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Chapter 19 - Using Securities Markets for Financing and Investing Opportunities
19-88
Trading in commodities, however, can also be used as a means of protecting businesspeople,
farmers, and others from wide fluctuations in commodity prices and thus for them can be a very conserva-
tive investment strategy. A commodity exchange specializes in the buying and selling of precious metals
and minerals (e.g., silver, foreign currencies, gasoline) and agricultural goods (e.g., wheat, cattle, sugar).
The Chicago Board of Trade (CBOT), with its 60,000-square-foot trading floor, is the largest commodity
exchange in terms of floor size. The CBOT is involved with a wide range of commodities, including corn,
plywood, silver, gold, and U.S. Treasury bonds.
Commodity exchanges operate much like stock exchanges: Members of the exchange meet on the
exchange’s floor to transact deals. Yet a commodities exchange looks quite different from a stock ex-
change, and is interesting to observe. Transactions for a specific commodity take place in a specific trad-
ing area, or “pit,” that can only be described as an exciting spectacle. Trades result from the meeting of a
bid and offer in an open competition among exchange members. The bids and offers are made in a seem-
ingly impossible-to-understand blend of voices, with all participants shouting at once. Today, however,
the old color and excitement of the pits are becoming somewhat obsolete. More and more traders and
brokers are working electronically at computer screens where millions of contracts are zipping around on
global computer networks. In fact, the CBOT has relinquished its long-standing title as the largest trading
futures exchange in the world to the Eurex exchange, based in Frankfurt, Germany.
Many companies use commodities markets to their advantage by dealing in the futures market.
Futures markets involve the purchase and sale of goods for delivery sometime in the future. Take, for ex-
ample, a farmer who has corn growing in the field. The farmer is not sure what price the corn will sell for
at harvest time. To be sure of a price, the farmer could sell the corn on the commodity floor for delivery
in the future at a fixed price. Since the price is now fixed, the farmer can plan the farm’s budget and ex-
penses accordingly. In contrast, as the owner of Very Vegetarian, you may be worried about the possibil-
ity that corn prices will rise. If you buy the corn in the futures market, you know what you will have to
pay and, like the farmer, can also plan accordingly. All of this is possible because of commodity exchang-
es.
Chapter 19 - Using Securities Markets for Financing and Investing Opportunities
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critical
thinking exercises
Name: ___________________________
Date: ___________________________
critical thinking exercise 19-1
FINANCING GROWTH
You’ve owned a tool and die company for the last five years. Even during the recession, you have
been earning a net profit of 30% on your investment and have been able to pay yourself a reasonable sala-
ry. You are feeling so confident that you are considering expanding. You believe that your profit potential
can improve greatly if you could expand your product line with newer high-tech equipment. You estimate
that you will need $1 million for the expansion.
1. What are your financing alternatives?
2. Would you consider selling bonds if you had to pay 12% interest?
3. What are the major advantages of using issuing bonds?
4. What are the major disadvantages of using issuing bonds?
Chapter 19 - Using Securities Markets for Financing and Investing Opportunities
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notes on critical thinking exercise 19-1
1. What are your financing alternatives?
2. Would you consider selling bonds if you had to pay 12% interest?
Probably not. You have been realizing a return higher than that, but 12% is simply too much to
3. What are the major advantages of using issuing bonds?
4. What are the major disadvantages of using issuing bonds?
Chapter 19 - Using Securities Markets for Financing and Investing Opportunities
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Name: ___________________________
Date: ___________________________
critical thinking exercise 19-2
PLAYING THE STOCK MARKET
Suppose you are a stockbroker, who has just sold a new client 500 shares of a stock your broker-
age recommends. The very next day after the sale, the price of the stock drops $3. The client calls you as
soon as he’s looked in The Wall Street Journal. He’s obviously upset that he “lost” $1,500 in only one
day. Although you assure him that your researchers rate the stock highly and that the stock market as a
whole had a low day yesterday, the client still threatens to sell his shares and take his business elsewhere.
1. Why would a good stock drop $3 in one day?
2. What do you tell your client if the market drops again tomorrow and his stock drops with it?
3. Are some people emotionally unsuited to handle the stresses of the ups and downs of the stock
market? Should such people stay out of the stock market? If so, what are their investment alterna-
tives?
Chapter 19 - Using Securities Markets for Financing and Investing Opportunities
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notes on critical thinking exercise 19-2
1. Why would a good stock fall $3 in one day?
The price of a stock depends on the supply and demand for that stock. It can easily fall $3 if a
2. What do you tell your client if the market drops again tomorrow and his stock drops with it?
If you want to minimize your losses in a stock, put in a stop loss order when you buy it. This
means that the stock is sold automatically if it falls a certain amount. This gets you out before the stock
3. Are some people emotionally unsuited to handle the stresses of the ups and downs of the stock
market? Should such people stay out of the stock market? If so, what are their investment alterna-
tives?
Yes, some are. They are better off investing in money market funds or putting their money in a
Chapter 19 - Using Securities Markets for Financing and Investing Opportunities
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Name: ___________________________
Date: ___________________________
critical thinking exercise 19-3
DOW JONES COMPONENTS
Go to the Dow Jones Indexes website (www.djindexes.com). (Sometimes the address for a loca-
tion changes. You might need to search to find the exact location mentioned.) Using the information
about the Dow Jones Industrial Average given on the site, answer the following questions:
1. What is the Dow Jones Industrial Average Index value at the end of yesterday’s trading?
2. What is the percentage change in the index in the year to date?
3. The website contains information about the composition of the DJIA index. Use this information
to answer the following questions:
a. In what year was the DJIA index expanded to twelve stocks?
b. In what year was General Motors added to the index?
c. In what year was Microsoft added to the index?
