Chapter Nineteen - Ridgeview High School | Ridgeview...
Transcript of Chapter Nineteen - Ridgeview High School | Ridgeview...
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* Chapter
Nineteen
Using
Securities
Markets for
Financing &
Investing
Opportunities
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
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• With a net worth of $50 billion,
Buffett was the richest person
in the world in 2008.
• Got his big break when he
gained control of Berkshire
Hathaway.
• He invests in undervalued
companies with strong
management.
WARREN BUFFETT Berkshire Hathaway
Profile
19-2
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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
LG1
19-3
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• Securities markets are divided into primary and
secondary markets:
- Primary markets handle the sale of new securities.
- Secondary markets handle the trading of securities
between investors with the proceeds of the sale going to
the seller.
• Initial Public Offering (IPO) -- The first offering
of a company’s stock.
TYPES of SECURITIES MARKETS The Function
of Securities
Markets
LG1
19-4
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• Investment Bankers -- Specialists who assist in the
issue and sale of new
securities.
• Institutional Investors -- Large organizations such as
pension funds or mutual
funds that invest their own
funds or the funds of others.
INVESTMENT BANKERS
and INSTITUTIONAL INVESTORS
The Role of
Investment
Bankers
LG1
19-5
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• Stock Exchange -- An organization whose
members can buy and sell securities on behalf of
companies and individual investors.
• Over-the-Counter (OTC) Market -- Provides
companies and investors with a means to trade
stocks not listed on the national securities
exchanges.
• NASDAQ -- A telecommunications network that links
dealers across the nation so they can exchange
securities.
STOCK EXCHANGES Stock
Exchanges
LG2
19-6
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• NYSE Euronext
• NASDAQ
• London Stock Exchange
• Tokyo Stock Exchange
• Deutsche Borse
TOP STOCK EXCHANGES Stock
Exchanges
LG2
19-7
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• Securities and Exchange Commission (SEC) -
- The federal agency responsible for regulating the
various stock exchanges; created in 1934 through the
Securities and Exchange Act.
• Prospectus -- A detailed registration statement that
includes extensive economic and financial
information that must be sent to prospective
investors.
The SECURITIES and
EXCHANGE COMMISSION
Securities
Regulations
and the SEC
LG2
19-8
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• What’s the primary purpose of a stock exchange?
• Can you name the world’s largest stock
exchange?
• What does NASDAQ stand for? How does this
exchange work?
PROGRESS ASSESSMENT Progress
Assessment
19-9
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• After 35 years at Laddie Come Home, you’re
ready to retire as CEO and your compensation
package includes a bonus if the company’s stock
price reaches a certain amount.
• Another company would like to acquire the
company at a price that exceeds the bonus level.
• If you encourage the board to sell the company,
many jobs could be lost. What do you do?
WAGGING the DOG Making Ethical Decisions
19-10
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• With apprehensions after the financial crisis of
2008-2009, why would we want to invest in less
familiar global stocks?
• Analysts suggest investing money globally. From
2003-2008, markets in China and Brazil
outperformed the U.S.
• Reviewing suggestions in the text are a good
idea if you want to invest globally.
The WIDE, WIDE
WORLD of INVESTING Reaching Beyond Our Borders
19-11
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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
LG3
19-12
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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 stock can improve a
firm’s balance sheet since
stock creates no debt.
ADVANTAGES of
ISSUING STOCKS
Advantages &
Disadvantages
of Issuing Stock
LG3
19-13
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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 STOCK
Advantages &
Disadvantages
of Issuing Stock
LG3
19-14
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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 STOCK
Issuing Shares
of Common
Stock
LG3
19-15
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• Name at least two advantages and
disadvantages of issuing stock as a form of
equity financing.
• What are the major differences between common
stock and preferred stock?
PROGRESS ASSESSMENT Progress
Assessment
19-16
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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
LG4
• 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.
19-17
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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
LG4
19-18
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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
LG4
19-19
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* BOND RATINGS
Advantages &
Disadvantages
of Issuing Bonds
LG4
Rating
Moody’s Standard & Poor’s Description
Aaa AAA Highest Quality
Aa AA High Quality
A A Upper-Medium Grade
Baa BBB Medium Grade
Ba BB Lower-Medium Grade
B B Speculative
Caa CCC, CC Poor
Ca C Highly Speculative
C D Lowest Grade
19-20
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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
LG4
2. Secured bonds:
backed by
collateral (land or
equipment).
19-21
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• Sinking Fund -- Reserve account set up to ensure
that enough money will be available to repay
bondholders on the maturity date.
• Callable bonds permit bond issuers to pay off the
principal before the maturity date.
• Convertible bonds allow bondholders to convert
their bonds into shares of common stock.
SPECIAL FEATURES in
BOND ISSUES
Special Bond
Features
LG4
19-22
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• Why are bonds considered a form of debt
financing?
• What does it mean if a firm issues a 9% bond due
in 2025?
• Explain the difference between an unsecured and
secured bond.
• Why are convertible bonds attractive to
investors?
PROGRESS ASSESSMENT Progress
Assessment
19-23
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• Stockbroker -- A registered
representative who works as
a market intermediary to buy
and sell securities for clients.
• Online trading services,
such as TD Ameritrade,
E*Trade, and Scottrade,
offer securities trading
services online to buy and
sell stocks and bonds.
BUYING SECURITIES How
Investors
Buy
Securities LG5
19-24
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* PRIMARY INVESTMENT SERVICES
CONSUMERS NEED LG5
• Savings and investing advice
• Help with 401k plans
• Retirement planning
• Tax planning
• Estate planning
• Education expense planning
Source: Investment Company Institute.
Major Services
Consumers Seek
from Financial
Advisers
19-25
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1. Investment risk
2. Yield
3. Duration
4. Liquidity
5. Tax consequences
FIVE INVESTMENT CRITERIA Choosing the
Right
Investment
Strategy LG5
19-26
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* AVERAGE ANNUAL RETURN of
ASSET CLASSES (1926-2007) LG5
Choosing the
Right
Investment
Strategy
Investment Return
Small company stocks 12.2%
Large company stocks 9.5%
Corporate bonds 6.0%
Long-term government bonds 5.8%
Treasury bills 4.1%
Source: Ibbotson Associates and Morningstar. 19-27
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• What’s the key advantage of investing through
online brokers? What’s the key disadvantage?
• What’s the primary purpose of diversifying
investments?
PROGRESS ASSESSMENT Progress
Assessment
19-28
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• Bulls: Investors who believe stock prices are
going to rise.
PERCEPTIONS of the MARKET Investing in
Stocks
LG6
• Bears: Investors who
expect stock prices to
decline.
19-29
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* BEAR MARKET DECLINES
in the S&P 500 LG6
Time Period % Drop in Prices
2007-2009 52.5%
2000-2002 51%
1973-1974 48.2%
1968-1970 36.1%
1987-1988 33.5%
Investing in
Stocks
Source: Stock Traders Almanac 2009. 19-30
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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 STOCKS Investing in
Stocks
LG6
19-31
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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 the investment’s
value.
• Firms can never be forced to spilt their stocks.
STOCK SPLITS Stock Splits
LG6
19-32
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• Buying Stock on Margin -- Borrowing some of the
stock’s purchase cost from the brokerage firm.
BUYING STOCK on MARGIN Buying Stock
on Margin
LG6
• Margin is the portion of the
stock’s purchase price that
the investor must pay with
their own money.
• If a broker issues a margin
call, the investor has to come
up with money to cover
losses. 19-33
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* TOP FINANICIAL NEWS and
RESEARCH SITES LG6
• Yahoo Finance
• AOL Money and Finance
• MSN Money
• Forbes
• Dow Jones & Co.
Source: Entrepreneur Magazine, March 2009.
Understanding
Stock
Quotations
19-35
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• First-time bond investors generally ask two
questions:
- Do you have to hold a bond until the maturity date?
- How can I assess the investment risk of a particular bond
issue?
• Junk Bonds -- Bonds that have a high risk and
high default rates.
IMPORTANT BOND QUESTIONS Investing in
Bonds
LG7
19-36
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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 LG8
Investing in
Mutual Funds &
Exchange-
Traded Funds
19-37
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* PERCENTAGE of HOUSEHOLDS
OWNING MUTUAL FUNDS LG8
Source: Investment Company Institute.
Investing in
Mutual Funds &
Exchange-
Traded Funds
Year % of Households
1980 5%
1990 24%
2000 43%
2005 42%
2009 44%
19-38
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* THREE VARIETIES of ETFs
LG8
Source: Schwab and E*Trade.
Investing in
Mutual Funds &
Exchange-
Traded Funds
ETF Description
Traditional Most common; include large U.S. stocks,
small U.S. stocks, international stocks, or
investment-grade bonds.
Niche Focus on an individual sector like healthcare,
high-yield bonds, or a single country.
Exotic Invest in unusual, more volatile sectors such
as commodities like gold and concepts like
clean technology.
19-39
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* UNDERSTANDING
MUTUAL FUND QUOTATIONS LG8
Investing in
Mutual Funds &
Exchange-
Traded Funds
19-40
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• A number of socially responsible investment
funds (SRIs) are prospering.
INVESTING with INTEGRITY Thinking Green
• SRIs invest only in companies
with exceptional environmental,
social and governance practices.
• SRIs are good investments for
long-term investors - they’re lower
risk than alternative investments.
19-41
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* GROWTH of SOCIALLY
RESPONSIBLE INVESTING LG8
Source: Charles Schwab on Investing.
Investing in
Mutual Funds &
Exchange-
Traded Funds
Year Number of SRIs Total Net Assets
1995 50 $10 Billion
1997 130 $90 Billion
2001 175 $170 Billion
2004 200 $210 Billion
2007 250 $260 Billion
19-42
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• What’s a stock split? Why do companies
sometimes split their stock?
• What does buying stock on margin mean?
• What are mutual funds and ETFs?
• What’s the key benefit to investors in investing in
a mutual fund or ETF?
PROGRESS ASSESSMENT Progress
Assessment
19-44
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• Dow Jones Industrial Average -- The average
cost of 30 selected industrial stocks.
• Critics say the 30-company Dow is too small a
sample and suggest following the S&P 500.
• S&P 500 tracks the performance of 400
industrial, 40 financial, 40 public utility, and 20
transportation stocks.
KEY STOCK MARKET
INDICATORS
Understanding
Stock Market
Indicators
LG9
19-45
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• The stock market has its shares of ups and
downs:
MARKET TURMOIL Investing
Challenges in
the 21st Century
Market
LG9
- October 29, 1929 - Black
Tuesday; the market lost 13%
of its value.
- October 19, 1987 - The market
suffered its worst one-day drop
when it lost 22% of its value.
- October 27, 1997 - Fears of an
economic crisis in Asia cause
widespread panic and losses.
19-46
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• The market collapsed into a deep decline in
2000-2002 with the dot-com bubble burst.
- Investors lost $7 trillion in market value.
• In 2008-2009, the collapse of the real estate
market sent financial markets into panic.
- The U.S. government made significant investments in
private banks and offered a large stimulus package to re-
energize the economy.
TURMOIL in the 2000s Investing
Challenges in
the 21st Century
Market
LG9
19-47
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• Wall Street - Issued exotic securities; paid excessive
compensation based on bonuses; and investment banks got
the SEC to relax capital requirement.
• Main Street - Americans lived beyond their means;
lenders gave favorable loans to homebuilders; greedy
homeowners took out equity loans; and teaser mortgage
rates let people live large.
• Washington - Gramm-Leach-Billey Act allowed
commercial and investment banks to partner; housing
interest rates were kept low; and Community Reinvestment
Act forced lending to people with bad credit.
WHO’S at FAULT for the
ECONOMIC CRISIS? LG2
Investing
Challenges in
the 21st Century
Market
Source: Fortune Magazine, www.fortune.com. 19-48
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• Fannie Mae bought huge numbers of mortgages
and bundled them into securities they sold.
• Loans were riskier and more complex.
• Borrowers didn’t fully understand and unqualified
borrowers were granted loans they couldn’t
afford.
• As borrowers defaulted on loans, real estate
prices fell. Financial institutions were left with
loans that wouldn’t be repaid.
GAMBLING with INVESTORS’
SECURITY Legal Briefcase *
19-49