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PAGE ONE Economics

®

Financing Businesses and Public
Projects with Stocks and Bonds
Barbara Flowers, Coordinator, Economic Education

GLOSSARY
Bond: A certificate of indebtedness issued by a
government or corporation.
Commercial bank: A business that accepts
deposits and makes loans.
Dow Jones Industrial Average: An index consisting of stock prices of 30 companies in various
industries reflecting U.S. economic activity.
Gross domestic product (GDP): The total market
value, expressed in dollars, of all final goods and
services produced in an economy in a given
year.
Initial public offering (IPO): A company’s first sale
of stock to the public.
Investment banker: Someone who works with a
business to determine how much money
should be raised to accomplish the goals of
the business and the price and number of
shares that should be sold to reach those
financial goals.
Investors: People or institutions who provide
money or other assets to a company in return
for possible financial gain in the future.
Mutual fund: A company that pools investors’
money and then issues shares to its investors.
NASDAQ: The National Association of Securities
Dealers Automated Quotations system—a stock
exchange where trades are made electronically.

“Brexit turmoil deepens: Dow down nearly 900 points in 2 days.”
—CNN Money, June 27, 20161
“Dow gets post-’Brexit’ bounce, gains 270”
—USA Today, June 28, 20162

No doubt you have heard “the Dow” mentioned in the news. But do you
know what it means? It’s the Dow Jones Industrial Average (the Dow),
an index consisting of the stock prices of 30 large companies in various
industries reflecting U.S. economic activity. When newscasters refer to
the Dow, they quote a figure reflecting the approximate combined
stock prices of the companies. The companies represent producers of
industrial and consumer goods, entertainment, financial services, and
information technology, so the Dow is designed to represent U.S. eco­
nomic activity and is considered representative of the stock market in
general.3 More than a few people might experience euphoria over gains
in the Dow, just as more than a few might experience depression over
losses. Why? Because people rely on the money they may gain from stocks
in the Dow, as well as the tens of thousands of other stocks sold across
the world, to fund their homes, educations, and retirements.

Secondary market: The market in which investors
buy and sell securities among each other.

When people buy stock, they are buying a share of ownership in a com­
pany. Businesses can also issue bonds to raise money; investors can also
buy bonds to save money. A bond is a certificate of indebtedness issued
by a government or corporation—an IOU. Although stocks and bonds can
gain or lose value, people consider them important methods of saving
money to use in the future. Let’s look at the important role of stocks and
bonds in growing businesses and funding important public projects.

Special purpose districts: Government entities
existing to support a special function, such as
fire protection, libraries, or mass transit.

Stocks

Primary market: The market in which new stocks
and bonds, in the form of initial public offerings
(IPOs), are issued.
Retained earnings: A portion of a company’s profit
used as savings, to pay off debt, or to reinvest
in the company.
Revenue: Money received; income.

Stock: A share of ownership in a company. Stocks
are often traded publicly.
Stock exchange: A market in which stocks are
bought and sold.

October 2016	

Entrepreneurs are individuals who are willing to take risks in order to
develop new products and start new businesses. They recognize opportu­
nities, enjoy working for themselves, and accept challenges. But how do
entrepreneurs raise money for their businesses? New businesses usually
must rely on the entrepreneur’s own money or money the entrepreneur
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PAGE ONE Economics®
can raise from friends, family, or private equity investors.
Investors are people or institutions who provide money
or other assets to a company in return for possible finan­
cial gain in the future. If and when the business becomes
sufficiently successful, it may be difficult to achieve greater
production without more money than it can raise simply
by saving or going back to the original investors. If this
is the case, the business may seek to issue an initial public
offering (IPO). As the name implies, an IPO is a company’s
first sale of stock to the public.

Raising Money for Business Expansion
When a business needs money to grow, it has several
options.

•

It can save money from its revenue—the money it
receives or income it earns. This is called retained
earnings—a portion of a company’s profit used as
savings, to pay off debt, or to invest in the company.

•

It can borrow money from a bank, which can be diffi­
cult if a new business does not have a long enough
history to prove to a bank that it can be successful
and is reliable.

•

It can find private investors. Those who invest get
partial ownership of the company. Many companies
start this way. Some continue to operate this way
indefinitely. However, this option can be difficult. The
entrepreneur must have some very wealthy friends
and family members or the attention of private equity
investors to make this work.

•

It can find public investors. This means allowing
strangers to own part of the business by buying stock,
but it also allows the business to raise a lot of money
quickly.

•

It can issue a bond, which involves asking an individual
or institution to lend the business money.

All of these avenues for financing are available to busi­
nesses, but let’s focus on finding public investors by
selling stock, which takes place in the primary market.

