CHAPTER 19– USINGSECURITIES MARKETS FOR FINANCING AND
INVESTING OPPORTUNTIES
LEARNING GOALS:
After you have read and studied this chapter you should be able to:
1.Describe the role of securities markets and of investment bankers.
2. Identify the stock exchanges where securities are traded
3. Compare the advantages and disadvantages of equity financing by issuing stock, and detail the differences between common and preferred stock.
- Compare the advantages and disadvantages of obtaining debt financing by issuing bonds and identify the classes and features of bonds.
- Explain how to invest in securities markets and set investment objectives such as long-term growth, income, cash, and protection from inflation.
6. Analyze the opportunities stocks offer as investments
7.Analyze the opportunities bonds offer as investments.
8.Explain the investment opportunities in mutual funds and exchange-traded funds (ETFs).
9. Describe how indicators like the Dow Jones Industrial Average affect the market.
LEARNING THE LANGUAGE
Listed below are important terms found in the chapter. Choose the correct term for the definition and write it in the space provided.
Bond / Institutional investors / Program tradingBuying stock on margin / Interest / Prospectus
Capital gains / Investment bankers / Securities and Exchange Commission (SEC)
Common stock / Junk bonds / Sinking fund
Debenture bond / Maturity date / Stockbroker
Diversification / Mutual fund / Stock certificate
Dividends / (NASDAQ) / Stock exchange
Dow Jones Industrial Average (the Dow) / Over-the-counter market (OTC) / stocks
Exchange traded funds (ETFs) / Preferred stock / Stock splits
Initial public offering (IPO)
1.Large investors known as ______are organizations such as pension funds, mutual funds, insurance companies, and banks that invest their own funds or the funds of others.
2The ______is an exchange that provides a means to trade stocks not listed on national exchanges.
3.Evidence of stock ownership is called a ______and specifies the name of the company, the number of shares it represents, and the type of stock being issued.
4.Trading known as ______means giving instructions to computers to automatically sell if the price of stock dips to a certain point to avoid potential losses.
5.The most basic form of ownership in a firm is ______, which confers voting rights and the right to share in the firm’s profits through dividends, if offered by the firm’s board of directors.
6.A ______is a reserve account in which the issuer of a bond periodicallyretires 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.
7.A registered representative who works as a market intermediary known as a ______, buys and sells securities for clients.
8. An organization that is known as a ______is one whose members can buy and sell securities for companies and investors.
9.The exact date the issuer of a bond must pay the principal to the bondholder is known as the ______.
10.Stock called ______gives its owner's preference in the payment of dividends and an earlier claim on assets than common stockholders if the business is forced out of business and its assets sold.
11.Specialists called ______assist in the issue and sale of new securities.
12. The payment the issuer of a bond makes to the bondholders to pay for the use of borrowed money is called ______.
13.A ______is a bond that is unsecured (i.e. not backed by any collateral.)
14.The process of ______is the purchase of stocks by borrowing some of the purchase cost from the brokerage firm.
15.The part of a firm's profits that may be distributed to stockholders as either cash payments or additional shares of stock are called ______.
16.A ______is an action by a company that gives stockholders two or more shares of stock for each one they own.
17.The technique of ______means buying several different investment alternatives to spread the risk of investing.
18. Shares of ownership in a company are called ______.
19.A ______is an organization that buys stocks and bonds and then sells shares in those securities to the public.
20.A corporate certificate called a ______indicates that a person has lent money to a firm.
21.The average cost of 30 selected industrial stocks called the ______is used to give an indication of the direction of the stock market over time.
22.The ______is the federal agency that has the responsibility for regulating the various exchanges.
23.A condensed version of economic and financial information called a ______must be filed with the SEC before issuing stock; it must be sent to potential purchasers of the firm’s stock.
24.The ______is a nationwide electronic system that links dealers across the nation so that they can buy and sell securities electronically.
25.______are the positive differences between the purchase price of a stock and its sale price.
26.A (n) ______is the first public offering of a corporation’s stock.
27.High-risk, high-interest bonds are called ______.
