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Chapter 18

Chapter 18. Financing and Investing through Securities Markets. The Primary Market. Security —stock, bond, or money market instrument that represents an obligation on the part of the issuer.

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Chapter 18

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  1. Chapter 18 Financing and Investing through Securities Markets

  2. The Primary Market Security—stock, bond, or money market instrument that represents an obligation on the part of the issuer. • Primary Market—market where new security issues are first sold to investors; the issuer receives the proceeds from the sale. • Initial Public Offering (IPO) • Secondary Market—financial markets where previously issued securities are traded among investors., • Examples: NYSE, NASDAQ

  3. Securities Exchanges • The New York Stock Exchange • NYSE (Big Board)—the largest, and probably the most famous, stock market in the world • Also one of the oldest, having been founded in 1792

  4. Securities Exchanges • The NASDAQ Stock Market • NASDAQ stock market—second-largest stock market in U.S., trading stock issues of firms that are typically smaller, less well-known than those on the NSYE • Unlike trading on the NSYE, which takes place face-to-face or the trading floor, trading on the NASDAQ takes place on an electronic network

  5. Money Market Instruments—short-term debt issued by corporations, financial institutions, and governments. • Mature within 1 year, Low Risk Examples: U.S. Treasury bills – short-term securities issued by the U.S. Treasury and backed by the full faith and credit of the U.S. government. Maturities of 30, 90, 180, or 360 days. Commercial Paper - unsecured debt issued by corporations with high credit ratings to finance its short-term needs. Commercial paper is available in a variety of denominations and usually ranges in maturity from 2 to 270 days. Certificates of Deposit – a time deposit at a financial institution. Repurchase Agreement - one party sells the other a security at a specified price with a commitment to buy the security back at a later date for another specified price.

  6. Bonds – long-term debt security Issuer promises to pay to the bondholder principal and interest according to the terms and conditions of the bond. Sold to raise long-term funds for a corporation or government agency. Example: You buy a bond with a $1,000 face value, a 5% interest rate and a 10-year maturity • You would collect interest payments totaling $50 in each of those 10 years. When the decade was up, you'd get back your $1,000.

  7. Investors choose from among a variety of bonds • Secured Bond—bond backed by specific pledge of a company’s assets. • Debenture (Unsecured) Bond • Government - Issued by U.S. Treasury • Municipal – issued by state and local governments (not subject to Fed. Inc. tax) • Corporate

  8. How to Read Bond Quote Tables • Two factors determine a bond’s price: • risk and interest rate

  9. Moody’s and Standard & Poor’s Bond Ratings Bonds vary considerably in terms of risk

  10. Retiring Bonds • Bonds mature on a specific date • Borrowers must have the necessary funds available to pay the principal at that time • Call Provision - allows the issuer to redeem the bond before maturity • Serial Bonds – Issue bonds that mature on different dates • Sinking Fund – Make annual deposits to accumulate funds for use in redeeming bonds when they mature • Issue more…

  11. Stock • Common Stock • Share of ownership in a company. • can vote on major company decisions • They expect to receive cash dividends and to benefit from capital gains. (Often no dividends are issued.) • Preferred Stock • receive preference in payment of dividends • Seldom confers voting rights • Dividends are fixed

  12. Convertible Securities • Bonds or stock that contains a conversion feature • Gives the holder the right to exchange their securities for a fixed number of shares of common stock

  13. Securities Purchasers • Investment Motivations • Primary Investment Objectives by Type of Security

  14. Securities Purchasers • Taxes and Investing • Interest received from bonds, and dividends received from stocks, are considered ordinary income which is taxed at the investor’s marginal tax rate • Profits made from the sale of securities owned for over a year are taxed at the capital gains rate • Other, special tax rules apply for investment income

  15. Buying and Selling Securities Brokerage Firm—financial intermediary that buys and sells securities for individual and institutional investors. • When investors buy or sell securities through a brokerage firm, they pay a fee which vary widely among brokerage firms • A full-service firm charges higher fees, but provides a large number of services and offers investment advice • A discount firm charges lower fees, but offers less advice and fewer services - Etrade

  16. Buying and Selling Securities • Placing an Order • A market order instructs a brokerage firm to obtain the highest price possible – if the investor is selling – or the lowest price possible – if the investor is buying • A limit order instructs the brokerage firm not to pay more than a specified price for stock if the investor is buying, or accept less than a specified price if the investor is selling

  17. How to Read Stock Quote Tables

  18. Stock Indexes • Stock indexes reflect the general activity of the stock market • The most common indices include: • Dow Jones Industrial Average (DJIA) – average of 30 of the largest and most widely held public companies in U.S. • Standard & Poor’s 500 – 500 large publicly held companies that trade on NYSE or NASDAQ • NASDAQ composite – 3,000 stocks • Foreign indices include the DAX (Germany), and the Nikkei (Tokyo)

  19. Mutual Funds • Mutual Fund—financial institution that pools investment money from purchases of its shares and uses the money to acquire diversified portfolios of securities consistent with the fund’s investment objective. • Investors who buy shares of a mutual fund become part owners of a large number of securities, thereby lessening their individual risk • Diversified • Managed by professionals • Not traded on stock exchanges

  20. Distribution of Mutual Fund Assets by Type of Fund

  21. How to Read Mutual Fund Tables

  22. Legal and Ethical Issues in Securities • Examples of unethical trading practices include brokers urging investors to buy high-risk investments or “churning” accounts (excessive trading) just to generate higher commissions • Examples of illegal trading practices include brokers theft from a client’s portfolio and giving false or misleading information to investors

  23. Legal and Ethical Issues in Securities • Government Regulation of the Securities Markets • Full and Fair Disclosure—requirement that investors should be told all relevant information by issuers so the can make informed decisions. • Prospectus—document that gives a detailed description of a company issuing securities

  24. Legal and Ethical Issues in Securities • Government Regulation of the Securities Markets • Insider Training—the use of material non-public information to make an investment profit • Example: someone using non-public information about a pending merger, or a major oil discovery, to profit in the stock market at the expense of ordinary investors • Regulation FD – firms must share information with all investors at the same time

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