Fundamentals of Investing Dr John P Abraham Professor

Fundamentals of Investing Dr. John P. Abraham Professor UTRGV

Investing goals • Preserve capital • Increase in value • Agents: – financial institutions (banks, insurance companies) and financial markets (forums where suppliers and buyers are brought together). – Agents can be: government, business or individuals.

Government • Federal, state and local all require vast sums of money. • Borrow money to finance projects: war, buildings, schools, housing, bridges, etc. • They may loan surplus money for short term.

Business & Individuals • Borrow and loan funds

Security • Easy to buy and sell • Investments – Evidence of ownership in a business – Legal right to acquire or sell an ownership interest in a business – Bonds, stocks, and options • Direct investment or indirect investment – Direct – buy security – Indirect – own a share in a company that buys securities.

Property • Difficult to buy and sell • Real estate – Land, building • Tangible personal property – Gold, collectibles • Usually long term (longer than one year)

Steps in Investing • Carefully developed plan to achieve specific financial goal. • Must have living expenses, savings for emergency before investing. • Goal of investing: – Example in 3 years accumulate down payment for a house. • Selecting investments

Portfolio • Collection of investments assembled to meet goals. • Diversification – Limit risk and maximize returns • Managing portfolio – Selling, buying, rebalancing – Short tem CDs, money market, T-bills – Fixed income securities such as bonds and preferred stocks.

Stocks • Common stock – Represents ownership in a corporation – May yield dividends – Capital gain • Preferred stock – Ownership in a corporation with a stated dividend rate. (preference over common stock). – Convertible securities. Bond or preferred stock that may be converted to a specified number of shares of common stock.

Options • Provide investor with an opportunity to sell or buy an underlying security at a specified price within a given period of time. • Good in a volatile market. • Call is an option to buy • Put is an option to sell.

Mutual Funds • Professionally managed diversified portfolio of securities.

Bonds • Face value – what the borrower will pay you at maturity • Coupon : The agreed upon interest rate which is paid annually or semi annually. • Maturity: When the borrower will pay you back. • Example. Face value 1000, coupon 8%, and a maturity of 10 years. • This means you'll receive a total of $80 ($1, 000*8%) of interest per year for the next 10 years. Actually, because most bonds pay interest semi-annually, you'll receive two payments of $40 a year for 10 years. When the bond matures after a decade, you'll get your $1, 000 back.

Bond price can go up or down • In an increasing interest market, value of your bond could decrease (discount). In a decreasing interest market, value of your bond could increase (premium). • I explain this in lecture • Stock is ownership in a company, bond is lending to the company • Bond gives you predictable income

Zero Coupon Bond • bought at a price lower than its face value • with the face value repaid at the time of maturity (PAR VALUE) • Examples U. S. Treasury bills, U. S. savings bonds

Bond rating Bond Rating Grade Risk AAA Investment Highest Quality Aa AA Investment High Quality 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 Moody's S&P/ Fitch Aaa

Government bonds • Bills - debt securities maturing in less than one year. • Notes - debt securities maturing in one to 10 years. • Bonds - debt securities maturing in more than 10 years. • Munis • Zero coupon bond. (you buy at a discount)

Real Estate • Commercial • Residential

IRA, SEP-IRA, ROTH-IRA & 401/403 K • Tax sheltered • Pay tax up front and let it earn taxfree • Don’t pay tax up front, let earn, pay taxes when your income is low.

Investment Markets • IPO – initial public offering – sell directly as in case of Google – Sell through an investment banker (Goldman Sachs or Solomon brothers) • Buy stocks at a fixed price (discount price) and take risk of selling it (this is called underwriting). • Secondary market – After the initial offering, stock may be traded at secondary markets.

Secondary markets • Organized Securities and Exchanges – New York Stock Exchange NYSE – American Stock Exchange AMEX – Nasdaq (National association of securities dealers automated quotation) used to be main OTC. – Options exchanges – Futures Exchanges • Over the counter market – Sold over telecommunication network. Unlisted securities. • Foreign Securities Markets (ADR – american depositary receipts)

Things to Know • • • Insider trading Bull market Bear market Market crash Types of account – Single or joint, cash or margin • Types of orders – Market or limit – Stop loss order

In declining market • Short selling • Investors sell stocks they don’t have (borrowed selling) – borrowed from broker. • Must be purchased eventually

Practical Investment guide • Making a budget • Savings • Real Estate – Home – Rentals • Stocks • Bonds

Making a budget (live within your means) • • Budget is a plan Must be realistic Must be mutually agreed upon (if married) Must adhere to it as much as possible – Goal is to remain under budget in spending – And over budget in income • My advice: borrowing money is bad. – Using credit card is even worse – if you do not pay off entire amount each month.

Savings • The best time to save is when you get your first real job. Do not raise your standard of living immediately; instead save. • Minimum savings: – Enough to live for 3 to 6 months if you lost your job. – Enough to pay for a down payment on a house and a car.

Savings in buying • Don’t buy anything unless you have daily or periodic use for it. • Don’t be an impulsive buyer. Buy items on your buy list. • Find different devices that will do the same job, you may be able to save as much as 80% or more. • As much as possible, buy things that are on sale without sacrificing quality (moldy bread at deep discount is useless!)

Real estate • First investment should be a place to live. • Renting vs. buying (show calculation) • Only time borrowing is allowed (my opinion) – You are paying with cheaper money while your home is appreciating. – Government is subsidizing your interest.

Real Estate Investments • Positives – Appreciation – Tenants pay your loans • Negatives – May have negative cash flow – May be vacant – Not liquid

Land vs. income producing • Land in the right location will bring profits many fold. • Must pay (in my opinion) cash – no loans. • Income producing – you can borrow. • You need to do most of the repair & maintenance work.

Stocks

Bonds