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  • 1. Economics Finance Presentation Jamal Adams Fall Semester 2011
  • 2. Why Invest?
    • Long Term Financial Goals & Obligations
      • Retirement
      • College Cost for Children
      • Create a New Career or Business
    • Get our $ to work for us!
      • Compound Interest
  • 3. Compound Interest
    • Albert Einstein called compound interest as “the greatest mathematical discovery of all time.”
    • F v = P v (1 +i) n
    • F v = Future Value
    • P v = Present Value
    • i = Interest Rate/Rate of Return
    • N = Number of Periods (Yearly)
    • To allow this formula to work best you need to manage factors:
    • Time in the market
    • Rate of Return
  • 4.
    • Formula when Interest is compounded more than once per year
    • F v = P v (1 +i/c) n*c
    • F v = Future Value
    • P v = Present Value
    • i = Interest Rate/Rate of Return
    • N = Number of Periods
    • C=Number of compounds
    Compound Interest Cont.
  • 5. Investing Examples
    • How much does $1,000,000.00 grow into over 30 years with a 4% rate of return?
    • $3,243,397.51
    • How much does $1,000,000.00 grow into over 30 years with a 8% rate of return?
    • $10,062,656.89
  • 6. Modern Portfolio Theory Proposes that a rational investor can optimize his returns and minimize his risk through proper asset allocation (investing one ’s total asset amongst various classes of assets). Asset Class = A group of securities that exhibit similar characteristics, behave similarly in the marketplace, and are subject to the same laws and regulations. The three main asset classes are equities (stocks), fixed-income (bonds) and cash equivalents.
  • 7.  
  • 8.  
  • 9. More Evidence Year-Over-Year Returns Can Swing Dramatically Annual Returns of S&P 500 Index 1984 – 2008
  • 10. Asset Class Performance
  • 11. Investing in Bonds
    • What are you doing when you invest in a bond?
      • You are contractually loaning money to an institution
      • Your expectation is that you will receive interest payments (current income), as well as all of you money back at the end of the term.
      • Usually lower risk and lower returns
    • Why do Bond prices fluctuate?
      • Supply and Demand issues
      • Credit issues
      • Maturity
  • 12.
    • Parts of Bond
    • Face Value/Par Value – the amount of money that the borrower will receive when the bond matures. Also refers to the principal amount originally borrowed.
    • Issuer – Borrower of principal
    • Current Price – The price that the bonds are trading at in the market.
    • Coupon (Interest Rate, Yield) – the amount of interest payments that the borrower will receive during the contract. Usually expressed as a percentage of Par Value.
    • Maturity – the date that issuer must repay the par value of the bond. The day that principal is repaid.
    • Credit Rating – Rating system that helps investors determine each bonds default risk. Default risk is the chance that borrower can not pay interest payments and/or repay principal.
    Investing in Bonds
  • 13. Investing in Bonds
    • There are 3 major rating agencies: Moody ’s, Standard & Poor’s (S&P) & Fitch. Each agency thoroughly monitors all issuers of debt financial health. They try to project each issuers default risk.
    Bond Rating System Moody S&P/Fitch Grade Risk Aaa AAA Investment Highest Rating Aa AA Investment High Rating A A Investment Strong Baa BBB Investment Medium Grade Ba , B BB , B Junk Speculative Caa / Ca / C CCC / CC / C Junk Highly Speculative C D Junk In Default
  • 14.
    • Reading a Bond Quote
    Investing in Bonds Issuer Mrkt Price Coupon Maturity YTM Rating Goldman Sachs 103.18 3.700 Aug. 2015 2.999 A Anaheim Board of Ed 120.74 5.000 Aug. 2015 .700 AAA T-Note 4.500 115.16 4.500 Nov 2015 1.456 AAA
  • 15.
    • Link between Bond Prices and Yield
    • Price and Yield are inversely related. When Price rises, yield falls.
    • Prices fluctuate in the market due to supply and demand factors.
    • Important idea: Yield to Maturity (YTM)
    • YTM = the total return from all interest payments as well as any gain or loss from the bond price at time of purchase and maturity.
    • If bond is trading at discount (current price is lower that par value) then YTM will be higher that coupon value. If bond is trading at premium (current price is higher than par value) then YTM will lower that coupon value.
    Investing in Bonds
  • 16.
    • 3 Major types of Bonds
    • Treasury Bonds - securities offered by the US Government
    • Municipal Bonds - securities offered by state and local governments and their agencies.
    • Corporate Bonds – securities offered by corporations
    Investing in Bonds
  • 17.
