How to Trade Stocks and Bonds

7/27/2019 How to Trade Stocks and Bonds

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Chapter 18Financing and Investing Through Securities

Markets

Distinguish between the primary

and secondary securities markets.

Compare money market

instruments, bonds, and common

stock, including their benefits.

Identify the objectives of investors

and the types of securities that

best correspond to each.

Describe the characteristics of the

major stock exchanges.

Explain the process of buying orselling a security and the

information included in stock and

bond quotations and stock

indexes.

Discuss the role of mutual funds

and exchange-traded funds in the

securities market.

Evaluate the major

features of regulations

and laws designed to

protect investors.

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Securities Financial instrument such as stocks and bonds.

PRIMARY VERSUS SECONDARY

MARKETS

Primary market Market in which new security issues are first sold to investors;

issuers receive the proceeds from the sale.

Stock offering gives investors the opportunity to purchase ownership shares in a

firm and to participate in its future growth, in exchange for providing current

capital.

Initial public offering (IPO) The first sale of a companys stock to the general

public.

Securities are sold on the open market and through investment bankers.

U.S. Treasury accepts both competitive and noncompetitive bids

for its securities.


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Investment bankers Financial specialists who handle the sales of most

corporate and municipal securities.

Underwriting Process of purchasing an issue from a firm or government and

then reselling the issue to investors.

Investment bankers underwrite stock and bond issues at a discount, which is

their compensation for their services.

Secondary market Market in which existing security issues are bought and sold

by investors.

Examples:New York Stock Exchange,Nasdaq

On a typical day, more than $50 billion worth of stock is traded on NYSE.
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TYPES OF SECURITIESMoney Market Instruments

Money market instruments Short-term debt securities issued

by corporations, financial institutions, and governments.

Generally low-risk securities and are purchased by investorswhen they have surplus cash.

Bonds

Through bonds firms obtain long-term debt capital.

Claims of bondholders are satisfied before those of stockholders in cases of

bankruptcy.


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Types of Bonds

Government bonds Bonds sold by the U.S. Treasury.

Backed by the full faith and credit of the U.S. government

Municipal bonds Bonds issued by state or local governments.

Revenue bondproceeds are to be used to pay for a project

that will produce revenue, such as a toll road or bridge.

General obligation bondproceeds are to be used to pay for a project

that will not produce any revenue, such as a new state police post.

Can be sold only by governmental units that have the power to levy taxes.

Interest payments are exempt from federal income tax.

Secured bond Corporate bond backed by a specific pledge of company

assets.

Debentures Corporate bonds backed only by the issuing firms

financial reputation.

Mortgage pass-through security Backed by a self-liquidating pool

of mortgage loans purchased from lenders.


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Quali ty Rat ings for B ond s

Two factors determine the price of a bond: its risk and its interest rate.

Bond rating A rating of a bonds level of risk.


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Quali ty Rat ings for B ond s

Two factors determine the price of a bond: its risk and its interest rate.

Bond rating A rating of a bonds level of risk.

Higher interest rates bring higher bond prices.

Market interest rates also influences bond prices.

Ret i r ing B ond s Firms must have necessary funds to pay bonds at maturity.

Some firms issue serial bonds, an issue of bonds that mature at different rates.

Call provision Allows the issuer to redeem the bond before its maturity at a

prespecified price.


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Stock

Common stock Shares of ownership in a corporation.

Holders of common stock vote on major company

decisions.

In exchange for their investment, they receive

dividends and/or benefits of increased stock price.

Risk loss of investment if company fails.

Book value

Market value Price at which a stock is currently selling.

Company assets company liabilities

No. of outstanding shares of common stock


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Preferred Stock

Preferred stock Stock whose holders have priority over common stockholders in

the payment of dividends but usually have no voting rights.

Pays fixed dividend regardless of company performance.

Many investors consider it more like a bond than a common stock.

Convert ib le Secu r i t ies

Feature of bond or preferred stock that gives the holder the right to exchange the

bond or preferred stock for a fixed number of shares of common stock.

Convertible bonds pay a lower interest rate than those without a conversion

feature.


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SECURITIES PURCHASERS Two types of purchasers:

Institutional investors An organization that invests its own funds or those it

holds in trust for others.

Individual purchasers, many of who own shares through mutual funds or

employers retirement funds.

