Chapter 16
Securities and Investments
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16–1
LEARNING OUTCOMES
After reading this chapter, you should be able to:
Describe the role of securities markets and explain the difference
between primary securities markets and secondary securities
markets.
Discuss the value to shareholders of common and preferred
stock and identify the major stock exchanges and stock markets.
Distinguish among the various types of bonds in terms of their
issuers and safety.
Describe the investment opportunities offered by mutual funds.
Describe the risk-return relationship, and discuss the use of
diversification and asset allocation for investments.
Explain the process by which securities are bought and sold.
Explain how securities markets are regulated.
© 2007 Prentice Hall, Inc. All rights reserved.
16–2
What’s in It for Me?
By using this chapter’s presentation on
securities and investments, you will benefit in
two ways:
1. You’ll be better prepared to evaluate investment
opportunities for your personal finances
2. You’ll be better prepared for where and how to buy
and sell securities
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16–3
Securities Markets
Securities
 Represent secured, or financially valuable, claims on
the part of investors
Securities Markets
 Markets in which stocks and bonds are sold
Stock
 Represents an ownership claim on the assets of a
corporation
Bond
 Represents a financial claim of money owed by a
company to the bondholder
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16–4
Primary and Secondary
Securities Markets
Primary Securities Markets
 The market in which new stocks and bonds (but not
mutual funds) are bought and sold by firms and
governments
Secondary Securities Markets
 Where existing stocks and bonds are traded
Securities and Exchange Commission (SEC)
 The government agency that regulates U.S.
securities markets
 New securities must be approved by the SEC
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16–5
Primary and Secondary
Securities Markets (cont’d)
Investment banks help bring new securities to
the market by:
 Advising companies on the timing and financial
terms of new issues
 Underwriting—or buying—new securities, bearing
some of the risks of issuing them
 Distributing new securities through banks and
brokers to individual investors
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16–6
Stocks
Stock
 A portion (share) of the ownership of a corporation
Common stock
 Preferred stock

Dividend
 A payment to shareholders, on a per-share basis, out
of the company’s earnings
Stock Values
 Par—declared face value at time of issue
 Market—current share price in a market
 Book—proportional worth of owners’ equity
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16–7
Stocks (cont’d)
Investment Traits of Common Stock
 Price volatility
 Dividend payment uncertainty
 High growth potential
Preferred Stock
 Have preferential claim on dividends
Investor Preferences
 Capital gains
 Market appreciation (growth)
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16–8
Blue Chip Stocks:
A Changing Perspective?
“Old” Economy
 Established firm
 Sound financial history
 Stable pattern of dividends
“New” Economy
 Rapid growth in market value
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16–9
Stock Exchanges
Stock Exchange
 An organization formed to provide an institutional
setting in which stocks can be bought and sold
 The exchange enforces certain rules to govern its
members’ trading activities
Trading Floor
 The physical location in an exchange where stocks
are traded
Stock Brokers
 Earn commissions by executing buy-and-sell orders
from nonexchange members
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16–10
Stock Exchanges (cont’d)
Discount Brokers
 Offer lower fees to investors than do full-service
stock brokers
Online Trading
 Conditions favoring online trading

Convenient access to the Internet

Fast no-nonsense transactions

Opportunity for self-directed investors to manage their own
investments while paying low fees for trading
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16–11
Stock Exchanges (cont’d)
Full-Service Brokers
 A full-service brokerage can offer clients consulting
advice in personal financial planning, estate
planning, and tax strategies, along with a wider
range of investment products
Initial Public Offerings (IPOs)
 The first sale of a company’s stock to the general
public
IPOs are generally not available to the public through online
retail brokers
 Specialist is appointed by the exchange to control trading for
a particular stock

