SECURITIES.pptx

FINANCIAL MANAGEMENT SECURITIES How Securities Markets Bring Corporations and Investors Together Securities Markets -investors in the securities markets provide money directly to the firms that need it. versus Commercial Banks making deposits in commercial banks that then loan money to those firms. 4 Steps of Raising Money in the Securities Markets Step 1 The firm sells securities to investors. The firm raises money in the securities markets by selling either debt or equity. When it initially sells the securities to the public, the sale is considered to take place in the primary market. This is the only time the firm receives money in return for its securities. Step 2 The firm invests the funds it raises in its business. The firm invests the cash raised in the securities markets in hopes that it will generate cash flows —for example, it may invest in a new restaurant, a new hotel, a factory expansion, or a new product line. Step 3 The firm distributes the cash earned from its investments. The cash flow from the firm’s investments is reinvested in the firm, paid to the government 4 Steps of Raising Money in the Securities Markets Types of Securities  If you read the financial section of your newspaper or watch financial TV channels CNBC, you are already aware of the wide variety of investment alternatives to choose from. These choices fall into one of two basic categories: debt and equity  Debt Securities Firms borrow money by selling debt securities in the debt market. If the debt must be repaid in less than a year, these securities are sold in the short-term debt market, also called the money market. If the debt has a maturity (the length of time until the debt is due) of between 1 and 10 years, it is often referred to as a note, and if the maturity is longer than 10 years, it is called a bond; both are sold in the capital market, which is the market for long-term financial instruments. The vast majority of these bonds pay a fixed interest rate, which means that the interest the owner of the bond receives never changes over its lifetime. Bonds are generally described using fairly exotic terminology. For example, we might say that a bond has a face value or par value of PHP1,000 and that it pays an 8 percent coupon rate with two payments per year. What this means is that when the bond matures and the issuer (borrower) has to repay it, the owner of the bond (the lender) will receive a payment of PHP1,000. In the meantime, the owner will receive an interest payment every six months equal to PHP40, or PHP80 per year, which is 8 percent of PHP1,000. Types of Securities  Equity securities represent ownership of the corporation. There are two major types of equity securities: common stock and preferred stock. When you buy equity securities, you are making an investment that you expect will generate a return. However, unlike a bond, which provides a promised set of interest payments and a schedule for the repayment of principal, an equity security provides returns that are less certain. Common Stock Is a security that: 1. represents equity ownership in a corporation, 2. provides voting rights, and 3. entitles the holder to a share of the company’s success in the form of dividends and any capital appreciation in the value of the security. Investors who purchase common stock are the residual owners of the firm. This means that the common stockholders’ returns are earned only after all other security-holder claims (debt and preferred equity) have been satisfied in full. Types of Securities If you purchase 100 shares of Disney’s common stock, you are a part-owner in the company. In essence, you own an interest in the firm’s studios, a piece of its movies, and a piece of its theme parks, including the new park in Shanghai. The more shares you buy, the bigger the portion of Disney you own. What do you get as an owner of Disney’s stock? Don’t count on free tickets to Disney World or a copy of the latest Star Wars movie. As an owner of the firm, you have voting rights that entitle you to vote for the members of the firm’s board of directors, who, in turn, oversee the selection of the management team. But as a smalltime investor, you have limited voting rights—your 100 shares of Disney’s stock are about 0.00000617 percent of Disney’s shares. Thus, you aren’t going to have much say about who gets elected to the Disney board of directors. Nonetheless, if Disney earns a profit, you will probably receive a portion of those profits in the form of a dividend payment. It should be noted that firms that sell bonds must make bond payments, but firms that sell stock don’t have to pay dividends. For example, if a company needs money to invest in a new product or project, it can choose to retain all of its earnings within the firm and pay no dividends. Types of Securities Generally, firms that earn higher profits can pay higher dividends, and this often means that investors place a higher value on that firm’s stock. For example, in 1999 the stock price of Qualcomm, a high-tech communications firm, went up 2,621 percent! However, when Qualcomm’s profits and dividends, and people’s expectations about its future prospects, deteriorated, its stock price fell by 50 percent in 2000, by another 26 percent in 2001, and then by another 30 percent in 2002. Since the end of 2002, there have been ups and downs, but by early 2006, the price of Qualcomm had risen over three-fold from its 2003 level. This all goes to show that stock prices can fluctuate dramatically Types of Securities Preferred Stock Preferred stock, like common stock, is an equity security.  as the name implies, preferred stockholders take a “preferred” position relative to common shareholders. This means that preferred shareholders receive their dividends before any dividends are distributed to the common stockholders, who receive their dividends from whatever is left over.  if the company does not earn enough to pay its interest expenses, neither preferred nor common stockholders will be paid a dividend.  However, the dividends promised to the preferred stockholders will generally accrue and must be paid in full before common shareholders can receive any dividends.  This feature is oftentimes referred to as a cumulative feature, and preferred stock with this feature is often referred to as cumulative preferred stock.  Preferred stockholders have a preferred claim on the distribution of assets of the firm in the event that the firm goes bankrupt and sells or liquidates its assets. The firm’s creditors (bondholders) get paid first, followed by the preferred stockholders, and anything left goes to the common stockholders. Of interest is that not all firms issue preferred stock

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