Understanding SecuritiesUnderstanding Securitiesand Securities Marketsand Securities Markets

Understanding SecuritiesUnderstanding Securitiesand Securities Marketsand Securities Markets

Chapter 22

Chapter 22 Learning GoalsChapter 22 Learning Goals

1.1. WWhat is the function of the securities markets?

2.2. HHow do common stock, preferred stock, and bonds differ as investments?

3.3. WWhat other types of securities are available to investors?

4.4. WWhere can investors buy and sell securities, and how are these securities markets regulated?

Chapter 22 Learning GoalsChapter 22 Learning Goals (cont’d.) (cont’d.)

5.5. HHow do investors open a brokerage account and make securities transactions?

6.6. WWhich sources of investment information are the most helpful to investors?

7.7. WWhat can investors learn from stock, bond, and mutual fund quotations?

8.8. WWhat are the current trends in the securities markets?

Learning Goal 1Learning Goal 1

• WWhat is the function of the securities markets?– Securities markets

• Allow stocks, bonds, and other securities to be bought and sold quickly and at a fair price

• New issues are sold in primary market• Securities are traded in secondary market

– Investment bankers• Specialize in issuing and selling new security issues

– Stockbrokers• Licensed professionals who buy and sell securities on

behalf of their clients

SecuritiesSecurities::

Investment certificates issued by corporations or governments that represent wither equity or debt

Types of Securities MarketsTypes of Securities Markets

• Primary– new securities sold to the public

– issuer gets proceeds

• Secondary– already issued securities are traded

– stock exchanges, commodities exchanges, over-the-counter market

Learning Goal 2Learning Goal 2• HHow do common stock, preferred stock, and bonds differ as investments?

Common StockCommon Stock Preferred StockPreferred Stock BondsBonds

Represents ownership in a corporation

Represents ownership in a corporation

Form of debt; may be secured or unsecured

Stockholders have voting rights

Stockholders receive a stated dividend

Bondholders are creditors of issuing organization

Riskier than preferred stock and bonds

Dividends must be paid before they are paid to common stockholders

Bond issuer must pay interest

Offer potential for increased value and dividend payment income

Usually bought for dividend income rather than price appreciation

Bond issuer must repay principal at maturity

Neither price increases nor dividends are guaranteed

Provide steady source of income

Stock: Equity FinancingStock: Equity Financing

• Common stock– represents ownership interest

– returns: dividends, stock-price increases

• Preferred stock– represents ownership interest

– receive dividends before common stockholders

– provides fixed income

BondsBonds::

Long-term debt obligations (liabilities) of corporations & governments

• issuers must pay back:–principal (par value)–plus interest (coupon rate)

Bonds: Debt FinancingBonds: Debt Financing

• Corporate bonds– secured vs. unsecured– convertible bonds

• US government securities– treasury bills, notes, bonds

• Municipal bonds

• Bond ratings– letter grades represent the risk

Learning Goal 3Learning Goal 3

• WWhat other types of securities are available to investors?– Mutual funds

• Financial service companies that pool the funds of many investors to buy a diversified portfolio of securities

• Offer a convenient way to diversify• Professionally managed

– Futures contracts• Legally binding obligations to buy or sell specified quantities

of commodities at an agreed-on price at a future date• Very risky investments because price may change

drastically

Other Popular SecuritiesOther Popular Securities

• Mutual funds– pools investors’ funds

• Futures contracts

• Options

Learning Goal 4Learning Goal 4

• WWhere can investors buy and sell securities, and how are these securities markets regulated?– Securities are resold on:

• Organized stock exchanges, such as the New York Stock Exchange• Regional stock exchanges• Over-the-counter market

– Securities markets are regulated by• Securities Act of 1933

– Requires disclosure of important information on new securities issues

• Securities Exchange Act of 1934 and 1964 amendment– Formally empowered the SEC to regulate organized securities exchanges and

over-the-counter market

• Investment Company Act of 1940– Places investment companies such as mutual funds under SEC control

• Self-regulatory groups such as the NASD• “Circuit breakers” to halt trading if the Dow Jones Industrial Average drops

rapidly

Securities ExchangesSecurities Exchanges

• Organized stock exchanges– re-sell securities in an auction-type format– US stock exchanges

• New York Stock Exchange• American Stock Exchange

– Global trading & foreign exchanges

• Over-the-Counter Market– electronic-based Nasdaq

Securities Exchanges: NYSESecurities Exchanges: NYSE

• To prevent a fast crash, the New York Stock Exchange has several “trading trading breakersbreakers”– a 1,100-point drop1,100-point drop stops trading for

1 hour if it occurs before 2:00 pm– a 2,250-point2,250-point dropdrop stops trading for

2 hours if it occurs before 1:00 pm– a 3,350-point3,350-point dropdrop stops trading for the rest

of the day

Source: Associated Press in The Arizona Republic, Jan. 3, 2000, pg. D3.

