©2004 by Prentice-Hall, Inc Pearson Education Upper Saddle River, NJ 07458 AGRICULTURAL ECONOMICS,...

AGRICULTURAL ECONOMICS, 2 ed.By Drummond and Goodwin

©2004 by Prentice-Hall, IncPearson EducationUpper Saddle River, NJ 07458

UNIT 4FINANCIAL MARKETS

Classroom Presentation



HOW CAN A CORPORATION GET FUNDS?

• Sell stock to public

• Reinvest profits

• Borrow

from banks

from public



SAVINGCONSUMER

• Buys stock

• Buys bonds

• Makes deposits

• Sells stock

• Sells bonds

• Borrows from bank

BORROWING FIRM



MARKET FOR MONEY

• Savers (sellers of money)

• Borrowers (buyers of money)

• Are brought together by financial intermediaries



STOCK• It is created by the company and sold

to the public to obtain additional funds.

• One unit of stock=one unit of ownership of the corporation.

• If a company has 4,000 shares of stock outstanding, then the holder of one share of stock owns 1/4,000 of the company.



STOCK• The charter of the corporation

stipulates how many shares the Board of Directors may issue.

• Once created and sold, the owner of the stock is free to sell or transfer that stock to any other person at any price.



TWO MARKETS FOR STOCK

1. Newly issued stock sold by the corporation to raise capital.

2. Previously issued stock sold from one person to another person



1. Newly issued stock sold by the corporation to raise capital.

2. Previously issued stock sold from one person to another person

In the first case, it is the Board of Directors who decide to sell stock to the public

TWO MARKETS FOR STOCK



Owners

Board ofDirectors

Managers

THE MODERN CORPORATION



Owners

Board ofDirectors

Managers

Ownership of the company is by the public in the form of shares--one share, one vote.



Owners

Board ofDirectors

Managers

Ownership of the company is by the public in the form of shares--one share, one vote.Board is elected by shareholders to represent the best interests of the owners.



Owners

Board ofDirectors

Managers

Ownership of the company is by the public in the form of shares--one share, one vote.Board is elected by shareholders to represent the best interests of the owners.

Board hires and fires the management of the company.



RAISING FUNDS BY SELLING STOCK

• Board decides to sell stock to get funds to expand the company

• Board hires underwriters--financial companies that will buy the stock from the company wholesale and sell it to the public at retail

• Issue a prospectus

• Put a “tombstone” in the paper

• This is an “initial public offering”



THE TOMBSTONE

The Company



THE TOMBSTONE

The Offer



THE TOMBSTONE

The Underwriters



THE TOMBSTONE

“This announcement is

not an offer to sell. The offer is made

only by prospectus.”



ROLE OF UNDERWRITERS

• They work with company to determine the price of the new issue

• Underwriters buy the issue from the company at a discount (usually 7%)

• Then they sell to the public at the offer price

• If the IPO is not fully subscribed, then underwriters are left holding the bag. They can not lower the price



ROLE OF UNDERWRITERS

• Thus, the underwriters take the risk of undersubscription rather than the company

• As such, underwriters’ self-interest is to price the issue low enough that it will be fully subscribed



PREVIOUSLY ISSUED STOCK

• Once GIT sells stock to the public, then those stockholders are free to sell their shares to any one else

• When Jane sells her stock to John, GIT gets nothing--just like Ford gets nothing when a used Ford is traded

• Previously issued stock is bought and sold on the “stock market”

New York Stock Exchange, NASDAQ



• Most people who buy or sell stock on an exchange do so through a broker, i.e., Merrill-Lynch, E.F. Hutton, etc.

• The broker calls your buy order in to a representative on the floor of the exchange who hunts for a broker representing someone wanting to sell

• If a mutually agreeable price is found, the trade is made




• Most stock that is traded is previously issued stock

• At any point in time, the price of previously issued stock is determined by the ebb and flow of supply and demand

• What factors influence the price of stock?




FACTORS AFFECTING STOCK PRICE

• When you buy stock, you become a part owner of the company. What creates value in a company?

Book value

Earnings

Dividends



BOOK VALUE

• Value of all of the assets of the company---the buildings, the machines, etc.

• Divided by the number of shares of stock

• Since you are part owner, this is the value of what you own. If that value goes up, then the value of your shares should go up.



EARNINGS

• As part-owner, you share in the profits (called “earnings”) of the company.

• A company with high and growing profits is going to have a high stock price.



DIVIDENDS

• Most companies return part of the profits to stockholders on a regular basis.

• These payments to stockholders are called dividends.

• The higher the dividends paid, the higher the price of the stock.