28.Collections of stocks that are traded on exchanges are called ______, and are traded more like individual stocks than like mutual funds.
ASSESSMENT CHECK
Learning Goal 1
The Function of Securities Markets
- Describe the two major functions of securities markets.
- ______
b.______
2. Explain the difference between the primary and the secondary markets
3.What functions do investmentbankers perform for companies?
a.______
b.______
4.Give some examples of types of institutional investors
Learning Goal 2
Stock Exchanges
5.Describe the NYSE Euronext.
6.How does trading over the counter (OTC) differ from trading on the NYSE Euronext?
7.The NASDAQ is ______
______
8.How does the Securities Act of 1933 protect investors?
9.Discuss the provisions of the Securities and Exchange Act of 1934.
a.______
b.______
c.______
d.______
10.Insider trading is : ______
______
The term “insider” includes: ______
______
11.How is it possible for Americans to purchase stocks in foreign companies, and for foreigners to purchase stock in American companies?
Learning Goal 3
How Businesses Raise Capital by Selling Stock
12.What is meant by a stock’s par value?
13.Describe the important elements of dividends.
a. ______
b. ______
c. ______
14.List the advantages of raising funds through the sale of stock.
a.______
b.______
c.______
15. Describe the disadvantages of issuing stock.
a.______
b.______
c.______
16.What are three rights of holders of common stock?
a.______
b.______
c.______
17.What are the benefits of owning preferred stock?
a. ______
b.______
18.Normally, preferred stockholders do not get______
Preferred stock is generally issued with a par value that becomes ______
______
19.The special features of preferred stock are that it can be:
- ______
b.______
c.______
Learning Goal 4
How Businesses Raise Capital by Issuing Bonds
20.What legal obligation does a company have when selling bonds?
21.What is meant by the term “principal” when referring to a bond?
22.If a $1,000 bond has an interest rate of 10% and a maturity date of 2030, what does that mean to a bondholder?
23.What is meant by the term “coupon rate” with regard to bonds?
24.What factors affect the interest rate of a bond? Can the rate of interest change, once it has been set?
25.List the advantages of raising long-term capital by selling bonds.
a.______
b.______
c. ______
d.______
26. What are the disadvantages?
a. ______
b. ______
c. ______
27.Describe the two classes of corporate bonds.
28. Why are sinking funds attractive to firms and investors?
a.______
b.______
c.______
29.What the characteristics of a callable bond, and what is the benefit to a company?
30.What are the features of a convertible bond, and why would an investor convert a bond to common stock?
Learning Goal 5
How Investors Buy Securities
31.What is the process for an individual to invest in stocks and bonds?
32.What is the benefit of trading on-line?
33.What kind of customers use online trading?
34.The first step in any investment program is to: ______
Other factors to consider are: ______
______
35.Describe the five criteria to use when selecting an investment option.
a.______
b.______
c.______
d.______
e.______
36.What is the benefit of diversification in a portfolio of stocks and bonds?
Learning Goal 6
Investing in Stocks
37.In the stock market, describe:
Bulls (and a bull market): ______
______
Bears (and a bear market): ______
______
38.According to the text, what determines the market price of a stock?
39.Describe:
- Growth stocks: ______
______
- Income stocks: ______
______
- Blue chip stocks: ______
______
d.Penny stocks: ______
______
40.What is the difference between a market order and a limit order, when placing an order to buy stock?
41.What is the difference between a round lot and an odd lot?
42.Why would a company declare a stock split?
How does a two-for-one- stock split work?
How does a stock split benefit an investor?
43.What is a “margin”? What does a 50% margin rate mean?
44.What is the downside of buying on margin?
What is meant by the term “margin call”?
45.What information is included in a stock quote?
a.______
b.______
c.______
d.______
e.______
Learning Goal 7
Investing in Bonds
46.What are the best investments for those who desire limited risk and guaranteed income?
47.What are two questions first time corporate bond investors may ask? What are the answers to the questions?
48.What does it mean to sell a bond:
at a discount? ______
at a premium?______
49.Why are junk bonds considered “junk”?
50.How is the price of a bond quoted?
