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Lecture Notes.doc


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Lecture Notes.doc

  1. 1. Week #3 Stocks, Bonds, Mutual Funds, Etc. Week #3—Part A—Stocks, stock markets, indices
  2. 2. Investment—Introduction—Strauss pp. 259-260 1. Investors fall into two categories: a. Institutional—Banks, insurance companies, mutual funds and investment companies, endowment funds, corporate profit-sharing plans, pension funds b. Individuals 2. Investment information categories a. Descriptive—statistics, historical performance b. Analytical—Projections for future and analysis (opinion) such as advisory services 3. Typical dictionaries, encyclopedias, handbooks (how to invest guides) Strauss—269-271 In order to raise capital (funds) for company growth and expansion, companies issue stock. There are basically two types of stock: 1. Preferred—Almost a bond; guaranteed dividends; preference in the receipt of assets in case of liquidation 2. Common—Most often issued; last in line in receipt of assets in case of liquidation People buy stock to earn money one of two ways: 1. Collect dividends (either quarterly, semiannually, or annually); dispersal of dividends (also known as the payout) depends on the ex dividend date—a set date on which everyone who owns stock will received dividends. Actual payout date will be later. Dividends are declared by the board of directors. Dividend income must be declared as income on personal income tax 1040s. Dividends may be paid out in cash or more stock. 2. Sell the stock for a higher price than paid for; profits earned on stocks are subject to capital gains. If stocks sold at a loss, the loss can be declared on personal income tax 1040s. In 2008 the capital gains law will change. In addition to monetary gains, stock ownership provides the following benefits: 1. Receipt of quarterly and annual reports 2. Right to attend and speak at annual corporate meetings 3. Right to vote for the board of directors (or sign a proxy) Types of stock—There are many variations in types of stocks. The two main types of stocks are: 1. Common—Most common type; last in line if a company liquidates 2. Preferred—Paid stated dividends that are set when stock issued; have precedence over common stock in case of liquidation How stocks are issued 1. Company registers and files required documents with the SEC 2. Stocks are issued at “par value”—an arbitrary price that has no relation to the stock’s actual price on the stock market
  3. 3. 3. Investors get stock certificates (U. S. stocks) or American Depository Receipts (ADRs) (foreign stocks traded in U. S. markets) Stocks can be acquired in several ways: 1. Traditional brokerage houses (e.g., Merrill Lynch); charge a commission for buying and selling; brokers give recommendations 2. Online brokerages (e.g., Ameritrade); usually charge a lower, set commission 3. Dividend reinvestment plans (DRIPs)—Buying stock directly through the company or its agent; dividends are automatically reinvested in more shares. Ability to participate in DRIPs may be restricted (e.g., utility company customers). 4. Employee Stock Option Plans (ESOPs)—Stock-buying plans for employees (usually through payroll deductions) or through grants Where are stocks traded (Strauss 271-275): 1. National stock exchanges—NYSE, AMEX, BATS, NASDAQ (OTC), OTC BULLETIN BOARD, PINK SHEETS (OTC) 2. Regional stock exchanges (e.g. Pacific) 3. Foreign stock exchanges (e.g., London, Tokyo) Stocks are identified by the ticker symbol (usually 1-5 letters, e.g., HD for Home Depot); ticker symbols are easy to find in print and electronic stock services (e.g., Morningstar) and on free stock Web sites (e.g., Yahoo! Finance) Current stock prices are reported in stock tables (Strauss 276-278). Elements of stock tables vary among reporting sources; the Wall Street Journal and local newspapers have “streamlined” their stock tables, eliminating traditional information such as yearly high/low prices, etc. Tables usually include the ticker symbol (or abbreviated company name, closing price, and % change from the previous trading day. Stock analysis 1. Earnings per share (EPS) is one of the basic measures of a stock’s worth. Earnings per share is based on the net income (profit) of the company as reported on the income statement. Earnings per share is the net profit (less preferred dividends payout) divided by the number of common stock shares outstanding. If there is no preferred stock, then the formula is: Net income $4,000,000 net income No. of shares outstanding 1,000,000 shares outstanding = EPS = 4 2. Price-earnings ratio (P/E)—The price of an individual share of stock divided by earnings per share (EPS)
