16 chapter Business Essentials, 8 th Edition Ebert/Griffin Managing Finances Instructor Lecture...

16

chapter

Business Essentials, 8th EditionEbert/Griffin

Managing Finances

Instructor Lecture

PowerPoints PowerPoint Presentation prepared by Carol Vollmer Pope Alverno College

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall

After reading this chapter, you should be able to:

1. Explain the concept of the time value of money and the principle of compound growth.

2. Identify the opportunities offered by mutual funds and exchange-traded funds.

3. Describe the role of securities markets, and identify the major stock exchanges and stock markets

4. Explain how securities markets are regulated and tracked.

L E A R N I N G O B J E C T I V E SL E A R N I N G O B J E C T I V E S

16-2Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall

After reading this chapter, you should be able to:

1. Describe the risk-return relationship, and discuss the use of diversification and asset allocation for investments.

2. Describe the various ways firms raise capital and identify the pros and cons of each method.

3. Identify the reasons a company might make an initial public offering of its stock, and explain how stock value is determined.

L E A R N I N G O B J E C T I V E S (cont.)L E A R N I N G O B J E C T I V E S (cont.)


What’s in It for Me?

• By understanding the material in this chapter, you will understand the various ways individuals gather, either in person or, increasingly, online looking for ways to make their money work for them.

• This chapter will help you learn ways to make your money work for you

– Whether your goals are long- or short-term

– Whether you are motivated by profit or security

– Or simply because you enjoy the challenges inherent in investing


The Time Value of Money

• The time value of money is the most important concept in business finance– While money is invested, it grows, earning interest

or yielding some form of return– This stems from the concept of compound growth

• Compounding interest paid to investors over given time periods


FIGURE 16.1 The Amount to Which an Initial $10,000 Investment Grows


The Rule of 72

• The rule of 72 is an interesting concept.– If we want to double our money, how many years

will it take?• Divide 72 by the interest rate you will receive.

– To know how long it will take to double your money, divide 72 by the number of years in which you want this to occur.


Common Stock

• A stock is a portion of ownership in a company– The ownership of the company is divided into small parts

called shares– These shares can be bought or sold to determine who

owns what percent of the company– The most common form of shares is called common stock

• Shares are purchased in the hope that they will increase in value

– Common stock is normally valued in two ways:• Market value• Book value


Common Stock (cont.)

• Investment traits of common stock– Most risky form of investment– Offer high growth potential– Also vary the most with changes in the stock

market

• Dividends– A payment made to shareholders on a per share

basis from the company’s earnings.


Mutual and Exchange Traded Funds

• Mutual Funds and Exchange Traded Funds– Alternatives to stock– Easy to purchase with small sums of money

• Mutual funds– Created by investment firms– Pool cash investments into various investments to

create a portfolio– Grow in value across time and produce income


Reasons for Investing• Why should a person or business invest in the

market?– Stability and safety

• Money market mutual funds preserve capital and provide more current income

– Conservative capital growth• Balanced funds stress preservation of capital and

current income, as well as some growth

– Aggressive growth• Aggressive growth funds seek maximum long-term

growth


Exchange Traded Funds

• Exchange traded funds are a bundle of stocks and bonds that are in an index that tracks the overall movement of a market – Unlike mutual funds, they can be traded like stocks

• Advantages of ETFs:– Can be traded throughout the day like stocks– Have lower operating costs than mutual funds– Don’t require large amounts of investment


Securities Markets• Securities

– Represent secured, or financially valuable, claims on the part of investors

• Securities Markets– Markets in which stocks and bonds are sold

• Stock– Represents an ownership claim on the assets of a

corporation• Bond

– Represents a financial claim of money owed by a company to the bondholder


Primary and Secondary Securities Markets

• Primary Securities Markets– The market in which new stocks and bonds (but not mutual

funds) are bought and sold by firms and governments

• Secondary Securities Markets– Where existing stocks and bonds are traded

• Securities and Exchange Commission (SEC)– The government agency that regulates U.S. securities markets– New securities must be approved by the SEC


Primary and Secondary Securities Markets (cont.)

