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Understanding markets - Reynolds Week 2011


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Jimmy Gentry on 'Understanding Markets" at Reynolds Business Journalism Week, Feb. 4-7, 2011.

Reynolds Center for Business Journalism,, Arizona State University's Walter Cronkite School of Journalism.

Published in: Economy & Finance
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Understanding markets - Reynolds Week 2011

  1. 1. Understanding Markets <ul><ul><ul><ul><ul><li>Strictly Financials </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Jan. 4, 2011 </li></ul></ul></ul></ul></ul>
  2. 2. <ul><li>Donald W. Reynolds National Center </li></ul><ul><li>For Business Journalism </li></ul><ul><li>At Arizona State University </li></ul>Strictly Financials
  3. 3. <ul><li>James K. Gentry, Ph.D. </li></ul><ul><li>Clyde M. Reed Teaching Professor </li></ul><ul><li>School of Journalism and Mass Communications </li></ul><ul><li>University of Kansas </li></ul><ul><li>[email_address] </li></ul>Strictly Financials
  4. 4. Risk-Return Relationship Strictly Financials
  5. 5. Basic Types of Risk <ul><li>Systematic </li></ul><ul><li>Unsystematic </li></ul>Strictly Financials
  6. 6. Specific Types of Risk <ul><li>Business risk </li></ul><ul><li>Financial risk (credit or default risk) </li></ul><ul><li>Market risk </li></ul><ul><li>Interest rate risk </li></ul><ul><li>Purchasing power risk </li></ul><ul><li>Event risk </li></ul><ul><li>Exchange-rate risk (foreign exchange risk) </li></ul><ul><li>Liquidity risk </li></ul>
  7. 7. Types of Businesses <ul><li>Sole proprietorship </li></ul><ul><li>Partnership </li></ul><ul><li>Corporation </li></ul><ul><ul><li>Limited liability </li></ul></ul><ul><ul><li>Greater access to capital </li></ul></ul><ul><ul><li>Permanency </li></ul></ul><ul><ul><li>Flexibility </li></ul></ul><ul><ul><li>Double taxation </li></ul></ul>Strictly Financials
  8. 8. Types of Structures <ul><li>Private corporations </li></ul><ul><li>Public corporations </li></ul><ul><li>Non-profits </li></ul>Strictly Financials
  9. 9. Types of Investments <ul><li>Stocks </li></ul><ul><li>Bonds </li></ul><ul><li>Other </li></ul><ul><ul><li>Options, futures, commodities, real estate, collectibles, currencies </li></ul></ul>Strictly Financials
  10. 10. Types of Markets <ul><li>Equity: Stocks </li></ul><ul><li>Credit: Bonds, debt or fixed income </li></ul><ul><li>Others </li></ul><ul><ul><li>Derivatives (such as options and futures), commodities, real estate, collectibles, currencies </li></ul></ul><ul><li>Historically, the amount of long-term debt financing issued in the U.S. greatly exceeds the volume of equity financing </li></ul>
  11. 11. Stock <ul><li>Stockholders want: </li></ul><ul><ul><li>Stock price to increase </li></ul></ul><ul><ul><li>Dependable dividend stream </li></ul></ul><ul><ul><li>Increase in size of dividend </li></ul></ul>Strictly Financials
  12. 12. Types of Stock <ul><li>Common stock </li></ul><ul><li>Preferred stock </li></ul>Strictly Financials
  13. 13. Common Stock <ul><li>Risk: Lose your money if company falters </li></ul><ul><li>Reward: Owners share in success when company does well </li></ul><ul><ul><li>Appreciation </li></ul></ul><ul><ul><li>Dividends </li></ul></ul>Strictly Financials
  14. 14. Dividends <ul><li>Represent a return on capital invested by shareholders. </li></ul><ul><li>Board must declare dividend for it to be paid. </li></ul><ul><li>Dividend payment is not a business expense. It is an after-tax expense. </li></ul><ul><li>Usually relationship between company’s age and size, and the dividends it pays. </li></ul>Strictly Financials