    • Treasuries
    • Lowest Default risk of all bonds because they backed by US Government (historically 0% default rate).
    • Often income tax exempt at the state and local level.
    • 3 Types of Treasuries
    • T-Bills – Maturities of 1 year or less. Issued at a discount to par, do not pay a coupon.
    • T-Notes – Maturities of 1 year to 10 years.
    • T-Bonds – Maturities of 10 years or greater.
    Investing in Bonds
  • 18.
    • Municipal Bonds
    • Next lowest default risk (historically 1-2%).
    • Federally income tax exempt and often state and local tax exempt.
    • Tax saving make yields more competitive when compared with Treasuries and Corporates.
    Investing in Bonds
  • 19.
    • Corporate Bonds
    • Highest default risk of all bonds (historically between of 3 – 5%)
    • All income is fully taxable
    • Often broken in 2 categories:
    • Investment Grade – Top half of Bond Ratings – Low default rates.
    • Junk Bonds – Bottom half of Bonds Ratings – Higher default rates.
    Investing in Bonds
  • 20.
    • Cash
    • Represents all liquid forms of money
    • Forms of Cash:
    • $
    • Savings and Checking Account Balances
    • Money Market Accounts
    • Commercial Paper
    • Certificates of Deposit (less than 90 days)
    Investing in Cash
  • 21. Investing in Stocks
    • What are doing when we invest in the stock of a company?
      • Become an owner and investing in the profit stream of the company.
    • Why do stock prices fluctuate?
      • Supply and Demand Forces
      • Varying views within the investing community on qualitative and fundamental strengths of company
  • 22. Investing in Stocks
    • Qualitative Analysis
    • In depth look at the company ’s management team, their skills and experience to run a successful business in the company’s industry.
    • Fundamental Analysis
    • Using quantitative tools to measure a companies profitability and compare versus other companies
  • 23. Investing in Stocks
    • Fundamental Analysis
    • Market Capitalization - the total dollar market value of all of a company's outstanding shares.
    • Market Cap = (Current Share P x )(Shares Outstanding)
    • Shares Outstanding = the amount of shares that equal 100% of the company.
  • 24. Investing in Stocks
    • Fundamental Analysis
    • Market Capitalization Categories
    Category Minimum Maximum Micro Cap Up to $100 Million Small Cap $100 Million $1 Billion Mid Cap $1 Billion $10 Billion Large Cap $10 Billion $50 Billion Mega Cap $50 Billion and Above
  • 25.  
  • 26. Investing in Stocks
    • Fundamental Analysis
    • Earnings (Net Income) - Measure of Profitability
    • Earnings = Very simply Revenue - Costs
    • Earnings by themselves are hard to compare
    • Microsoft earned $69.9 Billion in 2010-2011
    • Nike earned $20.9 Billion in 2010-2011
    • Earnings Per Share(EPS) - Allows to get an Apples to Apples Comparison
    • EPS = Net Income/Shares Outstanding
    • Microsoft ’s 2011 EPS = $2.85 per share
    • Nike 2011 EPS = $4.83 per share
  • 27. Investing in Stocks
    • Fundamental Analysis
    • Most of EPS Numbers we use are estimates provided to us by Wall Street Analysts.To find EPS estimate information visit www.zacks.com
    • Various EPS Estimates to be familiar with:
    • Last Year EPS - Last Year EPS Estimate (i.e. 2010)
    • Current EPS - Current Year EPS Estimate (i.e. 2011)
    • Next Year EPS - Next Year EPS Estimate (i.e. 2012)
    • 5 year EPS Growth Rate - Percentage Estimate for yearly EPS Growth
  • 28. Investing in Stocks
    • Fundamental Analysis
    • Price to Earnings Ratio(PE Ratio) - A valuation ratio of a company ’s current share price compared to it per-share earnings.
    • PE Ratio = Current Share Price
    • Current EPS
    • PE Ratio is often stated as a Multiple i.e. 16X = “ABC is trading at 16 times earnings”
    • PE Ratio tells us what the market is willing to pay for every dollar of earnings that company earns.
    • We can now compare the value of various companies.
  • 29. Investing in Stocks
    • PE Ratio Table
    Company PE Ratio Microsoft(MSFT) 8.7X Home Depot(HD) 14.1X Google(GOOG) 16.7X Nike(NKE) 17.3X S&P 500 11.2X
  • 30. Investing in Stocks
    • Fundamental Analysis
    • PE Ratio to 5 year EPS Growth Rate - A valuation ratio of a company ’s current PE Ratio to it’s 5 year EPS Growth Rate
    • PEG Ratio = Current PE Ratio
    • 5 yr EPS Growth Rate
    • Conventional wisdom believes that a company is often fully valued when PE Ratio = 5 yr EPS Growth Rate.
