Finance Chapter 2

Preferred Stock (For the Investor)

- to corporate investors, it has a tax advantage because at minimum, 70 percent of dividends recited are tax free.

Investment companies

Are financial institution that pool the savings of individuals avers and invest the money, purely for investment purposes, in the securities issued by other companies.

Non-Bank Financial Intermediaries

Are highly specialize financial intermediaries that provide financial services to businesses. Financial Services Corporations Insurance Companies Investment Banks Investment companies

Capital Markets (Length)

"Long term" in capital markets means having maturities that extend beyond one year.

Money Markets (Length)

"Short term" in money markets means that maturities are one year or less.

Monkey Market Debt (For the Investor)

- Very Liquid: you have access to your money when you need it. - safe: generally invested in high quality investments for brief periods - Low returns - relates tend to be close to the rate of inflation

Long Term Debt and Fixed Income Securities Market (For the Investor)

- can be used to generate dependable current income. - some bonds produce tax free income - long term debt tends to provide higher returns than short term debt - less risky than common stock - investors can lock in an interest rate and know the future returns (assuming the issues does not default on its payments)

Preferred Stock (For the Insurer)

- dividends can be omitted without the risk of bankruptcy - has the disadvantage that dividends are not tax deductible for the issuer, whereas interest payments for debt are tax deductible.

Long Term Debt and Fixed Income Securities Market (For the Borrower)

- interest rates are lock in over the entire life of the debt -has a tax advantage over common stock in that interest payments are tax deductible, whereas dividend payments are not

Common Stock (For the Investor)

- over the long run, common stock has outperformed debt based financial assets - along with the increased expected return comes increased risk

Common Stock (For the Issuer)

- the issuing firm is not legally obligated to make payments - does not have a maturity date - issuance of common stock increases creditworthiness because the firm has more investor money to cushion the firm in the case of a loss. - has tax disadvantage relative to debt; whereas debt interest payments are deductible for tax purposes, common stock dividends are not.

Money Market Debt (For the Borrower)

-Good way of in expensively raising money for short periods of time. -Rates tend to be lower than long term rates -Can borrow money to match short term needs - if interest rates rise, the cost of borrowing will immediately rise accordingly.

Security Markets Bring Corporations and Investors Together

1 - The firms sells securities to investors: corporations raise money in the securities market by selling either debt or equity, when the firm initial sells the securities to the public, it is considered to take place in the primary markets, This is the only time the firm receives money in return for its securities. 2 - The firm invests the funds it raises in its business: the corporation invests the cash raised in the security market in hopes that it will generate cash flows. 3 - The firm distributes the cash earned from items investments: the cash flow form the firms investments is reinvested in the corporation, paid to the government in taxes, or distributed to the investors who own the securities issued in step 1. In the latter case, the chaos is distributed to the investors who lad the firm money ( bough the firms debt securities) through the payment of interest and principal. Cash is paid to the investors who bought equity (stock) through the payment of cash dividends or the repurchase of the share of the firms previously issued stock. 4 - Securities trading in the secondly market: immediately after the securities are sold to the public, the investors who purchased the are free to resell them to other investors, these subsequent transactions take place in the secondary market.

Mortgage Securitization (Steps)

1 - first homebuyers borrow money by taking out a mortgage to finance a home purchase 2 - Second, the lender, generally a bank, saving and load institutions, or mart age brokers that made the loan, then sells the mortgage to another firm or finial institution. 3 - Third, that financial institution pools together a portfolio of many different mortgages, and the purchase of that pool or mortgages is financed through the sale of securities called mortgage backed securities or MBS. 4 - Fourth these MBS are sold to investors who can hold them as an investment or resell them to investors.

Coupon Rate

A coupon rate is the yield paid by a fixed income security; a fixed income security coupon rate is simply just the annual coupon payments paid by the issuer relative to the bonds face or pay value.

Load Fund

A load fund is mutual fund that is sold through a broker, financial advisor, or financial planner who earns a commission in the form of the lead fee when he sells shares of the mutual fund.

No load fund

A mutual fund that doesn't charge a commission is referred to as a no load fund.

Primary Market

A primary market is a market in which new, as opposed to previously issued, securities are bought and sold for the first time. In this market firms firms issue new securities to raise money that they can then use to help finance their businesses, the key feature of the primary market is that the firms selling securities actually received the money raised.