  15. 15. Preferred Stock <ul><li>Reduced risk but reward may be limited </li></ul><ul><li>Dividend amount is stated and is paid before dividends on common </li></ul><ul><li>If company is liquidated, holders are preferred over common holders. </li></ul><ul><li>Dividends don’t necessarily increase if company prospers. </li></ul>Strictly Financials
  16. 16. Bond <ul><li>Bond is debt a company owes </li></ul><ul><li>Individual or company “loans” money to the company by buying a bond </li></ul><ul><li>Bond pays interest over a fixed period of time </li></ul><ul><li>Principal is repaid to the lender or holder of the bond at end of the term </li></ul><ul><li>Interest rate is typically fixed when the bond is sold (i.e., fixed income security) </li></ul><ul><li>Interest rate is comparable to what other bonds, with that rating, are paying </li></ul>Strictly Financials
  17. 17. Bond Terminology <ul><li>Interest rate: Fixed percentage of the bond’s purchase price that is paid annually to the bond holder </li></ul><ul><li>Yield: Return on investment if bond is held to maturity. Equals interest rate. If bond is traded before maturity date, yield could change although interest rate stays the same. </li></ul><ul><li>Par value: Dollar amount paid for bond at time of issue </li></ul><ul><li>Maturity date: When bond comes due </li></ul>Strictly Financials
  18. 18. A Quasi-Bond? <ul><li>Is preferred stock debt (i.e., a bond) in disguise? </li></ul><ul><li>Preferred holders have a “guaranteed” dividend. Is that like the fixed interest rate of a bond? </li></ul><ul><li>Why do investors pick common, preferred or bonds? </li></ul>Strictly Financials
  19. 19. Risk and Reward Strictly Financials
  20. 20. Yield Curve Yield Maturity Strictly Financials
  21. 21. Equity or Securities Markets <ul><li>Primary market </li></ul><ul><ul><li>Go public </li></ul></ul><ul><ul><li>Private placement </li></ul></ul><ul><li>Secondary market </li></ul>Strictly Financials
  22. 22. Going Public <ul><li>Entrepreneurs have an idea. Company grows with an investment from the private equity market (venture capital). </li></ul><ul><li>Owners decide to “go public.” </li></ul><ul><li>Register with SEC to make an initial public offering (IPO). </li></ul><ul><li>Investment bankers typically underwrite the offering through a syndicate. </li></ul>Strictly Financials
  23. 23. Going Public (cont.) <ul><li>Company prepares a prospectus, which is a detailed analysis of the company’s financial history, its products and services, as well as management’s background and experience. </li></ul><ul><li>Prospectus should identify and assess risk factors the company faces. </li></ul>Strictly Financials
  24. 24. IPO Terms <ul><li>Prospectus </li></ul><ul><li>Road show </li></ul><ul><li>Quiet period </li></ul><ul><li>Lockup period </li></ul>Strictly Financials
  25. 25. Secondary Offering <ul><li>If company already is public, it can sell more stock through a secondary offering. </li></ul><ul><ul><li>Causes dilution </li></ul></ul><ul><li>Major owners sell their shares. They get the funds so no dilution. </li></ul>Strictly Financials
  26. 26. Wall Street <ul><li>Got its name from a wall of brush and mud built by early settlers to protect the city of New York from attacks (1609) </li></ul><ul><li>Site of New York’s first organized stock trading </li></ul>Strictly Financials
  27. 27. New York Stock Exchange <ul><li>In March 1792, Wall Street leaders met to establish an improved auction market </li></ul><ul><li>In May 1792, 24 men signed an agreement to trade securities only among themselves, maintain fixed commission rates and avoid other auctions </li></ul><ul><li>Considered the origination of NYSE </li></ul>Strictly Financials
  28. 28. NYSE (cont.) <ul><li>Until March 2006, was owned by 1,366 seat-holding members </li></ul><ul><li>Highest price ever paid for a seat was $4 million </li></ul><ul><li>Price was determined by auction. </li></ul>Strictly Financials
