CHAPTER 19: UNDERSTANDING SECURITIES AND INVESTMENTS SECURITIES MARKETS Stocks and bonds are known as securities because

e they represent secured, or asset-based, claims on the part of the investors Stockholders have claims on some of a corporations assets because each share of stock represents part ownership Bonds represent strictly financial claims for money owed to bondholders by a company Companies sell bonds to raise long-term funds Markets in which stocks and bonds are sold are called securities markets Primary and Secondary Markets for Securities: Primary Securities Markets: the sale and purchase of newly issued stocks and bonds by firms or government New securities are sometimes sold to one buyer or a small group of buyer in private placements, the business that use them keep their plans confidential 1. Investment Banking Most new stocks and some bonds are sold to the wider public market Investment Banker: any financial institution that purchases and resells new stocks and bonds They provide three types of services: Advise the company on the timing and financial terms for the new issue By underwriting (buying) the new securities, investment bankers bear some of the risk of the issuing of the new security Create the distribution network that moves the new securities through groups of other banks and brokers into the hands of individual investors Market for existing stocks and bonds, the secondary securities market, is handled by organizations such as the Toronto Stock Exchange STOCKS Common Stock: Stock values are expressed in three different ways as par value, as market value, and as book value 1. 2. Par Value Is the face value of a share of stock; the arbitrary value of a stock set by the issuing companys board of directors and stated on stock certificates Each company must preserve the par value money in its retained earnings Par value cannot be distributed as dividends Market Value Is a stocks real value current price of a share on the stock market (secondary securities market) Reflect buyers willingness to invest in a company Market price of a stock can be influenced by both objective factors (i.e. companys profits) and subjective factors like rumours, investor relations, and stockbroker recommendations Book Value Is the value of a common stock expressed as total stockholders equity divided by the number of shares of stock Is used as a comparison indicator because for successful companies, the market value is usually greater than the book value Investment Traits of Common Stock Common stock are among the riskiest of all securities but offer high growth potential What Is a Blue-Chip Stock? Is stock that has been issued by a well-established, financially sound firm Performance guidelines for assigning blue-chip stock history of dividend payouts, steady growth in earnings per share, low price earnings ratio, etc

3. 4. 5.

a) Market Capitalization Is the dollar value (market value) of stocks listed on a stock exchange Is computed by multiplying the number of a companys outstanding shares times the value of each share Preferred Stock: Is stock that pays dividends that are expressed as a percentage of par value

Some preferred stock is callable issuing firm can require the preferred shareholders to surrender their shares in exchange for a cash payment, known as the call price

1.

Investment Traits of Preferred Stock Is less risky than common stock because of the dividends Most preferred stock is cumulative Cumulative Preferred Stock: preferred stock on which dividends not paid in the past must first be paid up before the firm may pay dividends to common shareholders But theyre not as certain as corporate bonds since company cant pay dividends if theres no profit Purchase price of preferred stock can also fluctuate and growth potential is limited due to its fixed dividend Stock Exchange: Most of secondary market for stocks is handled by organized stock exchanges Is an organization of individuals formed to provide an institutional setting in which shares of stock can be bought and sold Most exchanges are non-profit corporations established to serve their members To become a member, individual must purchase one of a limited number of memberships called seats on the exchange Only members are allowed to trade on the exchange Because all orders to buy or sell must flow through members, they have a legal monopoly Memberships can be bought and sold like other assets 1. 2. a) b) 3. 4. The Trading Floor Each exchange regulates the places and times at which trading may occur Used to be at an actual physical location but now computers are used to match buy and sell orders Brokers Receives buy and sell orders from those who are not members of the exchange and executes the orders In return, broker earns a commission from the order placer Brokerage assistance can be purchased at either discount or full-service prices Discount Brokers Offer well-informed individual investors a fast, low-cost way to participate in the market Their service costs less because sales personnel receive fees or salaries, not commission They dont generally offer investment advice or person-to-person sales consultations They do automated online services, such as stock research, industry analysis, and screening for specific types of stocks Online traders must use a broker Full-Service Brokers Help both new, uninformed investors and experiences investors who dont have time to keep up with all the latest developments Offer clients suggestions on investments that clients might overlook when trying to sift through an avalanche of online financial data Also provide real estate planning, tax strategies, and a wider range of investment products Canadian Stock Exchanges The Toronto Stock Exchange (TSX) is the largest stock exchange in Canada

