chapter 16 investment information and transactions lawrence j. gitman jeff madura introduction to...

Chapter

16

Investment Information and Transactions

Lawrence J. GitmanJeff Madura

Introduction to Finance

16-2Copyright © 2001 Addison-Wesley

Review background material on investing.

Describe the economic, industry, global, and market information sources used to make investment decisions.

Describe the firm-specific information services used to make investment decisions.

Identify the main United States and foreign securities exchanges in the United States that facilitate the investment process.

Describe the types of securities transactions requested by investors and explain how these transactions are accommodated by brokerage firms.

Learning Goals


Background on Investing

Individual Investors Long-term capital gains

Short-term capital gains

Day traders



Institutional Investors Employed by institutions

Invest on behalf of others

Also called portfolio managers

Types of institutional investors include mutual fund portfolio managers and pension fund portfolio managers.

16-5Copyright © 2001 Addison-Wesley Figure 16.1


Impact of Investment Decisions on Wealth

16-6Copyright © 2001 Addison-Wesley Table 16.1 (Panel 1)

General Information Used to Make Investment Decisions


Firm-Specific Information Used to Make Investment Decisions

Annual Report Income statement

Balance sheet

Statement of cash flows


Other Financial Reports Used to Make Investment Decisions

Other Financial Reports 8-K, 9-K, 10-K

Security prospectus

External publications


Firm-Specific Information Provided by Publications


Information Provided by Insider Trading


Information Provided by Insider Communication to Analysts


Information Signaled Through a Firm’s Financial Decisions

Dividend Policy

Earnings Surprises

Acquisitions

Secondary Stock Offerings

Stock Repurchases


Information Provided by Insider Communication to Analysts


Securities Exchanges

Securities exchanges facilitate the exchange of securities among investors.

The main organized exchanges are the New York Stock Exchange (NYSE) and American Stock Exchange (AMEX).

Both facilitate only secondary market transactions.

The over-the-counter (OTC) market is an intangible securities market that facilitates both primary and secondary market transactions.


Securities Exchanges

In 1998 the NASDAQ and AMEX merged and is expected to lead to an increase in the use of electronic orders.

United States investors can invest in foreign stocks by purchasing those listed on foreign stock exchanges.

United States investors can also invest in foreign stock by purchasing American depository receipts (ADRs) or through mutual funds which specialize in the purchase of foreign stocks.


Investor Transactions

Market and Limit Orders A market order is an order to buy or sell a stock

at the prevailing market price.

A limit order is an order to buy a stock at or below a specified price, or to sell a stock at or above a specified price.

Limit orders can be for the day, good until canceled, or open (in effect for 6 months).



Use of Technology Technology has increased the speed at which orders

are placed and executed.

There are now more than 5 million online brokerage accounts at services such as Ameritrade and E*Trade.

The typical trading commission on like is between $8 and $20 which is substantially less that what brokerage firms have traditionally charged.

The popularity of electronic orders and electronic execution of trades is continuing to grow.



Stop Orders Stop orders are orders to execute a transaction when

the stock reaches a specified level.

A buy stop order represents an order to buy a stock if the price reaches a specified level (above the prevailing price) to take advantage of subsequent expected increases in price.

A sell stop order, on the other hand, is an order to sell a stock if the price reaches a specified level (below the prevailing price) to prevent further losses when prices are falling.



Buying Stock on Margin Buying on margin means that investors use borrowed

funds to finance the purchase of securities.

Buying on margin allows investors to used financial leverage to magnify their gains (and losses).

Margin requirements are regulations imposed by the Federal Reserve on the proportion of invested funds that must be paid in cash.

The present margin requirement is that at least 50 percent of the invested funds must be in cash.



Buying Stock on Margin Margin requirements are intended to ensure

that investors can cover their position if the value of their investment declines over time.

If investors purchase a stock on margin and the value of the stock declines, investors may receive a margin call from their broker, requesting that they put additional funds (maintenance margin) in the margined account.



How Investing on Margin Affects Returns



How Investing on Margin Affects Returns Stan Adams determined that a new Internet stock

called Rocket.com is undervalued at its prevailing price of $10 per share. The stock is not expected to pay a dividend. Stan is trying to decide if he should purchase 100 shares with cash, or buy the 100 shares by borrowing half the funds needed. The loan would have a 10% annual interest rate. Stan plans to sell the stock in one year.



How Investing on Margin Affects Returns Stan wants to determine his expected return when

paying for his entire investment using (1) 100% of his own funds, (2) borrowing 30% ($300 out of $1000), and (3) borrowing 50% ($500).

Stan wants to estimate his return based on two possible outcomes: (1) the stock rises to $14 in one year, and (2) the stock declines to $6 in one year. The results are shown on the following slide.



How Investing on Margin Affects Returns



Short Sales A short sale is the sale of a stock by an investor

who does not own the stock.

Investors will typically “short a stock” when they believe the stock is overvalued and is likely to decline—hoping to sell high and buy low.

To short a stock, an investor must borrow a stock from another investor who owns it, and sell it in the market at the prevailing price.



Short Sales The investor has an obligation to later repurchase the

stock in the market so that it can be returned to the investor from whom it was borrowed.

An investor in a short sale will make a profit from the difference between the original sale price and the subsequent purchase price, less any dividends received.

If a stock price rises, the investor in a short sale will have to pay more to repurchase resulting in a loss.


Largest Short Positions

Chapter

16

End of Chapter

Lawrence J. GitmanJeff Madura

Introduction to Finance

chapter 16 investment information and transactions lawrence j. gitman jeff madura introduction to...

Documents