Investing in Stocks and Bonds


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Investing in Stocks and Bonds

  1. 1. Investing in Stocks and Bonds <ul><li>Text by Vickie Bajtelsmit with Linda Rastelli </li></ul><ul><li>PowerPoints by Christine Mooney </li></ul>12-1
  2. 2. Common Stock <ul><li>Common stock represents a share of ownership in a corporation. </li></ul><ul><li>A common shareholder’s claim on the firm is said to be a residual claim, which means the person shares in the assets and income of the corporation. </li></ul><ul><li>Each shareholder has the right to vote for members of the board of directors. </li></ul><ul><li>If a shareholder is unable to vote in person they may do so by proxy . </li></ul>12-2
  3. 3. Stockholder Rights <ul><li>Shareholders enjoy limited liability </li></ul><ul><li>If the firm issues a stock dividend stockholders are entitled to a dividend. </li></ul><ul><li>They are also entitled to preemptive rights . When companies sell additional shares of stock, shareholders are entitled to maintain their proportionate interest in the company. </li></ul><ul><li>In a stock split a shareholder is entitled to maintain their proportionate share of ownership in the corporation. </li></ul>12-3
  4. 4. The Stock Market <ul><li>The stock market has two parts: </li></ul><ul><li>Primary market – where stocks are sold to the public for the first time. </li></ul><ul><li>Secondary market – where stocks that have already been issued are traded between investors. </li></ul><ul><li>As a part of going public in the primary market, a company goes through an initial public offering. </li></ul><ul><li>New stock issues are advertised in the financial press in the form of a tombstone ad. </li></ul><ul><li>Anyone interested in purchasing the stock can request a prospectus. This document details all important information about the stock and company. </li></ul>12-4
  5. 5. Securities Exchanges <ul><li>Trading among investors can be accomplished through an organized securities exchange. This is a physical location where trading takes place or through an electronic marketplace called the over the counter market. </li></ul><ul><li>To effect trades a brokerage contacts the representative at the exchange, and puts in the bid price, then the ask price is relayed. </li></ul>12-5
  6. 6. Classifications of common stock 12-6 This stock is less sensitive to market ups and downs and can help to stabilize a portfolio. Defensive stock This stock exhibits above average sensitivity to the business cycles. Cyclical stock One issued by large, stable, mature companies. Blue Chip Stock One that compensates investors primarily through increases in the value of the shares over time. Growth stock Pays investors a regular dividend rather than concentrating on the reinvestment of profits. Income stock Characteristics Type of Stock
  7. 7. Market Capitalization <ul><li>Market capitalization is the total value of a company’s shares at its current market price. </li></ul><ul><li>Companies are referred to in three ways: </li></ul><ul><li>Large-cap – have market caps of $5 billion or more. </li></ul><ul><li>Mid-cap – have $1 billion to $3 billion in market cap. </li></ul><ul><li>Small-cap – generally has market cap of than $1 billion. </li></ul>12-7
  8. 8. Buying & Selling stock <ul><li>To determine how much to pay for a stock, look up the current price. This can be done in The Wall Street Journal or online. </li></ul><ul><li>If you see the close price , this represents the price the stock sold for at closing the previous day. </li></ul><ul><li>Orders are normally made in round lots, or a unit of 100 shares. </li></ul><ul><li>When you make a market order , you ask the broker to execute your trade based upon the market price at the time the buy is made. </li></ul><ul><li>You can also place a limit order , whereby you limit the amount per share you are willing to pay. </li></ul>12-8
  9. 9. Buying & Selling <ul><li>Investors sometimes decide to sell short . This occurs when they issue a sell order to their broker but do not actually have the shares, instead they borrow from their brokers account. </li></ul><ul><li>A stockbroker is a licensed professional who facilities securities transactions for clients. </li></ul>12-9
  10. 10. Brokerage firms <ul><li>Full service brokers provide services such as account management and investment research. </li></ul><ul><li>Discount brokers , are generally much less expensive and offer fewer services. </li></ul><ul><li>You are required to open a brokerage account and keep a certain amount of money in that account. </li></ul><ul><li>If you don’t have enough money you can buy on margin . Buying on margin means that you borrow funds from the brokerage firm. However, if the price of the stock falls you might get a margin call , a request to repay the money at once. </li></ul>12-10