  4. 4. Stock price (single share) $24.00 price of a single share of stock Latest earnings per share 4 (EPS) = P/E 6 3. Dividend yield—A percentage value of the annual dividends divided by the price of a single share of stock Dividend $2.40 (annual dividend) Stock price (single share) 24.00 = dividend yield of 10% Stock indicators are used to evaluate stocks in several ways: 1. Compare the company’s stock performance over time 2. Compare the company’s stock to other stocks in the same industry 3. Compare the company’s stock to the performance of the stock in comparison to the stock market index (e.g., Dow Jones) or to the stock market as a whole Stock Analysis Wall Street investment firms, stock brokerages, and online services offer stock analysis and give stock ratings for potential investors. These analysts are usually assigned to certain sectors of the economy (e.g., airlines or the entertainment industry) and periodically report to their clients on the investment potential of the companies that they cover. They conduct conference calls with the senior management of their assigned companies as well analyze financial reports, strategic plans, etc. Sources of Stock Information—Selected Stock services 1. Investext Plus (analytical) 2. Mergent stock guides (print and Mergent Online) (descriptive) 3. Morningstar Library Edition (analytical; no projections) 4. OSIRIS (descriptive) 5. Standard & Poor’s stock guides (print and NetAdvantage) (descriptive) 6. Value Line Investment Survey (also online) (analytical and projections) 7. Free Web sites (e.g., Yahoo! Finance) Morningstar Library Edition includes the following analytic features: • Stock quotes (price per share) • Analyst’s report • Morningstar ratings (*-*****) • Business risk—Above average, etc. • Economic moat—Ability to stay ahead of competitors • Fair value estimate—Morningstar’s estimate of what the stock price should be in relation to the actual market price • Data interpreter
  5. 5. o Compares performance of a company’s stock to its industry and to the S & P 500 o Style box—Rating of market capitalization (stock price x no. of shares outstanding) o Growth %--Revenue growth and EPS o Profitability—Return on assets (ROA) (Net income Total assets) • Financial health—Measure of debt • EPS—Estimates of future EPS • Dividends--% of dividend yield • Various ratios • Stock charts (price, fundamentals (price compared to P/E ratios), technical (high/low price on one day) • Fair value—Estimated fair value price compared to actual price • Dividends and returns—Comparison to industry group, S & P 500, 5 year dividend history • Stock screens—Compares stocks to various criteria to monitor current stocks in relation to other stocks; ID stocks for future investment o Standard criteria (e.g., industry group, dividends) o Morningstar criteria (e.g., “Warren Buffet” stocks) Finding historical prices (particular day, month, year, etc) (Morningstar goes back only 10 years) • Newspapers (one day delay) • Free Web sites—Yahoo! Finance • For companies that are not currently traded: Directory of Obsolete Securities (year- end closing price only) Value Line Investment Survey (print/electronic) • Comprehensive service with 17 years worth of data and projections (quarterly and annually) for the upcoming year • Analyst’s reports • Rating stocks for timeliness (stock price) and risk (safety); rating 1-5 Investext Plus • Investment house analysts’ reports • Conference call transcripts Print sources Mergent—Mergent’s Dividend Achievers, Mergent Dividend Record, Mergent’s Handbook of Common Stocks Standard & Poor’s—Security Owner’s Stock Guide, Security Price Index Record (part of S & P Statistical Service), Standard & Poor’s Dividend Record, Standard & Poor’s Stock Reports
  6. 6. How to invest guide—Online Publications for Investors (SEC)— Stock Indexes—A collection of securities that define all or some portion of an investment market. • Dow Jones Industrial Average (DJIA)—30 stocks; selected by editorial board of the Wall Street Journal; started in the 1890s with 12 stocks • Standard & Poor’s 500 Stock Composite (S & P 500)—Started in the 1920s with 200+ stocks a. 400 industrials; 40 utilities; 20 transportation; and 40 finance cos. b. Based on total market value (price per share x no. shares outstanding) (e.g., a stock price of $50 x 1 million shares=$50,000,000 market value Part B. Mutual funds, investment funds, unit investment trust, hedge funds— Strauss, ch. 14 Investment funds—Shares in a pool of diverse security portfolios • Open-end (mutual funds)—Sell unlimited shares • Closed-end—Investment companies that sell a fixed no. of shares • Advantages—Diversification, professional management, reviewed and rated o Mutual funds require minimum investment, dividends automatically reinvested; can be easily redeemed • Unit investment trust (UIT)—Pool of investments that pays out a regular income for a stated amount of time (usually long-term) • Hedge fund—Unregulated pool of investments; does not have to report financial information; only for wealthy investors Mutual funds (Strauss, 315-318) • Funds have different investment objectives and risk levels (e.g., conservative, moderate, aggressive, growth, income, bear market) • Types of funds (Morningstar categories) (Strauss had different categories) o Domestic stocks o International stocks o Taxable bond funds o Municipal (“muni”) bond funds • Load and no-load funds—Ways fees are charged (load=fee paid when buying in; no-load=no fees when buying in) • Usually minimum amount to buy in (e.g., $3,500) Mutual fund quotes—Instead of shares mutual funds have the NAV (net asset value)= Total value of mutual fund holdings Total no. of shares outstanding
