Chapter 19 Securities Markets

Chapter 19 Securities Markets I. Securities Markets Securities Markets Definition: financial marketplaces for stocks, bond and other investments 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 Primary Markets Definition: handle the sale of new securities. Corporations make money only when they sell their stock on the primary market. Initial Public Offering IPO Definition: the first public offering of a corporation's stock. The only time a company can make any money is during the initial sale. Secondary Markets Definition: handles the trading of securities between investors, with the proceeds going to the investor selling the stock, not the corporation whose stock is sold. Investment Bankers Definition: specialists who assist in the issue and sale of new securities Institutional Investors Definition: large organizations- such as pension funds, mutual funds, and insurance companies- that invest their own funds or the funds of others. II. Stock Exchanges Stock Exchange Definition: an organization whose members can buy and sell (exchange) securities on behalf of companies and individual investors. Over-the-Counter Market Definition: companies and investors with a means to trade stocks not listed on the large securities exchanges. An exchange that provides a means to trade stocks not listen on the national exchanges NASDAQ Definition: National Association of Securities Dealers Automated Quotations World's first electronic stock market, links dealers so they can buy and sell securities electronically rather than in person. NYSE Definition: New York Stock Exchange, largest floor based exchange. Today it is primarily on electronic networks. Securities and Exchange Commission's (SEC) Definition: federal agency responsible for regulating the various stock exchanges. Helps protect investors by requiring full disclosure of financial information by firms selling bonds or stocks. Created after the great depression. Created by the Securities and Exchange Act of 1934 Prospectus Definition: a condensed version of economical and financial information that a company must file with the SEC before issuing stock. Must be sent to prospective investors. III. Raise Capital by Selling Stocks Stocks Definition: shares of ownership in a company Stock Certificate Definition: represents stock ownership. Specifies the name of the company, number of shares owned, and the type of stock it represents. Not done anymore, everything is recorded electronically. Dividends Definition: part of a firm's profits that the company may distribute to stockholders as either cash payments or additional shares of stock. Can either go to retained earnings or into stocks decided by the board of directors Companies pay dividends because they want to increase the value of their company from a shareholder perspective. net income (after tax)→ Dividends → Retained Earnings Advantages Issuing Stock ● 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. Disadvantages of Issuing Stock ● Stockholders have the right to vote for a company's board of directors. They have influence. Issuing new shares of stock can thus alter the control of the firm. ● Dividends are paid from after-tax profits and are not tax-deductible. “Double Taxation” income was already taxed and now dividends are taxed after. ● The need to keep stakeholders happy can affect managers decisions. More short term actions than long term outlook. Common Stock Definition: most basic form of ownership in a firm. If a company issues only one type of stock, by law it must be common stock. Preferred Stock Definition: given preference in the payment of company dividends and must be paid their dividend in full before any common stock dividends can be distributed. Won't increase at the same rate as common stock. ● Callable ● Convertible ● Cumulative IV. Raise Capital by Issuing Bonds Bonds Definition: corporate certificate indicating that an investor has lent money to a firm or a government. Usually offered in $1000 dollars, which is bought from a secondary market. Company uses bonds to fund their long term investments. Company pays interest to the bondholder until the maturity date when they pay it back in full. Advantages of Issuing Bonds ● Bondholders are not owners. ● Bond interest is tax-deductible ● Bonds are temporary source of funding and are eventually repaid. ● Bonds can be repaid before the maturity date if they are callable Maturity Date Definition: the exact date that an issuing company of a bond is legally bound to repay the principal to the bondholder. Bond Rating Definition: Independent rating firms such as Standard & Poor’s, Moody’s Investors Service, and Fitch Ratings rate bonds according to their degree of risk. AAA-C/D Interest Definition: the payment the bond issuer makes to the bondholders to compensate for the use of their money Debenture Bonds Definition: unsecured bonds, not backed by any specific collateral. Only firms with excellent reputations and credit ratings can issue debenture bonds. Secured Bonds Definition: mortgage bonds, backed by collateral. Sinking Fund Definition: Reserve account thats purpose is to ensure that enough money will be available to repay bondholders on the bonds maturity date. ● Provide for an orderly repayment of bond issue ● Reduce the risk the bond will not be repaid ● Support the market price of the bond because they reduce the risk the bond will not be repaid Callable Bond Definition: permits the bond issuer to pay off the bonds principal before its maturity date Convertible Bonds Definition: investors can convert convertible bonds into shares of common stock in the issuing company. V. Investors Buy Securities Stockbroker Definition: registered representative who works for a brokerage firm as a market intermediary to buy and sell securities for clients Online Brokers Investment Strategy 1. Investment Risk the chance that an investment will be worth less at some future time than it is worth now 2. Yield the expected return on an investment, such as interest or dividends, usually over the period of one year. Return on Investment. 3. Duration the length of time your money is committed to an investment. If it is longer risk increases. 4. Liquidity how quickly you can get back your invested funds in cash if you want or need them. Can you go to stockbroker and get the cash that day? 5. Tax Consequences how the investment will affect your tax situation. Diversification Definition: involves buying several different types of investments to spread the risk of investing ● 25% in U.S growth stocks ● 25% in government bonds ● 25% dividend paying stocks ● 20% international mutual fund ● Rest into a savings account. VI. Investing in Stocks Perceptions in the Market Bulls: Investors who believe stock prices are going to rise Bears: Investors who expect stock prices to decline Capital Gains Definition: the positive difference between the purchase price of a stock and what you sell if for Buy a stock for 100, sell for 120, gain 20. Taxed at lower rate than ordinary income. Growth Stocks Definition: stocks of corporations whose earnings are expected to grow at a faster rate than other stocks. Riskier, offer the potential for higher returns Income Stocks Definition: stocks of public utilities, offer investors a high dividend yield that generally keeps pace with inflation. Market Order Definition: tells a broker to buy or sell a stock immediately at the best price available Limit Order Definition: tells the broker to buy or sell a stock at a specific price if that price becomes available Stock Splits Definition: gives stockholders two or more shares of stock for each one they own Buying Stock on Margin Definition: borrowing some of the stocks purchase cost from the brokerage firm. The margin is the portion of the stocks purchase price that investors must pay with their own money. VII. Investing in Bonds VIII. Investing in Mutual Funds and Exchange Traded Funds Mutual Fund Definition: managers that buys stocks, bonds and other investments and the sells shares in those securities to the public. Like an investment company that pools investors money and then buys stocks or bonds in many companies Exchange-Traded Funds Definition: resemble both stocks and mutual funds. Collection of stocks, bonds and other investments that are traded on securities exchanges, but traded more like individual stocks that like mutual funds. IX. Understanding Stock Market Indicators Dow Jones Industrial Average (The Dow) Definition: The average cost of 30 selected industrial stocks. The financial industry uses it to give an indication of the direction up or down of the stock market overtime. Program Trading Definition: investors give their computers instructions to sell automatically to avoid potential losses. Occurs if the price of their stock dips to a certain point. Blammed for market turmoil. Inv Definition: