Chapter 19- Using Securities Markets for Financing and Investing Opportunities

What type of information do stock quotations give you?

Stock quotations provide the highest and lowest price in the las 52 weeks; the dividend yield; the price/earnings ratio; the total shares traded that day; and the closing price and net change in price from the previous day.

What is a market order?

A market order tells a broker to buy or sell a security immediately at the best price available.

What are stock exchanges?

Stock exchanges are securities markets whose members are engaged in buying and selling securities such as stocks and bonds.

What is the key benefit to investors investing in a mutual fund or ETF?

Mutual funds and ETF-s lower risk by diversifying investments.

Explain program trading and the problems it can create?

Program trading is when investors give their computers instructions to sell automatically to avoid potential losses, if the price of their stock dips to a certain point. This can be problematic because computers malfunction, and if a key computer is turned off, program trading halts.

What is the primary purpose of a securities exchange?

Securities exchange's primary purpose is to serve as a place for businesses to find long-term funding to finance capital needs.

What does it mean if a firm issues a 9 percent debenture bond due in 2025?

The bond is unsecured (has no collateral), has an annual interest rate of 9%, and has a maturity date of 2025.

NASDAQ

a nationwide electronic system that communicates over-the-counter trades to brokers

What information does a bond quotation give you?

A bond quotation gives the bond's interest rate (coupon rate), maturity date, rating, current price, and whether it's callable.

stock splits

an action by a company that gives stock holders two or more shares of stock for each one they own

debenture bonds

bonds that are unsecured (i.e., not backed by any collateral such as equipment)

diversification

buying several investment alternatives to spread the risk of investing

What is a limit order?

A limit order tells the broker to buy or sell if the stock reaches a specific price.

What are mutual funds and ETF-s?

A mutual fund is an organization that buys stocks and bonds and then sells shares in those securities to the public enabling individuals to invest in many more companies than they could otherwise afford. Like mutual funds, ETFs are collections of stocks that are traded on securities exchanges, but they are traded more like individual stocks.

What opportunities do securities markets provide businesses and individual investors?

By issuing securities businesses are able to raise much-needed funding to help finance their major expenses. Individual investors can share in the success and growth of emerging or established firms by investing in them.

Why are convertible bonds attractive to investors?

Convertible bonds can be attractive to investors because common stock value tends to grow faster than a bond.

What is insider trading?

Insider trading is the use of information or knowledge that individuals gain that allows them to benefit unfairly from fluctuations in security prices.

What role do investment bankers play in securities markets?

Investment bankers are specialist who assist in the issue and sale of new securities.

What is a junk bond?

Junk bonds are high-risk (rated BB or below), high-interest debenture bonds that speculative investors often find attractive.

stock certificate

evidence of stock ownership that specifies the name of the company, the number of shares it represents, and the type of stock being issued

over-the-counter (OTC) market

exchange that provides a means to trade stocks not listed on the national exchanges

program trading

giving instructions to computers to automatically sell if the price of a stock dips to a certain point to avoid potential losses

junk bonds

high-risk, high-interest bonds

institutional investors

large organizations--such as pension funds, mutual funds, and insurance companies--that invest their own funds or the funds of others

dividends

part of a firm's profits that the firm may distribute to stock holders as either cash or additional shares of stock

buying stock on margin

purchasing stocks by borrowing some of the purchase cost from the brokerage firm

stocks

shares of ownership in a company

Dow Jones Industrial Average (the Dow)

the average cost of 30 selected industrial stocks used o give an indication of the direction (up or down) of the stock market over time

maturity date

the exact date the issuer of a bond must pay the principal to the bondholder

Explain the difference between an unsecured and secured bond.

Unsecured (debenture) bonds are not supported by any collateral, whereas secured bonds are backed by tangible assets such as mortgages, buildings, and equipment.

bond

a corporate certificate indicating that a person has lent money to a firm

mutual fund

an organization that buys stocks and bonds and then sells shares in those securities to the public

stock exchange

an organization whose members can buy and sell (exchange) securities for companies and investors

exchange-traded funds (ETFs)

collections of stock that are traded on exchanges but are traded more like individual stocks than like mutual funds

Securities and Exchange Commission (SEC)

federal agency that has responsibility for regulating the various exchanges

investment bankers

specialists who assist in the issue and sale of new securities

preferred stock

stock that gives its owners preference in the payment of dividends and an earlier claim on assets than common stockholders if the company is forced out of business and its assets sold

initial public offering (IPO)

the first public offering of a corporation's stock

What does buying stock on the margin mean?

