Financing and Investing

Securities Stocks, bonds, or money market instruments that represent an obligation on the part of the issuer. A. Stocks and bonds are commonly called securities, because both represent obligations on the part of issuers to provide purchasers with expected or stated returns on the funds invested or loaned. B. Securities are bought and sold in two markets - the primary market and the secondary market. C. Stocks, bonds, and money market instruments are short-term debt securities, and investors choose specific securities that best help them to meet their investment objectives. The Primary Market 1. In the primary market, firms and governments issue securities and sell them initially to the public. 2. Both profit-seeking corporations and government agencies also rely on primary markets to raise funds by issuing bonds.

The Markets Primary Market—market where new security issues are first sold to investors; the issuer receives the proceeds from the sale. Initial Public Offering (IPO) Secondary Market—financial markets where previously issued securities are traded among investors. Examples: NY Stock Exchange and the NASDAQ

Securities Three major asset classes Cash Bonds (fixed income) Stocks (equities) Asset allocation The percent of your assets in each category Very important concept in investing

Cash Securities that do not go down in nominal value Money Market Instruments—short-term debt securities Mature within one year Examples: U.S. Treasury Bills, commercial paper, repurchase agreements Certificates of Deposit (CDs) Treasury Bills are special The “risk-free asset” Generally low-risk securities that are purchased by investors when they have surplus cash.

Bonds Attributes Par value – amount on the bond (principal) Usually denominated in $1000 Interest rate to be paid (usually 2x a year) Maturity date – when principal is paid back Also known as fixed income Interest payments do not change over the life of the bond 1. By selling bonds, a firm obtains long-term debt capital. 2. issued in various denominations (face values), usually between $1,000 and $25,000 3. Because bondholders are creditors, they have a claim on the firm’s assets that must be satisfied before any claims of the stockholders in the event of the firm’s dissolution.

Types of Bonds Corporate Bonds Secured Bond—bond backed by a pledge of a company’s specific assets. (Think collateral) Debenture—bond backed by the reputation of the issuer. (Think IOU) Secured bond a. backed by a specific pledge of company assets b. firms can issue secured bonds at lower interest rates than would be to paid for comparable unsecured bonds. Unsecured bond a. also called a debenture b. is backed only by the financial reputation of the issuing corporation

Types of Bonds Government Bonds issued by U.S. Treasury Sovereign debt Municipal Bonds Issued by state and local governments Revenue bond is a bond whose proceeds are to be used to pay for a project that will produce revenue (e.g., a toll bridge) General obligation bond is a bond whose proceeds are used to pay for a non-revenue producing project (e.g., a fire station) Government bonds a. bonds issued by the U.S. Treasury b. are backed by the full faith and credit of the U.S. government c. they are considered the least risky of all bonds.

Bond Risk Default risk Company or government is unable to pay Interest rate risk Bond interest payment does not change from what is printed on the bond (fixed income) If market interest rates change, it will affect how much people are willing to pay for the bond – the bond price Rates go up -> price goes down and vice versa Inflation risk – same story as interest rates

Moody’s and Standard & Poor’s Bond Ratings Junk Warning, junk bonds are often called “high yield” bonds

Bond Returns Interest Usually paid twice a year Contractually obligated to pay Yield = interest payment / current price Par value Paid at maturity Usually $1000 If sell before maturity Price has probably changed from $1000 Will have a capital gain or loss

Types of Stock Common stock Preferred stock Half stock, half bond. We’ll cover next time.

Equity Returns Dividends Optional Usually quarterly Sometimes one-time event Not guaranteed for common stock Change in price Based on investors’ view of a firm’s future Will cause a capital gain or loss

Securities Risk Return Cash Very low Low Bonds (fixed income) Moderate – High Moderate Stocks High

Security Returns Note the risk – return trade-off U.S. Treasuries are considered risk free how do you expect their return to compare to corporate bonds?

Discussion The Fed announced a rate hike. What do you expect to happen to bond yields? What do you expect to happen to bond prices? If long-term yields do not increase, what might that tell you?