  29. 29. NYSE Members <ul><li>Floor brokers </li></ul><ul><ul><li>House brokers </li></ul></ul><ul><ul><li>Independent brokers </li></ul></ul><ul><li>Specialists </li></ul><ul><ul><li>Manage auction process </li></ul></ul><ul><ul><li>Execute orders for brokers </li></ul></ul><ul><ul><li>Serve as catalysts </li></ul></ul><ul><ul><li>Provide capital </li></ul></ul><ul><ul><li>Stabilize prices </li></ul></ul>Strictly Financials
  30. 30. In The Day, Buy or Sell Order <ul><li>Tell your broker or “registered representative” to buy or sell a stock at the current price, or market price. Called a market order. </li></ul><ul><li>If you name the price to buy or sell, you’re making a limit order. </li></ul><ul><li>Tell your broker to buy or sell once the price hits a specific price, you’re placing a stop order at a stop price. </li></ul>Strictly Financials
  31. 31. Trading on the NYSE Floor <ul><li>Trading occurs in the “Big Room” </li></ul><ul><li>Numerous stations, each with a roughly figure-eight shape, with counters and screens above. Called “trading posts.” </li></ul><ul><li>Each counter is a “specialist’s” post </li></ul>Strictly Financials
  32. 32. NYSE Floor (cont.) <ul><li>Order comes to the booth that is rented by a brokerage house </li></ul><ul><li>Floor broker takes order to appropriate specialist’s post </li></ul><ul><li>Specialist keeps a list of unfilled orders. Processes orders as prices move. </li></ul><ul><li>Specialist’s job is to maintain an orderly market in the stock (match buyers/sellers) </li></ul>Strictly Financials
  33. 33. NYSE Floor (cont.) <ul><li>Stocks or groups of stocks are traded at trading posts near the specialists’ positions. </li></ul><ul><li>Floor brokers can use a specialist or trade between themselves, called trading in the “crowd” </li></ul><ul><li>Terminals display the stock’s activity. </li></ul><ul><li>After every trade, a reporter records the stock symbol, price and initiating broker. </li></ul><ul><li>Successful trades are confirmed. </li></ul>Strictly Financials
  34. 34. NYSE Floor (Then & Now) Strictly Financials
  35. 35. Round or Odd Lots <ul><li>Round lots: Buying or selling stock in multiples of 100 shares </li></ul><ul><li>Odd lots: Buying or selling stock in other quantities </li></ul>Strictly Financials
  36. 36. Super DOT System <ul><li>Designated Order Turnaround </li></ul><ul><li>Allows orders to be transmitted electronically to specialist. </li></ul><ul><li>Now makes up a substantial percentage of NYSE trading, particularly smaller orders </li></ul>Strictly Financials
  37. 37. American Stock Exchange <ul><li>Non-members of NYSE couldn’t afford office space so traded in the street </li></ul><ul><li>1842: New York Curb Exchange </li></ul><ul><li>By late 1870s known as “curbstone brokers” and their market was known as the Curb. </li></ul><ul><li>Merged with NASDAQ in 1998 </li></ul><ul><li>Acquired by NYSE Euronext in 2009 </li></ul>Strictly Financials
  38. 38. NASDAQ <ul><li>National Association of Securities Dealers Automated Quotations system </li></ul><ul><li>NASDAQ is a computer network with no physical location for trading </li></ul><ul><li>Uses a multiple market maker system, not the specialist system </li></ul><ul><li>About 4,000-plus companies </li></ul>Strictly Financials
  39. 39. Trading on the NASDAQ <ul><li>Trading is through an open market, multiple dealer system, with many market makers competing to handle each transaction. </li></ul><ul><li>The computer network checks for matches, which can be handled instantly. </li></ul>Strictly Financials
  40. 40. To Be Listed <ul><li>NYSE: Minimum 1.1 million publicly held shares; $40 million minimum market capitalization. </li></ul><ul><li>NASDAQ: Qualitative and quantitative requirements for national and small cap markets </li></ul><ul><li>AMEX: Minimum 500,000 publicly held shares; minimum $3 million market cap </li></ul>Strictly Financials
