CHAPTER 19: INVESTMENT AND PERSONAL FINANCE

CHAPTER 19: INVESTMENT AND PERSONAL FINANCE

Layout of Chapter:

1.                  Securities: A Firm’s Source of Long-Term Fund-Raising

§         Use of Bonds

§         Use of Stocks

2.                  Who Invests in the Securities Market

3.                  Why Individuals Invest in Securities

4.                  Choices for Investment

§         Bull Market

§         Bear Market

§         Options Market

1.                  Securities:

A Firm’s Source of Long-Term Fund-Raising

Documents, such as stocks and bonds, that be bought or sold and that reflect ownership or debt.

Corporations use securities, i.e. stocks and bonds, as a means to provide long-term funding.

A Firm’s use of Securities for funding is referred to as-

1)     either Debt Capital (Bonds)

2)     or Equity Capital (Stocks- sharing of ownership).

Use of Bonds (Debt Capital)

a.      Advantages:

§         Bond-holder is not an owner.

§         Using bonds allows the firm to maintain complete management control, since bond-holders have no vote in decision making.

§         Interest paid to bondholders is a tax-deductible expense.

b.      Disadvantages:

§         Bonds increase a firm’s debt

§         interest is a legal obligation; and

§         The face value of the bonds must be repaid at maturity.

Use of Stocks (Equity Capital)

The sale of stock means a company has decided to arrange funds by selling some ownership in the firm itself.

1. Advantages:

§         Shareholders never have to be paid.

§         There is no legal obligation to pay dividends.

§         The sale of stock can improve the balance sheet.

2.  Disadvantages:

§         Company must give up some control to voting shareholders.

§         They must pay dividends out of after-tax profits.

§         Managers sometimes become so focused on shareholders that they change decision to satisfy them.

A firm can issue 2 types of stocks:

                           I.            Preferred Stock – stock that has preference over common stock in the payment of dividends and in claims against the assets of the firm, but does not confer voting rights.

                         II.            Common Stock –

·  Stock that confers voting rights but not preferential rights of dividends or claims against the assets of the firm.

·  Dividend value is not fixed.

·  Common stocks has 2 values-

a)           Market Value – the price at which a share of common stock is currently selling.

b)           Book Value – the value of common stock relative to the vale of the company.

Making a Stock or Bond Offering

Stock and bond offerings appear daily in the form of simple announcements in business newspapers.

While a corporation can market its own bond or stock issue, investment bankers handle most large offerings.

Investment Banker: A financial specialist who handles the sale of new stock or bond offers. (S)He advises the issuer on the timing, pricing, and appropriate size of the offering, and purchases the total issue from the company at a discount.

Example – Company X needs Tk. 100,000. It sells to investment banker at discount Tk. 90,000. Investment banker may sell this to underwriter for Tk. 85,000 and underwriter sells them to public.

2.                  Who Invests In the Securities Market?

2 types of Investors-

a)     Institutional Investors – professional investors who invest for large groups or organizations, such as, pension funds, insurance companies, universities etc.

b)     Private Investors

3.                  Why Individuals Invest In Securities?

The objective of personal investment falls into one of the 5 categories:

1)     GROWTH

·    To increase personal wealth.

·    Capital gains are the profit individuals make when selling an investment for more than he/she paid for it. (150 - 100 = 50)

2)     INCOME

·    To get additional income.

·    Investors desiring steady income may look at Treasure bills, corporate bonds, and some common stocks, such as utilities or blue-chip stocks.

·    Blue-Chip stocks are issued by large, well-capitalized companies, such as IBM or Exxon, that have paid consistent dividends.

3)     SECURITY

·    Typically the higher the risk, the higher the rate of return.

·    Investors must be willing to assume a certain level of risk in order to accomplish higher rates of return, either in growth or income.

·    Those interested in security may invest in secure investments such as Government secured bonds, savings bonds, Certificates of deposit, T-bills etc.

4)     LIQUIDITY

·    Some investors want to or need to keep their money as liquid as possible.

·    People want to invest in stable investments, those with little fluctuations.

5)     TAX DEFEREMENT OR AVOIDANCE

·    Investors may want to put off by paying taxes on a portion of their income and some investment vehicles do allow tax deferment.

·    Investing in primary share, secondary share, government bonds, insurance, DPS etc.

4.                  Choices for Investment

The principal investment choices are stocks, bonds, government securities, certificates of deposit, money market funds, and commodities. Real estate and collectibles are other options. But one needs to know the general trend of the market.

Over time the market tends to rise and fall as the economy expands and contracts. (i) Bull market, and (ii) Bear Market.

Bull Market:

·        A market state in which stock values are general rising and investors are generally optimistic.

·        During boom years, the market is usually bullish.

·        Some stocks may go down in a bull market either because of the nature of their industry, or because of company’s performance is questionable.

Bear Market:

·        a market state in which stock values are generally declining and investors are generally pessimistic

·        during recessions, the market typically becomes bearish

·        some stocks can go up in price during a bear market

Options Market:

Stock option- A stock option is the purchased right to buy or sell shares of stock at a predetermined price within a specified time period.

*        PUT Option:  An option to buy stock shares at market price and sell at a specified price.

*        CALL Option:  An option to buy stock shares at a specified price and sell at a market price.

Ordering:

Once you have decided to purchase a particular stock to meet your goals, your broker can place the order for that particular stock through the appropriate stock exchange.