Section 8 (Investing)


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Section 8 (Investing)

  1. 1. Personal & Family Finance Section 8 Investing 9-
  2. 2. <ul><li>Why would you want to invest your money? </li></ul><ul><li>What are some ways you can invest your money? </li></ul>9-
  3. 3. Goals and Investment Alternatives <ul><li>Reasons for investing: </li></ul><ul><ul><li>Enjoyment such as your home or antiques </li></ul></ul><ul><ul><li>Current income such as interest or dividends </li></ul></ul><ul><ul><li>Providing for future needs such as retirement </li></ul></ul><ul><ul><li>To reduce your current tax liability </li></ul></ul><ul><li>Types of investments </li></ul><ul><ul><li>Tangible assets: Assets you can touch such as a house </li></ul></ul><ul><ul><li>Intangible investments: Assets such as stocks and bonds that are paper assets </li></ul></ul>9-
  4. 4. Tangible Investments <ul><li>Advantages: </li></ul><ul><ul><li>Can enjoy or use </li></ul></ul><ul><ul><li>May provide a good hedge against inflation </li></ul></ul><ul><ul><li>May have greater control over return </li></ul></ul><ul><ul><li>May offer significant tax advantages </li></ul></ul><ul><li>Disadvantages: </li></ul><ul><ul><li>Can involve work and inconveniences </li></ul></ul><ul><ul><li>Not liquid so not easily bought and sold </li></ul></ul><ul><ul><li>Usually have high carrying costs, such as insurance or taxes </li></ul></ul>9-
  5. 5. Factors to Consider Before Investing <ul><li>Do you want current or future return? </li></ul><ul><ul><li>Investing versus speculating </li></ul></ul><ul><li>What is your income tax situation? </li></ul><ul><li>What is your attitude towards risk? </li></ul><ul><ul><li>Risk averse investors have a low tolerance for risk. </li></ul></ul><ul><ul><li>Risk seeking investors have a high tolerance for risk. </li></ul></ul><ul><ul><li>Investors need to understand their risk profile before investing. </li></ul></ul><ul><ul><li>If an investor wants a higher rate of return, they must accept higher risk to earn a higher rate of return. </li></ul></ul>9-
  6. 6. Basic Investment Alternatives <ul><li>Investments Held for Liquidity </li></ul><ul><li>Securities with Long or No Maturities </li></ul><ul><li>Pooling Arrangements </li></ul><ul><li>Contractual Claims </li></ul><ul><li>Tangible Assets </li></ul>9-
  7. 7. Investments Held for Liquidity <ul><li>Bank accounts </li></ul><ul><ul><li>Savings </li></ul></ul><ul><ul><li>Certificates of deposit </li></ul></ul><ul><ul><li>Money market deposit accounts </li></ul></ul><ul><li>Money market mutual funds </li></ul><ul><li>Series EE and Series HH bonds </li></ul>9-
  8. 8. Securities with Long or No Maturities <ul><li>Bonds and notes issued by: </li></ul><ul><ul><li>The U.S. Treasury and other federal agencies </li></ul></ul><ul><ul><li>State and local governments </li></ul></ul><ul><ul><li>Corporations </li></ul></ul><ul><li>Preferred stock issued by corporations </li></ul><ul><li>Common stock issued by corporations </li></ul><ul><li>Bonds and notes mature from one to thirty years </li></ul><ul><li>Stock never matures because it is ownership in a business </li></ul>9-
  9. 9. Pooling Arrangements <ul><li>Mutual funds </li></ul><ul><ul><li>Income funds </li></ul></ul><ul><ul><li>Growth funds </li></ul></ul><ul><ul><li>Balance funds </li></ul></ul><ul><ul><li>Index funds </li></ul></ul><ul><li>Investment trusts </li></ul><ul><li>Limited partnerships </li></ul>9-
  10. 10. Contractual Claims <ul><li>These are very high risk investments because their value is dependent upon the value of other assets </li></ul><ul><li>Some of these assets are: </li></ul><ul><ul><li>Warrants and rights </li></ul></ul><ul><ul><li>Call and put options </li></ul></ul><ul><ul><li>Commodity futures </li></ul></ul><ul><ul><li>Financial futures </li></ul></ul>9-
  11. 11. Tangible Assets <ul><li>Real estate </li></ul><ul><ul><li>Personal residence </li></ul></ul><ul><ul><li>Rental properties </li></ul></ul><ul><li>Gold and other metals/minerals </li></ul><ul><li>Jewelry and collectibles </li></ul>9-
  12. 12. Organized Exchanges <ul><li>A physical place where buyers and sellers meet to trade securities. Examples are the New York and American Stock Exchanges </li></ul><ul><li>New York Stock Exchange (NYSE): </li></ul><ul><ul><li>It is the largest exchange in the world. </li></ul></ul><ul><ul><li>It is known as the “Big Board”. </li></ul></ul><ul><li>American Stock Exchange (AMEX): </li></ul><ul><ul><li>It is much smaller than the NYSE. </li></ul></ul><ul><ul><li>It is now affiliated with NASDAQ. </li></ul></ul>9-
