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.
- Advantages:
§
Shareholders never have to be paid.
§
There is no legal obligation to pay dividends.
§
The sale of stock can improve the balance
sheet.
- 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.
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