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Chapter 9

chapter 9 notes

Management (MGT)
Course Code
Chris Bovaird

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Chapter 9 Understanding Securities and Investments Notes
Securities Markets
x securities Æ stocks and bonds (which represent a secured-asset-based claim on the part of investors) that can be bought and sold
x in other words, holders of stocks and bonds have a stake in the business that issued them
x stockholders have claims on some of a corporation’s assets (and a say in how the company is run) because each share represents
pat ownership; in contrast, bonds represent strictly financial claims for money owed to holders by a company
x the markets in which stocks and bonds are sold are called securities markets
Primary and Secondary Markets for Securities
x primary securities markets Æ the sale and purchase of newly issued stocks and bonds by firms or governments
x new securities are sometimes sold to one buyer or a small group of buyers
x these so-called private placements allow the businesses that use them to keep their plans confidential
Investment Banking
x most new stocks and some bonds are sold to the wider public market
x to bring a new security to market, the issuing corporation must obtain approval from a provincial securities commission
x investment banker Æ any financial institution engaged in purchasing and reselling new stocks and bonds
x such well-known firms provide three types of investment banking services:
1) They advise the 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) They create the distribution network that moves the new securities through groups of other banks and brokers into the
hands of individual investors.
x secondary securities market Æ the sale and purchase of previously issued stocks and bonds
x the secondary securities market is handled by organizations such as the Toronto Stock Exchange
x each year, financial managers, along with millions of individual investors, buy and sell the stocks of thousands of companies
x this widespread ownership has become possible because of the availability of different types of stocks and because markets have
been established for conveniently buying and selling them
Common Shares
x individuals and other companies buy a firm’s common shares in the hope that the shares will increase in value, affording them a
capital gain, and/or will provide dividend income
x share values are expressed in two different ways: as market value and as book value
Market Value
x market value Æ the current price of one share of a stock in the secondary securities market; the real value of a share
x the market price of a share can be influenced by both objective factors (e.g., a company’s profits) and by subjective factors
x subjective factors include rumours (unverified information such as a claim that a company has made a big gold strike), investor
relations (playing up the positive aspects of a company’s financial condition to financial analysts and financial institutions), and
stockbroker recommendations (a recommendation to buy a stock may increase demand for the stock and cause its price to
increase, while a recommendation to sell can decrease demand and cause the price to fall)
Book Value
x owner’s equity Æ the sum of a companys stated capital, retained earnings, and additional paid-in capital
x book value Æ value of a common stock expressed as total ownersequity divided by the number of shares of stock
x book value is used as comparison indicator because, for successful companies, market value is usually greater than book value
x when market price falls near book value, some investors buy stock on principle that it is underpriced and will increase in future
Investment Traits of Common Shares
x uncertainties about the stock market itself can quickly change a given stock’s value
x when companies have unprofitable years, they often cannot pay dividends—shareholder income and share price may both drop
x at the same time, however, common shares offer high growth potential
x naturally the prospects for growth in various industries change from time to time, but the blue-chip stocks of well-established,
financially sound firms such as IBM and Imperial Oil have historically provided investors with steady income through consistent
dividend payouts as well as long-term capital gains
What is a Blue-Chip Stock?
x blue-chip stocks Æ stocks of well-established, financially sound firms
x market capitalization Æ the dollar value (market value) of stocks listed on a stock exchange
x market capitalization is computed by multiplying the number of a company’s outstanding shares times the value of each share
Preferred Shares
x preferred shares are usually issued with a stated price
x dividends paid on preferred shares are usually expressed as a percentage of the stated value
x some preferred shares are callable—the issuing firm can require the preferred shareholders to surrender their shares in exchange
for a cash payment, known as the call price, which is specified in the agreement between the preferred shareholders and the firm
Investment Traits of Preferred Shares
x because of its preference on dividends, preferred shares’ income is less risky than the common shares of the same company
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x cumulative PS Æ PS on which dividends not paid in past must first be paid up before paying dividends to common shareholders
x even the income from cumulative preferred shares is not as certain as the corporate bonds of the same company