51.What information is included in a bond quote?
a. ______
b. ______
c. ______
d. ______
e. ______
Learning Goal 8
Investing in Mutual Funds and Exchange-Traded Funds
52.What benefit does a mutual fund offer to an investor?
53.Describe an index fund.
54.What is the difference between a no-load and a load fund?
55.What is the difference between an open-end fund and a closed-end fund?
56.Discuss the primary characteristics of ETFs.
57.What information is contained in a mutual fund quote?
- ______
- ______
- ______
- ______
- ______
58.What is the net asset value, or NAV and how is it calculated?
Learning Goal 9
Understanding Stock Market Indicators
59.The financial industry used the Dow Jones Industrial Average to ______
______
60.Do the companies included in the Dow ever change?
61.What is a criticism of the Dow Jones Industrial Average?
What do many investors prefer to follow instead of the Dow?
62.What happens in a stock market “crash” and how often has it happened?
63.What do analysts many feel has been the cause of the market turmoil in the last two decades??
64What are curbs and when are they put into effect?
65.What are circuit breakers and when are they put into effect?
66.What is believed to be the cause of the deep decline of 2000-2002?
67.What has happened in the real estate market which has contributed to the financial crisis and market crash of 2008-2009?
68.What should you do when considering investing in today’s economic environment?
CRITICAL THINKING EXERCISES
Learning Goal 1
1.Sun-2-Shade is a young company that makes self-darkening windshields for the automotive industry. The financial manager of Sun-2-Shade has convinced management that new capital is needed for future growth. He hasn’t yet decided on whether or not to issue stocks or bonds, but he knows that he wants to avoid the difficulty of looking for and marketing to potential investors himself, and prefers to let "experts" perform those functions. How should he go about pursuing this issue?
Learning Goal 2
2.The three major ways stock is traded the United States are:
NYSE Euronext
NASDAQ
OTC
Match the correct answer to each of the following statements.
a. ______The largest stock exchange in the world.
b. ______Provides companies and investors with a means to trade stocks not listed on the national exchanges.
c. ______Some large companies, like Microsoft are traded on this exchange as well as federal, state and city government bonds.
d. ______Lists approximately 3,200 companies, including many technology companies.
e. ______Merged with Archipelago, a securities trading company that specializes in electronic trading and recently purchased the second largest exchange in the U.S. the AMEX.
f. ______A network of several thousand brokers, who maintain contact with each other and buy and sell securities through a nationwide electronic system.
Learning Goals 3,4
3.As the finance manager of Sun-2-Shade, Eric the owner has come to you for advice about whether or not to issue stock, or bonds to raise new capital. What would you tell him about the advantages and disadvantages of each type of security?Learning Goal 3
4.In discussing stocks, there are several terms with which you need to be familiar:
StockPre-emptive right
Stock certificatePreferred stock
DividendsCumulative preferred stock
Common stockCallable preferred stock
Match the correct term to each of the following:
a. ______Carmen Arauz was considering buying this type of stock, but was somewhat concerned about the risk when she learned that as a stockholder of this type, if the firm closed, she would be the last to share in the firm's assets.
b. ______When her grandson was born, Judi Burton bought 100 shares of her favorite stock, and gave his parents this, as evidence of his ownership, which showed the number of shares owned, the name of the company, and the type of stock.
c. ______As Judi’s grandson Burke grew he received these periodic payments from his stock, which his parents invested for college.
d. ______When Judi was deciding which kind of stock to purchase, she decided upon this type, because the dividends are fixed and must be paid before other dividends are paid. Further, there are no voting rights with this type of stock.
e. ______What Burke doesn't have is this, which is the right of the stockholder to purchase new shares when the firm makes a new issue, so that his proportionate ownership in the company is maintained.
f. ______One of the advantages of Burke's stock is that if the company misses his dividend, the company must pay it before it pays any other, and the missed dividends accumulate.
g. ______Either common or preferred, this represents ownership in a firm.
h. ______When Judi Burton bought these shares she made sure her stock didn’t have this feature, which would require her grandson Burke to sell his shares back to the corporation.