Primary Market
The primary market is the market in which new stocks
and bonds are issued. The primary market consists of
businesses and their initial investors. This is where new
stocks are born. Although businesses have other options,

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their initial investors are usually acquired through an
IPO issued by an investment banker. An investment
banker is someone who works with a business to deter­
mine how much money should be raised to accomplish
the goals of the business and the price and number of
shares that should be sold to reach those goals. The
investment banker also assesses a business’s potential
for growth and profit, as well as its risks.
The investment banker works for an investment bank
that will purchase the IPO shares or advise other inves­
tors to purchase shares of the new stock, including large
institutional investors such as mutual funds or commer­
cial banks.4 A mutual fund is a company that pools
investors’ money and then issues shares to its investors.
Commercial banks are businesses that accept deposits
and make loans. The buyers of the stock provide the
business with the money it needs to grow. So compa­
nies raise money by issuing an IPO with the assistance
of an investment banker. If the company wants to raise
money in the future, it can talk with an investment banker
about issuing a secondary public offering. Companies
aren’t limited to a single public offering.

Secondary Market
The secondary market is the market in which investors
buy and sell securities with other buyers and sellers. The
secondary market connects people who want to buy stock
in a business with those who have stock to sell. The
National Association of Securities Dealers Automated
Quotations (NASDAQ) and the New York Stock Exchange
(NYSE) are examples of U.S. stock exchanges—markets
in which stocks are bought and sold. The NASDAQ and
NYSE are part of the broader stock market. Many people
think that when they buy stock, say through the NASDAQ
stock exchange, the business that issued the stock gets the
money. This is not the case. The company gets the money
from the stock sold through the IPO in the primary market.
After the IPO, owners of the stocks can sell it at the mar­
ket price on the stock exchange on which it is traded—
in this case, the NASDAQ. The purchaser of the stock
pays for the stock, and the seller of the stock—not the
business—receives the money. (See the boxed insert
“An IPO Example.”)
Companies often buy and sell their own stock in the sec­
ondary market. They might buy their stock to decrease

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An IPO Example
You’ve probably heard of Groupon. Groupon issued an IPO in
2011 through three investment banks, Morgan Stanley, Goldman
Sachs, and Credit Suisse.1 Institutional investors bought shares
of Groupon stock through the IPO, and the money from the sale
of the stock was used to fund Groupon’s business activities. The
stock then traded on the NASDAQ stock exchange. When the
institutions that bought the stock through the IPO decided to sell
the stock, they sold it to buyers through the NASDAQ. When the
institutions sold the stock, they—not Groupon—got the money.
Groupon received only the proceeds from the IPO.
1 De La Merced, Michael. “Three Banks Grab Groupon I.P.O.” DealBook,
New York Times, June 2, 2011; http://dealbook.nytimes.com/2011/06/02/
three-banks-grab-groupon-i-p-o/?_r=0.

3

The Bond Report Card
We all understand the meaning of grades, right? An “A” on
your algebra exam is better than a “B,” which is better than a
“C.” Bonds are graded similarly. Credit rating agencies, such as
Moody’s Investors Services and the Standard & Poor’s, assign
grades to bonds issued by corporations. Different agencies use
different grading structures, but generally the grades are much
like a report card: An A grade indicates a high-quality bond
issued by a company with a high capacity to repay the bond.
However, where you might simply get an A grade, or even an
A+, the highest grade for a bond is AAA. Wouldn’t your parents
like to see that on your report card! Another difference is that
while a C might indicate an average grade on a report card,
investors must beware of buying a bond with a C grade. Such
bonds are very susceptible to default.
SOURCE: Investopedia; http://www.investopedia.com/terms/a/aaa.asp.

the number of shares that are available in the market.
Such a purchase will often have the effect of increasing
the price per share. So why would a company care about
its price per share if it doesn’t get the money when its
stock is sold? Actually, there are at least three very good
reasons. First, a higher stock price is good for the com­
pany’s employees who may own the company stock. Sec­
ond, the company is seen as having a higher value (one
measure of value is the price of its stock multiplied by the
number of shares in the hands of the public). So, if the
company would want to issue more stock through the
primary market in a secondary public offering, the price
it could ask would be higher. A higher value also would
help if the company were to seek a loan from a bank.

Bonds
A bond is another tool businesses can use to raise money
and investors can use to save money. A bond is a certifi­
cate of indebtedness issued by a government or corpo­
ration—an IOU. When a business wants to raise money
for expansion, it can issue a bond, which is simply asking
an individual or institution to lend the business money.
The business will use the money for expansion, and the
terms of the bond will explain how and when the bond­
holder will be repaid.

Using Bonds for Public Projects
Bonds are also a common way to fund projects for public
use, such as libraries, stadiums, or bridges. Let’s say that
a city wants to install a top-of-the-line recreational center
with a pool, tennis courts, and a fitness center for its

residents. The city could fund the center using money it
has saved; it could increase taxes and wait to build it; or
the city might choose to issue a bond. The city would
receive the money needed to build the recreational center
and repay the money to the bondholders, with interest,
over a specified period of time. (See the boxed insert
“The Bond Report Card” to learn about bond ratings.)
Many municipalities and special purpose districts issue
bonds. Special purpose districts are government entities
existing to support a special function, such as fire protec­
tion, libraries, or mass transit. Generally, bonds are issued
for a specific reason. A school district may issue a bond
to build a new school building; a fire district may issue
one to buy new equipment. After the bond is issued by
the municipality or district in the primary market, it is
traded in a bond market, which works much like the stock
market described earlier. The entity issuing the bond (the
issuer) gets the money for the project from the bond issue.
After the issuer gets the money, the bonds may be traded
among people and institutions in the secondary bond
market, and the issuer gets no additional money. The
bonds are simply traded among individuals and institu­
tions: The bond buyer pays for the bond and then owns
the bond, and the bond seller gets the money in exchange
for the bond.

