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Copyright © 2015 by the McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

Using Securities Markets for Financing & Investing Opportunities

CHAPTER 19

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LEARNING OBJECTIVES

19-*

  • Describe the role of securities markets and of investment bankers.
  • Identify the stock exchanges where securities are traded.
  • Compare the advantages and disadvantages of equity financing by issuing stock, and detail the differences between common and preferred stock.
  • Compare the advantages and disadvantages of obtaining debt financing by issuing bonds, and identify the classes and features of bonds.

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LEARNING OBJECTIVES

19-*

  • Explain how to invest in securities markets and set investment objectives such as long-term growth, income, cash, and protection from inflation.
  • Analyze the opportunities stocks offer as investments.
  • Analyze the opportunities bonds offer as investments.
  • Explain the investment opportunities in mutual funds and exchange-traded funds (ETFs).
  • Describe how indicators like the Dow Jones Industrial Average affect the market.

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MELODY HOBSON
Ariel Investments

19-*

  • Hobson started as an intern at Ariel Investments after graduating from Princeton in 1991.
  • Now, as president of the company, she oversees more than $9 billion in assets.
  • Preaches patience in investing.
  • Ariel Investments focuses on stocks and equity funds that should perform in the long term.

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NAME that COMPANY

19-*

If someone had bought 100 shares in this company when it was first available to the public in 1965, it would have cost $2,250. If they held on to the stock, the number of shares they’d have today would be 74,360 (after 12 stock splits) with a value of approximately $7.4 million.

Name that company!

Company: McDonald’s

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The BASICS of
SECURITIES MARKETS

19-*

  • Securities markets are financial marketplaces for stocks and bonds and serve two primary functions:
  • Assist businesses in finding long-term funding to finance capital needs.
  • Provide private investors a place to buy and sell securities such as stocks and bonds.

LO 19-1

See Learning Objective 1: Describe the role of securities markets, and of investment bankers.

TYPES of
SECURITIES MARKETS

19-*

LO 19-1

  • Securities markets are divided into primary and secondary markets:
  • Primary markets handle the sale of new securities.
  • Secondary markets handle the trading of securities between investors with the proceeds of the sale going to the seller.
  • Initial Public Offering (IPO) -- The first offering of a corporation’s stock.

See Learning Objective 1: Describe the role of securities markets, and of investment bankers.

Facebook’s 2012 IPO raised $16 billion for the company.

  • Investment Bankers -- Specialists who assist in the issue and sale of new securities.

INVESTMENT BANKERS
and INSTITUTIONAL INVESTORS

19-*

LO 19-1

  • Institutional Investors -- Large organizations such as pension funds or mutual funds that invest their own funds or the funds of others.

See Learning Objective 1: Describe the role of securities markets, and of investment bankers.

Investment bankers help companies by: (1) gaining approval from the SEC for a firm to issue stocks or bonds and (2) underwriting.

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STOCK EXCHANGES

19-*

LO 19-1

  • Stock Exchange -- An organization whose members can buy and sell (exchange) securities on behalf of companies and individual investors.
  • Over-the-Counter (OTC) Market -- Provides companies and investors with a means to trade stocks not listed on the national securities exchanges.
  • NASDAQ -- A telecommunications network that links dealers across the nation so they can exchange securities electronically.

See Learning Objective 2: Identify the stock exchanges where securities are traded.

  • In 2013, the NYSE Euronext was acquired by the Intercontinental Exchange (ICE) for $8.2 billion.
  • The trading floor is largely symbolic now as most trading is done electronically.

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See Learning Objective 2: Identify the stock exchanges where securities are traded.

Top Stock Exchanges

  • This slide profiles the largest stock exchanges in the world.
  • To be listed on the NYSE, the company must have at least 2200 shareholders, average daily volume of at least 100,000 shares, a market cap of $750 million, or pretax earnings of $10 million.
  • NASDAQ is an acronym which stands for the National Association of Securities Dealers Automated Quotations.
  • London Exchange merged with the Italian Exchange, both of which have been operating for over 200 years.
  • Tokyo exchange operated a trading floor for 120 years. In 1999, the trading floor was closed as the Tokyo Stock Exchange went to all electronic trading similar to NASDAQ.
  • The Deutsche Borse is located in Frankfurt, Germany.