• Investment banks help bring new securities to the market by:– Advising companies on the timing and financial

terms of new issues

– Underwriting—or buying—new securities, bearing some of the risks of issuing them

– Distributing new securities through banks and brokers to individual investors


New York Stock New York Stock ExchangeExchange

Global Stock Global Stock ExchangesExchanges

American American Stock Stock

ExchangeExchange

Regional Stock Regional Stock ExchangesExchanges

NASDAQNASDAQ

The Major Exchanges and Markets


The Major Exchanges and Markets (cont.)

• The New York Stock Exchange– For many people, “the stock market” means the New York

Stock Exchange (NYSE)• The American Stock Exchange (AMEX)

– The second-largest floor-based U.S. exchange is also located in New York City

• Regional Stock Exchanges– Seven regional stock exchanges were organized to serve

investors in places other than New York• Global Stock Exchanges

– The value of shares listed on foreign exchanges continues to grow


TABLE 16.1 Selected Global Stock Exchanges and Markets


The Major Exchanges and Markets (cont.)

• National Association of Securities Dealers Automated Quotation (NASDAQ) system– The world’s oldest electronic stock market– Orders are gathered and executed on a

computer network• Electronic communication networks have

allowed for:– Cross-border ownership– International consolidation of markets


Individual Investor Trading• Stock Brokers

– Earn commissions by executing buy-and-sell orders from nonexchange members

• Discount Brokers– Offer lower fees to investors than do full-service stock

brokers• Full-Service Brokers

– Offer full services to investors who do not have the time to manage their own portfolios

• Online Trading– Conditions favoring online trading

• Convenient access to the Internet• Fast, no-nonsense transactions• Opportunity for self-directed investors to manage their own

investments while paying low fees for trading• Ownership records have been helped by book-entry ownership


The S&PThe S&P500500

The NASDAQ The NASDAQ CompositeComposite

Dow Jones Industrial AverageDow Jones Industrial Average

Market Indexes

The Russell 2000

Index-matching FTFs


Market Indexes (cont.)• The Dow Jones Industrial Average (DJIA)

– The most widely cited U.S. market index

– Measures the performance of financial markets by focusing on 30 blue-chip companies as reflectors of economic health

• The S&P 500 Composite Index – Consists of 500 stocks, including 400 industrial

firms, 40 utilities, 40 financial institutions, and 20 transportation companies


Market Indexes (cont.)• NASDAQ Composite Index

– All NASDAQ-listed companies are included in the index, for a total of more than 3,300 firms (both domestic and foreign)

• The Russell 2000– A specialty index that measures the

smallest companies based on market capitalization

• Index matching ETFs– Includes countless other specialty

indexes


FIGURE 16.2 Bull and Bear Markets


The Risk Return Relationship

• Each type of investment has a risk return relationship

• There are three main types of returns:– Dividends– Price appreciation– Total return


FIGURE 16.3 Uncertainty About Financial Returns on Investments


Reducing Risk With Diversification and Asset Allocation

• Diversification– Buying several different kinds of investments so the risk of

loss is reduced by spreading the total investment across more stocks

• Asset Allocation– The proportion—the relative amounts—of funds invested

in (or allocated to) each of the investment alternatives• Performance Differences for Different Portfolios

– A portfolio is the combination of all the investments—stocks, bonds, real estate, and mutual funds

– Portfolios have different investment objectives, and can be managed through asset allocation


Financing the Business

• Secured loans for equipment– Businesses usually need some financing to start

operations – Secured loans provide capital for such loans

• With a secured loan, the borrower needs to guarantee repayment

• The loan needs to be secured by pledging the asset as collateral to the lender

• If the borrower defaults and doesn’t pay the loan, the lender can claim the equipment in lieu of payment


Financing the Business (cont.)