  11. 11. Stock Performance <ul><li>The two components of a stock’s rate of return are dividend yield and capital gains yield. </li></ul><ul><li>Dividend yield = Annual dividend/Market price of stock </li></ul><ul><li>Capital gains yield = Annual change in price/Market price of stock </li></ul>12-11
  12. 12. Stock Returns <ul><li>The most widely watched ratio is the earnings per share. (EPS) </li></ul><ul><li>EPS = After tax net income/Number of shares outstanding. This can also be compared to the price-to-earnings ratio. </li></ul><ul><li>P/E ratio = stock price/eps </li></ul><ul><li>The P/E ratio is used as a measure of future earnings potential. </li></ul>12-12
  13. 13. Stock Indexes <ul><li>A stock market index tracks the performance of a particular group of stocks. </li></ul>S & P 500 Index 12-13 Dow Jones Industrial Average (DJIA) NYSE Composite Index
  14. 14. Bonds <ul><li>A bond is a type of financial security that represents your long term loan of money to the government or a company. </li></ul><ul><li>Bonds generally provide a lower rate of return to investors than stocks, but they make up a large portion of investors’ portfolios. </li></ul>12-14
  15. 15. Advantages of Bonds <ul><li>Diversification – bond income can help offset losses. </li></ul><ul><li>Predictable sources of income </li></ul><ul><li>Profit on price changes </li></ul><ul><li>Lower risk </li></ul><ul><li>Matching time horizon </li></ul>12-15
  16. 16. Bond Terminology 12-16 Allows a bondholder to convert the bond to shares of common stock. Convertibility A bond issuer wants to repay the bond early, they have the right to call it and repay it. Call provisions The fixed interest rate that the issuer pays the holder of the bond. Coupon rate This is when the bond comes due and will be repaid. Maturity date Also known as par value, amount holder is repaid. Face Value Contract between the bondholder and the issuer of the bond. Indenture A company must provide information about the offering. Prospectus Definition Term
  17. 17. Types of Bonds <ul><li>Corporate Bonds – long term interest bearing securities issued by a corporation. </li></ul><ul><li>U.S. Treasury Bonds – regularly issued by the U.S. government, with various terms to maturity, these assist the government in financing the national debt. </li></ul><ul><li>Agency issues – when a federal agency, like Ginnie Mae, issues a bond they are issued in large denominations and sold to institutional investors. </li></ul><ul><li>Municipal bonds – a long term debt security issued by a state or local entity. They are classified as either revenue or general obligation. Their benefit is that they are tax exempt. </li></ul><ul><li>Most corporate and government bonds are debenture , a legal term for unsecured bonds. A secured bond is backed by some type of collateral. </li></ul>12-17
  18. 18. Coupons & Risk <ul><li>A zero coupon bond makes no coupon payments, but is instead discounted at the time of sale. </li></ul><ul><li>Bonds are classified according to risk. Bonds are given investment grades from Moody’s and S&P. These grades help investors determine risk. </li></ul><ul><li>A unique investment strategy that can be used with bonds is laddering . It is a type of buy and hold investing strategy in which you purchase a collection of bonds with different maturities. Another type is maturity matching , similar to laddering, but it requires that you purchase assets with cash flows. </li></ul>12-18
  19. 19. Preferred Stock <ul><li>Offers the advantage of paying a regular, fixed dividend that takes precedence over dividends to common stockholders. </li></ul><ul><li>It is issued by a company as a means of raising capital. It is also called cumulative preferred stock, because under this type of stock the dividend accumulates for an investor. </li></ul><ul><li>Preferred stockholders are open to interest rate risk, call risk and default risk. </li></ul>12-19
  20. 20. Copyright Notice <ul><li>© 2008 John Wiley & Sons, Inc. </li></ul><ul><li>All rights reserved. Reproduction or translation of this work beyond that permitted in section 117 of the 1976 United States Copyright Act without express permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information herein. </li></ul><ul><li>All clipart and photos courtesy of, unless otherwise noted. </li></ul>12-20