  41. 41. In Which Market? <ul><li>In general, but with exceptions: </li></ul><ul><ul><li>NYSE: Oldest, largest, best known </li></ul></ul><ul><ul><li>AMEX: Smaller, younger </li></ul></ul><ul><ul><li>NASDAQ: Youngest, least experienced </li></ul></ul><ul><ul><li>Some of NYSE’s most actively traded stocks are also quoted on the NASDAQ </li></ul></ul>Strictly Financials
  42. 42. ECNs <ul><li>Electronic Communications Networks </li></ul><ul><li>Are basically Web sites that allow investors to trade directly with one another </li></ul><ul><li>Archipelago and Instinet were best known </li></ul><ul><li>BATS Trading </li></ul>Strictly Financials
  43. 43. NYSE - Archipelago Marriage <ul><li>Merged in March 2006 to create NYSE Group, Inc., a publicly-held company. </li></ul><ul><li>Largest merger ever between securities exchanges. </li></ul><ul><li>Combined leading equities market with most successful electronic exchange. </li></ul><ul><li>Archipelago: low fees, user-friendly technology </li></ul>Strictly Financials
  44. 44. NYSE Euronext <ul><li>Merged April 2007 </li></ul><ul><li>Operates world’s largest, most liquid exchange with diverse products and services </li></ul><ul><li>Six equities exchanges in five countries and six derivatives exchanges </li></ul>Strictly Financials
  45. 45. NYSE ‘Hybrid Market’ <ul><li>Floor trading and automated trading </li></ul><ul><li>Specialists or Archipelago strengths </li></ul><ul><li>Why? Customers’ desire for faster access to liquidity and greater anonymity </li></ul>Strictly Financials
  46. 46. NASDAQ Response <ul><li>NASDAQ acquired Instinet Group Inc., another ECN </li></ul>Strictly Financials
  47. 47. Exchanges v. OTC Market <ul><li>Stocks in almost 10,000 companies aren’t listed on any exchanges. </li></ul><ul><li>They are traded “over the counter” (OTC) </li></ul><ul><li>Typically handled by phone or computer </li></ul><ul><li>Generally, comparatively inexpensive and infrequently, or “thinly,” traded </li></ul>Strictly Financials
  48. 48. BATS <ul><li>Newer exchange </li></ul><ul><li>Located in Kansas City </li></ul><ul><li>Competes on technology and cost </li></ul><ul><li>Also offers an options trading platform </li></ul><ul><li>An ECN </li></ul>Strictly Financials
  49. 49. BATS (cont.) Strictly Financials
  50. 50. Direct Edge <ul><li>Another ECN </li></ul><ul><li>Has exchange status </li></ul>Strictly Financials
  51. 51. Cyclical, Income, Growth <ul><li>Cyclical: Highly dependent on the state of the economy. When things slow, earnings and stock price fall. When economy recovers, earnings and stock prices rise. </li></ul><ul><li>Income: Stocks that pay dividends regularly. </li></ul><ul><li>Growth: Pay little or no dividend while profits are reinvested. </li></ul>Strictly Financials
  52. 52. Stock Ownership <ul><li>56.9 million households owned stock in 2005 </li></ul><ul><li>Compares with 54.1 million in ’02 and 40 million in ’95 </li></ul><ul><li>Due mainly to spread of mutual funds, 401(k) plans, etc. </li></ul>Strictly Financials
  53. 53. Institutional Investors <ul><li>Organizations that invest their own assets or pool those it holds in trust for others. </li></ul><ul><li>Examples: Investment companies (including mutual funds), pension systems, insurance companies, universities and banks. </li></ul><ul><li>Trade regularly and in tremendous volume. </li></ul><ul><li>Must buy or sell at least 10,000 shares for a transaction to be an “institutional trade.” </li></ul>Strictly Financials
  54. 54. Changing Attitudes <ul><li>Institutional investors who own large blocks of stock are increasingly demanding a say in corporate management. </li></ul><ul><li>Socially or environmentally conscious individual shareholders also are becoming more involved. </li></ul>Strictly Financials