• Principal and Interest Rates– Loan Principal is the amount of money that is

owed on a loan– Interest is also paid at an annual percentage rate

(APR) agreed to by the commercial lender and the borrower

• Interest is a fee paid by the borrower to the lender for the use of the loan principal


Working Capital and Unsecured Loans from Banks

• Firms need cash to operate their businesses• Working capital = Current assets – current liabilities

– If working capital is positive for the firm, they are able to cover operating expenses

– If the result of this equation is negative, the firm may need to borrow funds in the short term to pay operating expenses

• Unsecured loans from banks can be obtained without pledging collateral– Firms need a good credit rating to obtain this type of loan– They may be required to keep a portion of the loan balance—called a

compensating balance—in a separate, non-interest-bearing account with the bank


Angel Investors and Venture Capital• Once a business is started, it

may need additional capital• Angel investors provide what is

called venture capital– Usually wealthy individuals or

corporations that seek to invest in a new business

– Require a sizeable return (up to 50% ownership of the company) in exchange for their investment

– In general, firms turn toward angel investors and venture capital when they are too new to have established credit with a commercial bank


Sale of Corporate Bonds

• Corporations can raise capital by selling corporate bonds

• A corporate bond is a formal pledge (IOU) obligating the issuer to pay interest periodically and repay the principal at maturity (a preset future date) to the lender

• The government also offers municipal bonds


Characteristics of Corporate Bonds• A bondholder has no claim to corporate ownership• Each new bond has a bond indenture

– Sets forth the borrower’s obligations and the financial returns for lenders

• An important point for a bond is its maturity date– Date by which the company must repay the face value (or

par value) of the bond to the lender• Bond default

– A bond is in default when it fails to make payment to the lender

– If this occurs, the bondholders can file a bondholders’ claim

– If the company cannot pay back its debt, it may declare bankruptcy, which gives the company relief from repaying some or all of its debts


TABLE 16.2 Bond Rating Systems


Becoming a Public Corporation

• Initial Public Offerings (IPOs) are a significant form of funding for corporations– IPOs are the first sale of a company’s stock to the general

public

• Going public means selling off part of the company– Means giving up control of some of the company– Large investors can become corporate raiders


Stock Valuation

• Stock valuation– Prices of stocks vary in value due to many factors

• Why do prices of stocks vary?– The price of a stock depends on the demand for

and supply of a specific company’s stock– The corporation may want the stock to be valued

in a specific price range• Stock split: If the price of a company’s stock gets too

high, it can restore it to its original range by paying a special dividend in shares of stock to its shareholders


TABLE 16.3 Financial Comparison of Coca-Cola and PepsiCo


TABLE 16.4 Corporation Sizes Basedon Capitalization


Pros and Cons of Debt Financing

• Debt financing– Long-term borrowing from sources outside the

company – Major source of funding– Long-term loans are attractive:

• Speed of availability due to limited parties involved• No public disclosure required


Pros and Cons of Equity Financing

• Equity financing – Looking inside the company for funding sources

• The expense of common stock– Paying dividends to shareholders is more

expensive than paying interest on corporate bonds

• Retained earnings as a source of capital– Means smaller dividends to shareholders– Means no interest paid on debt


Key Terms

aggressive growth fundsAmexangel investorsasset allocationbalanced fundsbear marketbond indenturebondholders’ claimbond rating systemsbondsbook entry ownershipbook valuebull marketcollateralcommon stock compound growthcorporate bond

corporate raidersdebt financingdefaultdiscount brokersdiversificationdividendselectronic communication networksequity financingexchange traded fundsface valuefull-service brokersinitial public offeringinterestinvestment banksloan principal


Key Terms (cont.)

sharesstockstock brokersstock splittime value of moneyunsecured loanventure capitalworking capital

market capitalizationmarket value maturity datemoney market mutual fundsmutual fundsNASDAQNYSEonline tradingpar valueportfoliorisk return relationshiprule of 72secured loansecuritiessecurities market (primary and

secondary)16-42Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.


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16 chapter Business Essentials, 8 th Edition Ebert/Griffin Managing Finances Instructor Lecture...

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