GIVING SMALL BUSINESS
a JUMP on FUNDING

19-*

  • The goal of the JOBS Act is to ease small business financing problems.
  • The SEC adopted new rules, including:
  • Raised from 500 to 2,000 the number of shareholders a company could have before it must register its stock with the SEC.
  • Allows equity crowdfunding through brokers or portals.
  • Expanded the abilities of private companies to raise capital through limited stock offerings.

See Learning Objective 2: Identify the stock exchanges where securities are traded.

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The SECURITIES and
EXCHANGE COMMISSION

19-*

LO 19-2

  • Securities and Exchange Commission (SEC) -- The federal agency responsible for regulating the various stock exchanges; created in 1934 through the Securities and Exchange Act.
  • Prospectus -- A condensed version of economic and financial information that a company must file with the SEC before issuing stock; the prospectus must be sent to prospective investors.

See Learning Objective 2: Identify the stock exchanges where securities are traded.

The Securities and Exchange Act also prohibits insider trading by using knowledge or information gained through a person’s position in a firm that allows them to benefit unfairly.

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TEST PREP

19-*

  • What is the primary purpose of a securities exchange?
  • What does NASDAQ stand for? How does this exchange work?
  • The primary purpose of a securities exchange is to allow members of the exchange to buy or sell securities on behalf of investors.

  • NASDAQ stands for National Association Securities Dealers Automated Quotations. This exchange is completely electronic allowing for orders to be quickly matched up via computers.

LEARNING the
LANGUAGE of STOCKS

19-*

LO 19-3

  • Stocks -- Shares of ownership in a company.
  • Stock Certificate -- Evidence of stock ownership.
  • Dividends -- Part of a firm’s profits that the firm may distribute to stockholders as either cash or additional shares.

See Learning Objective 3: Compare the advantages and disadvantages of equity financing by issuing stock, and detail the differences between common and preferred stock.

ADVANTAGES of
ISSUING STOCK

19-*

LO 19-3

  • Stockholders are owners of a firm and never have to be repaid their investment.
  • There is no legal obligation to pay dividends.
  • Issuing stock can improve a firm’s balance sheet since stock creates no debt.

See Learning Objective 3: Compare the advantages and disadvantages of equity financing by issuing stock, and detail the differences between common and preferred stock.

DISADVANTAGES of
ISSUING STOCK

19-*

LO 19-3

  • Stockholders have the right to vote for a company’s board of directors.
  • Issuing new shares of stock can alter the control of the firm.
  • Dividends are paid from after-tax profits and are not tax deductible.
  • The need to keep stockholders happy can affect management’s decisions.

See Learning Objective 3: Compare the advantages and disadvantages of equity financing by issuing stock, and detail the differences between common and preferred stock.

TWO CLASSES of STOCK

19-*

LO 19-3

  • Common Stock -- The most basic form; holders have the right to vote for the board of directors and share in the profits if dividends are approved.
  • Preferred Stock -- Owners are given preference in the payment of company dividends before common stock dividends are distributed. Preferred stock can also be:
  • Callable
  • Convertible
  • Cumulative

See Learning Objective 3: Compare the advantages and disadvantages of equity financing by issuing stock, and detail the differences between common and preferred stock.

In the event of bankruptcy, the rights of common stock holders are subordinated to preferred stock holders.

TEST PREP

19-*

  • Name at least two advantages and disadvantages of a company’s issuing stock as a form of equity financing.
  • What are the major differences between common stock and preferred stock?
  • Advantages of issuing stock: equity never has to be repaid, the company is under no legal obligation to pay dividends, and selling stock can improve a company’s balance sheets since it doesn’t create debt. Disadvantages: equity holders have the right to vote, dividends are not tax deductible, and the need to keep shareholders happy can affect managers decisions.

  • Common stock holders have the right to vote, while preferred stock holders do not. Preferred stock holders have rights if the company enters bankruptcy. Preferred stock holders receive a fixed dividend, while common holders are not guaranteed to be paid a dividend.

  • Bond -- A corporate certificate indicating that an investor has lent money to a firm (or a government).

LEARNING the
LANGUAGE of BONDS

19-*

LO 19-4

  • The principal is the face value of the bond.
  • Interest -- The payment the bond issuer makes to the bondholders to compensate them for the use of their money.

