BK18.ppt

Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved.18-1

2DAY: Finish Chapter 17 2DAY: All of Chapter 182DAY: Stock Pickin’ Contest Ends2DAY: Last attendance dayTuesday, May 3rd: REVUE

FOUR 28FOUR 28


1. Google $6,1982. TOMMY BOY 5,2563. Goldman Sachs 5,2374. Tooty Roll 4,9275. Cancer Sticks 4,9186. Crackhouse 4,560

Stock Market ReportStock Market Report


7. Grease Monkeys $4,5518. Starbucks 4,2989. HOGS 4,02510. Gold Dust 3,98011. Ariba Ariba 2,480

Stock Market ReportStock Market Report


FINAL EXAM BREAKDOWNFINAL EXAM BREAKDOWN

Chapter 1 3 Chapter 2 3 Chapter 3 5 Chapter 4 5 Chapter 5 4 Chapter 6 2 Chapter 7 3 Chapter 8 3 Chapter 9 2 Chapter 10 3

Chapter 11 3 Chapter 12 3 Chapter 13 4 Chapter 14 4 Chapter 15 3 Chapter 16 6 Chapter 17 9 Chapter 18 8 NCE 24 Other 3


Final Exam InfoFinal Exam InfoBring a scantron!! (and one for your

neighbor)Basics: Tuesday, May 10th, 1:30-

3:30 P.M., HERE!! Final exam key will be posted to e-

reserve (eventually)



Characteristics and Functions of MoneyCharacteristics and Functions of Money

Characteristics of MoneyMoney—anything generally

accepted as payment for goods and services.



Characteristics of Money

Divisibility—Ability to be broken down into smaller units

Portability—Ability to be easily moved from place to place

Durability—Ability to survive repeated usage over time



Characteristics of Money

Difficulty in Counterfeiting—Currency should be hard for anyone, other than the government, to produce

Stability—Should maintain a relatively stable value



Basic Functions of Money


The Money SupplyThe Money Supply

The money supply consists of coins and currency as well as financial assets that also serve as a medium of exchange (traveler’s checks, bank checking accounts, other so-called demand deposit accounts, and credit union share draft accounts)


Components of M1


The Money SupplyThe Money Supply

Another, broader definition of the money supply is the M2

M2—includes the M1 plus a number of other financial assets that are almost as liquid as cash, but do not serve directly as a medium of exchangeThese assets include various savings

accounts, certificates of deposit and money market mutual funds


Why Organizations Need MoneyWhy Organizations Need Money

Organizations require funds to run day-to-day operations, compensate employees and hire new ones, pay for inventory, make interest payments on loans, pay dividends to shareholders, and purchase property, facilities, and equipment


Sources of FundsSources of Funds

Debt capital—funds obtained through borrowing.

Equity capital—funds provided by the firm’s owners when they reinvest earnings, make additional contributions, or issue stock to investors.


Debt and Equity Capital: Two Basic Sources of Funds


Comparison of Debt and Equity Capital



Short-Term Sources of FundsShort-term sources of funds are repaid

within one yearMajor sources of short-term funds include:

Trade creditShort-term loansCommercial paper



Long-term Sources of FundsLong-term sources are repaid over many yearsThree common sources of long-term funds are:

Long-term loansBonds—certificates of indebtedness sold to

raise long-term funds for a corporation or government agency

Equity financing—acquired by selling stock in the company or reinvesting company earnings



Long term Sources of FundsPublic Sale of Stock and Bonds

Sales of stocks and bonds represent a major source of funds for corporations

They provide cash inflows for the issuing firm and either a share in its ownership or a specified rate of interest and repayment at a stated time



Long term Sources of FundsPrivate Placements—stock or bond

issues sold to a small, select group of large investors such as pension funds and life insurance companies

Venture Capitalists—raise money from wealthy individuals and institutional investors and invest these funds in promising firms


Financial LeverageFinancial Leverage

Leverage—technique of increasing the rate of return on an investment by financing it with borrowed fundsThe key to managing leverage is

ensuring that the company’s earnings remain larger than its interest payments, which increases the leverage on the rate of return on shareholders’ investment


Table 14.2Table 14.2 How Leverage Works How Leverage Works


The Financial System andThe Financial System andFinancial InstitutionsFinancial Institutions

Financial System—process by which funds are transferred from savers to users.


