’s balance sheet
since stock creates no
debt.
19-15
DISADVANTAGES of
ISSUING STOCK
LO 19-3
• 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.
19-16
TWO CLASSES of STOCK
LO 19-3
• 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
TEST PREP
• Name at least two advantages and disadvantages
of a company’s 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
LO 19-4
• 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
TYPES of BONDS
LO 19-4
19-20
ADVANTAGES of
ISSUING BONDS
LO 19-4
• Bondholders are creditors, not owners of the firm
and cannot 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 are callable.
19-21
DISADVANTAGES of
ISSUING BONDS
LO 19-4
• Bonds increase debt and can affect the market’s
perception of the firm.
• Paying interest on bonds is a legal obligation.
• If interest is not paid, bondholders can take legal
action.
• The face value of the bond must be repaid on the
maturity date.
19-22
BOND RATINGS
LO 19-4
19-23
DIFFERENT CLASSES of
CORPORATE BONDS
LO 19-4
• 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).
19-24
SPECIAL FEATURES in
BOND ISSUES
LO 19-4
• 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.
19-25
TEST PREP
• 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?
19-26
BUYING SECURITIES
LO 19-5
• 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.
19-27
MONEY GOING UP in SMOKE
• 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 that is primary
product is tobacco.
• Will you invest your inheritance in a company that
markets tobacco?
19-28
FIVE INVESTMENT CRITERIA
LO 19-5
1. Investment risk
2. Yield
3. Duration
4. Liquidity
5. Tax consequences
19-29
INVESTING 101
LO 19-5
Things to Do Before Making Your First Investment
• Take an investing class.
• Attend a conference.
• Head to the library and
pick up investing books.
Source: Money, www.money.com, accessed November 2014.
19-30
AVERAGE ANNUAL RETURN of
ASSET CLASSES (Since 1926)
Investment
Return
Small company stocks
12.2%
Large company stocks
9.5%
Corporate bonds
6.0%
Long-term government bonds
5.8%
Treasury bills
4.1%
Source: Ibbotson Associates and Morningstar.
LO 19-5
19-31
DIVERSIFICATION
•
LO 19-5
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
19-32
GLOBAL STOCKS:
LOVE THEM or LEAVE THEM
• Suggestions for building your financial future:
- Invest in familiar global companies with a solid
reputation and performance records.
- Invest only in global stocks listed on U.S.
exchanges.
- Invest in global mutual funds that focus on specific
countries or regions.
- Use extreme caution if investing in unstable
countries!
19-33
PRIMARY INVESTMENT SERVICES
CONSUMERS NEED
LO 19-5
• Savings and investing
advice
• Help with 401k plans
• Retirement planning
• Tax planning
• Estate planning
• Education expense planning
Source: Investment Company Institute.
19-34
TEST PREP
• What is the key advantage of investing through
online brokers? What is the key disadvantage?
• What is the primary purpose of diversifying
investments?
19-35
PERCEPTIONS of the MARKET
LO 19-6
• Bulls: Investors who
believe stock prices
are going to rise.
• Bears: Investors who
expect stock prices to
decline.
19-36
BEAR MARKET DECLINES
in the S&P 500
Time Period
% Drop in Prices
2007-2009
52.5%
2000-2002
51%
1973-1974
48.2%
1968-1970
36.1%
1987-1988
33.5%
Source: Stock Traders Almanac 2011.
LO 19-6
19-37
SELECTING STOCKS
LO 19-6
• 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
19-38
STOCK SPLITS
LO 19-6
• 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 firm’s ownership
structure and no change in the investment’s
value.
• Firms can never be forced to spilt their stocks.
19-39
BUYING STOCK on MARGIN
LO 19-6
• Buying Stock on Margin -- Borrowing some of the
stock’s purchase cost from the brokerage firm.
• 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.
19-40
UNDERSTANDING STOCK
QUOTATIONS
LO 19-6
19-41
TOP FINANICIAL NEWS and
RESEARCH SITES
LO 19-6
• Yahoo Finance
• DailyFinance
• MSN Money
• Forbes
• Dow Jones & Co.
19-42
IMPORTANT BOND QUESTIONS
LO 19-7
• 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.
19-43
UNDERSTANDING BOND
QUOTATIONS
LO 19-7
19-44
INVESTING in MUTUAL FUNDS
and EXCHANGE-TRADED FUNDS
LO 19-8
• 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 are traded more like individual stocks
than mutual funds.
19-45
WHAT MUTUAL FUNDS CAN
LEARN FROM KaChing
LO 19-8
1. Reform the ratings
system
2. Give information for
free
3. Cut out useless fees
4. Be transparent
5. Share insights
Source: Fast Company, www.fastcompany.com, accessed November 2014.
19-46
PERCENTAGE of HOUSEHOLDS
OWNING MUTUAL FUNDS
Year
% of Households
1980
5%
1990
24%
2000
43%
2005
42%
2010
48%
Source: Investment Company Institute Factbook.
LO 19-8
19-47
VARIETIES of ETFs
ETF
Traditional
Description
Most common; include large U.S.
stocks, small U.S. stocks,
international stocks, or investmentgrade bonds.
Niche
Focus on an individual sector like
healthcare, high-yield bonds, or a
single country.
Exotic
Invest in unusual, more volatile
sectors such as commodities like
gold and concepts like clean
technology.
Source: Schwab and E*Trade.
LO 19-8
19-48
UNDERSTANDING
MUTUAL FUND QUOTATIONS
LO 19-8
19-49
COMPARING INVESTMENTS
LO 19-8
19-50
TEST PREP
• 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?
19-51
The DOW
LO 19-9
19-52
KEY STOCK MARKET
INDICATORS
LO 19-9
• 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.
19-53
MARKET TURMOIL
LO 19-9
• 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.
19-54
TURMOIL in the 2000s
LO 19-9
• 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 reenergize the economy.
19-55
The WALL STREET of NOW
Then
LO 19-9
Now
Town Car
Transportation
Uber
21 Club
Restaurant
Subway
The Penthouse Club
After Hours
Dave & Buster’s
Johnny Walker Blue
($200)
Drink
Bud Light
($5)
American Express
Black
Card
Metrocard
Bottle Service
Pastime
Trivia Night
Source: Bloomberg Businessweek, www.businessweek.com, accessed November 2014.
19-56
The UPS and DOWNS
of the MARKET
LO 19-9
• 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.
19-57
WHO’S at FAULT for the
ECONOMIC CRISIS?
LO 19-9
• 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 November 2014.
19-58
CLEANING UP the STREET
LO 19-9
19-59
TEST PREP
• 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.
19-60