Private Equity Firms

A private equity firm is a financial intermediary that invests in equites that are not traded on the public captivating markets.

Security

A security is a negotiable instrument that represents a financial claim. If can take the form of ownership (stocks) or a debt agreement. The securities markets allow businesses and individual investors to trade the secures issued by public corporations. Public corporations are those whose debt and equity are traded in public markets.

Mutual Fund Shares

A share in a mutual fund is not really like a share of stock because you can only buy and sell share in the mutual fund directly from the mutual fund itself.

Stock Market

A stock market is a public market in which the stock of companies is traded

Organized security exchanges

Are tangible entities, that is they physically occupy space ( such as a building or part of a building) and financial instruments are traded on their premises.

Commercial Banks

Banks collect the savings of individuals as well as business and then lend these pooled saving to other individuals and businesses. They make money by charging a rate of interest to borrowers that exceeds the rebate they pay to savers.

Capital Markets

Capital Markets are for long term financial instruments.

Institutions the make up the financial marketplace consist of...

Commercial banks Finance companies Insurance companies Investment banks Investment companies

Financial intermedaries

Financial intermediaries are institutions that stand between those who have money to invest and those who need money. These include: Commercial Banks Finance companies Insurance companies Investment banks Investment companies

Debt Securities

Firms borrow money by selling debt securities in the debt market. If the debt must be repaid in less than a year, these securities are sold in the short term debt market (money market).

Note

If the debt ( of a debt security) has a maturity (the length of time until the best is due) between 1 and 10 years, it is often referred to as a note.

Bond

If the debt (of a debt security) is longer than 10 years it is called and bond and is sold in the capital market.

History

In response to the Great Depression and the failures of 4,004 banks in 1933, congress enacted the National banking act of 1933 which several sections are commonly referred to s the Glass Stegall Act. An important comparing of the glass Stegall act was the separation of commercial banking and the investment industry. Specifically the act prohibited commercial banks from entering the investment industry in order to limit risks to banks. However, in 1999 Glass Steagall was repealed and many commercial banks acquired investment banks whereas others entered the investment banking business. In 2010 the Dodd Frank Wall Street Reform and Consumer Protection act was passed. Under this act banks as well as non bank financial institutions are subject to considerably more oversight and are required to be more transparent. Another important feature of this legislation is hat is know as the Volker Rule which prohibits banks that take deposits from proprietary trading which is using the banks captivating to make speculative bets on derivatives and securities. The hope is that these changes will increase the stability of the US financial system and ensure that we will not longer be subject to financial crises that throw our economy into a severe recession.

Industrial Corporations and Banks

In the US, although banks can loan money to industrial corporations, banks are prohibited by law from owning them. This restriction prevents banks from loading money to indisputable firms that they own' however, this restriction is not universal around the world.

Over the Counter Markets

Include all security markets except the organized exchanges.

AIG not only sells insurance products but also provides financial services...

Including aircraft and equipment leasing, consumer finance, insurance premium financing, and debt and loan insurance. Of Particular note in this listing of services is debt and loan insurance, which includes selling guarantees to Leander's that reimburse them should the loans they make do into default.

Insurance Companies

Insurance companies are by definition in the business of selling insurance to individuals and businesses to protect their investments. This means that they collect premiums, hold the premiums in reserves until there is an insured loss, and then pay out claims to the holders of the insurance contracts. Note that in the course of collecting and holding premiums, the insurance companies build up huge pools of reserves to pay these claims. These reserves are then used in various types of investments, including loads to individuals and businesses.

Investment Banks

Investment banks are specialize financial intermediaries that help companies and governments raise money and provide advisory services to client firms when they enter into major transactions such as biting or merging with other firms.

Residual Owners

Investors who purchase common stock are the residual owners of the firm.

Exchange Treated Fund (EFT)

Is very much like a mutual fund except for the fact that the ownership shares in the ETF can be bough and sold on the stock exchanges. (Dow Jones Average or S&P 500)

Hedge Fund

Is very much like a mutual fund, but the hedge funds are less regulated and tend to take more risk. They also tend to more actively influence the managers of the corporations that they invest in.