Overview of the Financial System and Its Components



Depository Institutions—financial institutions that accept deposits that can be converted into cash demand.



Commercial BanksLargest and probably most important

financial institutionsApproximately 7,900 commercial banks in

the U.S.Total Assets: $7.1 trillionDown from over 18,000 in 1985



Commercial BanksHow Banks Operate

Banks raise funds by offering checking and savings accounts

They then pool these deposits and lend most of them out to consumers and businesses


Types of Outstanding Bank Loans



Commercial BanksElectronic BankingMore and more funds are moving through

Elections Funds Transfer Systems (EFTS)EFTS—computerized systems for

conducting financial transactions over electronic linksIncludes automatic teller machines

(ATMs), debit or check cards, and direct deposit of paychecks



Commercial BanksOnline Banking

Regular online bank users now 1 out of every 5 U.S. households

Projected to grow to 1 in 3 households by 2010

Two types of online banks:Internet-only banksTraditional bricks and mortar banks

with Web sites



Bank RegulationWho Regulates Banks?

State chartered banks are regulated by the appropriate state banking authorities

Most are federally insured, and also subject to FDIC regulation

Federally chartered banks are regulated by the Federal Reserve, the Federal Deposit Insurance Corporation, and the Comptroller of the Currency



Bank RegulationFederal Deposit Insurance

Deposits are insured by the FDIC up to a set amount – currently $100,000

Federal deposit insurance was enacted by the Banking Act of 1933 to restore public confidence in the banking system


Other Financial InstitutionsOther Financial Institutions

Savings Banks and Credit UnionsSavings banks and credit unions are also

important financial institutionsThey offer many of the same services as

commercial banksA series of crises cause many of the

predecessors of savings banks to merge with financially stronger institutions

Credit Unions are cooperative financial institutions, owned by their depositors, all of whom are members


Other Financial InstitutionsOther Financial Institutions

Nondepository Financial InstitutionsAccept funds from businesses and

households, much of which they then investInsurance CompaniesPension FundsFinance Companies


The Federal Reserve SystemThe Federal Reserve System

Central bank of the United States. Has four basic responsibilities:Regulating commercial banksPerforming banking-related activities for

the U.S. TreasuryServicing member banksMonetary policy



Organization of the Federal Reserve SystemNation is divided into 12 federal reserve

districts, each with its own Federal Reserve Bank

Each district Bank supplies banks within its district with currency and facilitates the clearing of checks

District banks are run by a nine-member board of directors



Governing body of the Fed is the Board of GovernorsThe board consists of seven members,

appointed by the president and confirmed by the Senate

The Fed is designed to be politically independentFed Governors are appointed to 14-year terms

– staggered so that a president could not appoint a majority during a single term

Federal Open Markets Committee (FOMC)



Check Clearing and the FedClearing of a check—process by which funds

are transferred from the Check writer to the recipient

If both the writer in the recipient have accounts at the same bank, a check will clear in house

If both have accounts at banks in the same town, the two banks may clear the check directly with one another

If one has an account with a bank in a state different than the other, the check will likely be cleared through the Federal Reserve system



Monetary PolicyMonetary Policy—managing the growth

rate in the supply of money and credit, usually through the use of interest rates.