An investor buying on margin borrow part (the percentage allowed to be borrowed is set by the Federal Reserve) of the cost of a stock from the broker to get shares of stock without immediately paying the fully price.

How do investors normally purchase in securities markets?

Investors can purchase investments through market intermediaries called stockbrokers, who provide many different services. Online investing, however, has become extremely popular.

What is the key advantage of investing through online brokers? What is the key disadvantage?

One key advantage of investing through online brokers is lower fees, because the investor does their own research. The key disadvantage is the lower level of information.

What does the Dow Jones Industrial Average measure? Why is it important?

The Dow Jones Industrial Average is the average price of 30 specific stocks that analysts use to track the directions (up or down) of the stock market.

What does NASDAQ stand for? And How does it work?

The NASDAQ (originally know as the National Association of Securities Dealers Automated Quotations) was the world's first electronic stock market. The NASDAQ is an electronic-based network that links dealers so they can buy and sell securities electronically rather than in person.

What are the different exchanges?

The NYSE Euronext lists the stock of over 8,000 companies. The NASDAQ is a telecommunications network that links dealers across the nation so that they can buy and sell securities electronically rather than in person. It is the largest U.S. electronic stock trading market. There are stock exchanges all over the world.

What is the over-the-counter (OTC) market?

The OTC market is a system for exchanging stocks not listed on the national exchanges.

How are securities exchanges regulated?

The Securities and Exchange Commission (SEC) regulates securities exchanges and requires companies that intend to sell bonds or stocks to provide a prospectus to potential investors.

common stock

the most basic form of ownership in a firm; it confers voting rights and the right to share in the firm's profits through dividends, if offered by the firm's board of directors

What is the primary purpose of diversifying investment?

Diversification means buying several different types of investments (government bond, corporate bonds, preferred stock, common stock, global stock) with different degrees of risk. The purpose is to reduce the overall risk an investor would assume by investing in just one type of security.

What are the major differences between common stock and preferred stock?

Holders of common stock have voting rights in the company. In exchange for having no voting rights, preferred stockholders receive a fixed dividend that must be paid in full before common stockholders receive a dividend. Preferred stockholders are also paid back their investment before common stockholders if the company is forced out of business.

interest

the payment the issuer of the bond makes to the bondholders for the use of borrowed money

capital gains

the positive difference between the purchase price of a stock and its sale price

Why are bonds considered a form of debt financing?

An organization that issues bonds has a legal obligation to make regular interest payments to investors and to repay the entire bond principle amount at a prescribed time.

What are the criteria for selecting investments?

Investors should determine their overall financial objectives and evaluate investments according to (1) risk, (2) yield, (3) duration, (4) liquidity, and (5) tax consequences.

Why do the 30 companies comprising the Dow change periodically?

The Dow changes periodically because the market changes.

What are the advantages and disadvantages of issuing bonds?

The advantages of issuing bonds include the following: (1) management retains control since bondholders cannot vote; (2) interest paid on bonds is tac deductible; (3) bonds are only a temporary source of financing, and after they are paid off the debt is eliminated; (4) bonds can be paid back early if they are callable; and (5) sometimes bonds can be converted to common stock. The disadvantages of issuing bonds include the following: (1) because bonds are an increase in debt, they may adversely affect the market's perception of the company; (2) the firm must pay interest on its bonds; and (3) the firm must repay the bond's face value on the maturity date.

Name at least two advantages and two disadvantages of a company's issuing stock as a form of equity financing.

The advantages of selling stock include the following: (1) the stock price never has to be repaid to the stock holders, since they become owners in the company; (2) there is no legal obligation to pay stock dividends; and (3) the company incurs no debt, so it may appear financially stronger. Disadvantages of selling stock include the following: (1) stockholders become owners of the firm and can affect its management by voting for the board of directors; (2) it is more costly to pay dividends since they are paid in after-tax profits; and (3) managers may be temped to make stockholders happy in the short term rather than plan for long-term needs.

What is a stock split? Why do companies sometimes split their stocks?

When a stock splits, stockholders receive two (or more) shares of stock for each share they own. Each is worth half (or less) of the original share, so while the number of shares increases, the total value of stockholders' holdings stays the same. Stockholders hope the lower per-share price that results may increase the demand for stock.

prospectus

a condensed version of economic and financial information that a company must file with the SEC before issuing stock; the prospectus must be sent to prospective investors

stockbroker

a registered representative who works as a market intermediary to buy and sell (exchange) securities for companies and investors

sinking fund

a reserve account in which the issuer of a bond periodically retires some part of the bond principal prior to maturity so that enough capital will be accumulated by the maturity date to pay off the bond