See Learning Objective 4: Compare the advantages and disadvantages of obtaining debt financing by issuing bonds, and identify the classes and features of bonds.

Unlike dividends, interest payments are tax deductible.

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TYPES of BONDS

19-*

LO 19-4

See Learning Objective 4: Compare the advantages and disadvantages of obtaining debt financing by issuing bonds, and identify the classes and features of bonds.

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ADVANTAGES of
ISSUING BONDS

19-*

LO 19-4

  • Bondholders are creditors, not owners of the firm and cannot vote on corporate matters.
  • Bond interest is tax deductible.
  • Bonds are a temporary source of funding and are eventually repaid.
  • Bonds can be repaid before the maturity date if they are callable.

See Learning Objective 4: Compare the advantages and disadvantages of obtaining debt financing by issuing bonds, and identify the classes and features of bonds.

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DISADVANTAGES of
ISSUING BONDS

19-*

LO 19-4

  • Bonds increase debt and can affect the market’s perception of the firm.
  • Paying interest on bonds is a legal obligation.
  • If interest is not paid, bondholders can take legal action.
  • The face value of the bond must be repaid on the maturity date.

See Learning Objective 4: Compare the advantages and disadvantages of obtaining debt financing by issuing bonds, and identify the classes and features of bonds.

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BOND RATINGS

19-*

LO 19-4

See Learning Objective 4: Compare the advantages and disadvantages of obtaining debt financing by issuing bonds, and identify the classes and features of bonds.

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  • Corporations can issue two classes of bonds:

DIFFERENT CLASSES of
CORPORATE BONDS

19-*

LO 19-4

  • Unsecured bonds (debenture bonds): not backed by specific collateral.
  • Secured bonds: backed by collateral (land or equipment).

See Learning Objective 4: Compare the advantages and disadvantages of obtaining debt financing by issuing bonds, and identify the classes and features of bonds.

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SPECIAL FEATURES in
BOND ISSUES

19-*

LO 19-4

  • Sinking Fund -- Reserve account set up to ensure that enough money will be available to repay bondholders on the maturity date.
  • Callable bonds permit bond issuers to pay off the principal before the maturity date.
  • Convertible bonds allow bondholders to convert their bonds into shares of common stock.

See Learning Objective 4: Compare the advantages and disadvantages of obtaining debt financing by issuing bonds, and identify the classes and features of bonds.

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TEST PREP

19-*

  • Why are bonds considered a form of debt financing?
  • What does it mean if a firm issues a 9% debenture bond due in 2025?
  • Explain the difference between an unsecured and secured bond.
  • Why are convertible bonds attractive to investors?
  • Bonds are considered debt financing, since they must be paid back when the bond matures.

  • A 9% debenture bond due in 2025 has a coupon rate or interest rate of 9 percent and matures in 2025.

  • A secured bond is backed by some form of collateral. While an unsecured bond or debenture is not backed or secured by any collateral.

  • Convertible bonds are attractive, because they give bondholders the option to convert their bonds into stock. This is attractive since stocks tend to appreciate faster than bonds do.

BUYING SECURITIES

19-*

LO 19-5

  • Stockbroker -- A registered representative who works as a market intermediary to buy and sell securities for clients.
  • Online trading services, such as TD Ameritrade, E*Trade, and Scottrade, offer securities trading services online to buy and sell stocks and bonds.

See Learning Objective 5: Explain how to invest in securities markets and set investment objectives such as long-term growth, income, cash, and protection from inflation.

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MONEY GOING UP in SMOKE

19-*

  • You recently received news that your Uncle Alex passed away after a long battle with lung cancer caused by smoking. He left you $25,000 in his will, saying you were his favorite nephew.
  • Your friend Jack recommends that you buy stock in a well-known multinational firm that is primary product is tobacco.
  • Will you invest your inheritance in a company that markets tobacco?

See Learning Objective 5: Explain how to invest in securities markets and set investment objectives such as long-term growth, income, cash, and protection from inflation.

FIVE INVESTMENT CRITERIA

19-*

LO 19-5

  • Investment risk
  • Yield
  • Duration
  • Liquidity
  • Tax consequences

See Learning Objective 5: Explain how to invest in securities markets and set investment objectives such as long-term growth, income, cash, and protection from inflation.