Foreign Stock Exchanges The New York Stock Exchange (NYSE), the American Stock Exchange (AMEX), U.S. Regional Stock Exchanges, the Over-the-Counter Market (OTC organization of securities dealers formed to trade stock outside the formal institutional setting of the organized stock exchanges), National Association of Securities Dealers Inc. (NASD), and National Association of Securities Dealers Automated Quotation (NASDAQ a stock market implemented by NASD that operates by broadcasting trading information on an intranet to more than 350,000 terminals worldwide) BONDS Is an IOU a written promise that the borrower will pay the lender at some stated future date, a sum of money (the principal) plus an additional amount (the interest) Bondholders have a claim on a corporations assets and earnings that comes before the claims of common and preferred shareholders Bonds differ from one another in terms of maturity, tax status, and level of risk vs. potential yield

 Not all companies issue bonds Shareholders provide equity (ownership), while bondholders are lenders Stock certificates represent ownership while bond certificates represent indebtedness Corporate Bonds: Are bonds issued by a company as a source of long-term funding Are riskier than short-term bonds Corporate bonds may be categorized in one of two ways: according to methods of interest payment, and according to whether they are secured or unsecured 1. Investment Payment: Registered and Bearer Bonds Registered Bonds: bonds where the names of holders are registered with the companys, cheques are mailed to the bondholders Bearer (or coupon) Bonds: require bondholders to clip coupons from certificates and send them to the issuer to receive payment; coupons can be redeemed by anyone, regardless of ownership

2. Secured and Unsecured Bonds Secured Bonds: issued by borrowers who pledge assets as collateral in the event of non-payment Debentures: unsecured bonds; have inferior claims on the corporations assets The Retirement of Bonds: Maturity dates on bonds of all kinds may be very long All bonds must be paid off or retired at some point With regard to maturity dates, there are three types of bonds: callable, serial and convertible 1. a) 2. Callable Bonds Are bonds that may be paid off by the issuer before the maturity date Usually happens when prevailing interest rates are lower than the rate being paid on the bond Issuer must pay a call price (difference between face value and call price) to the bondholder Sinking Funds Sinking Fund Provisions are a clause in the bond indenture (contract) that requires the issuing company to put enough money into a social bank account each year to cover the retirement of that bond issue on schedule Regarded as safer investments than many other bonds Serial Bonds Are bonds in which redemption dates are staggered so that a firm pays off portions of the issue at different predetermined dates

3. Convertible Bonds Can be converted into the common stock of the issuing company Holder can have payment in stock or cash (his/her choice) Government Bonds: Are bonds issued by the federal government Are among the safest investments available since Canadian government backs all federal bonds Municipal Bonds: bonds issued by provincial or local government Used to finance school, transportation systems, and a variety of other projects OTHER INVESTMENTS Financial managers are also concerned with investment opportunities in mutual funds, hedge funds, commodities, and stock options In striking the right balance for risk among investment alternatives, financial managers use diversification and asset allocation Mutual Funds: Are any company that pools the resources of many investors and uses those funds to purchase a portfolio of various types of financial securities, depending on the funds financial goals No-Loan Fund: a mutual fund in which investors are not charged a sales commission when they buy in to or sell out of the fund Loan Funds: a mutual fund in which investors are charged a sales commission when they buy in to or sell out of the fund Mutual funds vary by the investment goals they stress (i.e. some offer immediate income) Ethical Funds: mutual funds that focus on investing on companies that produce safe and useful products and do good in terms of employee relations, environmental practices and human rights