  55. 55. Stock Market Averages <ul><li>Dow Jones Industrial Average: Best known and most widely reported market indicator </li></ul><ul><li>Made up of 30 industrial companies </li></ul><ul><li>Dow Jones Transportation Average: 20 airlines, railroads and trucking companies </li></ul><ul><li>Dow Jones Utility Average: 15 gas, electric and power companies </li></ul><ul><li>Dow Jones 65 Composite Average: all 65 companies in the other three averages </li></ul>Strictly Financials
  56. 56. Stock Market Indexes <ul><li>NYSE Composite Index: All stocks traded on the NYSE. </li></ul><ul><li>Standard & Poor’s 500 Index: Broad base of 500 stocks. Considered benchmark for large-stock investors. </li></ul><ul><li>NASDAQ Stock Market Composite Index: Stocks traded through its electronic system. Often more volatile because of types of companies it covers. </li></ul>Strictly Financials
  57. 57. Market Indexes (cont.) <ul><li>AMEX Composite: Companies on the AMEX. </li></ul><ul><li>Russell 2000: Follows smallest two-thirds of the 3,000 largest U.S. companies. Includes many IPOs of past few years. Benchmark for small-company stocks. </li></ul><ul><li>Value-Line: 1,700 common stocks. </li></ul><ul><li>Wilshire 5000: Broadest index, including nearly all stocks traded in U.S. markets. </li></ul>Strictly Financials
  58. 58. Reg FD, Disclosure and Guidance <ul><li>Regulation Fair Disclosure, October 2000 </li></ul><ul><li>Bars public issuers from selectively revealing material nonpublic information to securities analysts, broker-dealers, investment advisers, and institutional investors, before disclosing it to the public. </li></ul><ul><li>Tension: Guidance vs. disclosure </li></ul>Strictly Financials
  59. 59. Blue-Chip Stock <ul><li>Company with national reputation for quality, reliability and ability to be profitable in good or bad times </li></ul>Strictly Financials
  60. 60. Bulls and Bears <ul><li>Bulls: Persons who think prices or values will rise. In general, being optimistic. </li></ul><ul><li>Bears: Persons with a pessimistic market outlook. </li></ul>Strictly Financials
  61. 61. Selling Short <ul><li>Selling a security not owned by seller </li></ul><ul><li>Investor borrows stock and sells it for later delivery. </li></ul><ul><li>Seller hopes to buy the stock later at a lower price, thereby making a profit, which comes from difference between price at sale and price at later purchase. </li></ul>Strictly Financials
  62. 62. Margin <ul><li>Buying on margin: Borrowing money from broker to buy securities. </li></ul><ul><li>Federal Reserve regulates margin. Today investor can borrow up to 50 percent of the price of the stock. </li></ul><ul><li>Broker requires a minimum balance and can issue a “margin call” if stock’s value declines. </li></ul>Strictly Financials
  63. 63. Classes of Stock <ul><li>Some firms have more than one class </li></ul><ul><li>Primarily done to assure control of the firm by one group, such as Ford Motor Company’s Class B, which isn’t publicly traded (held by family) but has 40 percent of voting power, although it represents less than 10 percent of total shares outstanding. </li></ul>Strictly Financials
  64. 64. Stock Split <ul><li>If stock price increases significantly, a company might do a split to lower the price, which it expects to stimulate trading. </li></ul><ul><li>In a split, more shares are available but total market value is still the same. </li></ul><ul><li>Price may move up after split, therefore increasing the value of your stock. </li></ul><ul><li>Reverse split: Exchange more shares for fewer, say 10 for five. To boost share price. </li></ul>Strictly Financials