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INVESTING 101
Things to Do Before Making Your First Investment

Source: Money, www.money.com, accessed November 2014.

19-*

LO 19-5

  • Take an investing class.
  • Attend a conference.
  • Head to the library and pick up investing books.

See Learning Objective 5: Explain how to invest in securities markets and set investment objectives such as long-term growth, income, cash, and protection from inflation.

  • Some people want to jump right into an investment.
  • This slide shows three ways to learn about investment strategies.
  • Ask students: Would you take an investing class or jump straight into the market? Would you know how to do the needed research?

AVERAGE ANNUAL RETURN of
ASSET CLASSES (Since 1926)

Source: Ibbotson Associates and Morningstar.

19-*

LO 19-5

See Learning Objective 5: Explain how to invest in securities markets and set investment objectives such as long-term growth, income, cash, and protection from inflation.

Average Annual Return of Asset Classes

  • This slide profiles average returns since 1926 for various asset classes.
  • Although the recession since 2008 has been harsh, this chart shows that over the long-term equity is a solid investment.
  • Ask students: Why do you think small companies have a higher rate of return than any other asset class?

DIVERSIFICATION

19-*

LO 19-5

  • Diversification -- Buying several different types of investments to spread the risk of investing.
  • If diversifying, an investor may put:
  • 25% of his/her money into U.S. growth stocks
  • 25% in government bonds
  • 25% in dividend-paying stocks
  • 10% in an international mutual fund
  • The rest in a savings account

See Learning Objective 5: Explain how to invest in securities markets and set investment objectives such as long-term growth, income, cash, and protection from inflation.

Diversification helps spread risk by buying different types of investments.

*

GLOBAL STOCKS:
LOVE THEM or LEAVE THEM

19-*

  • Suggestions for building your financial future:
  • Invest in familiar global companies with a solid reputation and performance records.
  • Invest only in global stocks listed on U.S. exchanges.
  • Invest in global mutual funds that focus on specific countries or regions.
  • Use extreme caution if investing in unstable countries!

See Learning Objective 5: Explain how to invest in securities markets and set investment objectives such as long-term growth, income, cash, and protection from inflation.

PRIMARY INVESTMENT SERVICES
CONSUMERS NEED

Source: Investment Company Institute.

19-*

LO 19-5

  • Savings and investing advice
  • Help with 401k plans
  • Retirement planning
  • Tax planning
  • Estate planning
  • Education expense planning

See Learning Objective 5: Explain how to invest in securities markets and set investment objectives such as long-term growth, income, cash, and protection from inflation.

This slide presents the needs of consumers when it comes to financial planning.

  • Today’s brokers provide more than simply the buying and selling of stocks and bonds.

  • Companies like Charles Schwab and Fidelity help individuals plan for the future.

TEST PREP

19-*

  • What is the key advantage of investing through online brokers? What is the key disadvantage?
  • What is the primary purpose of diversifying investments?
  • The main advantage of investing through online brokers is that the fees charged tend to be lower than traditional brokers. The key disadvantage is that investors must generally do their own research and make their own investment decisions without direct assistance from their broker.

  • The goal of diversification is to reduce the overall risk an investor assumes.

PERCEPTIONS of the MARKET

19-*

LO 19-6

  • Bulls: Investors who believe stock prices are going to rise.
  • Bears: Investors who expect stock prices to decline.

See Learning Objective 6: Analyze the opportunities stocks offer as investments.

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BEAR MARKET DECLINES
in the S&P 500

Source: Stock Traders Almanac 2011.

19-*

LO 19-6

See Learning Objective 6: Analyze the opportunities stocks offer as investments.

  • This slide profiles the bear market declines over the past forty years.
  • The past decade has been abysmal with two significant bear markets.
  • Have students think about the times when bear markets have caused declines in the S&P. What was going on in the country or world at these times? What might have been the causes of these bear markets? What were the effects?

SELECTING STOCKS

19-*

  • Capital Gains -- The positive difference between the price at which you bought a stock and what you sell it for.
  • Investors can also choose stocks according to their strategy:
  • Blue-chip stocks
  • Growth stocks
  • Income stocks
  • Penny stocks

LO 19-6

See Learning Objective 6: Analyze the opportunities stocks offer as investments.

