FBP C19 - stocks and bonds Flashcards
Security markets
Security markets – financial marketplaces for stocks, bonds and other investments, serve two major functions:
1- Assist businesses in finding long term funding to finance capital needs
2- They provide private investors a place to buy and sell investments, such as stocks and bonds.
Categories of security markets:
1) Primary markets – handle the sale of new securities (stock). Corporations make money on the sale of their securities (stock) only once: when they’re sold to the primary market.
Initial public offering (IPO) – the first public offering of a corporation’s stock.
2) Secondary market – handles the trading of these securities (stock) between investors, with the proceeds of the sale going to the investor selling the stock, not the corporation whose stock is sold.
Initial public offering (IPO)
the first public offering of a corporation’s stock.
Investment bankers
Investment bankers – are specialists who assist in the issue and sale of new securities.
They can also unwrite new issues of stocks and bonds. That is when the investment banking firm buys the entire stock or bond issue at an agreed-on discount which is quite sizeable and then sells then issues to private or institutional investors at full price.
Institutional investors
large organizations, such as pension funds, mutual funds and insurance companies – that invest their own funds or the funds of others. Because of their vast buying power, institutional investors are a powerful force in security markets.
Stock exchange
the places where stocks and bonds are traded and who regulates the industry.
Stock exchange
an organization whose members can buy and sell (exchange) securities on behalf of companies and individual investors.
What are the different exchanges?
- NYSE is the oldest and largest floor exchange but today does very little stock trading on its floor.
- NASDAQ – is a telecommunications network that links dealers across the nation so that they can buy and sell securities electronically rather than in person. Largest US electronic market.
NASDAQ (National Association of Securities Dealers Automated Quotations)
NASDAQ (National Association of Securities Dealers Automated Quotations) – was the worlds first electronic stock market. It is an electronic based network that links dealers so they can buy and sell securities electronically rather than in person.
What is the over-the-counter OCT market?
OCT – market is a system for exchanging stocks not listed on the national exchanges
Over the counter (OTC) market – provides companies and investors with a means to trade stock not listed on the large securities exchanges. The OCT market is a network of several thousand brokers who maintain contract with one another and buy and sell securities through nationwide electronic system. Trading is conducted between two parties directly instead of through an exchange.
How are securities exchanges regulated:
Securities and Exchange Commission (SEC) – is the federal agency responsible for regulating the various stock exchanges.
Securities and Exchange Commission (SEC)
is the federal agency responsible for regulating the various stock exchanges.
Prospectus
a condensed version of economic and financial information that a company must file with the SEC before issuing stock: the prospectus must be sent to prospective investors
What is insider trading?
Insider trading – is using knowledge or information that individuals gain through their position that allows them to benefit unfairly from fluctuations in security prices.
Penalties for insider trading:
- Hefty fines
- Imprisonment
Stocks
are shares of ownership in a company
A stock certificate
represents stock ownership. Specifies the company name, the number of shares owned, and the type of stock it represents.
Dividends are part of a firms profit that the company may (not is not always required to) distribute to stockholders as either cash payments or additional shares of stock.
Advantages and Disadvantages of issuing stock
Advantages:
- Stockholders never have to be repaid for their investment as they are owners of the business
- There’s no legal obligation ot pay dividends to the stockholders: firms can reinvest the income (retained earnings) to finance future needs
- Selling stock can improve the condition of a firms balance sheet since issuing stock creates no debt (a corporation can also buy its stock back to improve its balance sheet and stock price and make the company appear financially stronger)
Disadvantages:
- Issuing new stocks can alter the control of the firm, as owners the stockholders have the right to vote for the company’s board of directors
- The need to keep stockholders happy can affect managers decisions
- Dividends are paid from profit after taxes and are not tax deductible
Common stock
Holders of common stock have the right to:
is the most basic form of ownership in a firm. If a company only issues one type of stock, by law it must be common stock.
Holders of common stock have the right to:
Holders of common stock have the right to:
- Elect members of the company of board of directors and vote on important issues affecting the company
- Share in the firms profit through dividends if the board of directors improves
- They have the “preemptive right” to purchase new share of common stock before anyone else, allowing them to maintain their proportional share of ownership in the company
Preferred stock
Preferred stock – owners are given preference in payment of company dividends and must be paid their dividends in full before any common stock dividends can be distributed (hence the term preferred)
- They also have a prior claim on company assets if the firm is forced out of business and its assets sold but
- they have no voting rights.