  65. 65. Arbitrage <ul><li>Simultaneous purchase and sale of an asset to profit from a differential in the price. Usually takes place on different exchanges or marketplaces. </li></ul><ul><li>Ex: Buy stock in company on one exchange at one price and sell stock in the same company on another exchange at a different price. </li></ul>Strictly Financials
  66. 66. Insider Trading <ul><li>Buying and selling of company stock by officers, directors, employees, family members, etc. Person or trust owning 10 percent or more of a company's stock also considered an &quot;insider.&quot; </li></ul><ul><li>SEC calls them &quot;insiders&quot; because of access to early and potentially key company events. </li></ul>Strictly Financials
  67. 67. Option <ul><li>On an organized exchange, the right to buy or sell securities, commodities, etc. at some point for an agreed upon amount. </li></ul><ul><li>In a company, stock options are granted to corporate executives and others as part of their compensation packages. </li></ul>Strictly Financials
  68. 68. Warrant <ul><li>Type of security, usually issued with a bond or preferred stock, that entitles holder to buy a proportionate amount of common stock at a specified price, usually higher than the market price at time of issuance, for a period of time. </li></ul><ul><li>Also called a Subscription Warrant </li></ul>Strictly Financials
  69. 69. Global Marketplace <ul><li>Stocks are traded around the clock, around the world. There’s a market open somewhere, 24 hours a day, Monday through Friday. </li></ul><ul><li>Growing number of multinational companies on several exchanges. </li></ul><ul><li>Tendency of investors to buy in many markets, not just their own. </li></ul>Strictly Financials
  70. 70. American Depositary Receipts <ul><li>A bank buys and deposits actual foreign securities with another bank (called a depositary), which then issues certificates in the U.S. that represent (and are backed) by the deposited securities. </li></ul><ul><li>Depositary handles day-to-day interactions with ADR holders. </li></ul><ul><li>Advantages: As U.S. securities, ADRs are subject to U.S. regulations and protections. </li></ul>Strictly Financials
  71. 71. ADRs (cont.) <ul><li>Priced in dollars and dividends paid in U.S. dollars. </li></ul><ul><li>ADR prices follow closely (but not necessarily 1:1) the underlying foreign security, based on supply and demand. </li></ul><ul><li>Very few U.S. banks are depositaries. Bank of New York is largest with more than 50 percent of all ADR issues. </li></ul>Strictly Financials
  72. 72. Tracking Global Markets <ul><li>Wall Street Journal tracks 24 national stock markets outside the U.S. with 32 indexes. </li></ul><ul><li>Worldwide market performance is compared by looking at percentage change. </li></ul>Strictly Financials
  73. 73. Why International <ul><li>Rewards </li></ul><ul><ul><li>Diversification, capital gains, dividends, country’s currency rises against dollar </li></ul></ul><ul><li>Risks </li></ul><ul><ul><li>Tax treatments differ by country, accounting and trading rules can be different, converting dividends can add expenses, distance and language barriers </li></ul></ul>Strictly Financials
  74. 74. Credit or Debt Markets <ul><li>Historically, the amount of long-term debt financing issued in the U.S. greatly exceeds the volume of equity financing </li></ul><ul><li>Short-term or “money market” </li></ul><ul><li>Bond market </li></ul>Strictly Financials
  75. 75. Money Market <ul><li>Commercial paper </li></ul><ul><li>Bankers’ acceptance </li></ul><ul><li>Repurchase agreements </li></ul><ul><li>Certificates of deposit </li></ul><ul><li>Municipal notes </li></ul><ul><li>Treasury bills </li></ul><ul><li>Money market mutual funds </li></ul>Strictly Financials
  76. 76. Terminology <ul><li>Bills – Maturity dates up to one year </li></ul><ul><li>Notes – Maturity dates of two to 10 years </li></ul><ul><li>Bonds – 10 years or longer </li></ul>Strictly Financials