  13. 13. How the NYSE Works <ul><li>Securities are traded at designated sites on the floor, which are called “posts”. </li></ul><ul><li>You must have a “seat” to trade on the floor. </li></ul><ul><li>Seat owners are commission brokers, floor brokers, floor traders, and specialists. </li></ul><ul><li>Specialists play a key role in maintaining an orderly market. </li></ul><ul><ul><li>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. </li></ul></ul>9-
  14. 14. The Over-the-Counter Market <ul><li>Largest exchange, in terms of number of issues traded </li></ul><ul><li>Securities are traded through a communication system called National Association of Securities Dealers Automated Quotations System ( NASDAQ ). </li></ul><ul><li>Mostly small companies and high-tech companies are traded in this market. </li></ul><ul><ul><li>High-tech companies: Intel, Microsoft, etc. </li></ul></ul>9-
  15. 15. How SIPC Insurance Works <ul><li>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. </li></ul><ul><li>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. </li></ul><ul><li>SIPC only guarantees delivery of the shares; but, you lose $2,000. </li></ul><ul><ul><li>GM’s share price decline is unrelated to the failure of your broker. </li></ul></ul>9-
  16. 16. The Sarbanes-Oxley Act of 2002 <ul><li>This law was passed in response to some of the financial scandals of 1990 such as the failure of Enron, WorldCom, etc. </li></ul><ul><li>The act institutes reforms to improve corporate responsibility and financial disclosures. </li></ul><ul><ul><li>Stock analysts are also required to disclose potential conflicts of interest that might influence their stock ratings. </li></ul></ul><ul><li>It also was created to combat corporate and accounting fraud. </li></ul><ul><ul><li>It created the Public Company Accounting Oversight Board (PCAOB). </li></ul></ul>9-
  17. 17. Other Regulation <ul><li>States have what are called “Blue Sky” laws. </li></ul><ul><ul><li>These are similar to federal laws. </li></ul></ul><ul><ul><li>The laws apply to intrastate Security Sales. </li></ul></ul><ul><li>Self-regulation is also provided by the National Association of Securities Dealers (NASD) through: </li></ul><ul><ul><li>Dealers Rules of Fair Practice </li></ul></ul><ul><ul><li>Code of Procedure </li></ul></ul><ul><ul><li>Uniform Practice Code </li></ul></ul><ul><li>Binding arbitration is an important component of self-regulation. </li></ul>9-
  18. 18. Using the Services of a Stockbroker <ul><li>Most financial investments are bought and sold with the help of a securities dealer (stockbroker). </li></ul><ul><li>Stockbrokers are distinguished in terms of the level of service provided as well as the fees. </li></ul><ul><li>Investors can choose among the following: </li></ul><ul><ul><li>Full-service firms </li></ul></ul><ul><ul><li>Discount brokers </li></ul></ul><ul><ul><li>Internet trading </li></ul></ul>9-
  19. 19. Selecting a Stockbroker <ul><li>Full-service firms feature: </li></ul><ul><ul><li>Research that identifies investment opportunities </li></ul></ul><ul><ul><li>Representatives to help with portfolio planning </li></ul></ul><ul><ul><li>Access to new stock offerings </li></ul></ul><ul><ul><li>Dedicated advisor who works directly with customer </li></ul></ul><ul><ul><li>High commissions </li></ul></ul>9-
  20. 20. Selecting a Stockbroker (Con’t) <ul><li>Discount brokers feature: </li></ul><ul><ul><li>Possibly no personal contact; you trade over an 800 number or over the Internet </li></ul></ul><ul><ul><li>Therefore, discount brokers are most appropriate for customers who have some trading experience and are comfortable placing orders </li></ul></ul><ul><ul><li>Lower commissions-savings can be as high as 90% versus a full-service firm </li></ul></ul><ul><li>Internet trading: both full-service and discount brokers offer this service due to its low cost. </li></ul>9-
