CHAPTER 19 USING SECURITIES MARKETS FOR FINANCING AND INVESTING OPPORTUNITES Securities markets financial marketplaces for stocks and bonds serve two major functions o Assistant businesses in finding long term funding to finance capital needs such as expanding operations developing new products or buying major goods and services o Provide private investors a place to buy and sell securities investments such as stocks and bonds that can help them build their financial future Securities markets are divided into primary and secondary markets Primary markets handle the sale of new securities o Corporations make money on the sale of their securities stock only once when they sell it on the primary market Initial public offering IPO the first public offering of a corporation s stock After the IPO the secondary market handles the trading of these securities between investors To get the necessary approval for stock or bonds issues you must make extensive financial disclosures and undergo detailed scrutiny by the U S Securities and Exchange Commission SEC Investment bankers specialists who assist in the issue and sale of new securities o Can also underwrite new issues of stocks or bonds Institutional investors large organizations such as pension funds mutual funds and insurance companies that invest their own funds or the funds of others Stock exchange an organization whose members can buy and sell exchange securities Over the counter OTC markets exchange that provides a means to trade stocks not for companies and individual investors listed on the national exchanges NASDAQ National Association of Securities Dealers Automated Quotations A nationwide electronic system that links dealers across the nation so that they can buy and sell securities automatically Securities and Exchange Commission SEC federal agency that has responsibility for regulating the various exchanges The Securities and Exchange Act of 1934 created the SEC Prospectus a condensed version of economic and financial information that a company must file with the SEC before issuing stock the prospectus must be sent to prospective investors Insider trading is using knowledge or information that individuals gain through their position that allowed them to benefit unfairly from fluctuations in security prices o Key words here benefit unfairly Stocks shares of ownership in a company Stock certificate evidence of stock ownership that specifies the name of the company m 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 Dividends part of a firm s profits that the firm may distribute to stockholders as either cash payments or additional shares of stock Some advantages to a firm of issuing stock include 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 may also buy back its stock to improve its balance sheet and make the company appear financially stronger Disadvantages of issuing stock include o As owners stockholders usually only common stockholders have the right to vote for the company s board of directors Typically one vote is granted for each share of stock Issuing new shares of stock can thus 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 Companies can issue two classes of stock common and preferred 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 o Common stockholders also have a preemptive right to purchase new shares of common stock before any one else this allows common stockholders to maintain their proportional share of ownership in the company 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 It can be callable which means preferred stockholders could be required to sell their shares back to the corporation o Can be converted to shares of common stock but not the other way around o It can be cumulative which means 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 Bond a corporate certificate indicating that a person has lent money to a firm or a government o The principal is the face value of a bond which the issuing company is legally bound to repay in full to the bond holder on the maturity date Maturity date the exact date the issuer of a bond must pay the principal to the bondholder Interest the payment the issuer of the bond makes to the bondholders for use of the borrowed money o Bond interest is sometimes called the coupon rate a term that dates back to when bonds were issued as bearer bonds Bonds offer long term financing advantages to an organization o Bondholders are creditors of the firm not owners They seldom vote on corporate matters thus management maintains control over the firm s operations o Bond interest is tax deductible to the firm see Ch 17 o Bonds are temporary sources of funding They re eventually repaid and the debt obligation is eliminated o Bonds can be repaid before the maturity date if they contain a call provision They can also be converted to common stock Bonds also have drawbacks o Bonds increase debt long term liabilities and may adversely affect the markets perception of the firm o Paying interest on bonds is a legal obligation If interest is not paid bondholders can take legal action to force payment o The face value must be repaid on the maturity date Without careful planning this obligation can cause cash flow problems when the repayment comes due Corporations can issue two different classes of corporate bonds Unsecured bonds usually called debenture bonds are not backed by any specific collateral Debenture bonds bonds that are unsecured not backed by any collateral such as equip Secured bonds sometimes called mortgage bonds are backed
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