Financing%20and%20Investing%20Through%20Securities%20Markets

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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.  Stock offering gives investors the
opportunity to purchase ownership shares in a
firm and to participate in its future growth, in
exchange for providing current capital.
Initial public offering (IPO) The first sale of a
companys stock to the general public.  Securitie
s are sold on the open market and through
investment bankers.  U.S. Treasury accepts both
competitive and noncompetitive bids for its
securities.
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  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.  Investment
bankers underwrite stock and bond issues at a
discount, which is their compensation for their
services. Secondary market Market in which
existing security issues are bought and sold by
investors.  Examples New York Stock Exchange,
Nasdaq  On a typical day, more than 50 billion
worth of stock is traded on NYSE.
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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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Types of Bonds  Government bonds Bonds sold by
the U.S. Treasury. Backed by the full faith
and credit of the U.S. government  Municipal
bonds Bonds issued by state or local governments.
 Revenue bondproceeds are to be used to pay
for a project that will produce revenue, such
as a toll road or bridge.   General obligation
bondproceeds are to be used to pay for a project
that will not produce any revenue, such as a
new state police post.  Can be sold only by
governmental units that have the power to levy
taxes.  Interest payments are exempt from
federal income tax.  Secured bond Corporate
bond backed by a specific pledge of company
assets.  Debentures Corporate bonds backed only
by the issuing firms financial reputation.
 Mortgage pass-through security Backed by a
self-liquidating pool of mortgage loans
purchased from lenders.
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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.
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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.  Risk loss
of investment if company fails.  Book
value  Market value Price at which a stock
is currently selling.
Company assets company liabilities
No. of outstanding shares of common stock
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Preferred Stock Preferred stock Stock whose
holders have priority over common stockholders in
the payment of dividends but usually have no
voting rights.  Pays fixed dividend regardless
of company performance.  Many investors consider
it more like a bond than a common
stock. 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  Two types of
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. Investment
Motivations  Five primary sources of
motivation  Growth in capital  Stability of
principal  Liquidity  Current income
Income growth
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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.
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New York Stock Exchange  One of worlds oldest,
founded in 1792.  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.  Trading takes place face-to-face on
trade floor.  Only members are allowed to trade
on the floor. 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 opening up to smaller,
individual investors.  Buyers and sellers meet
trade directly with one another in a virtual
stock market.
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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  Mostly by the federal government,
primarily the Securities and Exchange Commission.
 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.  Regulation FD Requires firms to share
information with all investors at the same
time.  Public corporations must file several
reports annually.
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• Industry Self-Regulation
• Professional Rules of Conduct
•  Rules of conduct established and updated by the
  National Association of Securities Dealers
•  Ensure that brokers perform their basic
  functions honestly and fairly, under constant
  supervision.
• Market Surveillance
•  Techniques for spotting possible violations of
  trading rules or securities laws.
•  NYSE uses Stock Watch to flag unusual price and
  volume activity.
•  Market participants keep detailed records about
  transactions.

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Perfection is not just for the movies.
Self-regulation means that Professional Rules
of Conduct should always be followed.