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Text 15: When Business Borrows

Business loans are generally classified as either short-termor long-term loans.For short-term loans, the principal(the amount borrowed) must be repaid within one year. Long-term loans mature (come due) in more than a year. Creditors, people who make loans, expect to receive interest, payments for the use of their money, and the return of the principal (the amount loaned) at the end of a specific period of time. Interest is expressed as a percentage of the principal.

Short-term Financing.Short-term loans are used to finance the everyday costs of doing business, such as payrolls, raw materials and merchandise. Long-term loans are more likely to be used to purchase equipment, buildings and other high-cost items. The most common types of short-term financing are trade credit, loans from financial institutions, and loans from investors.

Trade creditis like a department store charge account. Customers charge purchases to their accounts for payment at a later date. In the case of trade credit, the customers are busi­nesses whose suppliers allow them to charge purchases for payment at a later date.

Loans from financial institutions,such as banks and finance companies, are another source of short-term credit.

Finally, some of the nation's largest businesses can look to loans from investorsto meet their short-term financial needs. If, for example, General Motors needed $10 million to finance a payroll, it could raise the money by selling commercial paper—a kind of IOU issued by a corporation, promising to repay a sum of money at a specified rate of interest. Investors wishing to earn interest on their surplus funds can buy these IOU's from brokers specializing in such investments.

Long-term Financing.Long-term financing is money that will be used for a year or more. Building a factory, purchasing equipment, launching a major research effort are the kinds of projects that require long-term financing.

Why would anyone lend money to a business for a year or more? The reason is that revenues from these kinds of projects (like a new factory) continue to flow for a long period of time. This makes it possible for borrowers to repay their loans as promised.

The most common sources of long-term financing are retained earnings, long-term loans, and the sale of stock.


Text 16: Buying And Selling Stocks And Bonds

Stocks as a Source of Funds.Large corporations often raise funds through the sale of their stocks to the general public.

Unlike bondholders who are creditors of the corporation, stock­holders are its owners. This entitles them to a voice in the selection of the board of directors and a share of the potential profits, when and if the directors elect to distribute them.

Common and Preferred Stock.All corporations issue common stock; some, however, also issue preferred stock.

Common stockentitles the holder to a voice in the manage­ment of a corporation and a share of the profits. Unlike common stockholders, preferred stockholders usually do not have voting rights. However, preferred stockreceives preferential treatment over common stock in two ways: 1) it receives a specified dividend before any dividends are paid on the common stock, and 2) it receives a share of the assets ahead of the common stockholders if the corporation should be liquidated.

Protecting the Investing Public. The Securities and Exchange Commission (SEC),an agency of the federal government, is responsible for protecting investors in the sale of securities. It operates on the principle of caveat emptor,a Latin phrase meaning "let the buyer beware." In applying this principle, the SEC requires corporations to provide the public with essen­tial information about their operations and finances. Having done that, they let investors determine the risks for themselves.

Similar to the annual report distributed to stock­holders, a prospectus is prepared for any new issue of securities.

Securities Exchanges and the Over-the-Counter Market.A securities exchangeis a market where brokers meet to buy and sell stocks and bonds for their customers. Securities exchanges list the securities of approximately 3,000 of the nation's largest publicly owned corporations.

Largest of the securities exchanges are the New York Stock Exchange and the American Stock Exchange. The New York Stock Exchange handles about 80 percent of all securities trans­actions, whereas the American Stock Exchange handles 10 percent. The remaining transactions are made at a number of regional exchanges located around the nation.

If you wanted to buy or sell corporate securities, you would probably call upon the services of a local brokerage firm. An account executive (salesperson licensed to sell securities) would take your order and transmit it to the company's representa­tive on the floor of the exchange. The exchange works like an auction. Brokers representing buyers and sellers bid against one another for the best possible price.


Text 17

The over-the-counter marketconsists of brokerage firms around the nation that buy securities of the smaller, "unlisted" firms and sell them to the public. There are more than 40,000 corporations whose securities are traded "over the counter."

Investing and Speculating.Those who buy stocks to share in the profits and growth of a corporation over a long period of time are described as "investors." Those who buy or sell stocks as a way to earn a fast profit are known as "speculators."

Investing in Corporate Stocks.Investors share in a corpora­tion's profits by receiving periodic dividends. In addition, if the corporation prospers over the years, its stock will increase in value. Investors will be able to sell the stock for more than they paid for it, thereby earning a capital gainor "profit" from the sale.

Speculating in Corporate Stocks.Stock market speculators fall into two groups. One group, commonly known as bulls,hopes to profit by correctly predicting an increase in the value of a stock. The other group, bears,hopes to profit by correctly predicting a decrease in the value of a stock.

Bulls are said to "buy long." That is, they buy stocks intending to hold them until they can be sold at a higher price.

Buying and Selling Corporate Bonds.When a corporation sells its bonds to the public, it makes two important promises: to pay the bondholder a fixed rate of interest for a specific number of years and to repay the face value of the bond when it comes due.

The sale of bonds is handled in the same way as the sale of stocks. Corporations in need of capital sell their bonds to under­writers for a fixed sum. The underwriter then sells the issue to the public. Once the bonds are in the hands of the public, future sales are handled by the stock exchanges and the over-the-counter market. As with stocks, the market value of bonds depends upon supply-and-demand conditions at the time. Individuals thinking of investing in corporate bonds should compare the safety and yield of those securities with those offered by thrift institutions. There is some risk of default(failure to pay interest or principal) on the bonds of even the strongest corporations, whereas most thrift institution accounts are insured by the government.


Text 18: Henry Ford (1863-1947)

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