Chapter 19 Using Securities Markets for Financing and Investing Opportunities The Function of Securities Markets Securities markets financial marketplaces for stocks and bonds o Serve 2 major functions Assist businesses in finding long term funding to finance capital needs Provide private investors a place to buy and sell securities investments such as stocks and bonds that can help them build their financial future o Primary markets handle the sale of new securities corporations make money on the sale of their securities stock only once Initial public offering IPO the first public offering of a corporation s stock o Secondary markets handle the trading of these securities between investors with the proceeds of the sale going to the investor selling the stock not to the corporation whose stock is sold Investment bankers specialists who assist in the issue and sale of new securities buys the entire stock or bond issue at an agreed on discount and then sells the issue to private or institutional investors at full price Institutional investors large organizations such as pension funds mutual funds and insurance companies that invest their own funds or the funds of others Stock Exchanges Stock exchange an organization whose members can buy and sell exchange securities for companies and individual investors Over the counter OTC market exchange that provides a means to trade stocks not listed on the national exchanges trading is between 2 parties directly instead of through an exchange by the NYSE Euronext NASDAQ evolved from the OTC market but is no longer a part of it is a telecommunications network that links dealers across the nation so that they can buy and sell securities electronically rather than in person Securities and Exchange Commission SEC is the federal agency that has responsibility for regulating the various stock exchanges o Companies trading on the national exchanges must register with the SEC and provide it with annual updates o Before a company can issue stocks or bond to the public for sale it must file a detailed registration statement to the SEC including extensive economic and financial information a prospectus a condensed version of this registration document is given to prospective investors o Insider trading is using knowledge or information that individuals gain through their position that allows them to benefit unfairly from fluctuations in security prices How Businesses Raise Capital By Selling Stock Stocks shares of ownership in a company Stock certificate evidence of stock ownership that specifies the name of the company the number of shares it represents and the type of stock being issued o Sometimes indicates a stock s par value which is a dollar amount assigned to each share of stock by the corporation s charter since par values do not reflect the market value of a stock most companies issue no par stock Dividends part of a firm s profits that the firm may distribute to stockholders as either cash payments or additional shares of stock generally paid quarterly Advantages of a firm issuing stock o As owners of the business stockholders never have to be repaid their investment o There s no legal obligation to pay dividends to stockholders therefore the firm can reinvest income retained earnings to finance future needs o Selling stock can improve the condition of a firm s balance sheet since issuing stock creates no debt a corporation can also buy back its stock to improve its balance sheet and make the company appear stronger financially Disadvantages of a firm issuing stock o As owners common stockholders have the right to vote for the company s board of directors one stock one vote therefore issuing new shares of stock can alter the control of the firm o Dividends are paid from profit after taxes and are not tax deductible o The need to keep stockholders happy can affect managers decisions Common stock the most basic form of ownership in a firm it confers voting rights and the right to share in the firm s profits through dividends if approved by the firm s board of directors also have preemptive right to purchase new shares of common stock before anyone else Preferred stock stock that gives its owners preference in the payment of dividends and an earlier claim on assets than common stockholders if the company is forced out of business and its assets sold o Can be callable could be required to sell their shares back to the corporation o Can be converted to common stock but not the other way around o Can be cumulative if one or more dividends are not paid when promised they accumulate and the corporation must pay them later before it can distribute any common stock dividends How Businesses Raise Capital by Issuing Bonds Bond a corporate certificate indicating that a person has lent money to a firm or a government whoever issues the bond has a legal obligation to make regular interest payments to investors and to repay the entire bond principle amount at a prescribed time Principle face value of a bond Maturity date the exact date the issuer of a bond must pay the principle to the bondholder Interest the payment the issuer of the bond makes to the bondholders for use of the borrowed money Bond interest is sometimes called the coupon rate Bond interest rates depend on the size of the economy the reputation of the issuing company and the interest rate for bonds of similar companies Corporations can issue 2 different classes of corporate bonds o Unsecured bonds debenture bonds bonds that are unsecured not backed by any collateral only firms with excellent reputations and credit rates can issue these o Secured bonds mortgage bonds backed by collateral that is pledged to bondholders if interest or principle isn t paid when promised Sinking fund a reserve account in which the issuer of a bond periodically retires some part of the bond principle prior to maturity so that enough capital will be accumulated by the maturity date to pay off the bond Callable bond permits the bond issuer to pay off the principle before its maturity date Investors can convert convertible bonds into shares of common stock in the issuing company How Investors Buy Securities Stockbroker a registered representative who works as a market intermediary to buy and sell securities for clients Key criteria when selecting investment options o Investment risk o Yield the expected rate of return on an investment such as interest or dividends usually over a period of one year o Duration length
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