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STOCK SPLITS

19-*

LO 19-6

  • Stock Splits -- An action by a company that gives stockholders two or more shares of additional stock for every share that they own.
  • Splits cause no change in the firm’s ownership structure and no change in the investment’s value.
  • Firms can never be forced to spilt their stocks.

See Learning Objective 6: Analyze the opportunities stocks offer as investments.

  • An important point to note is investment value does not change immediately after the stock split. The investor has the same original dollar value as before the split. The hope for the investor is that the lower price will cause the demand for the stock to increase, raising the stock price (which will increase their total investment value since they have more shares due to the stock split).

  • Dividend rates are also divided according to the degree of split.

  • Most stock splits are two-for-one splits.

  • Since 1975, Wal-Mart has split their shares on eight different occasions. If an individual investor purchased 100 shares in 1980 they would own 25,600 shares after adjusting for splits!

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  • Buying Stock on Margin -- Borrowing some of the stock’s purchase cost from the brokerage firm.

BUYING STOCK on MARGIN

19-*

LO 19-6

  • Margin is the portion of the stock’s purchase price that the investor must pay with their own money.
  • If a broker issues a margin call, the investor has to come up with money to cover losses.

See Learning Objective 6: Analyze the opportunities stocks offer as investments.

  • Investors purchasing on margin are increasing their purchasing power, so they can own more stock without fully paying for it.

  • Students should know the risk associated with buying stocks on margin. Margin exposes investors to the following risks:
  • You can lose more money than you invested.
  • You may have to deposit additional cash or securities in your account on short notice to cover market losses.
  • You may be forced to sell some or all of your securities when falling stock prices reduce the value of your securities.
  • Your brokerage firm may sell some or all of your securities without consulting you to pay off the loan it made to you.
  • Know that your firm charges you interest for borrowing money which will affect the total return on your investments.

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UNDERSTANDING STOCK QUOTATIONS

19-*

LO 19-6

See Learning Objective 6: Analyze the opportunities stocks offer as investments.

Stock quotations are now readily available on numerous websites.

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TOP FINANICIAL NEWS and RESEARCH SITES

19-*

LO 19-6

See Learning Objective 6: Analyze the opportunities stocks offer as investments.

  • Financial information is now readily available online. This slide lists some of the sites where information can be easily gathered.
  • If time allows, encourage students to visit these web sites and evaluate their usefulness.
  • Ask students: Which of these web sites was the best? Why would it be a good idea to consult more than one of these web sites before deciding to invest?

IMPORTANT BOND QUESTIONS

19-*

  • Junk Bonds -- Bonds that are high-risk and have high default rates.

LO 19-7

  • First-time bond investors generally ask two questions:
  • Do you have to hold a bond until the maturity date?
  • How can I assess the investment risk of a particular bond issue?

See Learning Objective 7: Analyze the opportunities bonds offer as investments.

A junk bond has a rating of BB or less.

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UNDERSTANDING BOND
QUOTATIONS

19-*

LO 19-7

See Learning Objective 7: Analyze the opportunities bonds offer as investments.

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INVESTING in MUTUAL FUNDS
and EXCHANGE-TRADED FUNDS

19-*

LO 19-8

  • Mutual Fund -- An organization the buys stocks and bonds and then sells shares in those securities to the public. The fund pools investors’ money and buys stocks according to the fund’s purpose.
  • Exchange-Traded Fund (ETF) -- Collections of stocks and bonds that are traded on securities exchanges, but are traded more like individual stocks than mutual funds.

See Learning Objective 8: Explain the investment opportunities in mutual funds and exchange-traded funds (ETFs).

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WHAT MUTUAL FUNDS CAN
LEARN FROM KaChing

Source: Fast Company, www.fastcompany.com, accessed November 2014.

19-*

LO 19-8

  • Reform the ratings system
  • Give information for free
  • Cut out useless fees
  • Be transparent
  • Share insights

See Learning Objective 8: Explain the investment opportunities in mutual funds and exchange-traded funds (ETFs).

  • KaChing is a web site where professional investors share everything about their portfolios.
  • Fast Company shows how KaChing can help investors understand what they’re getting into.
  • The magazine uses the example of Morningstar and how most of its portfolio managers didn’t invest in their own funds. Potential investors would like to know information like that!

PERCENTAGE of HOUSEHOLDS OWNING MUTUAL FUNDS

Source: Investment Company Institute Factbook.