Exchange-Traded Fund (ITF): a bundle of stocks (or bonds) that are in an index that tracks the overall movement of a market; can be traded throughout the day like stock, and have lower operating expenses Hedge Funds: Are private pools of money that try to give investors a positive return regardless of stock market performance Often engage in risky practices like short-selling (betting that a companys stock price will go down) and leveraging (borrowing money against principal) Commodities: Are products ranging from coffee beans and hogs to propane and platinum Futures Contracts: agreement to purchase specified amounts of a commodity (or stock) at a given price on a set future date Can be bought and sold in the commodities market These contracts are available for stocks, not only commodities Because selling prices reflect traders estimates of future events and values, future prices are quite volatile and trading is risky 1. Margins Is the percentage of the total sales price that a buyer must put up to place an order for stock or a futures contract Stock Options: Is the right to buy or sell a stock Call Option: the purchased right to buy a particular stock at a certain price until a specified date Put Option: purchased right to sell a particular stock at a certain price until a specified date Making Choices for Diversification, Asset Allocation, and Risk Reduction: 1. Diversification Is the purchase of several different kinds of investments rather than just one Risk of loss is reduced 2. Asset Allocation Is the proportion of funds invested in (or allocated to) each of several investment alternatives BUYING AND SELLING SECURITIES Using Financial Information Services: 1. Stock Quotations Shows corporations name, number of shares sold, the high and low prices of the stock for that trading day, the closing price of the stock, and the change from the closing price on the previous day 2. 3. 4. a) b) c) Bond Quotations Coupon Rate: provides information for firms about the cost of borrowing funds Shows issuer of bond, coupon rate, maturity date, price, and yield Mutual Funds Quotations Funds net asset value (NAV), the current market value of one share, is the key term for understanding the quotations Market Indexes Are a measure of the market value of stocks; provides a summary of price trends in a specific industry or of the stock market as a whole Bull Market: a period of rising stock prices; a period in which investors act on a belief that stock prices will rise Bear Market: period of falling stock prices; period in which investors act on belief that stock prices will fall The Dow Jones Industrial Average (DJIA) Is the market index based on the prices of 30 of the largest firms listed on NYSE and NASDAQ Is the average of the stock price for these 30 large firms The Standard and Poors Composite Index (S&P 500) Is the market index based on the performance of 400 industrial firms, 40 utilities, 40 financial institutions, and 20 transportation companies Consists of 500 stocks (400 + 40 + 40 + 20) The S&P/TSX Index Is an average computed from 225 different large Canadian stocks from various industry groups

d) The NASDAQ Composite Index Is the value-weighted market index that includes all NASDAQ-listed companies, both domestic and foreign Buying and Selling Stocks: Market Order: an order to a broker to buy or sell a certain security at the current market price Limit Buy Order: an order to a broker to buy a certain security only if its price is less than or equal to a given limit Limit Sell Order: an order to a broker to sell a certain security only if its price is equal to or greater than a given limit Stop Order: an order to a broker to sell a certain security if its price falls to a certain level or below Round Lot: the purchase or sale of stock in units of 100 shares Odd Lot: the purchase or sale of stock in units other than 100 shares Financing Securities Purchases: Can use cash or credit 1. 2. Margin Trading As with futures contracts, you can buy stocks on margin putting down only a portion of the stocks price; can borrow the rest from broker who borrows from banks Losses and wins are amplified

Short Sales Is selling borrowed shares of stock in the expectation that their price will fall before they must be replaced, so that replacement shares can be bought for less than the original shares were sold for SECURITIES REGULATION Canadian Securities Regulations: Blue-Sky Laws: laws regulating how corporations must back up securities U.S. Securities Regulations: Prospectus: a detailed registration statement about a new stock filled with a provincial securities exchange; must include any data helpful to a potential buyer Program Trading: large purchase or sale of a group of stocks, often triggered by computerized trading programs that can be launched without human supervision or control