Stocks and bonds are the primary instruments for financing large corporations in the United States. In contrast to many European companies which depend primarily on bank loans for capital, American corporations rely heavily on public issuance of debt (bonds) and equity (stocks).
Bonds are IOUs of a company or government body. They typically pay a fixed (sometimes floating) rate of interest for a stated period of time. They may be backed by specific revenues or the credit quality of the entity. At maturity, the initial investment, or principal, is due to the investor. Stocks, on the other hand, represent a share of ownership in a company. Stockholders are entitled to a portion of any distributions and proceeds from a liquidation. Bonds are generally safer than stocks because interest on bonds must be paid before stockholders may receive any distributions. If a firm goes bankrupt, bondholders are paid before stockholders.
With added risk goes reward and thus stockholders stand to benefit more from success of the issuing company. A successful bond investment will provide little more than the stated interest and return of principal, while a stock investment’s return is only limited by the growth prospects of the company. Historically stocks have produced after-inflation returns of 7.2 percent, while bonds have earned just 3.7 percent (Henwood 1997:326).
Although stocks and bonds initially serve to finance an enterprise, there is an active secondary market for these financial instruments. The NYSE (New York Stock Exchange) and NASDAQ (National Association of Securities Dealers Automated Quotation) dominate the market for stock trading, while a network of institutional dealers dominate bond-market trading. The NYSE is an example of an organized exchange. In this environment, orders are transmitted to a central floor where brokers negotiate prices for their customers using an auction process. The NYSE dominates trading in the largest American companies. However, its conservative nature caused it to miss much of the explosive growth of computerized trading. The NASDAQ market is an example of an over-the-counter (OTC) trading environment. Here, brokers still represent customers, but trades are negotiated by phone or computer. The NASDAQ market includes technology firms such as Intel and Microsoft, as well as thousands of smaller firms that do not meet NYSE requirements.
The concept of “making a market” also defines exchanges. On the NYSE, “specialists” are charged with keeping an orderly market by providing liquidity, but most activity is between two customers. In the over-the-counter market, “market makers” hold themselves out as willing to buy and sell a security at almost any time. Thus, transactions take place between a customer and a market maker. The latter earns a spread—the difference between the price at which he or she will sell and that at which he or she will buy. While there are numerous regional exchanges, the NYSE and NASDAQ dominate US trading.
In the US, bonds are traded over-the-counter. Trading is led by financial institutions specializing in government debt. The yield on the thirty-year US Treasury Bond or “Long Bond” is a benchmark upon which numerous other rates such as savings-account and loan rates are set. Annual trading volume exceeds $100 trillion per year (Henwood 1997:25), but is primarily the domain of institutions using the market to manage their interest-rate exposure.
Investments in stocks and bonds were traditionally dominated by large institutions which managed pension plans, endowments and foundations. An acclaimed book, Where Are the Customers’ Yachts? (Schwed 1940), highlighted the fact that individuals faced an uphill battle in achieving investment success. The investing industry has seen broad changes since 1980. Greater tax incentives for investing, the growth of deep-discount (“do-it-yourself”) stockbrokers and the advent of the 401k retirement savings plan spurred heightened interest in investing and fueled the great bull market of the 1980s and 1990s. By 1983, 19 percent of households owned stock and over one-third owned mutual funds. This explosive growth has come on the heels of a decades-long bull market, meaning most new investors have never weathered a downturn in financial fortunes.
The tremendous growth of mutual funds has contributed to the democratization of investment. A mutual fund is an investment company that pools money in order to invest in a diversified portfolio of securities. This arrangement allows for professional management, economies of scale and exposure to a wide variety of investments, reducing overall risk (diversification). From its infancy in the 1970s, US mutual-fund assets have mushroomed from less than $100 billion to $4.5 trillion in 1997. Mutual funds hold 19 percent of all US stocks and a similar percentage of US bonds. They have become the primary vehicle for individual investment through the growth of defined-contribution (401k) plans.
Further investment democratization is coming in the form of Internet access to trading markets and greater individual control over pension assets (perhaps negatively affecting mutual funds). Brokerage commissions have plummeted as fullservice stockbrokers are threatened by deepdiscount brokerages that offer limited investment advice, but rockbottom commissions. Do-it-yourselfers have embraced Internet trading as an inexpensive way to gain exposure to surging equity markets (some firms even offer commission-free trades).
At the same time, traditionally defined benefit pensions managed by corporations are being replaced with defined-contribution plans that put the investment decision-making in individuals’ hands. While these developments have meant increasing control by investors over their savings, experts are concerned with the individual’s ability to remain calm during extended market downturns, the likes of which investors haven’t seen since the early 1970s.
- Part of Speech: noun
- Industry/Domain: Culture
- Category: American culture
- Company: Routledge
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- Aaron J
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