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*ChapterNineteen

UsingSecurities

Markets forFinancing &

Investing

Copyri ght 2010 by the McGraw-Hil l Companies, Inc. All ri ghts reserved.McGraw-Hill/Irwin

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With a net worth of $50 billion,Buffett was the richest personin the world in 2008.

Got his big break when hegained control of BerkshireHathaway.

He invests in undervaluedcompanies with strongmanagement.

WARREN BUFFETTBerkshire Hathaway

Profile

19-2
http://www.berkshirehathaway.com/http://www.berkshirehathaway.com/http://www.berkshirehathaway.com/http://www.berkshirehathaway.com/

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Securities markets arefinancial marketplaces for

stocks and bonds and servetwo primary functions:

1. Assist businesses in findinglong-term funding to finance

capital needs.

2. Provide private investors a placeto buy and sell securities suchas stocks and bonds.

The BASICS ofSECURITIES MARKETS

The Function

of Securities

Markets

LG1

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Securities markets are divided into primary andsecondary markets:

- Primary markets handle the sale of new securities.

- Secondary markets handle the trading of securitiesbetween investors with the proceeds of the sale going tothe seller.

Initial Public Offering (IPO) -- The first offeringof a companys stock.

TYPES of SECURITIES MARKETSThe Function

of Securities

Markets

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Investment Bankers --Specialists who assist in the

issue and sale of newsecurities.

Institutional Investors --

Large organizations such aspension funds or mutual

funds that invest their own

funds or the funds of others.

INVESTMENT BANKERSand INSTITUTIONAL INVESTORS

The Role of

Investment

Bankers

LG1

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Stock Exchange --An organization whosemembers can buy and sell securities on behalf of

companies and individual investors.

Over-the-Counter (OTC) Market -- Providescompanies and investors with a means to trade

stocks not listed on the national securities

exchanges.

NASDAQ --A telecommunications network that linksdealers across the nation so they can exchange

securities.

STOCK EXCHANGESStock

Exchanges

LG2

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NYSE Euronext

NASDAQ

London Stock Exchange

Tokyo Stock Exchange

Deutsche Borse

TOP STOCK EXCHANGESStock

Exchanges

LG2

19-7
http://www.nyse.com/http://www.nasdaq.com/http://www.londonstockexchange.com/home/homepage.htmhttp://www.tse.or.jp/english/http://deutsche-boerse.com/dbag/dispatch/en/kir/gdb_navigation/homehttp://deutsche-boerse.com/dbag/dispatch/en/kir/gdb_navigation/homehttp://www.tse.or.jp/english/http://www.londonstockexchange.com/home/homepage.htmhttp://www.nasdaq.com/http://www.nyse.com/

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Securities and Exchange Commission (SEC) -- The federal agency responsible for regulating the

various stock exchanges; created in 1934 through theSecurities and Exchange Act.

Prospectus --A detailed registration statement that

includes extensive economic and financialinformation that must be sent to prospective

investors.

The SECURITIES andEXCHANGE COMMISSION

Securities

Regulations

and the SEC

LG2

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Whats the primary purpose of a stock exchange?

Can you name the worlds largest stockexchange?

What does NASDAQ stand for? How does this

exchange work?

PROGRESS ASSESSMENTProgress

Assessment

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After 35 years at Laddie Come Home, youre

ready to retire as CEO and your compensation

package includes a bonus if the companys stockprice 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 DOGMaking Ethical Decisions

19-10

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With apprehensions after the financial crisis of2008-2009, why would we want to invest in less

familiar global stocks?

Analysts suggest investing money globally. From2003-2008, markets in China and Brazil

outperformed the U.S.

Reviewing suggestions in the text are a goodidea if you want to invest globally.

The WIDE, WIDEWORLD of INVESTING

Reaching Beyond Our Borders

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Stocks -- Shares ofownership in a company.

Stock Certificate --Evidence of stock ownership.

Dividends -- Part of a firmsprofits that the firm may

distribute to stockholders as

either cash or additional

shares.

LEARNING theLANGUAGE of STOCKS

Learning the

Language of

Stocks

LG3

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Stockholders are owners ofa firm and never have to be

repaid their investment.

Theres no legal obligation to

pay dividends.

Issuing stock can improve afirms balance sheet since

stock creates no debt.

ADVANTAGES ofISSUING STOCKS

Advantages &

Disadvantages

of Issuing Stock

LG3

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Stockholders have the right to vote for acompanys board of directors.

Issuing new shares of stock can alter the controlof the firm.

Dividends are paid from after-tax profits and arenot tax deductible.

The need to keep stockholders happy can affect

managements decisions.

DISADVANTAGES ofISSUING STOCK

Advantages &

Disadvantages

of Issuing Stock

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Common Stock -- The most basic form; holdershave the right to vote for the board of directors and

share in the profits if dividends are approved.

