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Section 8 (Investing)
 

Section 8 (Investing)

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    Section 8 (Investing) Section 8 (Investing) Presentation Transcript

    • Personal & Family Finance Section 8 Investing 9-
      • Why would you want to invest your money?
      • What are some ways you can invest your money?
      9-
    • Goals and Investment Alternatives
      • Reasons for investing:
        • Enjoyment such as your home or antiques
        • Current income such as interest or dividends
        • Providing for future needs such as retirement
        • To reduce your current tax liability
      • Types of investments
        • Tangible assets: Assets you can touch such as a house
        • Intangible investments: Assets such as stocks and bonds that are paper assets
      9-
    • Tangible Investments
      • Advantages:
        • Can enjoy or use
        • May provide a good hedge against inflation
        • May have greater control over return
        • May offer significant tax advantages
      • Disadvantages:
        • Can involve work and inconveniences
        • Not liquid so not easily bought and sold
        • Usually have high carrying costs, such as insurance or taxes
      9-
    • Factors to Consider Before Investing
      • Do you want current or future return?
        • Investing versus speculating
      • What is your income tax situation?
      • What is your attitude towards risk?
        • Risk averse investors have a low tolerance for risk.
        • Risk seeking investors have a high tolerance for risk.
        • Investors need to understand their risk profile before investing.
        • If an investor wants a higher rate of return, they must accept higher risk to earn a higher rate of return.
      9-
    • Basic Investment Alternatives
      • Investments Held for Liquidity
      • Securities with Long or No Maturities
      • Pooling Arrangements
      • Contractual Claims
      • Tangible Assets
      9-
    • Investments Held for Liquidity
      • Bank accounts
        • Savings
        • Certificates of deposit
        • Money market deposit accounts
      • Money market mutual funds
      • Series EE and Series HH bonds
      9-
    • Securities with Long or No Maturities
      • Bonds and notes issued by:
        • The U.S. Treasury and other federal agencies
        • State and local governments
        • Corporations
      • Preferred stock issued by corporations
      • Common stock issued by corporations
      • Bonds and notes mature from one to thirty years
      • Stock never matures because it is ownership in a business
      9-
    • Pooling Arrangements
      • Mutual funds
        • Income funds
        • Growth funds
        • Balance funds
        • Index funds
      • Investment trusts
      • Limited partnerships
      9-
    • Contractual Claims
      • These are very high risk investments because their value is dependent upon the value of other assets
      • Some of these assets are:
        • Warrants and rights
        • Call and put options
        • Commodity futures
        • Financial futures
      9-
    • Tangible Assets
      • Real estate
        • Personal residence
        • Rental properties
      • Gold and other metals/minerals
      • Jewelry and collectibles
      9-
    • Organized Exchanges
      • A physical place where buyers and sellers meet to trade securities. Examples are the New York and American Stock Exchanges
      • New York Stock Exchange (NYSE):
        • It is the largest exchange in the world.
        • It is known as the “Big Board”.
      • American Stock Exchange (AMEX):
        • It is much smaller than the NYSE.
        • It is now affiliated with NASDAQ.
      9-
    • How the NYSE Works
      • Securities are traded at designated sites on the floor, which are called “posts”.
      • You must have a “seat” to trade on the floor.
      • Seat owners are commission brokers, floor brokers, floor traders, and specialists.
      • Specialists play a key role in maintaining an orderly market.
        • A specialist stands ready to take the opposite side of a trade. If an investor wants to buy a stock and there is not another investor who wants to sell, the specialist will sell.
      9-
    • The Over-the-Counter Market
      • Largest exchange, in terms of number of issues traded
      • Securities are traded through a communication system called National Association of Securities Dealers Automated Quotations System ( NASDAQ ).
      • Mostly small companies and high-tech companies are traded in this market.
        • High-tech companies: Intel, Microsoft, etc.
      9-
    • How SIPC Insurance Works
      • Suppose you own 100 shares of GM when your broker closes down. GM’s price on that day is $50 a share. Your account is worth $5,000 that day.
      • Two weeks later, your account is taken over by a new broker who confirms your ownership of 100 shares. GM’s price has fallen to $30 a share.
      • SIPC only guarantees delivery of the shares; but, you lose $2,000.
