Download DISADVANTAGES of ISSUING BONDS LG4

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, Bartiromo’s 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.
• She’s lead anchor at two of
CNBC’s biggest shows, has
written several books and
numerous columns.
19-4
The Function
of Securities
Markets
LG1
The BASICS of
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.
19-5
The Function
of Securities
Markets
LG1
TYPES of
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 corporation’s stock.
19-6
The Role of
Investment
Bankers
LG1
INVESTMENT BANKERS
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.
19-7
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.
19-8
Stock
Exchanges
TOP STOCK EXCHANGES
LG2
• NYSE Euronext
• NASDAQ
• London Stock
Exchange
• Tokyo Stock Exchange
• Deutsche Borse
19-9
Securities
Regulations
and the SEC
LG2
The SECURITIES and
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.
19-10
How Businesses
Raise Capital by
Selling Stock
LG3
LEARNING the
LANGUAGE of STOCKS
• 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.
19-11
Advantages &
Disadvantages
of Issuing Stock
LG3
ADVANTAGES of
ISSUING STOCK
• 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.
19-12
Advantages &
Disadvantages
of Issuing Stock
LG3
DISADVANTAGES of
ISSUING STOCK
• 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.
19-13
Issuing Shares
of Common and
Preferred Stock
TWO CLASSES of 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
19-14
Learning the
Language of
Bonds
LG4
LEARNING the
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.
19-15
Advantages &
Disadvantages
of Issuing Bonds
LG4
ADVANTAGES of
ISSUING BONDS
• 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.
19-16
Advantages &
Disadvantages
of Issuing Bonds
LG4
DISADVANTAGES of
ISSUING BONDS
• 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.
19-17
Advantages &
Disadvantages
of Issuing Bonds
BOND RATINGS
LG4
Rating
Moody’s
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
19-18
Different
Classes of
Bonds
LG4
DIFFERENT CLASSES of
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).
19-19
Special Bond
Features
LG4
SPECIAL FEATURES in
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.
19-20
How
Investors
Buy
Securities
LG5
BUYING SECURITIES
• 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.
19-21
Choosing the
Right
Investment
Strategy
FIVE INVESTMENT CRITERIA
LG5
1. Investment risk
2. Yield
3. Duration
4. Liquidity
5. Tax consequences
19-22
Choosing the
Right
Investment
Strategy
LG5
INVESTING 101
Things to Do Before Making Your First Investment
• 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.
19-23
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
19-24
Reducing Risk
by Diversifying
Investments
LG5
PRIMARY INVESTMENT SERVICES
CONSUMERS NEED
• Savings and investing advice
• Help with 401k plans
• Retirement planning
• Tax planning
• Estate planning
• Education expense planning
Source: Investment Company Institute.
19-25
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.
19-26
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
19-27
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 firm’s ownership
structure and no change in the investment’s
value.
• Firms can never be forced to spilt their stocks.
19-28
Buying Stock
on Margin
BUYING STOCK on MARGIN
LG6
• 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.
19-29
Understanding
Stock
Quotations
LG6
TOP FINANICIAL NEWS and
RESEARCH SITES
• Yahoo Finance
• DailyFinance
• MSN Money
• Forbes
• Dow Jones & Co.
19-30
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.
19-31
Investing in
Mutual Funds &
ExchangeTraded Funds
LG8
INVESTING in MUTUAL FUNDS
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 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.
19-32
Investing in
Mutual Funds &
ExchangeTraded Funds
LG8
WHAT MUTUAL FUNDS CAN
LEARN FROM KaChing
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.
19-33
Understanding
Mutual Fund
Quotations
COMPARING INVESTMENTS
LG8
19-34
Understanding
Stock Market
Indicators
LG9
KEY STOCK MARKET
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.
19-35
Riding the
Market’s 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.
19-36
Riding the
Market’s 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 reenergize the economy.
19-37
Riding the
Market’s Roller
Coaster
LG9
The UPS and DOWNS
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.
19-38
Riding the
Market’s Roller
Coaster
LG9
WHO’S at FAULT for the
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.
19-39
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.
19-40