HOW TO READ STOCK QUOTES 52 Week Hi

52 Week LoStockSymbolDividendYield %Price Earnings RatioVolume in 100sHighLowCloseNet Change



Stock Sym

AT&T Cp T



52 WeeksHi Low

6409 3225



Div Yld%

PE

0.88 1.9 20



STOCK VALUE INDICATORS

Dividend Yield• Annual dividend paid as % of stock price

% Yield = Annual dividends

Current stock price100*

For AT&T: Yield =0.88

4738100* = 1.9%



STOCK VALUE INDICATORS

Price-Earnings Ratio• Current price per dollar of last 12 monthsearnings

P-E Ratio =Current stock price per share

Last 12 months profits per share

How much are investors willing to pay to buy a share of the earnings of the company?

20 = 4738 / 2.37



Vol100s

14256



Vol100s

1,425,600



Vol100s

001.4 million @ $47/share = $66 million

1,425,6



Hi Low Close

4762 4538 4738



NetChg

+238



Today'sClose

4738

NetChg

+238

NetChg

+238



Yesterday'sClose

45

NetChg

Today'sClose

NetChg

+238

4738 +238



STOCK SPLITS

• Most companies like for the price of their stock to be in the $10-$100 range.

• If price gets up to $100, split the stock by giving shareholders an additional share for each share owned.

• Price of the stock will fall to $50/share.



DOW JONES INDUSTRIAL AVERAGE• An index of 30 major, blue-chip

companies traded on NYSE

• Summation of the price of the 30stocks divided by divisor

• Divisor changes when stock splitsoccur or new companies are added

• Currently it is 0.1974063

• DJIA is most frequently quotedstock market index



WHY BUY STOCK?

• Investors

Stock ownership over the long haul is a form of saving

• Speculators

Buy low--sell high to make a quick buck; no interest in owning the underlying company



WHAT DRIVES STOCK PRICES?

• Market as a whole

DJIA

S&P 500

Wilshire 5000

• Market sector

Defense

Retailing

• The individual company and its fortunes



BONDSA Form of

Debt A bond is a promissory note issued whenthe company borrows from the public. Thecompany borrowing promises to:

1. Pay the holder of the note $x peryear until the note matures on aspecified date.

2. Repay the original amount borrowedon the maturity date.



BOND TERMINOLOGY• Principal or Face

Value

• Coupon rate

• Maturity date

• Call provisions



BOND TERMINOLOGY

• Principal or Face Value

• Coupon rate

• Maturity date

• Call provisions

The principal amount of the original loan from the bondholder to the bond issuer. Thisamount is always $1,000




• Coupon rate

• Maturity date

• Call provisions

BOND TERMINOLOGY

The amount of annual interestto be paid to the bond holderexpressed as a percent. Example:a 7% bond pays $70/year per $1,000of face value. Rate is annualized for short term bonds




• Coupon rate

• Maturity date

• Call provisions

BOND TERMINOLOGY

The date when the bond issuerpromises to repay the face amount to the bond holder. At that time the bond is redeemedand no further obligations exist.




• Coupon rate

• Maturity date

• Call provisions

BOND TERMINOLOGY

The conditions under which the issuer can redeem the bond priorto maturity and the amount of extra compensation the holder willreceive if called



MORE BOND TERMINOLOGY

• Subordinated

• Notes

• Bills



Coupon Rate



Maturity



MARKET RATE OF INTEREST

• The prevailing interest rate at any point of time.

• Over time it goes up and down, driven by: supply and demand of funds inflationary expectations Federal Reserve policy Investor confidence



BOND PRICES• Once issued, bonds are freely traded. The

holder of the bond has claims on the interest payments and the redemption value at maturity

• As bonds are traded, the price of the bondvaries inversely with the market rate of interest

• As market interest rates vary, the value (butnot the amount) of the fixed annual paymentfrom a previously issued bond varies



EXAMPLE In 1980, I bought a 12% U.S. Treasury

bond that matures in 2010.





What is that bond worth today???






Annual payment on the bond = $120







Annual payment, new bond today = $65








Payment on OLD bond Payment on NEW bond

Price of OLD bond Price of NEW bond



In 1980, I bought a 12% U.S. Treasury bond that matures in 2010.




EXAMPLE

120

X

65

1,000 ------ = ------





In 1980, I bought a 12% U.S. Treasury bond that matures in 2010.