        • GM’s share price decline is unrelated to the failure of your broker.
      9-
    • The Sarbanes-Oxley Act of 2002
      • This law was passed in response to some of the financial scandals of 1990 such as the failure of Enron, WorldCom, etc.
      • The act institutes reforms to improve corporate responsibility and financial disclosures.
        • Stock analysts are also required to disclose potential conflicts of interest that might influence their stock ratings.
      • It also was created to combat corporate and accounting fraud.
        • It created the Public Company Accounting Oversight Board (PCAOB).
      9-
    • Other Regulation
      • States have what are called “Blue Sky” laws.
        • These are similar to federal laws.
        • The laws apply to intrastate Security Sales.
      • Self-regulation is also provided by the National Association of Securities Dealers (NASD) through:
        • Dealers Rules of Fair Practice
        • Code of Procedure
        • Uniform Practice Code
      • Binding arbitration is an important component of self-regulation.
      9-
    • Using the Services of a Stockbroker
      • Most financial investments are bought and sold with the help of a securities dealer (stockbroker).
      • Stockbrokers are distinguished in terms of the level of service provided as well as the fees.
      • Investors can choose among the following:
        • Full-service firms
        • Discount brokers
        • Internet trading
      9-
    • Selecting a Stockbroker
      • Full-service firms feature:
        • Research that identifies investment opportunities
        • Representatives to help with portfolio planning
        • Access to new stock offerings
        • Dedicated advisor who works directly with customer
        • High commissions
      9-
    • Selecting a Stockbroker (Con’t)
      • Discount brokers feature:
        • Possibly no personal contact; you trade over an 800 number or over the Internet
        • Therefore, discount brokers are most appropriate for customers who have some trading experience and are comfortable placing orders
        • Lower commissions-savings can be as high as 90% versus a full-service firm
      • Internet trading: both full-service and discount brokers offer this service due to its low cost.
      9-
    • Kinds of Accounts
      • Cash account is similar to a charge account except the purchase must be paid for within three working days.
        • The broker will hold the securities or you can ask to have them sent to you.
      • Margin accounts allow you to borrow money to purchase securities.
        • Currently, you can borrow 50% of the cost of securities.
        • You are only required to deposit 50% of the amount.
        • Since you are borrowing money, you are charged interest.
        • Borrowing money increases your risk!
      9-
    • How Margin Works
      • You must deposit funds equal to 50% of the value of the securities purchased. This is your initial margin requirement.
      • There is also a maintenance margin requirement (MMR) of 25%. Your equity in the account cannot be less than 25%.
        • If the stock prices fall, you may get a margin call from the broker. You will be required to deposit additional funds.
      9-
    • Margin Example
      • You buy 100 shares of GM stock @ $50 per share
        • Total purchase = $5,000
        • You must deposit $2,500 to meet your initial margin.
        • You borrow the balance ($2,500) from the broker’s firm.
      • You will get a margin call if the total value of the securities falls below $3,333. Solve this equation:
        • Minimum value of securities = broker’s loan/(1 – MMR)
        • = $2,500/(1 – 0.25) = $3,333
        • With 100 shares, GM would have to fall to $33.33 per share for you to get a margin call. You would have lost $1,667 ($5,000 – $3,333)
      9-
    • Finding Investment Information
      • Company sources
        • The Annual and Quarterly Reports; also company Web site
      • Investment advisory services
        • Examples: Value Line, Moody’s, Standard and Poor’s
      • Newspapers and magazines
        • Examples: Wall Street Journal , Investor’s Business Daily , Barron’s
      • Computer data sources
        • Internet as well as companies such as Bloomberg
      9-
    • What Is a Bond?
      • A bond is simply a loan. It is a marketable IOU.
      • Bond parties
        • The issuer who is borrowing money
        • The investor who lends the money
      • The loan
        • Specifies interest payments
        • Has a maturity, such as 20 years
      • The bond certificate
        • Is a small part of the overall loan
        • Is easily traded in the bond market
      9-
    • 9- Bond Certificate
    • Your Rights as a Bondholder
      • Bondholders are creditors. They have rights comparable to the rights of other creditors.
      • A bond indenture is the contract between the issuer and the bondholders that spells out the rights of the bondholders.
        • It is similar to a loan agreement that you sign when you borrow money.