  7. 7. Mutual fund tables are listed along with stocks, bonds, etc., in the business section of newspapers. Quotes include the abbrev. Fund name, closing NAV, % change from closing price on previous business day Morningstar Library Edition—Morningstar began as a mutual fund service; reporting similar to stocks • Data Interpreter • Analyst research • Stewardship guide • Morningstar rating (*-***** stars) • Total returns • Tax analysis • Risk measures • Portfolio (mix of securities held) • Management • Fees & Expenses • Purchase info (amount to buy in; list of companies that sell the particular fund) • Fund screeners (standard criteria=fund category, annual rate of return; Morningstar criteria (e.g., High Yield Bond) Other mutual fund sources—Lipper, “Mutual Funds Report” (quarterly section of Sunday New York Times business section), Value Line Mutual Fund Survey, Value Line No-Load Fund Adviser Free Web sites • Business Week Online • Funds (CNNmoney) • Invest Wisely (SEC) • Investment Company Institute • Yahoo! Finance Bonds (Strauss ch. 13)—Also known as fixed-income securities because they pay a predictable rate of return Definition—An IOU from a company, government, etc., that will be paid back by a certain date at a certain rate of interest (bond yield); usually long-term (e.g., 10 years) Issuers—Government (federal, state, local, foreign) and corporate; may have a “sinking fund”—an account in which cash is deposited at regular intervals in order to accumulate enough money to pay off the bondholders on date of redemption Ratings—Bonds are evaluated by rating agencies who measure the risk of default; done by investment firms (Fitch, Mergent, Standard & Poor’s); ratings go from AAA (highest/ safest) to C (lowest/riskiest); D means the bond issuer is in default Types of bonds: • Bearer bonds—no registered owner; proceeds claimed by another with possession of the bond)
  8. 8. • Registered bonds—Only owner of record can sell, collect interest, collect payment upon redemption • Callable—Issuing entity (e.g., company) has the option to redeem the bond before the stated redemption date (e.g., a company that issued a 10-year bond can redeem it at 7 years) • Coupon—Attached to bond; sent in for interest payment • Zero-coupon—Interest is accrued and paid in one lump sum when bond redeemed • Tax-exempt bonds—“Munis” that offer lower interest rates • Adjustable rate bonds—Interest rate changes based on changes to other interest rates) Bond table information: • CUSIP/ISIN—Registration number • Name of issuer (e.g., company or agency) • Bond rating (Aa) • Interest pay dates (if not zero-coupon) • Call price/date • Yield (interest rate %) • High/how price • Dollar amount of bonds outstanding • State/price issued • Maturity date (when bond is redeemed) Bonds can be traded in the bond market; buying/selling bonds is usually tied to changes in interest rates. The Federal government issues several types of bonds through the Treasury Department ( There are three types: • Treasury bills—Short-term bonds for 3, 6, 12 months; no interest rate (issued at a discount); minimum purchase price • Treasury notes—Medium-term for 2, 3, 5 and 10 years; higher minimum purchase price • Treasury bonds—10 years + • TIPS (Treasury Inflation-Protected Securities)—Variable principal based on changes in CPI. Sources of information: Mergent and S & P bond guides (print/electronic) Free Web sites—Bondpage, Economy & Bonds (, Investing in Bonds (SIFMA), TreasuryDirect Futures and Options (Strauss chapter 16) Commodities (Strauss, p. 332-338) • Definition--Economic goods (crops, metals, ore, etc.); usually sold in futures contracts (agreement for futures delivery at a specific price) • Sold two ways:
  9. 9. o Spot market—Sold for cash that day o Futures contract • Sold on futures exchanges (e.g., Chicago Board of Trade, NY Mercantile Exchange) • Regulated by the Commodity Futures Trading Commission • Commodity prices are reported in daily newspapers in business section with stocks, bonds, etc. • Source: CRB Commodity Yearbook Other forms of investing • Currency market (foreign exchange) (Strauss p. 232-233); reported by the Federal Reserve Bank of New York (reported twice a day—10 am and noon; major currencies only) • Mortgage-backed securities • Real estate investment trusts (REITs)