BIZ Foundations Chapter 10 PDF

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Chapter 10 1. The role of Financial Institutions and their Key Players a. Financial markets: transfer funds from savers to borrowers (individuals and organizations that need additional funds to achieve their financial goals).

b. Depository Institutions: financial intermediaries that obtain funds by accepting checking and savings deposits from individuals, businesses, and other institutions, and then lending those funds to borrowers i. Commercial banks ii. Credit Unions: A depository institution that is organized as a cooperative, meaning that it is owned by its depositors iii. Savings and Loan Associations (S&Ls or Thrifts): A depository institution that has traditionally obtained most of its funds by accepting savings deposits, which have been used primarily to make mortgage loans

c. Nondepository Financial Institutions i. Institutional Investors 1. don’t accept deposits but amass huge pools of financial capital from other sources and use these funds to acquire a portfolio of many different assets. 2. Mutual funds, insurance companies, pension funds 3. Invest heavily in corporate stock, hold majority shares in most US corporations ii. Securities Brokers: A financial intermediary that acts as an agent for investors who want to buy and sell financial securities. Brokers earn commissions and fees for the services they provide 1. Agents for investors who want to trade in financial securities iii. Securities dealers: A financial intermediary that participates directly in securities markets, buying and selling stocks and other securities for its own account 1. Participate directly in securities markets 2. They earn a profit by selling securities for higher prices than they paid to purchase them (spread) iv. Investment Banks: A financial intermediary that specializes in helping firms raise financial capital by issuing securities in primary markets 1. help firms issue new securities to raise financial capital 2. can either buy themselves or just arrange the sale 2.

Regulating Financial Markets to Protect Investors and Improve Stability a. Federal Reserve Act of 1913: created the Federal Reserve System (the Fed) to serve as the central bank in the United States. The law gave the Fed the primary responsibility for overseeing our nation’s banking system. b. Banking Act of 1933 (Glass-Steagall Act): established the FDIC, which insured depositors against financial losses when a bank failed, in the wake of the Great Depression i. FDIC initially covered $2500, but not $250,000

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ii. Also banned commercial banks from dealing in securities markets, selling insurance, or otherwise competing with nondepository institutions such as insurance companies and investment banks iii. These activities exposed depositors to too much risk Securities Act of 1933: The first major federal law regulating the securities industry. It requires firms issuing new stock in a public offering to file a registration statement with the SEC i. It prohibited misrepresentation or other forms of fraud in the sale of newly issued stocks and bonds. ii. It also required firms issuing new stock in a public offering to file a registration statement with the SEC Securities Exchange Act of 1934: regulated the trading of previously issued securities i. created the Securities and Exchange Commission (SEC) and gave it broad powers to oversee the securities industry ii. also gave the SEC the power to prosecute individuals and companies that engaged in fraudulent securities market activities Financial Services Modernization Act of 1999 (Gramm-Bliley-Leach Act): reversed the GlassSteagall Act’s prohibition of banks selling insurance or acting as investment banks i. opened up the industry for consumers, new services such as mobile banking Sarbanes-Oxley Act of 2002: Ensured that external auditors offered fair opinions while examining a company’s financial statements i. SEC’s authority was increased to regulate financial markets ii. In response to Enron and Worldcom Dodd-Frank Act of 2010: Expanded the Fed’s regulatory authority over nondepository financial institutions i. Established the Financial Stability Oversight Council to identify emerging risks

Investing in Financial Securities: What are the Options? a. Common stock: the basic form of ownership in a corporation. Rights: i. Dividends (if issued) ii. Capital Gains (when stock price raises) iii. Preemptive right (sometimes can buy new stock before available to everyone else) iv. Residual claim on assets b. Preferred Stock: offers its holders preferential treatment in two respects i. Claim on Assets: get company assets before common stock owners ii. Payment of Dividends: unlike C.S., Div. are usually a stated amount & paid before C.S., can be cumulative if not paid during one period iii. Usually don’t have voting rights, dividends aren’t necessarily higher than C.S., stock price doesn’t increase as much as common stock c. Bond: formal IOU issued by a corporation or government entity (usually 10-30 years) i. Maturity date: date a bond comes due ii. Par value: what is owed once bond matures iii. Coupon Rate: Annual interest payment as a % on the bond’s par value