4. Choose one of the stocks included in the DJIA today and trace its history.
Chapter 19 - Using Securities Markets for Financing and Investing Opportunities
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critical thinking exercise 19-3 (continued)
5. The website includes a chart showing what happened to the Dow Jones Industrial Average after
major world events.
a. After the Oklahoma City bombing in 1995, what was the one-day effect on the Dow Jones In-
dustrial Average? What was the effect one year later?
b. After the September 11, 2001, terrorist attacks, what was the one-day effect on the Dow Jones
Industrial Average? What was the effect one year later?
c. After Hurricane Katrina hit the Gulf Coast in August 2005, what was the one-day effect on the
Dow Jones Industrial Average? What was the effect one year later?
Chapter 19 - Using Securities Markets for Financing and Investing Opportunities
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bonus
cases
bonus case 19-1
INVESTING AN INHERITANCE
Jason Heimberg’s grandmother died and left him $30,000. Jason needed $5,000 of the inher-
itance to finish his last year at County Community College. He had $25,000 left to invest. Jason investi-
gated several stocks that he felt were likely to grow rapidly. Most were high-tech stocks in industries such
as gene splicing and robotics. Jason’s stockbroker encouraged him to diversify his investments by buying
stock in two mutual funds. One was a fund that specializes in smaller-growth companies. Another special-
ized in bonds.
A broker Jason met at a party suggested that he really need not use a broker at all. Her suggestion
was to keep some funds in the bank for his use in an emergency. Other funds could be invested in several
different mutual funds that were managed by one firm. She called them no-load mutual funds and ex-
plained that they could be bought for no brokerage fee. She said the funds have an NL notation in the var-
ious mutual fund quotations, as found in The Wall Street Journal.
A financial adviser has suggested that Jason buy insurance first, even though he is not married.
The idea was to buy a policy that would invest money for Jason at what looked like a reasonable return.
Any excess funds would be placed in a bank (for emergencies) and in mutual funds that the adviser would
recommended.
discussion questions for bonus case 19-1
1. What are the criteria Jason should use in evaluating investment alternatives?
2. Look up no-load mutual funds in a newspaper or magazine that lists them. Do you understand
what is available? What are the advantages and disadvantages of buying a mutual fund through a
broker?
3. What questions does this case raise that you need to have answered before you can invest your
funds more intelligently? Where could you find answers to such questions?
Chapter 19 - Using Securities Markets for Financing and Investing Opportunities
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notes on discussion questions for bonus case 19-1
1. What are the criteria Jason should use in evaluating investment alternatives?
The investment criteria mentioned in the text include risk, yield, duration, liquidity, and tax con-
sequences. Another important consideration is diversification. By putting some money into the bank and
2. Look up no-load mutual funds in a newspaper or magazine that lists them. Do you understand
what is available? What are the advantages and disadvantages of buying a mutual fund through a
broker?
No-load mutual funds offer a full range of types, from growth funds to international funds and
3. What questions does this case raise that you need to have answered before you can invest your
funds more intelligently? Where could you find answers to such questions?
A good broker can answer most of your investment questions. It is also a good idea to read Mon-
Chapter 19 - Using Securities Markets for Financing and Investing Opportunities
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bonus case 19-2
THE NEXT GENERATION OF BUBBLES
For more than a decade the rapid inflation and subsequent bursting of several bubbles have de-
fined the American economy. From dot-coms to the subprime crisis, optimistic financial forecasts com-
bined with overeager investors worked to create moments of economic euphoria before the bottom even-
tually dropped out. In the case of the 2008 meltdown, the bursting of the American real estate bubble in-
curred consequences that reverberated around the globe. Three years later, some economists worry that
the world’s financial leaders have still not learned their lesson.
Analysts have outlined a number of areas where price increases don’t mirror economic funda-
mentals. For instance, the price of gold has risen 464% since 2001 thanks to the increasing prominence of
a trust that allows investors to speculate on the commodity. Some parts of the tech world also appear to be
inflating disproportionately. The movie streaming service Netflix saw its stock price skyrocket 304% over
2010 and 2011, 79 times larger than the earnings per share over the same time period. Economists worry
about social media companies most of all, however. After all, Facebook makes almost all of its money on
clickable ads, which some don’t think translates into a venture worth $65 billion.
Worried financial pundits point the blame at the Federal Reserve for fostering a bubble culture
due to their ultralow interest rates. While the Fed remains committed to keeping rates low while the econ-
omy bounces back, some see the flood of money as little more than fuel for the bubble fire. Even China
has requested an interest rate increase from the Fed in order to relieve its growing inflation problem. Oth-
ers have blamed the organization for inciting the recent jump in commodities costs that has led to price
increases on oil and food worldwide. The Fed cited “rising global demands and disruptions in global sup-
ply” in response. While the Fed may be correct on that point, it has still not addressed the alleged pres-
ence of new bubbles in the world economy. Only time will tell if its inaction will have global repercus-
sions or if the world’s outspoken economists are incorrectly convinced that the sky is falling.
discussion questions for bonus case 19-2
1. What key economic principles can we learn from “bubbles”?
2. Is it time for the Federal Reserve to increase interest rates?
Chapter 19 - Using Securities Markets for Financing and Investing Opportunities
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notes on discussion questions for bonus case 19-2
1. What key economic principles can we learn from “bubbles”?
From the tulip bubble, to the dot-com bubble, to the real estate bubble, it’s important to note that
2. Is it time for the Federal Reserve to increase interest rates?
Ask 100 economists this question and you’ll likely get a split verdict. Many support the Fed’s
Chapter 19 - Using Securities Markets for Financing and Investing Opportunities
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endnotes
