Chapter 11 – Understanding Shares and Other
Securities are stocks and bonds (which represent a secured-asset-based claim on the
part of investors) that can be bought and sold.
Holders of stocks and bonds have a stake in the business that issued them.
Stockholders have claims on some of a corporation’s assets because each share
represents part ownership.
Companies sell bonds to raise long-term funds.
The markets in which stocks and bonds are sold are called securities markets.
Primary and Secondary Markets for Securities
Primary securities market is the sale and purchase of newly issued stocks and bonds
by firms or governments.
New securities are sometimes sold to one buyer or a small group of buyers.
Investment banker is any financial institution engaged in purchasing and reselling
new stocks and bonds.
Investment bankers such as RBC Dominion Securities and TD Securities provide
three type of investment banking services:
oThey advise the company on the timing and financial terms for the new issue.
oBy underwriting the new securities, investment bankers bear some of the
risk of issuing the new security.
oThey create the distribution network that moves the new securities through
groups of other banks and brokers into the hands of individual investors.
Secondary securities market is the sale and purchase of previously issued stocks and
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 reflects buyers’ willingness to invest in a company.
The market price of a share can be influenced by both objective factors (a company’s
profits) and by subjective factors (rumors, investor relations, and stockbroker
Book value is the value of a common stock expressed as total owner’s equity divided
by the number of shares of stock.
Book value is used as a comparison indicator because the market value is usually
greater than its book value.
When market price falls to near book value, some investors buy the stock on the
principle that it is underpriced and will increase in the future.
Investment Traits of Common Shares
Common shares are among the riskiest of all securities.
When companies have unprofitable years, they often cannot pay dividends.
oShareholder income and share price may both drop.
Common shares offer high growth potential.
Market capitalization is the dollar value (market value) of stocks listed on a stock
It is computed by multiplying the number of a company’s outstanding shares times
the value for each share.
Preferred shares are usually issued with a stated value.
Dividends paid on preferred shares are usually expressed as a percentage of the
Some preferred shares are callable. The issuing firm can require the preferred
shareholders to surrender their shares in exchange for a cash payment called call
oCall price is specified in the agreement between the preferred shareholders
and the firm.
Investment Traits of Preferred Shares
Because of its preference on dividends, preferred shares’ income is less risky than
the common shares of the same company.
Cumulative preferred shares are preferred shares on which dividends not paid in the
past must first be paid up before the firm may pay dividends to common
The firm cannot pay any dividends to its common shareholders until it has made up
all late payments to preferred shareholders.
The purchase price of preferred shares can fluctuate.
The growth potential of preferred shares is limited due to its fixed dividend.
Stock exchange is a voluntary organization of individuals formed to provide an
institutional setting were members can buy and sell stock for themselves and their
clients in accordance with the exchange’s rules.
To become a member, an individual must purchase one of a limited number of
memberships called “seats” on the exchange.
Because all orders to buy or sell must flow through members, they have a legal