EXAMPLE

120

X

65

1,000 ------ = ------

X=$1,846





Annual Payment

Current Price of

Bond

(100)Current

Yield



BOND PRICES

Bond PRICES change such that

the CURRENT YIELDS on similar bonds

with different coupon rates

are EQUAL



Current

Yield

of Old

Bond

BOND PRICES CHANGE SUCH THAT



Current

Yield

of Old

Bond

Current

Yield

of New

Bond




Current

Yield

of Old

Bond

Current

Yield

of New

Bond

Market Rate of Interest




EXAMPLE: T-BONDS

Coupon Rate 6.25% 10.75%



EXAMPLE: T-BONDS


Maturity Feb 2003 Feb 2003



EXAMPLE: T-BONDS



Price $101:03 $114:21



EXAMPLE: T-BONDS



Price

Current Yield 5.87% 5.97%

$101:03 $114:21



Over time, prices of all bonds vary inversely with current market interest rates.




TimeIn

tere

st ra

tes




TimeIn

tere

st ra

tes

Bond prices




At any point in time, prices of previously issued bonds adjust so that the current yields of bonds with different coupon rates are similar.



READING BOND PRICES• GMAC 75/8 16 941/4

• Bond issued by GMAC that has a coupon rateof 7 5/8% and a maturity in 2016

• Bond prices are always listed as 1/10th of theactual price. Hence, this bond last tradedfor $942.50

• Prices for Treasury issues are listed as 94:8.Again the price listed is 1/10th of the actualprice. The 8 after the colon means 8/32.92:22 is 10(92 + 22/32) = $926.875



IN ADDITION, BOND PRICES VARY

INVERSELY WITH RISK




INVERSELY WITH RISK

Coupon Rate

Maturity

Price

Current Yield

Oregon Steel Treasury




INVERSELY WITH RISK

11.00% 11.75%


Coupon Rate

Maturity

Price

Current Yield




INVERSELY WITH RISK

in 2011

in 2010


11.00% 11.75%Coupon Rate

Maturity

Price

Current Yield




INVERSELY WITH RISKOregon Steel

$104 7/8 $124 27/32

Treasury

in 2011

in 2010


Maturity

Price

Current Yield




INVERSELY WITH RISK

10.5% 6.29%


$104 7/8 $124 27/32

in 2011

in 2010


Maturity

Price

Current Yield



AS BONDS APPROACH MATURITY,

PRICE APPROACHES $1,000




PRICE APPROACHES $1,000Treasury Treasury

Coupon Rate

Maturity

6.0% 6.0%

Oct. 1999 Feb. 2026




PRICE APPROACHES $1,000Treasury Treasury

Coupon Rate

Maturity

Price $100:05 $95:04

Current Yield 4.34% 6.49%

6.0% 6.0%

Oct. 1999 Feb. 2026



BOND ISSUERS

• Corporations

• U.S. Treasury

• Federal agency issues

• State & local governments

• Foreign bonds

• Yankee bonds



SPECIAL FEATURE BONDS

• Floating rate bonds

• Zero-coupon bonds

• Convertible bonds

• Callable bonds



MUTUAL FUNDS

• A professional investment management company (fund manager) pools money from many small investors.

• The investor receives shares of he mutual fund in proportion to the amount invested.

• The fund manager uses the money to purchase a diversified portfolio of stocks on behalf of the investors.



MUTUAL FUNDS• Stocks in the portfolio must be

consistent with the investment objectives stated in the prospectus.

• Fund managers may issue an unlimited number of shares of the fund.

• Fund managers are regulated by the Securities and Exchange Commission.



• As the value of the portfolio grows (or shrinks), the value of the investor’s share of the portfolio grows (or shrinks) proportionately.

• That is, the value of the fund shares acquired grow (or shrink).

MUTUAL FUNDS



• At any time, the investor in the fund can redeem (i.e., sell) his/her shares of the fund back to the fund manager.

• Fund manager must redeem shares of the fund at the net asset value of the fund.

MUTUAL FUNDS



NET ASSET VALUE



NET ASSET VALUE

Current value of the fund’s portfolio



NET ASSET VALUE


divided by



NET ASSET VALUE


divided by

number of shares issued by the fund



1. All commissions and fees are passed on to the mutual fund shareholders.

MUTUAL FUND MANAGERS




2. In addition, a management fee is paid to the fund manager.





2. In addition, a management fee is paid to the fund manager.

3. Fees can be very high




MUTUAL FUND QUOTATIONS• Fund families

• Investment objectives Stock Taxable bonds Tax-free bonds Balanced

• Expense ratio

• Load/no-load



SPECIAL KINDS OF MUTUAL FUNDS

• Money market funds

• Index funds

• Closed end funds



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©2004 by Prentice-Hall, Inc Pearson Education Upper Saddle River, NJ 07458 AGRICULTURAL ECONOMICS,...

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