PowerPoint Presentation by Charlie Cook Copyright © 2005 Prentice Hall, Inc. All rights reserved. Chapter 15 Understanding Securities and Investments

Copyright © 2005 Prentice Hall, Inc. All rights reserved.15–2 Key Topics Primary and secondary securities markets Common and preferred stock Various types of bonds Mutual funds and commodities Buying and selling securities Regulation of securities markets

Copyright © 2005 Prentice Hall, Inc. All rights reserved.15–3 Securities: Stocks and Bonds Stocks and bonds represent secured, or asset-based, claims by investors against issuers. Holders of stocks and bonds have a stake in the company that issued them.  Stocks: An ownership stake  Bonds: A financial stake Primary Securities Market  New stocks and bonds are sold by firms and governments  “private placements”  Investment bank: financial institution that helps issue and resell new securities. Secondary Securities Market  Market in which stocks and bonds are traded

Copyright © 2005 Prentice Hall, Inc. All rights reserved.15–4 Investment Banks Help Bring New Securities to the Market They advise companies on the timing and financial terms of new issues. They underwrite—or buy—new securities, bearing some of the risks of issuing them. They distribute new securities through banks and brokers to individual investors.

Copyright © 2005 Prentice Hall, Inc. All rights reserved.15–5 Common Stock: High Risk, High Potential Return Why own common stock?  Increase in value (capital gain) and (potential) dividends Par Value  The face value of a share of stock at the time it is originally issued Market Value  The current price of a share in the stock market Book Value  Stockholder’s equity divided by the number of shares

Copyright © 2005 Prentice Hall, Inc. All rights reserved.15–6 Blue Chip Stocks : A Changing Perspective? “Old” Economy  Established firm  Sound financial history  Stable pattern of dividends “New” Economy  Rapid growth in market value

Copyright © 2005 Prentice Hall, Inc. All rights reserved.15–7 Preferred Stock: Lower Risk, Lower Potential Return Fixed dividend First claim on assets No voting rights

Copyright © 2005 Prentice Hall, Inc. All rights reserved.15–8 Stock Exchanges: Institutional Settings for Trading Stocks Stock exchange is an organization formed to provide an institutional setting in which stocks can be traded.  There are a limited number of memberships on the exchange  There is a trading floor Brokers: receive and execute buy and sell orders for other people in return for a commission  Full service brokers  Discount brokers  On-line trading

Copyright © 2005 Prentice Hall, Inc. All rights reserved.15–9 The Major Exchanges and the OTC Market NYSE, London, Tokyo, Frankfurt, Shanghai etc. Over-the-counter market (OTC): has no trading floor and simply consists of many people in different locations linked by electronic communications. E.g. NASDAQ

Copyright © 2005 Prentice Hall, Inc. All rights reserved.15–10 Bonds Represent a promise by the issuer to pay the buyer a certain amount of money by a specified future date.  Government Bonds: long-term or short-term  Corporate Bonds: long-term funding for companies Nearly all secondary trading in bonds occurs in the OTC market.

Copyright © 2005 Prentice Hall, Inc. All rights reserved.15–11 Bond Rating Systems Table 15–1

Copyright © 2005 Prentice Hall, Inc. All rights reserved.15–12 Mutual Funds: Company that pools investments from individuals to purchase a portfolio of stocks and bonds goal: diversification, asset allocation, risk reduction Source: Stock Fund Inflows Plunge 90% in 2001, Los Angeles Times, C1, January 31, 2002

Copyright © 2005 Prentice Hall, Inc. All rights reserved.15–13 Bull and Bear Markets Figure 15–5

Copyright © 2005 Prentice Hall, Inc. All rights reserved.15–14 Market index: summary of price trends in a specific industry or the whole market: E.g., Dow Jones Industrial Average, IMKB -100, S&P 500 etc. Market Indexes

Copyright © 2005 Prentice Hall, Inc. All rights reserved.15–15 Investing in the Securities Markets Placing Orders  Market Order  Limit Order  Stop Order  Round Lot  Odd Lot Financing Choices  Margin Trading: borrow money from broker  Short Sales: borrow stock from broker High risk alert!

Copyright © 2005 Prentice Hall, Inc. All rights reserved.15–16 Securities Market Regulation Self-Regulation  Circuit breakers due to heavy program trading. Securities and Exchange Commission  Prospectuses  Insider trading: illegal practice of using special knowledge about a firm for profit

Copyright © 2005 Prentice Hall, Inc. All rights reserved.15–17 Chapter Review Explain the difference between primary and secondary securities markets. Discuss common and preferred stock. Distinguish among the various types of bonds. Describe mutual funds and commodities. Explain the buying and selling process for securities. Explain securities market regulation.