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16 chapter Securities and Investments Better Business 1st Edition Poatsy · Martin Slide presentation prepared by Pam Janson Stark State College of Technology © 2010 Pearson Education, Inc. 1 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. © 2010 Pearson Education, Inc. 2 Learning Objectives 1. 2. 3. 4. 5. 6. 7. 8. 9. What are the pros and cons of debt and equity financing? How do companies issue bonds and stocks? How do risk return relationships, risk tolerance, and asset allocations relate to the fundamentals of investment? What are the different investment categories of stocks, and how does the stock trade process work? What is stock performance, and what are the factors that lead to changes in stock price? What are the different types and characteristics of bonds, and how is the safety of bonds evaluated? What is the difference among bond mutual funds, money market funds, and equity funds? What are the advantages and disadvantages of mutual fund investment? What is an option or a futures contract? © 2010 Pearson Education, Inc. Publishing as Prentice Hall 3 Raising Capital with Securities • For large capital-intensive projects or general expansion, business owners can raise funds with securities • They decide between bonds (debt) and stock (equity) depending on: o Corporate earnings, cash flow, and taxes o Existing bonds or stocks o Environmental factors, such as the economy © 2010 Pearson Education, Inc. Publishing as Prentice Hall 4 Financing with Bonds • Project returns should be greater than the cost of bond financing o The rate of interest the company pays is affected by: • Issuer risk • The length of the bond term • The general state of the economy • Bond debt is paid back with interest annually and principal at maturation • Bond financing advantages o Uses money from investors, not company profits o Doesn’t give up any ownership or control • Bond financing disadvantage o Debt © 2010 Pearson Education, Inc. Publishing as Prentice Hall 5 Financing with Stock • Companies issue stock (equity) to finance long-term general funding and ongoing expansion • Stock advantages o Equity financing doesn’t need to be repaid o No interest and principal payments needed • Disadvantages o Dilution of ownership o Potential dividend payment © 2010 Pearson Education, Inc. Publishing as Prentice Hall 6 Debt or Equity Financing © 2010 Pearson Education, Inc. Publishing as Prentice Hall 7 Issuing Bonds and Stocks • Financial advisory firm • Securities and Exchange Commission (SEC) o Prospectus • Capital market o Primary market o Secondary market • Stocks o Initial public offering (IPO) © 2010 Pearson Education, Inc. Publishing as Prentice Hall 8 Risks and Returns of Investing © 2010 Pearson Education, Inc. Publishing as Prentice Hall 9 How to Start Investing • Strategies o Diversification o Asset allocation © 2010 Pearson Education, Inc. Publishing as Prentice Hall 10 Types of Stocks • Two main types o Common • Vote on corporate policy and board of directors • Have a lesser right to dividends and assets o Preferred • Have no voting rights • Receive a fixed dividend before common stockholders • Have a greater right to assets © 2010 Pearson Education, Inc. Publishing as Prentice Hall 11 Stocks by Company Type Income Blue chip Cyclical Growth Defensive © 2010 Pearson Education, Inc. Publishing as Prentice Hall 12 Choosing Stocks • Know your goals and risk tolerance • Many start with a managed 401(k) account • If you are choosing stocks on your own o Evaluate company financial and other data o Look at past stock performance o Understand how current events could impact the stock o Compare other companies’ performance to spot trends o View industry analysts’ opinions © 2010 Pearson Education, Inc. Publishing as Prentice Hall 13 Buying and Selling Stocks • Before Internet trading, buyers had to use a full-service stockbroker • Now individuals can use online discount brokers • Either way, stock is purchased through the broker on a stock exchange Selecting a Broker 1. Know your objectives 2. Interview brokers 3. Check the firm’s history 4. Ask about fees 5. Ask about SIPC 6. Take time to decide © 2010 Pearson Education, Inc. Publishing as Prentice Hall 14 The Stock Exchanges • New York Stock Exchange (NYSE) o Trades made electronically or on the trading floor • National Association of Securities Dealers Automated Quotation (NASDAQ) o Trades made electronically only © 2010 Pearson Education, Inc. Publishing as Prentice Hall 15 A Typical Stock Trade © 2010 Pearson Education, Inc. Publishing as Prentice Hall 16 Changing Stock Prices • Stock prices change daily/changes based on supply and demand • Value: Stock price x number of shares = market capitalization • Investors look at expected future growth © 2010 Pearson Education, Inc. Publishing as Prentice Hall 17 Stock Performance • Stock performance is directly related to changes in stock price, which is impacted by supply and demand. • Stock prices change in reaction to company actions and broader news based on economic forecasts, industry or sector concerns, or global events. • In a bull market, there is increasing investor confidence and the market increases in value. • In a bear market, there is decreasing investor confidence and the market declines in value. © 2010 Pearson Education, Inc. Publishing as Prentice Hall 18 Stock Indexes • Standard and Poor’s 500 Composite Index (S&P 500) • Dow Jones Industrial Average (DJIA) • NASDAQ 100 © 2010 Pearson Education, Inc. Publishing as Prentice Hall 19 Making Money Investing in Stocks • Collecting dividends • Capital gains © 2010 Pearson Education, Inc. Publishing as Prentice Hall 20 Types of Bonds • Corporate o Secured o Debenture o Convertible • Serial bonds • Callable bonds • Government o Treasury bills o Treasury notes o Treasury • Municipal bonds o General