Learning Goal 5Learning Goal 5

• HHow do investors open a brokerage account and make securities transactions?– Choose a brokerage firm and stockbroker– Open a cash account or a margin account

• Cash account - all securities transactions are paid in full• Margin account - allows investors to put up 50% of price of

securities and borrow the rest from broker

– Give an order to broker to buy or sell securities– Broker sends the order to the stock exchange to

be carried out– If stock is an over-the-counter stock, broker finds the

dealer with the best price

How to Buy and Sell SecuritiesHow to Buy and Sell Securities• Securities transactions

– place order with broker– broker makes the transaction– blocks of 100 are round lotsround lots– market orders, limit orders, stop-loss orders

• Online investing– lower transaction costs– 15% of people in a Consumer Reports survey

had purchased stock or other investments online (Source: Consumer Reports, Dec. 1999, p. 10)

Learning Goal 6Learning Goal 6

• WWhich sources of investment information are the most helpful to investors?– Popular investment information sources:

• Economic and financial publications– The Wall Street Journal– Barron’s– Business Week– Fortune– Smart Money– Money

• Numerous Internet sites• Subscription services• Investment newsletters• Security price quotations

Popular Sources ofPopular Sources ofInvestment InformationInvestment Information

• Economic & financial publications– Barron’s– Wall Street Journal– Business Week

• Online information resources• Security price quotations

– stocks, bonds, mutual funds

• Market averages & indexes– Dow Jones Industrial Average

Learning Goal 7Learning Goal 7• WWhat can investors learn from stock, bond, and mutual fund

quotations?– Stock quotationsStock quotations

• Show highest and lowest prices paid for stock during previous 52 weeks• Annual dividend and dividend yield• Price/earnings ratio and the day’s trading volume• High, low, and closing price for the day• Change from the previous day’s closing price

– Bond quotationsBond quotations• Show coupon interest rate• Maturity date• Current yield and trading volume• Closing price and change in closing price from previous day

– Mutual fund quotationsMutual fund quotations• Provide fund’s net asset value• Net change in NAV from previous day• Year-to-date percent return

Example Stock QuotationExample Stock Quotation

Yld Vol NetHi Lo Stock Sym Div % PE 100s Hi Lo Close Chg

40 25 HormelFood HRL.66 1.7 21 1107 39 38 38 -

High price for previous 52 weeks

Abbreviatedcompany name

Symbol for the company

Annual dividendper share

Dividendyield

Price/earnings ratio

Volume of shares traded

High price for the day

Closing price for the day

Net change

price from previous

day

Stock PerformanceStock Performance

Some reasons why stock prices tend to increase every January:January:

• small companies often record gains in late Dec., which carries through Jan.

• investors who sell ‘bad’ stocks late in the year (to deduct the losses on taxes) buy them back in Jan.

Source: The Arizona Republic, Jan. 2, 2000, pg. D2.

Example Bond QuotationExample Bond Quotation

Cur. NetBonds Yld. Vol. Close Chg

DukeEn 705 7.6 46 99 - Abbreviated company name

Current interest

yield

Number of bonds traded

Closing price for the day

Net change

price from previous

day

Annual interest rate & maturity

date

Learning Goal 8Learning Goal 8

• WWhat are the current trends in the securities markets?– Securities markets and the investment industry are

changing considerably• New York Stock Exchange no longer dominates equity market

activity

• Nasdaq is challenging the Big Board

• Emergence of electronic exchanges

– Individual investors are becoming a market force• Improved technology

• Relative ease of online investing

• Move toward self-management of retirement funds

Trends in SecuritiesTrends in Securities

Market competition Nasdaq, AMEX, NYSE

electronic communications networks

(ECNs)

More individuals investing

Rise in Internet InvestmentRise in Internet Investment

0

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300

400

500

600

700

Bil

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1998 1999 2000 2003

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Money Invested in the Internet is Estimated to Rise to $700 billion$700 billion by 2003

Source: Newsweek, Dec. 13, 1999, p. 63.