MGMT 1 Chapter 19: MGMT 1—Chapter 19

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University of California - Irvine
Grace Mc Laughlin

MGMT 1—Chapter 19: Using Securities Markets for Financing and Investing Opportunities • The Function of Securities Markets: o Securities market assist businesses in finding long-term funding to finance capital needs, or buying major goods and services and they provide private investors a place to buy and see securities (investment). o Primary markets handle the sale of new securities o Secondary market handles the trading of these securities between investors with the proceeds of the sale going to the investor selling the stock not the corporation whose stock is sold. o Selling stock in the corporation is a form of equity financing and issuing corporate bonds is a form of debt financing o The Role of Investment Bankers: ▪ Investment Bankers: Specialists who assist in the issue and sale of new securities • Investment bankers can underwrite new issues of stocks and bonds meaning they can buy the entire stock or bond issue at an agreed-on discount then sell the issue 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 • Stock Exchanges: o Stock exchange: An organization whose members can buy and sell (exchange) securities for companies and investors o Today, most trading takes place on computers that can transact thousands of stock trades within seconds o Over-the-counter (OTC) market: Exchange that provides a means to trade stocks not listed on the national exchanges o NASDAQ: A nationwide electronic system that communicates over-the-counter trades to brokers o Securities Regulations and the Securities and Exchange Commission: ▪ Securities and Exchange Commission (SEC): Federal agency that has responsibility for regulating the various exchanges ▪ The Securities Act of 1933 helps protect investors by requiring full disclosure of financial information by firms selling bonds or stock ▪ The Securities and Exchange Act of 1934 created the SEC ▪ 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 ▪ Insider trading is using knowledge or information that individuals gain through their position that allows them to benefit unfairly from fluctuations in security prices • How Businesses Raise Capital By Selling Stock: o Stocks: Shares of ownership in a company o Stock certificate: Evidence of stock ownership that specifies the name of the company, the number of shares it represents, and the type of stock being issued 2 o Stock certificates sometimes indicate a stock’s par value, which is a dollar amount assigned to each share of stock by the corporation’s charter o Dividends: Part of a firm’s profits that the firm may distribute to stockholders as either cash payments or additional shares of stock o Advantages and Disadvantages of Issuing Stock: ▪ Advantages: • As owners of the business, stockholders never have to be repaid their investment • There’s no legal obligation to pay dividends to stockholders; therefore, the firm can reinvest income (retained earnings) to finance future needs • Selling stock can improve the condition of a firm’s balance sheet since issuing stock creates no debt ▪ Disadvantages: • As owners, stockholders have the right to vote for the company’s board of directors; issuing new shares of stock can thus alter the control of the firm • Dividends are paid from profit after taxes and are not tax-deductible • The need to keep stockholders happy can affect managers’ decisions o Issuing Shares of Common Stock: ▪ Common stock: The most basic form of ownership in a firm; it confers voting rights and the right to share in the firm’s profits through dividends, if offered by the firm’s board of directors 3 • Common stockholders also have a preemptive right to purchase new shares of common stock before anyone else o Issuing Shares of Preferred Stock: ▪ Preferred stock: Stock that gives its owners preference in the payment of dividends and an earlier claim on assets than common stockholders if the company is forced out of business and its assets sold ▪ Preferred stockholders do not get voting rights in the firm ▪ Preferred stock can be callable meaning preferred stockholders could be required to sell their shares back to the corporation ▪ Preferred stock can also be converted to shares of common stock (but not the other way around) and it can be cumulative • How Businesses Raise Capital By Issuing Bonds: o Bond: A corporate certificate indicating that a person has lent money to a firm o 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 o Learning the Language of Bonds: ▪ Maturity date: The exact date the issuer of a bond must pay the principal to the bondholder ▪ The principal is the value (dollar value) of a bond ▪ Interest: The payment the issuer of the bond makes to the bondholders for use of the borrowed money ▪ The interest rate paid by U.S. government bonds influences the bond interest rate businesses must pay 4 ▪ o Advantages and Disadvantages of Issuing Bonds: ▪ Bonds offer long-term financing advantages to an organization: • Bondholders are creditors of the firm, not owners • Bond interest is a business expense and tax- deductible to the firm • Bonds are a temporary source of funding • Bonds can be repaid before the maturity date if they are callable; Bonds can also be converted to common stock ▪ Bonds also having financing drawbacks: • Bonds increase debt (long-term liabilities) and may adversely affect the market’s perception of the firm • Paying interest on the bonds is a legal obligation 5 • The face value of the bond must be repaid on the maturity date o Different Classes of Bonds: ▪ Debenture bonds: Bonds that are unsecured (i.e., not backed by any collateral such as equipment) ▪ Secured bonds, sometimes called mortgage bonds are backed by collateral such as land or buildings that is pledged to bondholders if interest or principal isn’t paid when promised o Special Bond Features: ▪ Sinking fund: A reserve account in which the issuer
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