  21. 21. Kinds of Accounts <ul><li>Cash account is similar to a charge account except the purchase must be paid for within three working days. </li></ul><ul><ul><li>The broker will hold the securities or you can ask to have them sent to you. </li></ul></ul><ul><li>Margin accounts allow you to borrow money to purchase securities. </li></ul><ul><ul><li>Currently, you can borrow 50% of the cost of securities. </li></ul></ul><ul><ul><li>You are only required to deposit 50% of the amount. </li></ul></ul><ul><ul><li>Since you are borrowing money, you are charged interest. </li></ul></ul><ul><ul><li>Borrowing money increases your risk! </li></ul></ul>9-
  22. 22. How Margin Works <ul><li>You must deposit funds equal to 50% of the value of the securities purchased. This is your initial margin requirement. </li></ul><ul><li>There is also a maintenance margin requirement (MMR) of 25%. Your equity in the account cannot be less than 25%. </li></ul><ul><ul><li>If the stock prices fall, you may get a margin call from the broker. You will be required to deposit additional funds. </li></ul></ul>9-
  23. 23. Margin Example <ul><li>You buy 100 shares of GM stock @ $50 per share </li></ul><ul><ul><li>Total purchase = $5,000 </li></ul></ul><ul><ul><li>You must deposit $2,500 to meet your initial margin. </li></ul></ul><ul><ul><li>You borrow the balance ($2,500) from the broker’s firm. </li></ul></ul><ul><li>You will get a margin call if the total value of the securities falls below $3,333. Solve this equation: </li></ul><ul><ul><li>Minimum value of securities = broker’s loan/(1 – MMR) </li></ul></ul><ul><ul><li>= $2,500/(1 – 0.25) = $3,333 </li></ul></ul><ul><ul><li>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) </li></ul></ul>9-
  24. 24. Finding Investment Information <ul><li>Company sources </li></ul><ul><ul><li>The Annual and Quarterly Reports; also company Web site </li></ul></ul><ul><li>Investment advisory services </li></ul><ul><ul><li>Examples: Value Line, Moody’s, Standard and Poor’s </li></ul></ul><ul><li>Newspapers and magazines </li></ul><ul><ul><li>Examples: Wall Street Journal , Investor’s Business Daily , Barron’s </li></ul></ul><ul><li>Computer data sources </li></ul><ul><ul><li>Internet as well as companies such as Bloomberg </li></ul></ul>9-
  25. 25. What Is a Bond? <ul><li>A bond is simply a loan. It is a marketable IOU. </li></ul><ul><li>Bond parties </li></ul><ul><ul><li>The issuer who is borrowing money </li></ul></ul><ul><ul><li>The investor who lends the money </li></ul></ul><ul><li>The loan </li></ul><ul><ul><li>Specifies interest payments </li></ul></ul><ul><ul><li>Has a maturity, such as 20 years </li></ul></ul><ul><li>The bond certificate </li></ul><ul><ul><li>Is a small part of the overall loan </li></ul></ul><ul><ul><li>Is easily traded in the bond market </li></ul></ul>9-
  26. 26. 9- Bond Certificate
  27. 27. Your Rights as a Bondholder <ul><li>Bondholders are creditors. They have rights comparable to the rights of other creditors. </li></ul><ul><li>A bond indenture is the contract between the issuer and the bondholders that spells out the rights of the bondholders. </li></ul><ul><ul><li>It is similar to a loan agreement that you sign when you borrow money. </li></ul></ul><ul><li>Protective covenants are restrictions on the issuer. These are included in the indenture and they are intended to strengthen the bondholders’ position. </li></ul>9-
  28. 28. Zero Coupon Bonds <ul><li>Zero coupon bonds do not pay interest during the life of the bond. </li></ul><ul><li>Interest is earned by paying less than the face value of $1,000 to buy the bond. </li></ul><ul><ul><li>Example: you pay $500 today to buy a bond that will be redeemed in eights years for $1,000 </li></ul></ul><ul><li>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. </li></ul>9-
  29. 29. Convertible Bonds <ul><li>These bonds can be converted into common stock. </li></ul><ul><ul><li>The conversion rate is the number of shares of stock acquired by converting 1 bond; e.g., 40 shares per bond. </li></ul></ul><ul><li>Conversion value of the bond </li></ul><ul><ul><li>This is the bond value if it was converted into common stock. </li></ul></ul><ul><ul><li>It is determined by multiplying the stock price by the conversion rate. </li></ul></ul><ul><ul><li>For example: Stock price = $30; the conversion rate is 40 shares per bond; conversion value = $30 × 40 = $1,200 </li></ul></ul>9-