Fed’s job is to ensure that the money supply grows at an appropriate rate allowing the economy to expand and inflation to remain in check



Monetary PolicyIf money supply grows too slowly economic

growth will slow, unemployment will increase, and the risk of recession will increase

If the money supply grows to rapidly, inflationary pressures build


Federal Reserve Tools


U.S. Financial Institutions:U.S. Financial Institutions:A Global PerspectiveA Global Perspective

Major U.S. banks have extensive international operations, with offices that lend money and accept deposits from customers worldwide

Only three of the 20 largest banks are U.S. institutionsThe others are based in France, Germany,

Holland, Japan, Switzerland, and the UK


Study QuestionsStudy Questions

1. Financial professionals rarely become CEOs of major corporations.

2. Virtually all financial decisions involve a tradeoff between risk and return.

3. “Risk” is the uncertainty regarding the gain or loss on an investment.

4. Investments that promise the highest returns tend to be the most risky.

5. Sharp fluctuations in the value of a currency rarely have any significant impact on national economies.


Study QuestionsStudy Questions 6. “M1” includes currency plus financial

assets that serve as a medium of exchange. 7. Currency accounts for the largest portion

of M1. 8. The amount of outstanding credit card

debt in the U.S. has tripled during the past twenty years.

9. To qualify as an M1 component, a financial asset must serve as a medium of exchange.

10. Mutual fund shares are more “liquid” than checking accounts.



11. Treasury bills are short-term securities issued by the U.S. government.

12. Equity capital represents funds obtained from banks and other lenders.

13. When venture capitalists invest in a start-up business, they almost always contribute debt capital rather than equity capital.

14. Debt capital is always preferable to equity capital for a corporation.

15. Profits are a source of equity capital.



16. Firms often rely on short-term sources to pay for large, permanent assets, such as buildings.

17. A private placement is the sale of a new security issue directly to a large investor such as a life insurance company.

18. Whenever a company borrows, it creates leverage.

19. U.S. households save more, as a percentage of their incomes, than do citizens of most other developed countries.

20. A key feature of bank regulation in the U.S. is federal deposit insurance.


Study QuestionsStudy Questions 21. Underwriting is the process used by

insurance companies to determine who to insure and what to charge.

22. Credit union deposits are insured by private companies, not by a federal agency.

23. Most banks are federally chartered and, as a result, regulated by federal banking agencies.

24. The Comptroller of the Currency regulates both federally and state chartered banks.

25. If the money supply grows too rapidly, inflationary pressures will begin to build.


Study QuestionsStudy Questions 26. Raising the reserve requirement tends

to increase the supply of money, lowering interest rates.

27. When the Fed buys government securities, it adds to the supply of money and thus lowers interest rates. T

28. There are 15 Federal Reserve districts. 29. The Fed uses “open market operations”

as a monetary policy tool more often than changes in the reserve requirement.

Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved.

Chapter 18Chapter 18

Financing and Investing through Securities Markets

Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved.

Bizness Bizness QuoteQuote

There are two fools in every

market: one asks too little, while the

other asks too much.

Russian proverb


Price College of BusinessPrice College of Business . . . Other . . . Other learning opportunitieslearning opportunities

FIN 4613 Student Investment Fund

FIN 4103 Investments FIN 4113 Derivative Securities

and Markets


Current Events: 2003 KPMG Fraud Current Events: 2003 KPMG Fraud SurveySurvey

75% of all U.S. businesses reported one instance of fraud

36% of U.S. companies reported a fraud that cost them at least $1 million

1 in 14 U.S. companies intentionally issued misleading or fraudulent financial reports

77% of U.S. companies now have anti-fraud programs (up from 51% in 1999)

Corporate employees are responsible for reporting nearly 2/3 of all corporate frauds


Key Job Role: Outside DirectorKey Job Role: Outside Director

A member of a company’s board of directors who has no other ties to that company.

Intended to provide an objective point of view regarding key operating, legal, and administrative issues facing a company.

Outside directors typically serve on a company’s audit committee.

Many outside directors have been criticized in recent years for being lax in carrying out their responsibilities.


