Financing and Investing Through Securities Markets

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Chapter 18 Financing and Investing Through
Securities Markets
Learning Goals
Explain the process of buying or selling a
security and the information included in stock
and bond quotations and stock indexes. Discuss
the role of mutual funds and exchange-traded
funds in the securities market. Evaluate the
major features of regulations and laws designed
to protect investors.
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Distinguish between the primary and secondary
securities markets. Compare money market
instruments, bonds, and common stock, including
their benefits. Identify the objectives of
investors and the types of securities that best
correspond to each. Describe the characteristics
of the major stock exchanges.
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Securities Financial instrument such as stocks
and bonds. PRIMARY VERSUS SECONDARY
MARKETS Primary market Market in which new
security issues are first sold to investors
issuers receive the proceeds from the sale.
Initial public offering (IPO) The first sale of a
companys stock to the general public.  
Investment bankers Financial specialists who
handle the sales of most corporate and municipal
securities.  Underwriting Process of purchasing
an issue from a firm or government and then
reselling the issue to investors. Secondary
market Market in which existing security issues
are bought and sold by investors.  Examples
New York Stock Exchange, Nasdaq
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TYPES OF SECURITIES Money Market
Instruments Money market instruments Short-term
debt securities issued by corporations,
financial institutions, and governments.  General
ly low-risk securities and are purchased by
investors when they have surplus
cash. Bonds  Through bonds firms obtain
long-term debt capital.  Claims of bondholders
are satisfied before those of stockholders in
cases of bankruptcy.
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Quality Ratings for Bonds  Two factors determine
the price of a bond its risk and its interest
rate.  Bond rating A rating of a bonds level of
risk.  Higher interest rates bring higher bond
prices.  Market interest rates also influences
bond prices. Retiring Bonds  Firms must have
necessary funds to pay bonds at maturity.  Some
firms issue serial bonds, an issue of bonds that
mature at different rates.  Call provision
Allows the issuer to redeem the bond before its
maturity at a prespecified price.
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Stock Common stock Shares of ownership in a
corporation.  Holders of common stock vote on
major company decisions.  In exchange for
their investment, they receivedividends and/or
benefits of increased stock price. Preferred
stock Stock whose holders have priority over
common stockholders in the payment of dividends
but usually have no voting rights. Convertible
Securities  Feature of bond or preferred stock
that gives the holder the right to exchange the
bond or preferred stock for a fixed number of
shares of common stock.  Convertible bonds pay a
lower interest rate than those without a
conversion feature.
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SECURITIES PURCHASERS  Institutional investors
An organization that invests its own funds or
those it holds in trust for others.  Individual
purchasers, many of who own shares through mutual
funds or employers retirement funds.
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Investment Motivations
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Taxes and Investing  Interest from government
and corporate bonds is income taxed at the
investors marginal tax rate.  Dividends are
taxed at a lower rate.  Profits from stock sales
are taxed as capital gains.  Tax considerations
are an important factor in investment decisions.
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SECURITIES EXCHANGES Stock exchanges Financial
market where stocks are traded.  Exist
throughout the world, and most countries have at
least one. New York Stock Exchange  Lists more
than 3,000 common and preferred stocks with
market value of more than 13 trillion.
 Worlds largest, as measured by total value of
stock traded. The Nasdaq Stock Market  A
computerized communications network that links
member investment firms.  Worlds largest
intranet.  Lists approximately 5,000 stocks.
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Other U.S. Stock Markets  American Stock
Exchange, or AMEX, in New York.  Daily trading
volume around 60 million shares.  Regional stock
exchanges include Chicago, Pacific (San
Francisco), Boston, Cincinnati, and Philadelphia
Stock Exchanges. Foreign Stock Markets  Most
countries have at least one stock exchange.  One
of largest outside U.S. is the London Stock
Exchange.  Lists 2,900 companies.  Handles
two-thirds of all cross-border trading
worldwide. ECNs and the Future of Stock
Markets  Electronic communications networks
(ECNs) Fourth market in which buyers and sellers
meet trade directly with one another.
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BUYING AND SELLING SECURITIES Brokerage firm
Financial intermediary that buys and sells
securities for individual and institutional
investors.  Examples A. G. Edwards, Raymond
James, Morgan Stanley, and Wachovia
Securities. Placing an Order  Investor initiates
purchase by contacting brokerage firm.  Market
order Instructs the brokerage firm to obtain the
highest price possible, if the investor is
selling, or the lowest price possible, if the
investor is buying.  Limit order Instructs the
brokerage firm not to pay more than a specified
price for a stock, if the investor is buying, or
not to accept less than a specified price, if the
investor is selling.
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Stock Indexes  Examples include the Dow Jones
Industrial Average, Standard Poors 500, and
the Nasdaq Composite indexes.  Dow Jones
Industrial Average, started in 1884, has served
as a general measure of overall stock prices and
a reflection of the economy.  Only original
remaining member is General Electric.
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MUTUAL FUNDS AND EXCHANGE-TRADED FUNDS Mutual
fund Financial institution that pools money from
purchases of its shares and uses the money to
acquire diversified portfolios of securities
consistent with the funds investment
objectives. Mutual Funds  Investors become part
owners of large number of securities, lessening
individual risk.  Total mutual fund assets
exceed 8 trillion.  55 million American
households own mutual fund shares.
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Exchange-Traded Funds  Raises funds by selling
shares to investors and then uses those funds to
purchase a portfolio of securities.  Sells a
fixed number of shares to investors in what is
effectively an initial public offering.  Then
ETF shares trade on stock exchanges much like
shares of individual companies.  Almost 200
ETFs with total assets of around 250
billion.  Two main appeals Shareholders are
charged little or nothing for annual operating
expenses.  Can be more tax efficient because
they dont generate a lot of taxable capital
gains.
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LEGAL AND ETHICAL ISSUES IN SECURITIES
TRADING Government Regulation of the Securities
Market  SEC requires registration of all new
public issues of corporate securities. Full and
fair disclosure Requirement that investors should
be told all relevant information by stock or bond
issuers so they can make informed
decisions. Insider trading Use of material,
nonpublic information to make investor
profits. Industry Self-Regulation  Rules of
conduct established and updated by the National
Association of Securities Dealers  Markets use
surveillance for spotting possible violations of
trading rules or securities laws.  NYSE uses
Stock Watch to flag unusual price and volume
activity.