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RSM100Y1 (431)
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Chapter 19

RSM100- Chapter 19.docx

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University of Toronto St. George
Rotman Commerce
John Oesch

Understanding Securities and Investments [Chapter 19] Securities Markets  Securities: stocks and bonds (which represent a secured-asset-based claim on the part of investors) that can be bought and sold o Bonds represent strictly financial claims for money owed to bondholders by a company (companies sell bonds to raise long term funds) o Security markets are where bonds and stocks are sold Primary and Secondary Markets for Securities  Primary securities market: the sale and purchase of newly issued stocks and bonds by firms or governments o New securities are sometimes sold to one buyer or a small group of buyers (private placements) and these allow businesses that use them to keep their plans confidential  Investment banking: o Investment banker: any financial institution engaged in purchasing and reselling new stocks and bonds o Most common investment banking services include:  Advise the company on the timing and financial terms for the new issue  By underwriting (buying) the new securities, investment bankers bear some of the risk of issuing the new security  They 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: the sale and purchase of previously issued stocks and bonds Stocks Common Stock  Individuals and other companies buy a firms common stock in the hope that the stock will increase in value, affording them a capital gain, or will provide dividend income  Value of them are expressed in 3 different ways- par vale, market value, book volume o Par value: the arbitrary value of a stock set by the issuing company’s board of directors and stated on stock certificates; used by accountants but of little significance to investors (cannot be distributed as dividends) o Market value: the current price of one share of a stock in the secondary securities market; the real value of a stock o Book value: value of a common stock expressed as total stockholders’ equity divided by the number of shares of stock  Used as a comparison indicator because for successful companies, the market value is usually greater than the book value  Investment traits of common stock: common stocks are among the riskiest of all securities (because of uncertainties)  What is a blue chip stock? o It is stocks from well-established, financially sound firms o The company’s history of dividend payouts, steady growth in earnings per share etc are not indicators any more o Market capitalization: the dollar value (market value) of stocks listed on a stock exchange  Computed by multiplying the number of a company’s outstanding share times the value of each share Preferred stock  Stock that pays dividends that are expressed as a percentage of par value  So this stock is issued with a stated par value while dividends are paid as usually expressed percentage of the par value  Investment traits of preferred stock o Because of preference on dividends, preferred stock is less risky than the common stock of the same company o Most is cumulate preferred stock: preferred stock on which dividends not paid in the past must first be paid up before the firm may pay dividends to common shareholders Stock exchanges  An organization of individuals formed to provide an institutional setting in which shares of stock can be bought and sold o Memberships can be bought and sold like other assets (and only members are allowed to trade on the exchange)  The trading floor o Each exchange regulates the places and times at which trading may occur; trading used to take place only at an actual physical location called the trading floor (where specialists matched buy and sell orders they received from brokers) – now use computers to match buy and sell orders  Brokers: an individual licensed to buy and sell securities for customers in the secondary market; may also provide other financial services o Discount brokers: offer well informed individual investors a fast, low cost way to participate in the market o Full service brokers: despite discount brokers and online investing, there is still demand for full service brokerages; offer clients suggestions on investments that clients might overlook when trying to sift planning, tax strategies, and a wider range of investment products  Canadian stock exchanges o TSC (Toronto stock exchange) is the largest stock exchange in Canada; securities of most major corporations are listed there  Foreign stock exchanges o Most foreign countries also have active stock exchanges o The new york stock exchange o The american stock exchange o U.S. regional stock exchanges o Other foreign stock exchanges o The over-the-counter market: organization of securities dealers formed o trade stock outside the formal institutional setting of the organized stock exchanges  Consists of independent dealers who own the securities that they buy and sell at their own risk o NASDAQ and NASD: national association of securities dealers automated quotation: a stock market implemented by NASD that operates by broadcasting trading information on an intranet to more than 350,000 terminals worldwide Bonds  An IOU, a written promise that the borrower will pay the lender, at a stated future date, the principal plus a stated rate of interest  Shareholders provide equity (ownership) capital, while bondholders are lenders (although they are considered investors)  Stock certificates represent ownership, while bond certificates represented indebtedness Corporate Bonds  Bonds issued by a company as a source of long term funding  May be categorized in either o According to methods of interest payment o According to whether they are secured or unsecured  Interest payment: registered and bearer bonds o Registered bonds: bods where the names of holders are registered with the company o Bearer (or coupon) bonds: bonds that require bondholders to clip coupons from certificates and send them to the issuer to receive interest payments  Secured and unsecured bonds: o Secured bonds: bonds issued by borrowers who pledge assets as collateral in the event of non payment o Debentures: unsecured bonds – no specific property is pledged as security for the bonds The retirement of bonds  Maturity dates on bonds- which may be very long  There are 3 types of maturity dates: callable, serial, convertible o Callable bonds: bonds that may be paid off by the issuer before the maturity date (pay off at a price stipulated in the indenture, or contract, before the maturity date)  Sinking funds: sinking fund provision is a clause in the bond indenture (contract) that requires the issuing company to put enough money into a special bank account each year to cover the retirement of the bond issue on schedule o Serial bonds: a bond issue in which redemption dates are staggered so that a firm pays off portions of the issue at different predetermined dates o Convertible bonds: any bonds that offer bondholders the option of accepting common stock instead of cash in repayment  Firms can lower interest rates when bonds are issued since they are given such flexibility and there are potential benefits in converting bonds into stocks Gover
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