Textbook Tidbits: Chapter 18Textbook Tidbits: Chapter 18

U.S. pension funds have $7 trillion in assets

“There are two times in a man’s life when he should not speculate: when he can’t afford it and when he can.” Mark Twain

The “fourth market” is made up of electronic communications networks (ECN’s) such as Instinet


Textbook Tidbits: Chapter 18Textbook Tidbits: Chapter 18

Merrill Lynch employs 15,000 brokers There are more than 8,000 mutual funds in

the U.S. The SEC (Securities and Exchange

Commission) was created in 1934 “Pump and dump” schemes are illegal—

even for college students


Distinguish between the primary market for Distinguish between the primary market for securities and the secondary marketsecurities and the secondary market

Compare money market instruments, bonds, Compare money market instruments, bonds, and common stock, and explain why and common stock, and explain why particular investors might prefer each type of particular investors might prefer each type of securitysecurity

Identify the five basic objectives of investors Identify the five basic objectives of investors and the types of securities most likely to help and the types of securities most likely to help them reach each objectivethem reach each objective

Explain the process of buying or selling a Explain the process of buying or selling a security listed on an organized securities security listed on an organized securities exchangeexchange

LEARNING GOALSLEARNING GOALSLEARNING GOALSLEARNING GOALS


Investment MotivationsInvestment MotivationsInvestment MotivationsInvestment Motivations

Primary Investment Objectives by Type of SecurityPrimary Investment Objectives by Type of Security


The Primary MarketThe Primary Market

Security—stock, bond, or money market instrument that represents an obligation on the part of the issuer.

Primary Market—market where new security issues are first sold to investors; the issuer receives the proceeds from the sale.Initial Public Offering (IPO)


IPOExample of a Tombstone


The Secondary MarketThe Secondary Market

Secondary Market—financial markets where previously issued securities are traded among investors.Examples: NY Stock Exchange and the

NASDAQ


SecuritiesSecurities

Money Market Instruments—short-term debt securities issued by corporations, financial institutions such as banks, and governments.By definition, all short-term money market

instruments mature within one year from the date of issue

Examples include: U.S. Treasury Bills, commercial paper, repurchase agreements and bank Certificates of Deposit


Types of Bonds and the Significant Features ofTypes of Bonds and the Significant Features of Each EachTypes of Bonds and the Significant Features ofTypes of Bonds and the Significant Features of Each Each



Types of BondsSecured Bond—bond backed by specific

pledge of a company’s assets.

Debenture—bond backed by the reputation of the issuer rather than by a specific pledge of a company’s assets.



Types of BondsGovernment Bonds issued by U.S. TreasuryMunicipal Bonds are those issued by

governmentsRevenue 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)



Quality Ratings for BondsTwo factors determine a bond’s price: risk

and interest rateBonds vary considerably in terms of risk as

shown on the next slide


Moody’s and Standard & Poor’s Bond RatingsMoody’s and Standard & Poor’s Bond Ratings



Retiring BondsBonds mature on a specific dateBorrowers must have the necessary funds

available to pay the principal at that timeCall Provision


SecuritiesSecurities Stock

Common StockShare of ownership in a company.Common stock owners can vote on

major company decisionsThey expect to receive cash dividends

and to benefit from capital gains. (Often no dividends are issued.)



StockPreferred Stock

Stock whose holders receive preference in the payment of dividends

Seldom confers voting rightsDividends are fixed


SecuritiesSecurities Stock

Convertible SecuritiesBonds or stock that contains a

conversion featureGives the holder the right to exchange

their securities for a fixed number of shares of common stock


Figure 15.4 Relationship between Earnings Figure 15.4 Relationship between Earnings and Stock Prices for Johnson & Johnsonand Stock Prices for Johnson & Johnson

Figure 15.4 Relationship between Earnings Figure 15.4 Relationship between Earnings and Stock Prices for Johnson & Johnsonand Stock Prices for Johnson & Johnson


Securities PurchasersSecurities Purchasers

The general types of investors who buy securities include institutions and individuals

