16 Investment Information and Transactions Introduction to Finance Chapter 16 Lawrence J. Gitman Jeff Madura Introduction to Finance Investment Information and Transactions

Learning Goals Review background material on investing. Describe the economic, industry, global, and market information sources used to make investment decisions. Describe the firm-specific information services used to make investment decisions. Identify the main United States and foreign securities exchanges in the United States that facilitate the investment process. Describe the types of securities transactions requested by investors and explain how these transactions are accommodated by brokerage firms.

Background on Investing Individual Investors Long-term capital gains Short-term capital gains Day traders

Background on Investing Institutional Investors Employed by institutions Invest on behalf of others Also called portfolio managers Types of institutional investors include mutual fund portfolio managers and pension fund portfolio managers.

Background on Investing Impact of Investment Decisions on Wealth Figure 16.1

General Information Used to Make Investment Decisions Table 16.1 (Panel 1)

General Information Used to Make Investment Decisions Table 16.1 (Panel 2)

General Information Used to Make Investment Decisions Table 16.2 (Panel 1)

General Information Used to Make Investment Decisions Table 16.2 (Panel 2)

General Information Used to Make Investment Decisions Table 16.3 (Panel 1)

General Information Used to Make Investment Decisions Table 16.3 (Panel 2)

General Information Used to Make Investment Decisions Table 16.4 (Panel 1)

General Information Used to Make Investment Decisions Table 16.4 (Panel 2)

Firm-Specific Information Used to Make Investment Decisions Annual Report Income statement Balance sheet Statement of cash flows

Firm-Specific Information Used to Make Investment Decisions Table 16.5 (Panel 1)

Firm-Specific Information Used to Make Investment Decisions Table 16.5 (Panel 2)

Other Financial Reports Used to Make Investment Decisions 8-K, 9-K, 10-K Security prospectus External publications

Firm-Specific Information Provided by Publications Table 16.6 (Panel 1)

Firm-Specific Information Provided by Publications Table 16.6 (Panel 2)

Firm-Specific Information Provided by Publications Figure 16.2 (Panel 1)

Firm-Specific Information Provided by Publications Figure 16.2 (Panel 2)

Firm-Specific Information Provided by Publications Figure 16.2 (Panel 3)

Information Provided by Insider Trading Figure 16.3

Information Provided by Insider Trading Figure 16.4

Information Provided by Insider Communication to Analysts Figure 16.5

Information Signaled Through a Firm’s Financial Decisions Dividend Policy Earnings Surprises Acquisitions Secondary Stock Offerings Stock Repurchases

Information Provided by Insider Communication to Analysts Figure 16.6

Securities Exchanges Securities exchanges facilitate the exchange of securities among investors. The main organized exchanges are the New York Stock Exchange (NYSE) and American Stock Exchange (AMEX). Both facilitate only secondary market transactions. The over-the-counter (OTC) market is an intangible securities market that facilitates both primary and secondary market transactions.

Securities Exchanges In 1998 the NASDAQ and AMEX merged and is expected to lead to an increase in the use of electronic orders. United States investors can invest in foreign stocks by purchasing those listed on foreign stock exchanges. United States investors can also invest in foreign stock by purchasing American depository receipts (ADRs) or through mutual funds which specialize in the purchase of foreign stocks.

Investor Transactions Market and Limit Orders A market order is an order to buy or sell a stock at the prevailing market price. A limit order is an order to buy a stock at or below a specified price, or to sell a stock at or above a specified price. Limit orders can be for the day, good until canceled, or open (in effect for 6 months).

Investor Transactions Use of Technology Technology has increased the speed at which orders are placed and executed. There are now more than 5 million online brokerage accounts at services such as Ameritrade and E*Trade. The typical trading commission on like is between $8 and $20 which is substantially less that what brokerage firms have traditionally charged. The popularity of electronic orders and electronic execution of trades is continuing to grow.

Investor Transactions Stop Orders Stop orders are orders to execute a transaction when the stock reaches a specified level. A buy stop order represents an order to buy a stock if the price reaches a specified level (above the prevailing price) to take advantage of subsequent expected increases in price. A sell stop order, on the other hand, is an order to sell a stock if the price reaches a specified level (below the prevailing price) to prevent further losses when prices are falling.

Investor Transactions Buying Stock on Margin Buying on margin means that investors use borrowed funds to finance the purchase of securities. Buying on margin allows investors to used financial leverage to magnify their gains (and losses). Margin requirements are regulations imposed by the Federal Reserve on the proportion of invested funds that must be paid in cash. The present margin requirement is that at least 50 percent of the invested funds must be in cash.

Investor Transactions Buying Stock on Margin Margin requirements are intended to ensure that investors can cover their position if the value of their investment declines over time. If investors purchase a stock on margin and the value of the stock declines, investors may receive a margin call from their broker, requesting that they put additional funds (maintenance margin) in the margined account.

Investor Transactions How Investing on Margin Affects Returns

Investor Transactions How Investing on Margin Affects Returns Stan Adams determined that a new Internet stock called Rocket.com is undervalued at its prevailing price of $10 per share. The stock is not expected to pay a dividend. Stan is trying to decide if he should purchase 100 shares with cash, or buy the 100 shares by borrowing half the funds needed. The loan would have a 10% annual interest rate. Stan plans to sell the stock in one year.

Investor Transactions How Investing on Margin Affects Returns Stan wants to determine his expected return when paying for his entire investment using (1) 100% of his own funds, (2) borrowing 30% ($300 out of $1000), and (3) borrowing 50% ($500). Stan wants to estimate his return based on two possible outcomes: (1) the stock rises to $14 in one year, and (2) the stock declines to $6 in one year. The results are shown on the following slide.

Investor Transactions How Investing on Margin Affects Returns

Investor Transactions Short Sales A short sale is the sale of a stock by an investor who does not own the stock. Investors will typically “short a stock” when they believe the stock is overvalued and is likely to decline—hoping to sell high and buy low. To short a stock, an investor must borrow a stock from another investor who owns it, and sell it in the market at the prevailing price.

Investor Transactions Short Sales The investor has an obligation to later repurchase the stock in the market so that it can be returned to the investor from whom it was borrowed. An investor in a short sale will make a profit from the difference between the original sale price and the subsequent purchase price, less any dividends received. If a stock price rises, the investor in a short sale will have to pay more to repurchase resulting in a loss.

Largest Short Positions Figure 16.7

16 End of Chapter Introduction to Finance Chapter Lawrence J. Gitman Jeff Madura Introduction to Finance End of Chapter