Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
14 Real Firms and Their Financing: Stocks and Bonds A bargain that is going to become a greater bargain is no bargain. MARTIN SHUBIK, YALE UNIVERSITY Contents ● Corporations and Their Financing ● Financing Corporate Activity: Stocks and Bonds ● Buying Stocks and Bonds ● Stock Exchanges and Their Functions ● Speculation Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Corporations and Their Financing ● U.S. firms are of three types: ♦ Proprietorships (largest number of firms) ♦ Partnerships ♦ Corporations (have largest amount of business) Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Corporations and Their Financing ● The largest U.S. firms are corporations, which are treated by law as entities separate from their owners. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Corporations and Their Financing ● Advantages: ♦ Limited liability ♦ Access to large amounts of capital ♦ Ease of operation with help of hired management ♦ Remain permanent even when the owners change Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Corporations and Their Financing ● Disadvantages: ♦ Double taxation ♦ Hired managers may act against the interest of the owners Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Corporations and Their Financing ● The Effect of Double Taxation of Corporate Earnings ♦ Reduces the extent of corporate activities ♦ Does not reduce the net returns to individual investors Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Financing Corporate Activity: Stocks and Bonds ● Why do corporations need additional funds? ♦ To add to plant or equipment ♦ To finance other types of real investment Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Financing Corporate Activity: Stocks and Bonds ● How does a corporation get additional funds? ♦ Take out a loan ♦ Print and sell new stock certificates or new bonds ♦ Reinvest its own earnings (rather than paying them out as dividends to stockholders) Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Financing Corporate Activity: Stocks and Bonds ● Loans ♦ A company can obtain money by borrowing from banks, insurance companies, other private firms, or a U.S. government agency. ● Sell Stocks ♦ Common stock conveys an ownership claim and entitles the stockholder to a proportionate share of the dividends, if any. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Financing Corporate Activity: Stocks and Bonds ● Sell bonds ♦ A bond purchase is like a loan. ♦ It conveys no ownership stake, and entitles the bondholder to be repaid a certain fixed amount if the bond is held to maturity. ♦ Bondholders have a prior claim to stockholders. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Financing Corporate Activity: Stocks and Bonds ● Stock “ownership” may be an illusion since large blocks are needed to exert influence ● Bonds can be a very risky investment due to fluctuations in market price and inflation. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Financing Corporate Activity: Stocks and Bonds ● From the point of view of the corporation, bonds are typically (not always) cheaper than stocks, in terms of expected interest payments versus return to the stockholders; they are, however, riskier because they establish a fixed obligation. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Financing Corporate Activity: Stocks and Bonds ● Stockholders usually demand a higher return than bondholders do because, to them, stocks are riskier. ● In other words, bonds are a way of transferring some (not all) of the risk from the investor to the company. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Financing Corporate Activity: Stocks and Bonds ● Plowback or Retained Earnings ♦ As well as issuing stocks and bonds, firms can finance their investments through plowback or retained earnings. ♦ Firms often find this preferable and, in fact, in 1996, plowback constituted about 62 percent of total U.S. corporate financing. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Financing Corporate Activity: Stocks and Bonds ● What Determines Stock Prices? The Role of Expected Company Earnings ♦ Since most bonds carry a fixed nominal return, their current market value fluctuates inversely with interest rates. ♦ The market price of bond is equal to the coupon divided by the current market interest rate. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. 14-2 Sources of New Funds for U.S. Corporations FIGURE 80 72.8 70 60 50 Percent 40 30 21.2 20 10 0 –10 –20 18.9 New stocks Plowback New bonds and other debt Other external sources –12.9 Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Buying Stocks and Bonds ● Selecting a Portfolio: Diversification ♦ Investors reduce their risk by acquiring a variety of assets. ♦ An easy way for an individual investor to diversify is to invest money in an index fund. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Buying Stocks and Bonds ● Selecting a Portfolio: Diversification ♦ Index funds ■Buy the securities used in one of the standard stock price indexes ■Return reflects the performance of the whole market Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Stock Exchanges and Their Functions ● Stocks are bought and sold on stock exchanges, the largest and most important of which is the New York Stock Exchange. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Stock Exchanges and Their Functions ● Regulation of the Stock Market ♦ Stock exchanges are regulated internally and by the Securities and Exchange Commission. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Stock Exchanges and Their Functions ● Stock Exchanges and Corporate Capital Needs ♦ A special type of bank called an investment bank usually handles new stock issues. ♦ Stock exchanges deal in previously issued stock; they do not provide capital to firms directly. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Stock Exchanges and Their Functions ● Stock Exchanges and Corporate Capital Needs ♦ Stock exchanges have two critically important functions for corporate financing: ■By providing a second-hand market for stocks, they make individual investment in a company much less risky. ■The stock market determines the current price of the company’s stock. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Stock Exchanges and Their Functions ● Stock Exchanges and Corporate Capital Needs ♦ A high price of its stock on the exchange is important to a firm because it allows the issuance of new stock at a good price. ♦ If a firm has a promising future, its stock will tend to command a high price on the stock exchanges. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Stock Exchanges and Their Functions ● Stock Exchanges and Corporate Capital Needs ♦ The stock market helps to allocate the economy’s resources to firms that can best use those resources. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. The Surge in Takeovers ● Takeover = group of outside financiers buys a sufficient amount of company stock to gain control of the firm. ♦ There has been an increase in takeovers, including “hostile takeovers,” through the buying of stock. ♦ Opinion is divided as to whether this is good or bad for the economy. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. Speculation ● Speculators get bad press, but they usually perform important, socially useful tasks. ● They protect other people against risk and they help to smooth out price fluctuations. ● In some circumstances, they may even prevent famine. Copyright© 2003 South-Western/Thomson Learning. All rights reserved. ? Unpredictable Stock Prices as “Random Walks” ● Even skilled analysts cannot accurately predict individual stock prices. ● Rather, they move in a random fashion, around a long-run market trend for stocks in general. ● The reason for this may be the great skill and foresight of investors or, alternately, their irrational behavior. Copyright© 2003 South-Western/Thomson Learning. All rights reserved.