Preferred Stock -- Owners are given preference inthe 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

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Name at least two advantages anddisadvantages of issuing stock as a form of

equity financing.

What are the major differences between commonstock and preferred stock?


Assessment

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Bond --A corporate certificate indicating that aninvestor has lent money to a firm.

LEARNING theLANGUAGE of BONDS

Learning the

Language of

Bonds

LG4

The principal is the face valueof the bond.

Interest -- The payment thebond issuer makes to the

bondholders to compensate them

for the use of their money.

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Bondholders are creditors, not owners of thefirm and cant vote on corporate matters.

Bond interest is tax deductible.

Bonds are a temporary source of funding andare eventually repaid.

Bonds can be repaid before the maturity date ifthey contain a call provision.

ADVANTAGES ofISSUING BONDS

Advantages &

Disadvantages

of Issuing Bonds

LG4

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Bonds increase debt and can affect the markets

perception of the firm.

Paying interest on bonds is a legal obligation.

If interest isnt paid, bondholders can take legal

action.

The face value of the bond must be repaid onthe maturity date.

DISADVANTAGES ofISSUING BONDS

Advantages &

Disadvantages

of Issuing Bonds

LG4

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*BOND RATINGS

Advantages &

Disadvantages

of Issuing Bonds

LG4

Rating

Moodys Standard & Poors 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 SpeculativeCaa CCC, CC Poor

Ca C Highly Speculative

C D Lowest Grade

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Corporations can issue two classes of bonds:

1. Unsecured bonds (debenture bonds): not backed

by specific collateral.

DIFFERENT CLASSES ofCORPORATE BONDS

Different

Classes of

Bonds

LG4

2. Secured bonds:backed bycollateral (land or

equipment).

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Sinking Fund -- Reserve account set up to ensurethat enough money will be available to repay

bondholders on the maturity date.

Callable bonds permit bond issuers to pay off theprincipal before the maturity date.

Convertible bonds allow bondholders to converttheir bonds into shares of common stock.

SPECIAL FEATURES inBOND ISSUES

Special Bond

Features

LG4

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Why are bonds considered a form of debtfinancing?

What does it mean if a firm issues a 9% bond duein 2025?

Explain the difference between an unsecured and

secured bond.

Why are convertible bonds attractive toinvestors?


Assessment

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Stockbroker --A registeredrepresentative 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 tradingservices online to buy andsell stocks and bonds.

BUYING SECURITIESHow

Investors

Buy

SecuritiesLG5

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http://www.tdameritrade.com/welcome1.htmlhttp://www.etrade.com/http://www.scottrade.com/http://www.scottrade.com/http://www.etrade.com/http://www.tdameritrade.com/welcome1.html

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*PRIMARY INVESTMENT SERVICES

CONSUMERS NEEDLG5

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

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1. Investment risk

2. Yield

3. Duration

4. Liquidity

5. Tax consequences

FIVE INVESTMENT CRITERIAChoosing the

Right

Investment

StrategyLG5

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*AVERAGE ANNUAL RETURN ofASSET 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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Whats the key advantage of investing through

online brokers? Whats the key disadvantage?

Whats the primary purpose of diversifying

investments?


Assessment

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Bulls: Investors who believe stock prices aregoing to rise.

PERCEPTIONS of the MARKETInvesting in

Stocks

LG6

Bears: Investors whoexpect stock prices todecline.

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*BEAR MARKET DECLINES

in the S&P 500LG6

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 betweenthe price at which you bought a stock and what you

sell it for.

Investors can also choose stocks according totheir strategy:

- Blue-chip stocks

- Growth stocks

- Income stocks

- Penny stocks

SELECTING STOCKSInvesting in

Stocks

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Stock Splits --An action by a company that givesstockholders two or more shares of additional stock

for every share thats outstanding.

Splits cause no change in the firms ownership

structure and no change in the investments

value.

Firms can never be forced to spilt their stocks.

STOCK SPLITS Stock Splits

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Buying Stock on Margin -- Borrowing some of thestocks purchase cost from the brokerage firm.

BUYING STOCK on MARGIN Buying Stockon Margin

LG6

Margin is the portion of thestocks purchase price thatthe investor must pay withtheir own money.

If a broker issues a margincall, the investor has to comeup with money to coverlosses.

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*UNDERSTANDING STOCK

QUOTATIONS

Understanding

Stock

Quotations

LG6

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*TOP FINANICIAL NEWS and

RESEARCH SITESLG6

Yahoo Finance

AOL Money and Finance MSN Money

Forbes

Dow Jones & Co.

Source: Entrepreneur Magazine, March 2009.

Understanding

Stock

Quotations

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http://finance.yahoo.com/http://money.aol.com/http://moneycentral.msn.com/home.asphttp://www.forbes.com/finance/http://www.dj.com/http://www.dj.com/http://www.forbes.com/finance/http://moneycentral.msn.com/home.asphttp://money.aol.com/http://finance.yahoo.com/

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First-time bond investors generally ask twoquestions:

- Do you have to hold a bond until the maturity date?