  77. 77. Who Issues Bonds <ul><li>Issued by U.S. companies </li></ul><ul><li>Issued by the U.S. Treasury </li></ul><ul><li>Issued by federal, state and local government agencies </li></ul><ul><li>Issued by overseas companies and governments. When sold in dollars, are sometimes called Yankee Bonds. </li></ul>Strictly Financials
  78. 78. Issuers Prefer Bonds <ul><li>When companies need to raise money, they can issue stock or sell bonds </li></ul><ul><li>They often prefer bonds, in part because issuing more stock tends to dilute the value of shares investors already own </li></ul><ul><li>Bonds also may have income tax advantages </li></ul>Strictly Financials
  79. 79. Treasury Issues <ul><li>Life, or term, is fixed at time of issue </li></ul><ul><li>Treasury bill: One year or less </li></ul><ul><li>Treasury note: One to 10 years </li></ul><ul><li>Treasury bond: 10 years or more </li></ul><ul><li>Generally, the longer the term the higher the interest rate </li></ul>Strictly Financials
  80. 80. Uses of Bonds <ul><li>Corporations use bonds: </li></ul><ul><ul><li>To raise capital to pay for expansion or modernization </li></ul></ul><ul><ul><li>To cover operating expenses </li></ul></ul><ul><ul><li>To finance corporate takeovers or other changes in management structure </li></ul></ul>Strictly Financials
  81. 81. Uses of Bonds (cont.) <ul><li>U.S. Treasury uses bonds: </li></ul><ul><ul><li>To finance a wide range of government activities </li></ul></ul><ul><ul><li>To pay off (actually refinance) the national debt </li></ul></ul>Strictly Financials
  82. 82. Uses of Bonds (cont.) <ul><li>States, cities, counties and towns issue bonds: </li></ul><ul><ul><li>To pay for a wide variety of public projects </li></ul></ul><ul><ul><li>To supplement their operating budgets </li></ul></ul>Strictly Financials
  83. 83. How Bonds Are Sold <ul><li>Issuing bonds has similarities to an IPO </li></ul><ul><li>Bonds are sold at par, or face value, in units of $1,000 </li></ul><ul><li>After issue, bonds trade in secondary market and are bought and sold through brokers </li></ul><ul><li>Government bonds are directly available through a Federal Reserve Bank program called Treasury Direct or through a broker </li></ul><ul><li>Most municipals are sold through a broker </li></ul>Strictly Financials
  84. 84. How Bonds Are Traded <ul><li>Most already-issued bonds are traded over the counter </li></ul><ul><li>Bonds also can be purchased from the inventory of a brokerage firm that might make a market in the bonds </li></ul><ul><li>Commissions and markups </li></ul>Strictly Financials
  85. 85. Bonds Then and Today <ul><li>Until 1983, all bondholders received certificates </li></ul><ul><li>Some of these Bearer Bonds had coupons attached to the certificate </li></ul><ul><li>To collect interest, investor detached the coupon and exchanged it for cash. Hence, the bond interest rate is called the Coupon Rate. </li></ul><ul><li>Today most new bonds are called Book Entry bonds and are registered electronically </li></ul>Strictly Financials
  86. 86. Rating Bonds <ul><li>Standard & Poor’s, Moody’s Investors Services and Fitch are best known </li></ul><ul><li>Corporate, international and municipal bonds are rated </li></ul><ul><li>Credit ratings influence interest rates </li></ul><ul><li>If a company’s rating is downgraded, investors demand a higher yield </li></ul>Strictly Financials
  87. 87. Bond Rating Code <ul><li>Aaa/AAA: Best quality </li></ul><ul><li>Aa/AA: High quality </li></ul><ul><li>A/A: High-medium quality </li></ul><ul><li>Baa/BBB: Medium quality </li></ul><ul><li>Ba/BB: Some speculative element </li></ul><ul><li>B/B: Future default risk </li></ul><ul><li>Caa/CCC: Poor quality, default danger </li></ul><ul><li>Ca/CC: Highly speculative </li></ul><ul><li>C/C: Lowest rated, poor prospects </li></ul>Strictly Financials