5.Why do you think Judi Burton decided to buy her grandson Burke preferred stock instead of common stock?
Learning Goal 4
6.In discussing bonds, there are several terms with which you need to be familiar:
BondSecured bonds
InterestSinking fund
PrincipalCallable bond
Maturity dateConvertible bond
Unsecured bonds (debentures)
Match the correct term to each of the following descriptions:
a. ______Gerry Hoffman will receive this on the date her bond becomes due in the year 2020.
b. ______Beth Galganski will receive the principle value of her bond on this date.
c. ______Tom Huff is in finance with Sun-2-Shade. Each quarter Sun-2-Shade puts money in this fund to pay off previously issued bonds, and Tom checks the amount of money the company has in the fund to be sure the company can pay off their bond issue on the maturity date.
d. ______Because it has declared bankruptcy in the past, and the future is uncertain, General Motors would probably not be able to issue this type of bond.
e. ______Bonnie Andersen receives $100 per year from her bond because this is a 10% bond.
f. ______Mobil Oil issued an unsecured one at 14.4 percent due in 2020.
g. ______TNG Enterprises issued this kind of bond, because they forecasted a decline in interest rates in a few years, and wanted the flexibility of being able to pay off the bond early.
h. ______Bill Paterson bought this type of bond because he anticipated exchanging it for common stock in the firm later.
i. ______Caldwell Industries used real estate holdings as collateral for their bonds.
Learning Goal 5
7.Five criteria to use when selecting a specific investment strategy are
Investment riskLiquidity
YieldTax consequences
Duration
Read the following situations and evaluate the criteria in terms of the needs of the potential investors.
a. A young couple wants to invest money to begin a college tuition fund for their 5-year-old child. Since the child has no income, they are going to put the account in his name to avoid taxes.
b. A two-career couple; both anticipate retirement within the next five years.
c. A single person, just graduating from college; just starting a high paying job and wants to build capital. Not concerned about losing money at first.
Learning Goal 6
8.As a potential investor in stocks, there are several terms used in securities trading with which you should be familiar:
StockbrokerStock splits
Growth stocksRound lots
Income stocksMargin calls
Blue chip stocksMutual funds
Penny stocksETFs
Market orderDiversification
Limit orderBulls
BearsProspectus
Capital gainsIndex fund
Buying on margin
Match the term that would apply to the following descriptions:
a. ______In 2006 Monsanto gave its stockholders one additional share of stock for every share they owned. This reduced the price from $80 per share to around $40 per share.
b. ______Evelyn Minervi likes to dabble in the stock market. Last year she bought a number of stocks of this type, which each sold for $1.45 cents per share, but which were considered fairly risky.
c. ______Joe Contino works in this job for a major brokerage firm, buying and selling stocks and bonds for his clients.
d. ______Ron Stahl recently purchased this amount, exactly 100 shares, of Navistar stock.
e. ______Dexter Inholt wanted to buy 500 shares of Ford at $40, each, but he only had $12,000 to invest, so he borrowed the $8,000 he still needed from his brokerage firm.
f. ______The stock of General Electric, which pays regular dividends and has had fairly consistent growth in its stock price, is considered this type of stock.
g. ______Marina Vasquez called her broker and asked him to buy Pepsico stock at the best price he could get, under this type of order.
h. ______Hong Le believed the stock market was going to take a big jump after the most recent national elections, and purchased the stocks she wanted in anticipation of stock price increases.
i. ______Lee Kornfeld, a prosperous doctor, has a lot of money invested in the market. He recently called his broker and told her to buy the stock of several firms after the price went down to a certain level under this type of order.
j. ______Dexter Inholt bought Pfizer stock on margin a few weeks ago. When Pfizer’s stock took a slight dip in price, Dexter Inholt got worried that his broker would issue this and would ask him to come up with some money to cover the losses the stock suffered.
k. ______LaTonya Adams is a first time investor, unfamiliar with the market. She wants to get into the market, but diversify her risk, and invest in lots of firms. Her brother advised her to get into one of these, because then an expert does the research and manages the fund.