      • Protective covenants are restrictions on the issuer. These are included in the indenture and they are intended to strengthen the bondholders’ position.
      9-
    • Zero Coupon Bonds
      • Zero coupon bonds do not pay interest during the life of the bond.
      • Interest is earned by paying less than the face value of $1,000 to buy the bond.
        • Example: you pay $500 today to buy a bond that will be redeemed in eights years for $1,000
      • A savings bond is an example of a zero coupon bond. You buy it for $50 and it is redeemed for $100 in the future.
      9-
    • Convertible Bonds
      • These bonds can be converted into common stock.
        • The conversion rate is the number of shares of stock acquired by converting 1 bond; e.g., 40 shares per bond.
      • Conversion value of the bond
        • This is the bond value if it was converted into common stock.
        • It is determined by multiplying the stock price by the conversion rate.
        • For example: Stock price = $30; the conversion rate is 40 shares per bond; conversion value = $30 × 40 = $1,200
      9-
    • Investing in Corporate Bonds
      • Trading costs can be high
        • Commission cost
        • The bid-ask spread
      • Callable bonds are bonds that can be called prior to maturity.
        • No interest is paid after the call date
      • Mutual funds may be the best way for individual investors to invest in bonds.
      9-
    • Government-Issued Bonds
      • U.S. Treasury Securities
      • U.S. Agency Bonds
        • Conventional
        • Mortgage-backed
      • Municipal Bonds
        • General obligation (GO) bonds
        • Revenue bonds
      9-
    • U.S. Treasury Bonds
      • The characteristics are the same as corporate bonds:
        • Face value of $1,000
        • A maturity date such as 10 years
        • Semiannual coupon payments
      • Investors can buy these directly from the Federal Reserve Bank
      • Free of default risk
      • May be subject to price risk but the degree depends on the time to maturity
      9-
    • U.S. Agency Bonds
      • Conventional bonds have the same characteristics as U.S. Treasury Bonds
      • Mortgage-Backed Bonds:
        • Issued by agencies such as Fannie Mae
        • Agency buys mortgages from local lenders
        • Creates a pool of similar mortgages and issued bonds backed by these pools of mortgages
        • Mortgage payments are “passed through” to the bond buyers
      • Due to the complexities of these bonds, it is best to invest through a mutual fund.
      9-
    • Municipal Bonds (Munis)
      • Issued by cities, counties, or states to fund projects
      • General obligation (GO) bonds
        • These are backed by the full taxing authority of the issuer.
      • Revenue bonds
        • Backed only by the revenues of the project that the bonds are financing
        • These bonds are considered more risky since they are dependent upon the revenues from a project.
      • Most municipal bonds are free of federal income tax and may be free of state income tax.
      9-
    • Mutual Funds
      • A mutual fund is an investment company that pools the funds of many individuals to invest in stocks, bonds, and other investment securities.
      • Investors buy shares in the mutual fund.
      • The mutual fund buys: Shares in companies and/or, bonds of companies, municipalities, governments and/or, other investment securities
      • A fund’s net asset value (NAV) is the total value of all the assets the fund owns (minus any liabilities) divided by the number of shares issued by the fund.
      9-
    • Selecting a Mutual Fund
      • Evaluate performance.
      • Review the fund’s current portfolio.
      • Examine expenses and turnover.
      • Review evaluations in popular magazines and newspapers.
      • Consult a professional evaluation service such as Morningstar or Lipper Analytical Services.
      9-
    • Other Evaluation Items
      • Review the fund’s current portfolio
        • Is there adequate diversification?
      • Review the fund’s operating expenses
        • Usually expressed as a percent of net assets
        • Low expense ratios are desirable
        • Compare to other funds with similar investment objectives
      • Examine the portfolio turnover percent
        • Turnover percent measures the trading frequency
        • High numbers = high trading
      9-
    • Portfolio Diversification
      • Reduces risk
      • Minimizes return
      9-
    • Investment Selection
      • Aggressive investor:
        • 100% stocks: 1/3 large company, 1/3 small company, 1/3 international
      • Cautious investor:
        • 30% large company growth stocks, the balance in bonds, including zero coupon
      • Investor who needs current income:
        • 50% high-quality corporate bonds, 25% medium-quality corporate bonds, and 25% income stocks
      9-