    • Stock is Undervalued when PEG Ratio < 1.0
    • Stock is Overvalued when PEG Ratio > 1.0
  • 31. Investing in Stocks
    • Fundamental Analysis
    • Book Value - The net asset value of a company, calculated by total assets minus intangible assets (patents, goodwill, etc.) and liabilities
    • Book Value is similar to the break up value of company if one were to sell all hard assets of company and pay off all debts.
    • Book Value per Share = Book Value / Shares Outstanding
    • Px to Book Value Ratio = Current Share Px
    • Book Value Per Share
    • Conventional wisdom looks for Px to Book Values < 1 , you get hard asset value greater than Current Share Px.
  • 32. Investing in Stocks
    • Investment Styles
    • Value Investor
    • Low PE Ratios (minimally below the Market PE)
    • PEG Ratio < 1
    • Px to Book Value <1
    • Debt to Equity < 1
    • Historical and Future EPS Growth > 7%
  • 33. Investing in Stocks
    • Investment Styles
    • Growth Investor
    • Strong Historical EPS Growth (approx. 10%)
    • Strong Forward EPS Growth (> 10-12%)
    • Stable or Increasing Profit Margins(% Revenues that hit the profit line)
    • Stable or Increasing Return on Equity (ROE = Net Income/Shareholder Equity, measures if management is efficiently using assets in terms of growing profits
    • Can the Stock Px double in 5 years?
  • 34. Investing in Stocks
    • Investment Styles
    • Growth at a Reasonable Px(GARP) Investor
    • EPS Growth in 10 - 20% Range; higher growth deemed too risky
    • Stable to Increasing ROE
    • PEG Ratio < 1, often looking for closer to .5
    • PE Ratios in the 10X to 20X; higher PE ’s deemed too risky
    • Px to Book Values < 1
  • 35. Other Investment Vehicles
    • Mutual Funds
    • An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money mangers, who invest the fund's capital and attempt to produce capital gains and income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus .
    • One of the main advantages of mutual funds is that they give small investors access to professionally managed, diversified portfolios of equities, bonds and other securities, which would be quite difficult (if not impossible) to create with a small amount of capital. Each shareholder participates proportionally in the gain or loss of the fund.
  • 36. Other Investment Vehicles
    • Hedge Funds
    • An aggressively managed portfolio of investments that uses advanced investment strategies such as leveraged, long, short and derivative positions in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark). Legally, hedge funds are most often set up as private investment partnerships that are open to a limited number of investors and require a very large initial minimum investment. Investment in hedge funds are illiquid as they often require investors keep their money in the fund for at least one year.
    • For the most part, hedge funds (unlike mutual funds) are unregulated because they cater to sophisticated investors. In the U.S., laws require that the majority of investors in the fund be accredited. That is, they must earn a minimum amount of money annually and have a net worth of more than $1 million, along with a significant amount of investment knowledge. You can think of hedge funds as mutual funds for the super rich. They are similar to mutual funds in that investments are pooled and professionally managed, but differ in that the fund has far more flexibility in its investment strategies.    It is important to note that hedging is actually the practice of attempting to reduce risk, but the goal of most hedge funds is to maximize return on investment. The name is mostly historical, as the first hedge funds tried to hedge against the downside risk of a bear market by shorting the market (mutual funds generally can't enter into short positions as one of their primary goals). Nowadays, hedge funds use dozens of different strategies, so it isn't accurate to say that hedge funds just &quot;hedge risk&quot;. In fact, because hedge fund managers make speculative investments, these funds can carry more risk than the overall market.
  • 37. Other Investment Vehicles
    • Private Equity
    • Private equity consists of investors and funds that make investments directly into private companies or conduct buyouts of public companies that result in a delisting of public equity. Capital for private equity is raised from retail and institutional investors, and can be used to fund new technologies, expand working capital within an owned company, make acquisitions, or to strengthen a balance sheet.   The majority of private equity consists of institutional investors and accredited investors who can commit large sums of money for long periods of time. Private equity investments often demand long holding periods to allow for a turnaround of a distressed company or a liquidity event such as an IPO or sale to a public company.
    • The size of the private equity market has grown steadily since the 1970s. Private equity firms will sometimes pool funds together to take very large public companies private. Many private equity firms conduct what are known as leveraged buyouts (LBOs), where large amounts of debt are issued to fund a large purchase. Private equity firms will then try to improve the financial results and prospects of the company in the hope of reselling the company to another firm or cashing out via an IPO.