19-*

LO 19-8

See Learning Objective 8: Explain the investment opportunities in mutual funds and exchange-traded funds (ETFs).

  • This slide presents the percentage of US households owning mutual funds over the past 30 years.
  • Ask the students – Do you or your parents own mutual funds? How did they get involved in purchasing them, and what type of research do they do before buying them? Did they develop investment objectives or was it based on some tip or advice?
  • It should be pointed out to the students that people may get into investing for the right reasons and with right intentions (retirement, savings for college, vacations, home buying, etc.). However, it is very important to maintain discipline. Many people, if not most, deviate from these investment objectives and start to invest based on the so-called “hot tip.” Mutual funds should be treated as investments which you commit to based on researched information and not hot tip or quick hit gambling.

VARIETIES of ETFs

Source: Schwab and E*Trade.

19-*

LO 19-8

See Learning Objective 8: Explain the investment opportunities in mutual funds and exchange-traded funds (ETFs).

  • This slide lists three varieties of ETFs that are available.
  • ETFs have numerous benefits when compared to mutual funds. If time permits, have students prepare a list of and/or discuss the advantages of ETFs. (Transparent pricing, lower fees, and returns at least equal to the index that the ETF tracks, are just some of the advantages students might discuss.)
  • Traditional ETFs include: SPY which tracks the S&P 500 and TIP which tracks inflation protected government bonds.
  • Niche ETFs include: IXJ which tracks the S&P Global Healthcare Sector.
  • Exotic ETFs include: FXA which tracks the Australian Dollar and GLD which tracks the price of gold.

UNDERSTANDING
MUTUAL FUND QUOTATIONS

19-*

LO 19-8

See Learning Objective 8: Explain the investment opportunities in mutual funds and exchange-traded funds (ETFs).

The price per share for a mutual fund is referred to as the net asset value or NAV.

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COMPARING INVESTMENTS

19-*

LO 19-8

See Learning Objective 8: Explain the investment opportunities in mutual funds and exchange-traded funds (ETFs).

This slide is based on Figure 19.8.

*

TEST PREP

19-*

  • What is a stock split? Why do companies sometimes split their stock?
  • What does buying stock on margin mean?
  • What are mutual funds and ETFs?
  • What is the key benefit to investors in investing in a mutual fund or ETF?
  • When a company splits its stock 2 for 1 the shareholders receive two shares of stock for each share they own. The current share price is cut in half, so the number of shares increases, the total value of the investment remains the same. The board may decide to split a company’s stock 2 for 1, 3 for 2 or any other ratio they determine is appropriate. The reason that a company splits its stock is to reduce the price of the stock which will hopefully increase the demand for the stock.

  • When an investor buys on margin, they use money borrowed from their broker to purchase stock.

  • A mutual fund is an investment fund that buys stocks and bonds then sells shares in those securities to the public. The pooling of funds allows small investors to invest in a broader selection of stocks and bonds. Most mutual funds are professionally managed. ETFs are similar to mutual funds, but are traded on exchanges like individual stocks and are passively managed.

  • The key benefit to investing in a mutual fund or ETF is that the investor gets instant diversification.

The DOW

19-*

LO 19-9

See Learning Objective 9: Describe how indicators like the Dow Jones Industrial Average affect the market.

*

KEY STOCK MARKET
INDICATORS

19-*

LO 19-9

  • Dow Jones Industrial Average -- The average cost of 30 selected industrial stocks.
  • Critics say the 30-company Dow is too small a sample and suggest following the S&P 500.
  • S&P 500 tracks the performance of 400 industrial, 40 financial, 40 public utility, and 20 transportation stocks.

See Learning Objective 9: Describe how indicators like the Dow Jones Industrial Average affect the market.

  • The Dow Jones Industrial Average is the oldest index which was originally created in 1896 by Charles Dow and Edward Jones.
  • The original average had twelve companies, one of which, GE, is still in the Dow Jones Industrial average after all these years.

*

  • The stock market has its shares of ups and downs:

MARKET TURMOIL

19-*

LO 19-9

  • October 29, 1929 - Black Tuesday; the market lost 13% of its value.
  • October 19, 1987 - The market suffered its worst one-day drop when it lost 22% of its value.
  • October 27, 1997 - Fears of an economic crisis in Asia cause widespread panic and losses.