Institutions invest their own funds or those held in trust for others

Individual investors still play a vital role . . . over half of all Americans now own stock


Securities PurchasersSecurities Purchasers

Taxes and InvestingInterest received from bonds, and

dividends received from stocks, are considered ordinary income which is taxed at the investor’s marginal tax rate

Profits made from the sale of securities owned for over a year are taxed at the capital gains rate

Other, special tax rules apply for investment income


Securities ExchangesSecurities Exchanges

Stock Exchange—centralized marketplace where primarily common stock are traded.Stock exchanges are secondary markets,

selling securities which have already been issued by firms and sold in the primary market


Securities ExchangesSecurities Exchanges The New York Stock Exchange

NYSE (Big Board)—the largest, and probably the most famous, stock market in the world

Also one of the oldest, having been founded in 1792



The NASDAQ Stock MarketNASDAQ stock market—second-largest

stock market in U.S., trading stock issues of firms that are typically smaller, less well-known than those on the NSYE

Unlike trading on the NSYE, which takes place face-to-face or the trading floor, trading on the NASDAQ takes place on an electronic network

World’s largest Intranet



Other U.S. Stock MarketsAmerican Stock Exchange (AMEX)—

focuses on stocks of smaller firms as well as other financial instruments such as options

Several regional stock exchanges also operate in the United States including the Chicago, Pacific (San Francisco) Boston, Cincinnati, and Philadelphia exchanges



Foreign Stock MarketsVirtually all developed, and many

developing, countries have stock exchanges

Examples include Bombay, Helsinki, Hong Kong, Mexico City, Paris, and Toronto



Direct Trading and ECNsFourth market—direct trading of

exchange-listed stocks off the floor of the NSYE, or outside the network, in case of NASDAQ-listed stocks

Electronic Communications Networks (ECNs)—such as Instinet, have become quite visible in recent years


Buying and Selling SecuritiesBuying and Selling Securities

Brokerage Firm—financial intermediary that buys and sells securities for individual and institutional investors.


Buying and Selling SecuritiesBuying and Selling Securities

Placing an OrderA market order instructs a brokerage firm

to obtain the highest price possible – if the investor is selling – or the lowest price possible – if the investor is buying

A limit order instructs the brokerage firm not to pay more than a specified price for stock if the investor is buying, or accept less than a specified price if the investor is selling


Costs of TradingCosts of Trading

When investors buy or sell securities through a brokerage firm, they pay a fee

These costs vary widely among brokerage firms

A full-service firm charges higher fees, but provides a large number of services and offers investment advice

A discount firm charges lower fees, but offers less advice and fewer services


Costs of TradingCosts of Trading

Direct InvestingA growing number of corporations offer

investors a direct way of purchasing stock through dividend reinvestment plans (DRIPs)

With DRIPs, the company uses the dividends paid on shares owned by an investor to buy additional shares of the company stock -- bypassing brokers -- and their fees

Another form of direct investing is the stock purchase program


Getting the FactsGetting the Facts Reading the Financial News

Current financial news may be found in most daily newspapers, numerous websites, and many television and radio programs


How to Read Stock Quote Tables


How to Read Bond Quote Tables


Stock IndexesStock Indexes

Stock indexes reflect the general activity of the stock market

The most common indices include the Dow Jones Average (Dow), the Standard & Poor’s 500, and the NASDAQ composite

Foreign indices include the DAX (Germany), the FT-100 or “Footsie” (London), and the Nikkei (Tokyo)


Mutual FundsMutual Funds

Mutual Fund—financial institution that pools investment money from purchases of its shares and uses the money to acquire diversified portfolios of securities consistent with the fund’s investment objective.Investors who buy shares of a mutual fund

become part owners of a large number of securities, thereby lessening their individual risk


Distribution of Mutual Fund Assets by Type of Fund


How to Read Mutual Fund Tables


Legal and Ethical Issues in SecuritiesLegal and Ethical Issues in Securities

Examples of unethical trading practices include brokers urging investors to buy high-risk investments or “churning” accounts (excessive trading) just to generate higher commissions

Examples of illegal trading practices include brokers theft from a client’s portfolio and giving false or misleading information to investors



Government Regulation of the Securities MarketsFull and Fair Disclosure—requirement

that investors should be told all relevant information by issuers so the can make informed decisions.