Investment Motivations

Five primary sources of motivation:

Growth in capital

Stability of principal Liquidity

Current income

Income growth


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Taxes and Investing

Interest from government and corporate bonds is income taxed at the investors

marginal tax rate.

Dividends are taxed at a lower rate.

Profits from stock sales are taxed as capital gains.

Tax considerations are an important factor in investment decisions.


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SECURITIES EXCHANGESStock exchanges Financial market where stocks are traded.

Exist throughout the world, and most countries have at least one.


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New York Stock Exchange

One of worlds oldest, founded in 1792.

Lists more than 3,000 common and preferred stocks

with market value of more than $13 trillion.

Worlds largest, as measured by total value of stock traded.

Trading takes place face-to-face on trade floor.

Only members are allowed to trade on the floor.

The Nasdaq Stock Market

A computerized communications network that links member investment firms.

Worlds largest intranet.

Lists approximately 5,000 stocks.


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Other U.S. Stock Markets

American Stock Exchange, or AMEX, in New York.

Daily trading volume around 60 million shares.

Regional stock exchanges include Chicago, Pacific (San Francisco), Boston,

Cincinnati, and Philadelphia Stock Exchanges.

Foreign Stock Markets Most countries have at least one stock exchange.

One of largest outside U.S. is the London Stock Exchange.

Lists 2,900 companies.

Handles two-thirds of all cross-border trading worldwide.

ECNs and the Future of Stock Markets

Electronic communications networks (ECNs) Fourth market

opening up to smaller, individual investors.

Buyers and sellers meet trade directly with one another in a

virtual stock market.


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BUYING AND SELL ING SECURITIESBrokerage firm Financial intermediary that buys and sells securities for

individual and institutional investors.

Examples: A. G. Edwards, Raymond James, Morgan Stanley, and Wachovia

Securities.

Placing an Order

Investor initiates purchase by contacting brokerage firm.

Market order Instructs the brokerage firm to obtain the highest price possible, if

the investor is selling, or the lowest price possible, if the investor is buying.

Limit order Instructs the brokerage firm not to pay more than a specified pricefor a stock, if the investor is buying, or not to accept less than a specified price,

if the investor is selling.
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Stock Indexes

Examples include the Dow Jones Industrial Average, Standard & Poors 500,

and theNasdaq Composite indexes.

Dow Jones Industrial Average, started in 1884, has served as a general measure

of overall stock prices and a reflection of the economy.

Only original remaining member is General Electric.
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MUTUAL FUNDS AND EXCHANGE-TRADED FUNDS

Mutual fund Financial institution that pools money from purchases of its shares

and uses the money to acquire diversified portfolios of securities consistent

with the funds investment objectives.Mutual Funds

Investors become part owners of large number of securities, lessening individual

risk.

Total mutual fund assets exceed $8 trillion.

55 million American households own mutual fund shares.


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Exchange-Traded Funds

Raises funds by selling shares to investors and then uses those funds to purchase

a portfolio of securities.

Sells a fixed number of shares to investors in what is effectively an initial public

offering.

Then ETF shares trade on stock exchanges much like shares of individual

companies.

Almost 200 ETFs with total assets of around $250 billion.

Two main appeals:

Shareholders are charged little or nothing for annual operating expenses.

Can be more tax efficient because they dont generate a lot of taxable capital

gains.


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LEGAL AND ETHICAL ISSUES INSECURITIES TRADING

Government Regulation of the Securities Market

Mostly by the federal government, primarily the Securities and Exchange

Commission.

SEC requires registration of all new public issues of corporate securities.

Full and fair disclosure Requirement that investors should be told all relevant

information by stock or bond issuers so they can make informed decisions.

Insider trading Use of material, nonpublic information to make investor profits.

Regulation FD Requires firms to share information with all investors at the

same time.

Public corporations must file several reports annually.
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Industry Self-Regulation

Professional Rules of Condu ct

Rules of conduct established and updated by the National Association of Securities

Dealers

Ensure that brokers perform their basic functions honestly and fairly, under constant

supervision.

Market Survei l lance

Techniques for spotting possible violations of trading rules or securities laws.

NYSE uses Stock Watch to flag unusual price and volume activity.

Market participants keep detailed records about transactions.


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Perfection is not just for the movies.

Self-regulation means that

Professional Rules of Conduct

should always be followed.
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How to Trade Stocks and Bonds