Chapter 9 Textbook Notes

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10 Nov 2010
MGTA04 / 01
Chapter 9: Understanding Securities and Investments
- Securities are stocks and bonds which represent a secured-asset-based claim on the part of
investors that can be bought or sold
o Stocks: holders of stocks have claims RQVRPHRIDFRUSRUDWLRQ¶VDVVHWVDQGKDYHD
say in how the company is run.
o Bonds: strictly represents financial claims for money owed to holders by a
- Markets in which stocks and bonds are sold are called securities markets
Primary and Secondary Markets for Securities
- Primary securities markets handle the buying and selling of new stocks and bonds by
firms or governments. New securities are sold to one buyer or a small group of buyers
called private placements to allow the business to keep their plans confidential
Investment Banking
- To bring a new security to market, the issuing corporation must obtain approval from a
provincial securities commission and the services of an investment banker
- Investment banker serve as any financial institution engaged in purchasing and reselling
new stocks and bonds
- Firms such as RBC Dominion Securities provide 3 types of investment banking services:
1. Advise company on the timing and financial terms for the new issue
2. By underwriting (buying) the new securities, investment bankers bear some of
the risk of issuing the new security
3. Create distribution network that moves the new securities through groups of
other banks and brokers into the hands of individual investors
- Secondary securities market sells and purchase previously issued stocks and bonds
- The availability of different types of stocks and markets have been established for
conveniently buying and selling stocks
Common Shares
- Individuals and other companies buy a firm`s common shares in hope that the shares will
increase in value, affording them a capital gain, and/or will provide dividend income
- The value of a common share is expressed in 2 different ways: market value & book value
Market Value
- The market value is the current price of one share of a stock in the secondary securities
market; the real value of a share
- Market value can be influenced by both objective factors and subjective factors
o Subjective factors: - rumours (e.g. unverified information of a company strike)
- investor relations (e.g. playing the positive aspects of a
Securities Markets (pg. 199)
Stocks (pg. 199 ± 207)
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FRPSDQ\¶VILQDncial condition to financial analysts
- stockbroker recommendations (e.g. recommendation to buy a
Book Value
- The book value of a common stock represents RZQHUV¶HTXLW\GLYLGHGE\WKHQXPEHURI
shares of stock
- Used as a comparison indicator because for successful companies, the market value is
usually greater than its book value
Investment Traits of Common Shares
- Common shares are among the riskiest of all securities because of uncertainty of the stock
profits, dividends may not be paid)
- Common shares also offer high growth potential where prospects for growth in various
industries change from time to time but the blue-chip stocks of well established companies
such as IBM provide investors with steady income through dividend payouts/capital gains
What Is a Blue-Chip Stock?
- Because the nature of the stock market is continuously changing, the future performance of
any stock is often unpredictable. Many of the old rules for judging the market prospects of
earnings per share (EPS), and low price-earning (PE) ratios
- Blue-chip stocks are stocks of well established, financially sound firms (e.g. Wal-Mart)
- Financial performance of newcomers ± America Online, eBay, Yahoo! [Internet Blue
Chips] ± quite different from that of traditional blue-chip stocks
Market Capitalization
- The dollar value (market value) of stocks listed on a stock exchange is known as its
market capitalization
Preferred Shares
- Preferred shares are usually issued with a stated value (e.g. $100) and dividends paid are
usually expressed as a percentage of the stated value (e.g. 6%) = $6 annual dividend/share
- Preferred shares that are callable means that the issuing firm can require the preferred
shareholders to surrender their shares in exchange for a cash payment (call price)
Investment Traits of Preferred Shares
common shares and most preferred shares are cumulative preferred shares (holder
receives dividends not paid in the past first before company pay dividends to commons)
- The income from cumulative preferred shares is not as certain as the corporate bonds of the
same company since the ability to pay dividends depend on whether the company makes a
profit or not. Also, growth potential of preferred shares is limited due to its fixed dividends
Stock Exchanges
- A stock exchange is an organization of individuals formed to provide an institutional
setting where members can buy and sell stock (secondary market of stocks) for themselves
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- To become a member and individual must purchase one of a limited number of
allowed to trade on the exchange
The Trading Floor
- Trading is allowed only at an actual physical location called the trading floor which is
equipped with a vast array of electronic communications equipment for conveying buy and
sell orders or confirming completed trades
- On April 23, 1997, the Toronto Stock Exchange trading floor closed after 145 years of
operation, buy and sell orders are now placed through computers
- Some of the people working on the trading floor are employed by the exchange, trade
stocks for themselves, or they are brokers
- Brokers receives buy and sell orders from those who are not members of the exchange and
executes the orders, in return, the broker earns a commission from the order placer
Discount Brokers
- Discount brokers offer well-informed individual investors a fast, low-cost way to
participate in the market
- Services are low cost because sales personnel receive fees or salaries not commissions.
Also, they do not offer investment advice or person-to-person sales consultations
Online Trading
- Popularity of online trading stems from convenient access to the internet, fast no-nonsense
transactions and the opportunity for self-directed investors to manage their own portfolios
while paying low fees for trading
- The competition among brokers has driven commission fees sharply downward
Full-Service Brokers
- Despite the growth in online investing, there remains an important market for full-service
have time to keep up with the latest developments
- Financial services of firms such as Merrill Lynch can offer client consulting advice in
personal financial planning, estate planning, and tax strategies
- Financial advisers do more than deliver information, they offer interpretations of and
suggestions on investments that clients might overlook
Canadian Stock Exchanges
- There are two major Canadian stock exchanges:
o the Toronto Stock Exchange (TSX) ± largest stock exchange in Canada which is
made up of about 100 individual members who hold seats and the securities of
most major corporations are listed here.
o Formerly, there were also stock exchanges in Calgary, Vancouver, and Montreal
but in 1999, an agreement was reached that
(1) created the new Canadian Venture Exchange (CDNX) from the
Vancouver and Alberta stock markets
(2) shifted all derivative trading to the Montreal stock exchange
(3) consolidated all senior equity trading at the TSE [the CDNX now
focuses on junior companies]
Foreign Stock Exchanges
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