obligation o Revenue o Serial © 2010 Pearson Education, Inc. Publishing as Prentice Hall 21 Bond Ratings © 2010 Pearson Education, Inc. Publishing as Prentice Hall 22 Characteristics of a Bond • Par (face) value • Coupon • Maturity date • Bond prices move in the opposite direction of interest rates o If a bond has a coupon of 10 percent: • And current interest rates are 8 percent, the bond is worth more to investors and its price will go up • And current interest rates are 12 percent, demand for your bond is not strong and will go down © 2010 Pearson Education, Inc. Publishing as Prentice Hall 23 Mutual Funds • Allows a group of investors to pool their money together with a predetermined investment objective • There are different types of mutual funds • Money market funds are popular o They invest in short-term debt obligations like Treasury Bills and certificates of deposit o Interest rates can be double savings accounts o Money market funds are very liquid o But these funds are not insured by the FDIC © 2010 Pearson Education, Inc. Publishing as Prentice Hall 24 Bond Mutual Funds © 2010 Pearson Education, Inc. Publishing as Prentice Hall 25 Stock Mutual Funds © 2010 Pearson Education, Inc. Publishing as Prentice Hall 26 Why Are Mutual Funds So Popular? • Good for those with little investment experience • Features o o o o Diversification Professional management Liquidity Cost • Financial gains through o o o o Dividends Interest Capital gains Fund appreciation • Mutual funds measured by net asset value (NAV) © 2010 Pearson Education, Inc. Publishing as Prentice Hall 27 Mutual Fund Investing Tips • Understand costs o Load o No-load • Understand fund management o Management team © 2010 Pearson Education, Inc. Publishing as Prentice Hall 28 Options and Futures • Option o A contract that gives a buyer the right to buy or sell a particular security at a specific price on or before a certain date • Futures contract o An agreement between a buyer and a seller to receive (or deliver) an asset in the future at a specific price that is agreed upon today • An option gives you the right to purchase the underlying asset while you have an obligation to purchase the asset with a futures contract © 2010 Pearson Education, Inc. Publishing as Prentice Hall 29 Exchange-Traded Funds (ETFs) • One of newest investment options • Pools of stocks similar to mutual funds • Trade like stocks on the exchanges o Prices change all day vs. at the end of the day for mutual funds • Fees are lower © 2010 Pearson Education, Inc. Publishing as Prentice Hall 30 Chapter Summary 1. 2. 3. 4. 5. 6. 7. 8. 9. What are the pros and cons of debt and equity financing? How do companies issue bonds and stocks? How do risk return relationships, risk tolerance, and asset allocations relate to the fundamentals of investment? What are the different investment categories of stocks, and how does the stock trade process work? What is stock performance, and what are the factors that lead to changes in stock price? What are the different types and characteristics of bonds, and how is the safety of bonds evaluated? What is the difference among bond mutual funds, money market funds, and equity funds? What are the advantages and disadvantages of mutual fund investment? What is an option or a futures contract? © 2010 Pearson Education, Inc. Publishing as Prentice Hall 31 Beyond the Book © 2010 Pearson Education, Inc. Publishing as Prentice Hall 32 Typical Sources of Equity Financing Public Stock Offer Private Placement of Stock Venture Capital Funds Wealthy Individual (Angel Investors) Family and Friends Personal Savings © 2010 Pearson Education, Inc. Publishing as Prentice Hall 33 Stock Exchanges • In addition to NYSE and NASDAQ, there are: o The American Stock Exchange o Regional stock exchanges o Global stock exchanges o Over-the-counter market © 2010 Pearson Education, Inc. Publishing as Prentice Hall 34 Mutual Fund Fees Basic Fee Structure • Front-end load: Fees for purchase of mutual fund shares • Back-end load: Fees charged when shares are sold • No load: Fees are withheld from earnings Other Possible Fees • Exchange fees are charged when money transferred from one fund to another • Annual account fees may be charged to maintain lowbalance accounts • Management fees are charged by the fund’s investment advisor © 2010 Pearson Education, Inc. Publishing as Prentice Hall 35 Institutional Investors are U.S. Corporate Stockholders • The largest investors in securities in the U.S. aren’t individuals; rather, they are pension funds, investment companies, insurance companies, banks and foundations. • Institutional investors have substantially and consistently increased their stock ownership in U.S. corporations 1980 1987 2000 2007 Institutional investor stock ownership in largest 1,000 U.S. corporations - 46.6% 61.4% 76.4% Total assets controlled by institutional investors $2.7 trillion - - $27.1 trillion Market value of total institutional equity holdings $571.2 billion - - $12.9 trillion © 2010 Pearson Education, Inc. Publishing as Prentice Hall 36 Stock Options: In General • Common form of employee incentive • Options to purchase a set amount of stock at a fixed price in the future o If the stock price drops, there’s no cost to the employee o If the stock price rises, the employee buys the stock at the option price and can make a profit © 2010 Pearson Education, Inc. Publishing as Prentice Hall 37 Stock Options at Google • An estimated 1,000 people each have more than $5 million worth of Google shares from stock grants and options • Current and former employees have cashed in options worth $2.1 billion • Current employees have unvested options of $4.1 billion • Nooglers (new Google employees) have an average exercise price of $500 o It takes a lot of money to exercise their options! © 2010 Pearson Education, Inc. Publishing as Prentice Hall 38