See Learning Objective 9: Describe how indicators like the Dow Jones Industrial Average affect the market.

*

TURMOIL in the 2000s

19-*

LO 19-9

  • The market collapsed into a deep decline in 2000-2002 when the dot-com bubble burst.
  • Investors lost $7 trillion in market value.
  • Starting in 2008, the collapse of the real estate market sent financial markets into panic.
  • The U.S. government made significant investments in private banks and offered a large stimulus package to re-energize the economy.

See Learning Objective 9: Describe how indicators like the Dow Jones Industrial Average affect the market.

*

The WALL STREET of NOW

Source: Bloomberg Businessweek, www.businessweek.com, accessed November 2014.

19-*

LO 19-9

See Learning Objective 9: Describe how indicators like the Dow Jones Industrial Average affect the market.

  • Since the economic crisis hit, Wall Street has taken many cuts.
  • This slide shows how Bloomberg Businessweek sees the new way for Manhattan bankers to unwind.

The UPS and DOWNS
of the MARKET

19-*

LO 19-9

  • Program Trading -- Giving instructions to computers to automatically sell if the price of a stock dips to a certain point to avoid potential losses.
  • Analysts believe program trading caused the turmoil in 1987.
  • The exchanges created mechanisms to restrict program trading.

See Learning Objective 9: Describe how indicators like the Dow Jones Industrial Average affect the market.

  • The downturn of 1987 prompted the U.S. exchanges to create mechanisms called curbs and circuit breakers to restrict program trading whenever the market moves up or down by a large number of points in a trading day. A key computer is turned off and program trading is halted.

  • If you watch programming on CNBC or MSNBC, you’ll see the phrase “curbs in” appear on the screen.

*

WHO’S at FAULT for the
ECONOMIC CRISIS?

Source: Fortune Magazine, www.fortune.com, accessed November 2014.

19-*

LO 19-9

  • Wall Street - Issued exotic securities; paid excessive compensation based on bonuses; and investment banks got the SEC to relax capital requirements.
  • Main Street - Americans lived beyond their means; lenders gave favorable loans to homebuilders; greedy homeowners took out equity loans; and teaser mortgage rates let people live large.
  • Washington - Gramm-Leach-Billey Act allowed commercial and investment banks to partner; housing interest rates were kept low; and Community Reinvestment Act forced lending to people with bad credit.

See Learning Objective 9: Describe how indicators like the Dow Jones Industrial Average affect the market.

  • This slide reviews some of the players in the economic crisis.
  • Like all complex problems, this crisis was not caused by one group.
  • You could actually include another culprit (not listed on this slide): worldwide saving surplus. Gulf States, China, Japan and Brazil all reinvested export earnings in US dominated assets, primarily government bonds. This had the effect of keeping interest low, thus allowing consumers and the United States Government (as well as many state and local governments) to spend beyond their means, racking up massive consumer and federal debt.
  • To discuss the crisis ask students: Who’s at fault for the economic crisis? (When discussing this highly charged topic it is important to make sure students understand that the fault lies not just with Wall Street and Washington, but with consumers including themselves.)

CLEANING UP the STREET

19-*

LO 19-9

See Learning Objective 9: Describe how indicators like the Dow Jones Industrial Average affect the market.

  • Dodd-Frank represents the most sweeping change in financial regulation since the Great Depression.
  • Although it’s not perfect, the Dodd-Frank Act at least resolves some of the most pressing issues facing our economy today, while setting the stage for a stronger financial future.

*

TEST PREP

19-*

  • What does the Dow Jones Industrial Average measure? Why is it important?
  • Why do the 30 companies comprising the Dow change periodically?
  • Explain program trading and the problems it can create.
  • The Dow Jones Industrial Average is the average price of 30 specific industrial stocks. It is important because it allows followers of the market to track the general direction of the stock market.

  • The Dow will delete and add new companies to the Dow Jones Industrial Average to reflect increased economic importance of a particular company or industry. Recently, Cisco and Travelers replaced Citi and GM.

  • Program trading occurs when investors give instructions to their computers to execute a sell order if the stock price dips to a certain point. Many attribute the stock market crash of 1987 to program trading as computer sell orders caused many stocks to fall to incredible levels.