Dividends (Common Stock

It should be noted that unlike bond payments, firms don't have to pay dividends. For example, if a company needs money to invest in a new product or projects it can choose to retain all of its earning within the firm and pay no dividends.

Money Markets

Money Markets are markets for short term debt instruments.

Mutual Fund Benefits

Mutual funds and EFT's provide a cost effective way to diversify, which reduces risk - a great benefit for the small investor.

NASDAQ

National Association of Securities Dealers Automated Quotations, is an over the counter market and describes itself as a "screen based, flourless market"

Accredited Investor

Only an accredited investor, which means an individual with a net worth that exceeds $1 million, can invest in a hedge fund.

Face Value

Par Value

Hybrid Securities

Preferred Stock is sometimes referred to hybrid security because it shares many characteristics of both common stock and bonds.

Preferred Stock is Similar to Bonds...

Preferred stock is similar to bonds in that the dividends paid on the stock, like the interest payments made on boards, are typically a fixed amount. Preferred stock is similar to bonds in that the it does not come with any voting rights.

Preferred Stock is Similar to Common Stock

Preferred stock is similar to common stock in that it has no fixed maturity date. Preferred stock is similar to common stock in that the nonpayment of dividends does not bring on bankruptcy for the firm. Preferred stock is similar to common stock in that the dividends paid on these security are note deductible for tax purposes.

Preferred Stock

Preferred stock, like common stock, is an equity security. Preferred stockholders received their dividends before any divides are distributed to the common stockholders, who received their dividends form whatever is left over. The dividends promised to the preferred stockholders will generally accrue and must be paid in full before common shareholders can received any dividends.

Cumulative Feature

Preferred stockholders will generally accrue and must be paid in full before common shareholders can received any dividends.

Venture Captial Firms

Raise money from investors (wealthy people and other financial institutions) which they then use to provide financing for private start up companies when they are first founded.

Equity Securities

Represent ownership of the corpoation

Financial Institutions (Intermediaries)

The financial institutions and markets that help bring borrowers and savers together.

Financial Markets Facilitate...

The financial markets facilitate the movement of money from savers, who tend to be individuals, to borrowers me who tend to be businesses. In return for the use of the savers money, borrowers produce the savers with a return on their investment.

Dividend Order

The firms creditors (bond holders) get paid first, followed by preferred stockholders, and anything left foes to the common stockholders.

Mutual Fund

The most widely known type of investment company is the mutual fund which is a special type of intermediary through which individuals can invest in in viticulture all of the securities offered in the financial markets.

Net Asset Value (NAV)

The price that you pay when you buy your shares and the price you receive when you sell your share is called the mutual funds net asset value, which is valued daily based on the total value of the fund divided by the number of mutual fund shares outstanding.

Securitization

The process of packaging mortgages is called securitization, because it takes loads that cannot be public ally traded and turn them into securities that can be freely bough and sol by financial institutions.

Secondary Market

The second art market is where all subsequent trading of previously issued security use takes place. In this market the issuing firm does not receive any new financing, as the securities it has sold are simply being transferred from one investor to another. The principal benefit of the secondary market for the shareholders of firms that sell their securities to the public is liquidity.

Load

The term load refers to the sales commission you pay when acquiring ownership shares.

Financial Market Boundaries

There are no national boundaries on financial markets.

Equity Securities (Two Types)

There are two major types of equity securities... Common stock Preferred stock

Leveraged Buyout Firms

These funds acquire established firms that typically have not been performing very well with the objective of making them profitable gain and then selling them.

Savers (Investors)

Those who have money to invest. These are principally individuals who save money for a variety of reasons, such as accumulating a down payment for a home or saving for a return to graduate school. Firms also save when they have excess cash.

Borrowers

Those who need money to finacne their pruchases. This includes business that need ommeby to finance their investments or to expand thier invetories as well as individuals who borrow money to purchase a new automobile or a new home.

Private Equity Firms (Two Types)

Venture Capital Firms Leveraged Buyout Firms

Credit Default Swap

When insurance companies sell guarantees to Leander's that reimburse them should the loans they made go into default.

Common Stock

is a security that represents equity ownership in a corpooation, provides voting rights, and entitles the holder to a share of the company's success in the form of dividends and any capital appreciation in the value of the security.