- How can I assess the investment risk of a particular bondissue?

Junk Bonds -- Bonds that have a high risk andhigh default rates.

IMPORTANT BOND QUESTIONSInvesting in

Bonds

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Mutual Fund --An organization the buys stocksand bonds and then sells shares in those securities

to the public. The fund pools investors money andbuys stocks according to the funds purpose.

Exchange-Traded Fund (ETF) -- Collections ofstocks and bonds that are traded on securities

exchanges but themselves are traded more like

stocks than mutual funds.

INVESTING in MUTUAL FUNDSand EXCHANGE-TRADED FUNDS

LG8

Investing in

Mutual Funds &

Exchange-

Traded Funds

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*PERCENTAGE of HOUSEHOLDS

OWNING MUTUAL FUNDSLG8

Source: Investment Company Institute.

Investing in

Mutual Funds &

Exchange-

Traded Funds

Year % of Households

1980 5%

1990 24%

2000 43%

2005 42%

2009 44%

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THREE VARIETIES of ETFsLG8

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, orinvestment-grade bonds.

NicheFocus on an individual sector like healthcare,high-yield bonds, or a single country.

ExoticInvest in unusual, more volatile sectors suchas commodities like gold and concepts likeclean technology.

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*UNDERSTANDING

MUTUAL FUND QUOTATIONSLG8

Investing in

Mutual Funds &

Exchange-

Traded Funds

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A number of socially responsible investmentfunds (SRIs) are prospering.

INVESTING with INTEGRITYThinking Green

SRIs invest only in companieswith exceptional environmental,social and governance practices.

SRIs are good investments forlong-term investors - theyre lowerrisk than alternative investments.

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*GROWTH of SOCIALLY

RESPONSIBLE INVESTINGLG8

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

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COMPARING INVESTMENTS

LG8

Investing in

Mutual Funds &

Exchange-

Traded Funds

19-43

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Whats a stock split? Why do companies

sometimes split their stock?

What does buying stock on margin mean?

What are mutual funds and ETFs?

Whats the key benefit to investors in investing ina mutual fund or ETF?


Assessment

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Dow Jones Industrial Average -- The averagecost of 30 selected industrial stocks.

Critics say the 30-company Dow is too small asample and suggest following the S&P 500.

S&P 500 tracks the performance of 400industrial, 40 financial, 40 public utility, and 20transportation stocks.

KEY STOCK MARKETINDICATORS

Understanding

Stock Market

Indicators

LG9

19-45

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* The stock market has its shares of ups and

downs:

MARKET TURMOILInvesting

Challenges in

the 21stCentury

Market

LG9

- October 29, 1929 - Black

Tuesday; the market lost 13%of its value.

- October 19, 1987 - The marketsuffered its worst one-day drop

when it lost 22% of its value.- October 27, 1997 - Fears of an

economic crisis in Asia causewidespread panic and losses.

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The market collapsed into a deep decline in2000-2002 with the dot-com bubble burst.

- Investors lost $7 trillion in market value.

In 2008-2009, the collapse of the real estatemarket sent financial markets into panic.

- The U.S. government made significant investments inprivate banks and offered a large stimulus package to re-energize the economy.

TURMOIL in the 2000sInvesting

Challenges in

the 21stCentury

Market

LG9

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Wall Street - Issued exotic securities; paid excessivecompensation based on bonuses; and investment banks gotthe SEC to relax capital requirement.

Main Street - Americans lived beyond their means;lenders gave favorable loans to homebuilders; greedyhomeowners took out equity loans; and teaser mortgagerates let people live large.

Washington - Gramm-Leach-Billey Act allowedcommercial and investment banks to partner; housinginterest rates were kept low; and Community ReinvestmentAct forced lending to people with bad credit.

WHOS at FAULT for the

ECONOMIC CRISIS?LG2

Investing

Challenges in

the 21stCentury

Market

Source: Fortune Magazine, www.fortune.com. 19-48

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http://www.fortune.com/http://www.fortune.com/

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Fannie Mae bought huge numbers of mortgagesand bundled them into securities they sold.

Loans were riskier and more complex.

Borrowers didnt fully understand and unqualified

borrowers were granted loans they couldnt

afford. As borrowers defaulted on loans, real estate

prices fell. Financial institutions were left withloans that wouldnt be repaid.

GAMBLING with INVESTORS

SECURITY

Legal Briefcase*

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http://www.fanniemae.com/http://www.fanniemae.com/

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What does the Dow Jones Industrial Averagemeasure? Why is it important?

Why do the 30 companies comprising the Dowchange periodically?

Explain program trading and the problems it can

create.


Assessment

Documents

J0712 Pert13