The Economy
Businesses, public projects, and investors can all benefit
from stocks and bonds. But, there’s more! All of this

PAGE ONE Economics®
activity benefits the economy as a whole. IPOs help
businesses get the financial capital they need to increase
production. The increase in production increases U.S.
gross domestic product (GDP), which is the total mar­
ket value of all final goods and services produced in the
economy. As an added bonus, as businesses grow, they
hire more employees.

Conclusion
Financial capital—money used to fund businesses and
some public projects—is made available by issuing stocks
and bonds. Stocks are issued in the primary market, and
the money raised by a company’s stock issue is used pri­
marily to fund the expansion of the business, while often
providing repayment to the initial company investors.
After all the stock is issued, any further sale of the stock
takes place in the secondary market, which consists of
stock exchanges. When someone sells a share of stock,
the seller—not the company that originally issued the
stock—gets the money for the sale. The bond market
works similarly. Bonds are IOUs: When someone buys a
company’s bond, he or she is lending the company
money. The bond provides the details of how and when
the company will repay the money. The same is true with
bonds issued by cities or special purpose districts. If at
some point after buying the bond, but before the agreed-­
upon time for repayment, the bondholder wants to sell
the bond, he or she can sell it in the secondary bond
market. The seller gets the money for the sale.

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Stocks and bonds are efficient ways to help businesses
grow, and bonds are an efficient way for cities to fund
important public projects. For businesses, alternative
ways to raise money for growth, such as saving and
reinvesting its profits, can take a very long time. For cities,
asking for a tax increase to build a recreational center
or fund other projects might be unpopular. People can
voluntarily participate in the growth of the business or
the development of the project by purchasing stocks or
bonds. However, in the case of bonds for a public project,
the taxpayers are ultimately responsible for repaying
the bond. We’ll save that discussion for a later issue of
Page One Economics®: Focus on Finance. n

Notes
1 Yan, Sophia; Riley, Charles and Egan, Matt. “Brexit Turmoil Deepens: Dow Down
Nearly 900 Points in 2 Days.” CNN Money, June 27, 2016;
http://money.cnn.com/2016/06/26/investing/markets-brexit-reaction-monday/.
2 Shell, Adam and Hjelmgaard, Kim. “Dow Gets Post-‘Brexit’ Bounce, Gains 270.”
USA Today, June 28, 2016; http://www.usatoday.com/story/money/markets/2016/06/28/british-stocks-claw-back-brexit-losses/86458584/.
3 “Dow Jones INDU Average Index.” CNN Money;
http://money.cnn.com/data/dow30/.
4 “IPO Basics: Getting In on an IPO.” Investopedia;
http://www.investopedia.com/university/ipo/ipo1.asp.

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© 2016, Federal Reserve Bank of St. Louis. Views expressed do not necessarily reflect official positions of the Federal Reserve System.

PAGE ONE Economics®

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Name___________________________________ Period_______
Federal Reserve Bank of St. Louis Page One Economics ®:

“Financing Businesses and Public Projects with Stocks and Bonds”
After reading the article, answer the following questions:
1.	 What is the Dow Jones Industrial Average (the Dow) considered to represent?

2.	 What signal does the Dow index provide stock market watchers?

3.	 How do stocks and bonds serve the U.S. economy?

4.	 A business has several ways to grow without an IPO. List the ways to grow below.
	___________________________________________
	___________________________________________
	___________________________________________
	___________________________________________
	___________________________________________

PAGE ONE Economics®

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Primary Market or Secondary Market?
Indicate where the following transactions would take place. Circle the correct market.
5.	 ID Protectors, Inc. wants to expand into other cities but will need a large amount of cash. Management is working 		
	 with an investment banker to issue stock.
	

Primary market		

Secondary market

6.	 Fire Recovery Systems recently issued an IPO. Its stock is trading on the NASDAQ.
	

Primary market		

Secondary market

7.	 The City of Juniper is planning a new library. It will ask its voters to pass a bond issue. If successful, the city will 		
	 issue new bonds.
	

Primary market		

Secondary market

8.	 Mr. Peale just purchased 100 shares of Simon Manufacturing through a stock exchange.
	

Primary market		

Secondary market

9.	 DevelAPPers, Inc. wants to double its staff by hiring 100 app developers. It is working with an investment banker 		
	 to issue bonds.
	

Primary market		

Secondary market

10.	 Anthony Smith wants to sell his AJACKS Corp. bond.
	

Primary market		

Secondary market


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