  30. 30. Investing in Corporate Bonds <ul><li>Trading costs can be high </li></ul><ul><ul><li>Commission cost </li></ul></ul><ul><ul><li>The bid-ask spread </li></ul></ul><ul><li>Callable bonds are bonds that can be called prior to maturity. </li></ul><ul><ul><li>No interest is paid after the call date </li></ul></ul><ul><li>Mutual funds may be the best way for individual investors to invest in bonds. </li></ul>9-
  31. 31. Government-Issued Bonds <ul><li>U.S. Treasury Securities </li></ul><ul><li>U.S. Agency Bonds </li></ul><ul><ul><li>Conventional </li></ul></ul><ul><ul><li>Mortgage-backed </li></ul></ul><ul><li>Municipal Bonds </li></ul><ul><ul><li>General obligation (GO) bonds </li></ul></ul><ul><ul><li>Revenue bonds </li></ul></ul>9-
  32. 32. U.S. Treasury Bonds <ul><li>The characteristics are the same as corporate bonds: </li></ul><ul><ul><li>Face value of $1,000 </li></ul></ul><ul><ul><li>A maturity date such as 10 years </li></ul></ul><ul><ul><li>Semiannual coupon payments </li></ul></ul><ul><li>Investors can buy these directly from the Federal Reserve Bank </li></ul><ul><li>Free of default risk </li></ul><ul><li>May be subject to price risk but the degree depends on the time to maturity </li></ul>9-
  33. 33. U.S. Agency Bonds <ul><li>Conventional bonds have the same characteristics as U.S. Treasury Bonds </li></ul><ul><li>Mortgage-Backed Bonds: </li></ul><ul><ul><li>Issued by agencies such as Fannie Mae </li></ul></ul><ul><ul><li>Agency buys mortgages from local lenders </li></ul></ul><ul><ul><li>Creates a pool of similar mortgages and issued bonds backed by these pools of mortgages </li></ul></ul><ul><ul><li>Mortgage payments are “passed through” to the bond buyers </li></ul></ul><ul><li>Due to the complexities of these bonds, it is best to invest through a mutual fund. </li></ul>9-
  34. 34. Municipal Bonds (Munis) <ul><li>Issued by cities, counties, or states to fund projects </li></ul><ul><li>General obligation (GO) bonds </li></ul><ul><ul><li>These are backed by the full taxing authority of the issuer. </li></ul></ul><ul><li>Revenue bonds </li></ul><ul><ul><li>Backed only by the revenues of the project that the bonds are financing </li></ul></ul><ul><ul><li>These bonds are considered more risky since they are dependent upon the revenues from a project. </li></ul></ul><ul><li>Most municipal bonds are free of federal income tax and may be free of state income tax. </li></ul>9-
  35. 35. Mutual Funds <ul><li>A mutual fund is an investment company that pools the funds of many individuals to invest in stocks, bonds, and other investment securities. </li></ul><ul><li>Investors buy shares in the mutual fund. </li></ul><ul><li>The mutual fund buys: Shares in companies and/or, bonds of companies, municipalities, governments and/or, other investment securities </li></ul><ul><li>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. </li></ul>9-
  36. 36. Selecting a Mutual Fund <ul><li>Evaluate performance. </li></ul><ul><li>Review the fund’s current portfolio. </li></ul><ul><li>Examine expenses and turnover. </li></ul><ul><li>Review evaluations in popular magazines and newspapers. </li></ul><ul><li>Consult a professional evaluation service such as Morningstar or Lipper Analytical Services. </li></ul>9-
  37. 37. Other Evaluation Items <ul><li>Review the fund’s current portfolio </li></ul><ul><ul><li>Is there adequate diversification? </li></ul></ul><ul><li>Review the fund’s operating expenses </li></ul><ul><ul><li>Usually expressed as a percent of net assets </li></ul></ul><ul><ul><li>Low expense ratios are desirable </li></ul></ul><ul><ul><li>Compare to other funds with similar investment objectives </li></ul></ul><ul><li>Examine the portfolio turnover percent </li></ul><ul><ul><li>Turnover percent measures the trading frequency </li></ul></ul><ul><ul><li>High numbers = high trading </li></ul></ul>9-
  38. 38. Portfolio Diversification <ul><li>Reduces risk </li></ul><ul><li>Minimizes return </li></ul>9-
  39. 39. Investment Selection <ul><li>Aggressive investor: </li></ul><ul><ul><li>100% stocks: 1/3 large company, 1/3 small company, 1/3 international </li></ul></ul><ul><li>Cautious investor: </li></ul><ul><ul><li>30% large company growth stocks, the balance in bonds, including zero coupon </li></ul></ul><ul><li>Investor who needs current income: </li></ul><ul><ul><li>50% high-quality corporate bonds, 25% medium-quality corporate bonds, and 25% income stocks </li></ul></ul>9-