Preferred stock can have other special features that common stock doesn’t have:
- It can be callable: preferred stockholders could be required to sell their shares back to the corporation
- Cumulative – preferred stock can also be converted to share of common stock (but not the other way around). That is if one or more dividends are not paid when promised, they accumulate, and the corporation must pay them full at a later date before it can distribute any common stock dividends.
The differences between common and preferred stock:
- Preferred stock gives no voting rights to shareholders while common stock does
- Preferred shareholders have priority over company income, meaning they are paid dividends before common shareholders
Bond
is a cooperate certificate indicating an investor has lent money to a firm (or the government).
- An organization that issues bonds has a legal obligation to make regular interest payments to investors and to repay the entire bond principal amount at a prescribed time.
Bond maturity date
the exact date the issuer of a bond must pay the principal to the bondholder
Interest
the payment the issuer of the bond makes to the bondholders for use of the borrowed money
Bond interest is sometimes called the coupon rate.
Advantages and disadvantages of issuing bonds
Advantages:
- Bondholders are creditors of the firm, not owners. They seldomly vote so management maintains control over the firms’ operations.
- Bond interest is a business expense and tax deductible to the firm
- Bonds are a temporary source of funding. They’re eventually repaid, and the debt obligation is eliminated.
- Bonds can be repaid before the maturity date if they are callable. Bonds can also be converted to common stock.
Disadvantages:
- Bonds increase debt (long term liabilities) and may adversely affect the markets perception of the firm
- Paying interest on bonds is a legal obligation. If interest is not paid, bondholders can take legal action to force payment.
- The face value of the bond must be repaid on the maturity date. Without careful planning, this obligation can cause cash flow problems when the repayment comes due.
Different classes on Bonds:
There are two different types:
1) Debenture bonds (unsecured) – bonds that are unsecured (not backed up by any collateral such as equipment)
- Only firms with excellent reputations and credit ratings can issue them due to the lack of security they provide investors
2) Mortgage bonds (secured bonds) – Secured bonds, are backed up by collateral such as land / buildings that is pledged to bondholders if interest or principal isn’t paid when promised.
Debenture bonds (unsecured)
(unsecured) – bonds that are unsecured (not backed up by any collateral such as equipment)
- Only firms with excellent reputations and credit ratings can issue them due to the lack of security they provide investors
Mortgage bonds (secured bonds)
Secured bonds, are backed up by collateral such as land / buildings that is pledged to bondholders if interest or principal isn’t paid when promised.
Sinking fund
A reserve account in which the issuer of a bond periodically retires some part of the bond principal prior to maturity so that enough capital will be accumulated by the maturity date to pay off the bond.
Primary purpose: to ensure that enough money will be available to repay bondholders on the bond’s maturity date.
Sinking funds are generally attractive to both issuing firms and investors for several reasons:
- They provide for an orderly retirement (repayment) of a bond issue
- They reduce the risk the bond will not be repaid
- They support the market price of the bond because they reduce the risk the bond will not be repaid.
- A callable bond permits the bond issuer to pay the bonds principal before its maturity date. This gives companies some discretion in their long-term financial forecasting.
- Investors can convert convertible bonds into shares of common stock in the issuing company. This can be an incentive become common stock value tends to grow faster than a bond.
Stockbroker
A registered representative who works as a market intermediary to buy and sell securities for clients. Can also be a source of information about what investments are best.
Investors can purchase investments through market intermediaries called stockbrokers, who provide many different services. Online investing, however, has become extremely popular.
How to invest in the securities market
- Decide what stock or bond you want to buy.
- Find a brokerage firm authorized to trade securities to execute your order.
- Stockbrokers place an order and negotiate price
- After the transaction is completed, the trade is reported to your broker who notifies you.
Or
Investors can also choose from multiple trading services to buy and sell stocks and bonds. Investors who trade online are willing to do their own research and make investment decisions without the direct assistance of a broker.
Or
Robo advisors are automated online tools that use advanced algorithms to make investment suggestions, manage money.
Choosing the right investment strategy
Consider 5 key criteria when selecting investment options:
- Investment risk – the chance that an investment will be worth less at some future time than it’s worth now
- Yield – the expected return on an investment, such as interest or dividends, usually over a period of one year.
- Duration – the length of time your money is committed to an investment
- Liquidity – how quickly you can get back your investment funds in cash if you want or need them
- Tax consequences – how the investment will affect your tax situation