iv. Current Yield: expresses a bond’s interest payment as a percentage of the bond’s current market price rather than its par value d. Convertible Securities: bonds or shares of preferred stock that investors can exchange for a given number of shares of the issuing corporation’s common stock e. Conversion Ratio indicates the number of shares of common stock received for each convertible security turned in, ex. 10, 10 CS shares for 1 C.S. i. The ratio is set at the time the convertible securities are issued ii. allows investors to gain from an increase in the price of common stock, while limiting their risk if the price of the stock falls iii. The firm also can benefit from issuing convertible bonds, because the popularity of this feature with investors allows it to offer a lower coupon rate on convertible bonds (or a lower dividend on preferred stock), thus reducing its fixed payments f. Financial Diversification: the practice of holding many different securities in many different industries g. Mutual Funds: An institutional investor that raises funds by selling shares to investors and uses the accumulated funds to buy a portfolio of many different securities i. Closed end funds i. Fixed number of shares, invests money received in a portfolio of assets ii. Shares traded like stock among investors b. Open-ended mutual fund i. No fixed number of shares ii. Issues when demand increases or buys back (redeems) shares when people cash in iii. Based on NAVPS c. Net Asset Value per Share (NAVPS): computed by dividing the total value of the fund’s cash, securities, and other assets (less any liabilities) by the number of fund shares outstanding d. Benefits of Mutual Funds i. Diversification at relatively low cost ii. Professional management iii. Variety available iv. Liquidity e. Exchange Traded Fund: ETFs allow investors to buy ownership in what is called a market basket of many different securities. i. Market Basket: Reflects composition of broad based stock index ii. Traded like stocks, but have to pay brokerage fees when you buy/sell iii. Lower costs and fees compared to actively managed funds 4.

Issuing and Trading Securities: The Primary and Secondary Markets a. Primary Securities Market: where corporations raise additional financial capital by selling newly issued securities.

b. public offering: securities are sold (in concept, at least) to anyone in the investing public who is willing and financially able to buy them.

c. IPO: the first time a firm sells its stock in a public offering

i. complicated and high stakes process ii. Almost all firms enlist an investment bank to help give advice and arrange sale of shares iii. Registration statement: A long, complex document that firms must file with the SEC when they sell securities through a public offering iv. Best Efforts approach: the bank provides advice about pricing and marketing the securities and assists in finding potential buyers. Doesn’t guarantee that the firm will sell all of its securities at a high enough price to meet its financial goals v. Firm Commitment: bank underwrites the issue. This means that the investment bank itself purchases all of the shares at a specified price, thus guaranteeing that the firm issuing the stock will receive a known amount of new funds d. private placement: securities are sold to one or more private investors (who may be individuals or institutions) under terms negotiated between the issuing firm and the private investors. i. Accredited Investors: Individuals, businesses, or other organizations that meet specific financial requirements set by the SEC ii. quicker, simpler, and less expensive than IPO because they don’t have to register with the SEC iii. potential investors are limited to accredited investors, doesn’t have the potential to raise as much money as an IPO e. Secondary Securities Market: is where previously issued securities are traded. i. stock (or securities) exchange: provides an organized venue for stockbrokers and securities dealers to trade listed stocks and other securities ii. each exchange establishes its own requirements for the securities it lists iii. firms pay an initial fee when they are first listed and an annual fee iv. market makers: securities dealers that make a commitment to continuously offer to buy and sell (make a market in) specific NASDAQ-listed stocks with an ask-price and bid-price 1. each stock has several market makers who compete against each other f. over-the-counter market (OTC): where stocks of companies that don’t meet the SEC requirements or don’t want to pay the listing fees are traded g. electronic communications networks (ECNs): alternative trading systems because they represent an alternative to established stock exchanges as a venue for buying and selling securities, computer driven i. allow investors to bypass market makers used in NASDAQ and OTC markets ii. have to open an account with a broker-dealer that subscribes to an ECN

5. Personal Investing a. Full service broker: perform market research, investing advice, and tax planning, in addition b. c. d. e.

to carrying out trades Discount broker: Market orders: instruct broker to buy or sell a security at the current market price Limit orders: limits the prices at which orders are executed buy or sell at a specified value Stock index: Tracks prices of a large group of stocks that meet defined criteria

f. Dow Jones Industrial Average: Adjusted average price of 30 stocks picked by the editors of the Wall Street Journal

g. Standard & Poor’s 500: With 500 stocks it is a much broader index than the DJIA...