Principles of Managerial Finance

CHAPTER 1 The Role and Environment of Managerial Finance 25

capital market
A market that enables suppliers
and demanders of long-term
fundsto make transactions.

bond
Long-term debt instrument used
by business and government to
raise large sums of money,
generally from a diverse group of
lenders.

preferred stock
A special form of ownership
having a fixed periodic dividend
that must be paid prior to
payment of any common stock
dividends.

securities exchanges
Organizations that provide the
marketplace in which firms can
raise funds through the sale of
new securities and purchasers
can resell securities.

organized securities exchanges
Tangible organizations that act
as secondary marketswhere
outstanding securities are
resold.

The Capital Market

The capital marketis a market that enables suppliers and demanders of long-term

fundsto make transactions. Included are securities issues of business and govern-

ment. The backbone of the capital market is formed by the various securities

exchangesthat provide a forum for bond and stock transactions.

Key Securities Traded: Bonds and Stocks

The key capital market securities are bonds (long-term debt) and both common

and preferred stock (equity, or ownership). Bondsare long-term debt instruments

used by business and government to raise large sums of money, generally from a

diverse group of lenders. Corporate bondstypically pay interest semiannually

(every 6 months) at a stated coupon interest rate.They have an initial maturityof

from 10 to 30 years, and a par,or face, valueof $l,000 that must be repaid at

maturity. Bonds are described in detail in Chapter 6.

EXAMPLE Lakeview Industries, a major microprocessor manufacturer, has issued a 9 per-

cent coupon interest rate, 20-year bond with a $1,000 par value that pays interest

semiannually. Investors who buy this bond receive the contractual right to $90

annual interest (9% coupon interest rate$1,000 par value) distributed as $45

at the end of each 6 months (1/2$90) for 20 years, plus the $1,000 par value at

the end of year 20.

As noted earlier, shares of common stockare units of ownership, or equity,

in a corporation. Common stockholders earn a return by receiving dividends—

periodic distributions of earnings—or by realizing increases in share price. Pre-

ferred stockis a special form of ownership that has features of both a bond and

common stock. Preferred stockholders are promised a fixed periodic dividend

that must be paid prior to payment of any dividends to common stockholders. In

other words, preferred stock has “preference” over common stock. Preferred and

common stock are described in detail in Chapter 7.

Major Securities Exchanges

Securities exchangesprovide the marketplace in which firms can raise funds

through the sale of new securities and purchasers of securities can easily resell

them when necessary. Many people call securities exchanges “stock markets,”

but this label is misleading because bonds, common stock, preferred stock, and a

variety of other investment vehicles are all traded on these exchanges. The two

key types of securities exchanges are the organized exchange and the over-the-

counter exchange. In addition, important markets exist outside the United

States.

Organized Securities Exchanges Organized securities exchangesare tangi-

ble organizations that act as secondary marketswhere outstanding securities are

resold. Organized exchanges account for about 46 percent of the total dollar vol-

umeof domestic shares traded. The best-known organized exchanges are the

New York Stock Exchange (NYSE) and the American Stock Exchange (AMEX),