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*Chapter Nineteen

Using Securities

Markets for Financing and

Investing Opportunities

Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

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• Securities markets are financial marketplaces for stocks and bonds and serve two primary functions:

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.

The BASICS of SECURITIES MARKETS

The Function of Securities Markets

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• Stocks -- Shares of ownership in a company.

• Stock Certificate -- Evidence of stock ownership.

• Dividends -- Part of a firm’s profits that the firm may distribute to stockholders as either cash or additional shares.

LEARNING the LANGUAGE of STOCKS

Learning the Language of Stocks

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• Stockholders are owners of a firm and never have to be repaid their investment.

• There’s no legal obligation to pay dividends.

• Issuing a stock can improve a firm’s balance sheet since stock creates no debt.

ADVANTAGES of ISSUING STOCKS

Advantages & Disadvantages of Issuing Stock

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• Stockholders have the right to vote for a company’s board of directors.

• Issuing new shares of stock can alter the control of the firm.

• Dividends are paid from after-tax profits and are not tax deductible.

• The need to keep stockholders happy can affect management’s decisions.

DISADVANTAGES of ISSUING STOCKS

Advantages & Disadvantages of Issuing Stock

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• Common Stock -- The most basic form; holders have the right to vote for the board of directors and share in the profits if dividends are approved.

• Preferred Stock -- Owners are given preference in the payment of company dividends before common stock dividends are distributed. Preferred stock can also be:- Callable

- Convertible

- Cumulative

TWO CLASSES of STOCKIssuing Shares of Common Stock

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• Bond -- A corporate certificate indicating that an investor has lent money to a firm.

LEARNING the LANGUAGE of BONDS

Learning the Language of Bonds

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• The principal is the face value of the bond.

• Interest -- The payment the bond issuer makes to the bondholders to compensate them for the use of their money.

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• Bondholders are creditors, not owners of the firm and can’t vote on corporate matters.

• Bond interest is tax deductible.

• Bonds are a temporary source of funding and are eventually repaid.

• Bonds can be repaid before the maturity date if they contain a call provision.

ADVANTAGES of ISSUING BONDS

Advantages & Disadvantages of Issuing Bonds

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• Bonds increase debt and can affect the market’s perception of the firm.

• Paying interest on bonds is a legal obligation.

• If interest isn’t paid, bondholders can take legal action.

• The face value of the bond must be repaid on the maturity date.

DISADVANTAGES of ISSUING BONDS

Advantages & Disadvantages of Issuing Bonds

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• Corporations can issue two classes of bonds:

1. Unsecured bonds (debenture bonds): not backed by specific collateral.

DIFFERENT CLASSES of CORPORATE BONDS

Different Classes of Bonds

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2. Secured bonds: backed by collateral (land or equipment).

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1. Investment risk

2. Yield

3. Duration

4. Liquidity

5. Tax consequences

FIVE INVESTMENT CRITERIAChoosing the Right Investment Strategy

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• Capital Gains -- The positive difference between the price at which you bought a stock and what you sell it for.

• Investors can also choose stocks according to their strategy:

- Blue-chip stocks

- Growth stocks

- Income stocks

- Penny stocks

SELECTING STOCKSInvesting in Stocks

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• Stock Splits -- An action by a company that gives stockholders two or more shares of additional stock for every share that’s outstanding.

• Splits cause no change in the firm’s ownership structure and no change in investment’s value.

• Firms can never be forced to spilt their stocks.

STOCK SPLITS Stock Splits

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• Mutual Fund -- An organization the buys stocks and bonds and then sells shares in those securities to the public. The fund pools investors’ money and buys stocks according to the fund’s purpose.

• Exchange-Traded Fund (ETF) -- Collections of stocks and bonds that are traded on securities exchanges but themselves are traded more like stocks than mutual funds.

INVESTING in MUTUAL FUNDS and EXCHANGE-TRADED FUNDS

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Investing in Mutual Funds & Exchange-Traded Funds

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