x the company cannot pay dividends if it does not make a profit
x the purchase price of the preferred shares can also fluctuate, leading to a capital gain or loss for the shareholder
x and the growth potential of preferred shares is limited due to its fixed dividend
Stock Exchanges
x stock exchange Æ a voluntary organization of individuals formed to provide an institutional setting where members can buy and
sell stock for themselves and their clients in accordance with the exchange’s rules
x most exchanges are non-profit corporations established to serve their members
x to become a member, an individual must purchase one of a limited number of membershipscalled “seats—on the exchange
x only members (or their representatives) are allowed to trade on the exchange
x in this sense, because all orders to buy or sell must flow through members, they have a legal monopoly
x memberships can be bought or sold like other assets
The Trading Floor
x 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
x a variety of news services furnish important up-to-the-minute information about world events as well as business developments
x any change in these factors, then, may be swiftly reflected in share prices
x some of the people working on the trading floor are employed by the exchange; others trade stocks for themselves
x broker Æ individual licensed to buy and sell securities for customers in secondary market; may provide other financial services
x a broker receives buy and sell orders from those who are not members of the exchange and executes the orders
x in return, the broker earns a commission from the order placer
x discount brokers offer well-informed individual investments a fast, low-cost way to participate in the market
x discount brokerage services are low cost because sales personnel receive fees or salaries, not commissions
x unlike many full-service brokers, they do not offer investment advice or person-to-person sales consultations
x they do offer automated online services, such as stock research, industry analysis, and screening for specific types of stocks
x the 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
x despite the growth in online investing, there remains an important market for full-service brokerages, both for new, uninformed
investors and for experienced investors who do not have time to keep up with all the latest developments
x with full lines of financial services, firms (such as Merrill Lynch) can offer clients consulting advice in personal financial
planning, estate planning, ad tax strategies, along with a wider range of investment products
x financial advisers also do more than deliver information—they offer interpretations of and suggestions on investments that
clients might overlook when trying to shift through an avalanche of online financial data
Canadian Stock Exchanges
x there are two major Canadian stock exchanges: Toronto Stock Exchange (TSX), and Canadian Venture Exchange (CDNX)
x the TSX is the largest stock exchange in Canada; it is made up of 100 individual members who hold seats
x a company must pay a fee before it can list its security on the exchange
x formerly, there were stock exchanges in Calgary, Vancouver, and Montreal, but in 1999 agreement was reached that (1) created
the new CDNX from the Vancouver and Alberta stock markets, (2) shifted all derivative trading to the Montreal stock exchange,
and (3) consolidated all senior equity trading at the TSE
Foreign Stock Exchanges
x many foreign countries also have active stock exchanges
x in fact, several foreign stock exchangesmost notably those in US and Englandtrade far more shares each day than TSX does
x over-the-counter (OTC) market Æ organization of securities dealers formed to trade stock outside the formal institutional setting
of the organized stock exchanges; original traders were somewhat like retailers
x the OTC market consists of independent dealers who own the securities that they buy and sell at their own risk
x National Association of Securities Dealers Automated Quotation (NASDAQ) Æ stock market implemented by NASD (National
Association of Securities Dealers Inc.) that operates by broadcasting trading information on an intranet to more than 350 000
terminals worldwide; world’s first electronic stock market
x currently, NASDAQ is working with officials in an increasing number of countries who want to replace the trading floors of
traditional exchanges with electronic networks like NASDAQ
x with its electronic telecommunications system, NASDAQ possesses an infrastructure that could eventually lead to a truly global
stock market—one that would allow buyers and sellers to interact from any point in the world
x currently NASDAQ provides equal access to both the market and market information via simultaneous broadcasts of quotes
x NASDAQ communication networks enter customer orders and then display new quotes reflecting those orders
x bond Æ a written promise that the borrower will pay the lender, at a stated future date, the principal plus a stated rate of interest
x bondholders have a claim on a corporation’s assets and earnings that come before claims of common and preferred shareholders
x bonds differ from one another in terms of maturity, tax status, and level of risk versus potential yield (the interest rate)
x potential investors must take these factors into consideration to evaluate which particular bond to buy
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