Prospectus—document that gives a detailed description of a company issuing securities



Government Regulation of the Securities MarketsInsider Training—the use of material non-

public information to make an investment profit

Example: someone using non-public information about a pending merger, or a major oil discovery, to profit in the stock market at the expense of ordinary investorsRegulation FD



Industry Self-RegulationProfessional Rules of Conduct—rules of

conduct for members of the National Association of Securities Dealers that try to ensure that brokers perform their basic functions honestly and fairly, under constant supervision

Market Surveillance—techniques used by all securities markets to spot possible violations of trading rules or securities laws


Study QuestionsStudy Questions 1. When a company first sells stock to the public, it is

selling stock in the primary securities market. 2. Advertisements announcing stock and bond

offerings, which appear almost daily in financial publications, are referred to as “bulletins.”

3. Most new corporate and municipal securities issues are sold through investment banking firms.

4. The New York Stock Exchange is a secondary market.

5. Treasury bills and commercial paper are both money market instruments.

6. Money market instruments are generally low risk securities.


Study QuestionsStudy Questions 7. Most federal securities legislation came about as

a result of the 1929 stock market crash. 8. As market interest rates rise, bond prices fall. 9. The fundamental reason to invest in a common

stock is the belief that, as the given firm grows and prospers, the value of its common stock will rise.

10. While a number of variables cause stock prices to fluctuate in the short run, in the long run stock prices tend to be closely correlated with a company’s profits.

11. Institutional investors include life insurance companies, mutual funds, and pension funds.

12. For most investors, current income is the main motive for investing.


Study QuestionsStudy Questions 13. The percentage of Americans who own

stocks has risen sharply in recent years. 14. The dividend yield on a firm’s common stock

usually exceeds the rate of interest on the firm’s bonds.

15. The key investment objective of a young worker who is investing for retirement purposes should be “liquidity.”

16. In terms of the dollar value of securities traded, the NYSE is the largest stock market in the world.

17. The NASDAQ stock market is actually a computerized communications network.

18. Stock trading is normally done in “round lots” of 1,000 shares.


Study QuestionsStudy Questions 19. NASDAQ-listed companies tend to be smaller

and lesser known that NYSE companies. 20. The Tokyo stock exchange is the largest

outside of the U.S. 21. A “market order” is a stock purchase order to

buy the given security at the best possible price. 22. If a stock’s current price is $50 per share, its

earnings are $4 per share, and it is paying a dividend of $1.50 per share, then its P/E ratio is 12.5.

23. If a stock’s current price is $40 per share, its earnings are $2 per share, and it is paying a dividend of $1 per share, then its dividend yield is 5%.

24. A bond’s price is quoted as the percentage of the bond’s face value.



25. A stock that has a P/E ratio of 14, earnings per share of $5, and an annual dividend of $2 per share must be selling currently for $42 per share.

26. Which of the following stocks has remained a component of the DJIA ever since that stock index was first calculated in the late 1800s—GM, AT&T or GE?

27. Which stock market index—the DJIA or the S&P 500—is considered the best measure of overall stock market activity?


Study QuestionsStudy Questions 28. A key feature that makes mutual funds

attractive is “diversification.” 29. A mutual fund pools investment money from

purchasers of its shares and then uses those funds to acquire a diversified portfolio of securities.

30. A mutual fund’s net asset value is the market value of the securities owned by the fund divided by the number of outstanding shares.

31. The federal government’s approach to securities regulation can be summed up by the phrase “full and fair disclosure.”

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BK18.ppt

Economy & Finance