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16–12
The Major Exchanges and Markets
New York Stock
Exchange
American
Stock
Exchange
Regional Stock
Exchanges
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Global Stock
Exchanges
Over-theCounter
Market
Nasdaq
16–13
The Major Exchanges and Markets (cont’d)
The New York Stock Exchange
 For many people, “the stock market” means the New
York Stock Exchange (NYSE)
The American Stock Exchange (AMEX)
 The second-largest floor-based U.S. exchange is
located in New York City
Regional Stock Exchanges
 Seven regional stock exchanges were organized to
serve investors in places other than New York
Global Stock Exchanges
 The value of shares listed on foreign exchanges
continues to grow
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16–14
The Major Exchanges and Markets (cont’d)
Over-the-Counter (OTC) Market
 So called because its original traders kept supplies
of shares on hand and, as opportunities arose, sold
them over the office counter to interested buyers
National Association of Securities Dealers
Automated Quotation (Nasdaq) system
 The world’s oldest electronic stock market
 Orders are gathered and executed on a
computer network
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16–15
Fantasy Stock Markets
Fantasy Stock Markets
 Are Internet-based games that provide an
investment experience that is educational,
challenging, and entertaining
 Teach you how securities markets work
 Enable you to enter stock-ticker symbols, search
sources for information on companies, make buyand-sell decisions, and discover the financial results
as real market prices change
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16–16
Bonds
Bonds
 Represent a promise by the issuer to pay the buyer a
certain amount of money by a specified future date

U.S. government bonds

Municipal bonds

Corporate bonds
 Nearly all secondary trading in bonds occurs in the
OTC market
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16–17
Types of Corporate Bonds
Registered
Bonds
Bearer
Bonds
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Secured
Bonds
Debentures
16–18
Mutual Funds
Mutual Fund
 A portfolio of stocks, bonds, and other securities
purchased with pooled investments from individuals
and organizations
 No-load funds do not charge buy or sell commissions
 Load funds charge commissions
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16–19
Mutual Funds (cont’d)
Types of Funds
 Money market mutual funds: funds stressing safety
and stability
 Balanced funds: funds stressing conservative capital
growth
 Aggressive growth funds: funds stressing maximum
long-term capital growth
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16–20
Diversification and Asset Allocation
The Risk-Return Relationship
 Safer investments tend to offer lower returns; riskier
investments tend to offer higher returns.
Diversification
 Buying several different kinds of investments rather
than just one so that the risk of loss is reduced by
spreading the total investment across more stocks
Asset Allocation
 The proportion—the relative amounts—of funds
invested in (or allocated to) each of the investment
alternatives
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16–21
Buying and Selling Securities
Financial Information Services
 Stock quotations
 Bond quotations
 Mutual funds quotations
Market Indexes
 Bull markets
 Bear markets
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16–22
Market Indexes
Dow Jones Industrial Average
The S&P
500
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The Nasdaq
Composite
16–23
Market Indexes
The Dow Jones Industrial Average (DJIA)
 The most widely cited U.S. market index
 Measures the performance of financial markets by
focusing on 30 blue-chip companies as reflectors of
economic health
The S&P 500 Composite Index
 Consists of 500 stocks, including 400 industrial firms,
40 utilities, 40 financial institutions, and 20
transportation companies
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16–24
Market Indexes
Nasdaq Composite Index
 All Nasdaq-listed companies are included in the
index, for a total of more than 3,300 firms (both
domestic and foreign)
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16–25
Investing in the Securities Markets
Placing Orders
Financing Purchases
 Market Order
 Margin Trading
 Limit Order
 Short Sales
 Stop Order
 Round Lot
 Odd Lot
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16–26
Securities Market Regulation
The National Association of Securities Dealers
(NASD)
 The largest private-sector securities-regulation
organization in the world
 Every broker/dealer is required by law to be a
member of the NASD and to pass qualification
exams and meet standards for financial soundness
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16–27
Securities Market Regulation (cont’d)
NYSE Self-Regulation
 Circuit breakers
Securities and Exchange Commission
 Prospectuses
 Insider trading
State Government Regulation
 Blue-sky laws
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