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Investing in Stocks and Bonds
Objectives n Describe stocks and bonds and how they are used by corporations and investors. n Define everyday terms in the language of stock investing. n Classify stock according to their basic descriptive categories.
Objectives n Describe the major characteristics of bonds. n Differentiate among the four general types of bonds.
Objectives n Describe what the investor should consider before investing in bonds, particularly the current yield and yield to maturity. n List the advantages and disadvantages of investing in bonds.
Stocks and Bonds and How They are Used n Common stock n Preferred stock n Bonds
Investing in Stocks n Why do corporations issue common stock? w To raise money to start or expand a business w To help pay for ongoing business expenses w They don’t have to repay the money w Dividends are not mandatory w Stockholders have voting rights
Why Do Investors Purchase Stock? n Income from dividends n Dollar appreciation of stock value n Increased value from stock splits
Common vs. Preferred Stock n Common stock w get dividends depending on profit the company makes n Preferred stock w receive cash dividends before common stock holders w pre-determined dividend rate w most preferred stock is callable
Calculating Total Return 100 shares of common stock purchased December 21, 2008, sold December 21, 2009; total dividedts of $2. 60 per share for the investment period. Cost when purchased: 100 Shares @ $71 $7, 100 Commissions +55 Total investment $7, 155 Transaction Summary: Total Return Minus Total Investment Profit from Stock Sale Plus Dividends Total Return for the transaction Return when sold: 100 shares @ $89 Commissions Total Return $8, 830 7, 155 $1, 675 +260 $1, 935 $8, 900 - 70 $8, 830
Features of Preferred Stock n Cumulative preferred stock w unpaid cash dividends accumulate and are paid before cash dividends to common stock holders n Participation feature w rare form of investment w can share in earnings beyond stated dividend amount n Conversion feature w can be traded for shares of common stock
How to Evaluate a Stock n Read stock quotes in a newspaper, such as the Wall Street Journal w 52 week high and low w stock abbreviation and symbol w dividends per share in the last 12 months w percent yield w price earnings ratio w volume w high and low for the day w closing price and net change
Language of Stock Investing n Earnings per share (EPS) n Price/earnings ratio (P/E ratio) n Dividend payout ratio n Market price n Book value
Language of Stock Investing n Market-to-book ratio n Par value n Total return
Language of Stock Investing n Preemptive rights n Stock dividends n Stock splits n Voting rights
Classifications of Common Stock n Income stocks n Growth stocks n Speculative stocks n Other characterizations
Types of Stock Investments n Blue chip stock w low risk w consistent dividends w ex. AT&T, Kellogg's, General Electric n Income stock w higher than average dividends w ex. utility stock
Types of Stock Investments (continued) n Growth stock w earns above average profits w low or no dividends w Profits reinvested in company, so. . . w Stock price should go up w ex. Microsoft or Intel
Types of Stock Investments (continued) n Cyclical stock w follows business cycles of advance and declines in the economy w ex. new construction, cars, timber n Defensive stock w remains stable even if the economy is declining w ex. food and utility stocks
Numeric Measures to Consider When Evaluating a Stock n Look at book value of one share w net worth of company divided by the number of outstanding shares w if a share costs more than the book value the company may be overextended or it may have a lot of money in research and development
Numeric Measures to Consider When Evaluating a Stock (continued) n Look at the price earnings ratio w also called the P-E w price of one share of stock divided by the earnings per share of stock over the last 12 months w a low number means could be a good time to buy it, however many technology stocks have high P-Es n Look at the beta for the stock with a beta >1. 0 means more volatility
Long-Term and Short Term Investment Strategies Buy-and Hold Technique Dollar Cost Averaging Direct Investment and Dividend Reinvestment Plan (DRIP)
Long-Term and Short Term Investment Strategies Day Trading Buying Stocks on Margin Selling Short Trading in options
Make a Decision to Sell Stocks n 1. Stock reaches target price. n 2. Favorable development temporarily push up price. n 3. Good profits unlikely to continue. n 4. Stock lags behind others in industry group. n 5. Company profits begin to fall short of projections. n 6. Industry/company prospects are deteriorating. n 7. Losses are moderate. n 8. Stock’s price/earnings ratio appears too high.
Language of Bond Investing n Corporate bond n Face value n Maturity date n Bond indenture n Debenture n Mortgage bond n Trustee n Secured and unsecured n Senior and subordinated
Language of Bond Investing n Registered and bearer n Callable n Convertibility n Bond Ladder
Types of Bonds n Corporate bonds n U. S. government securities w Treasury bills, notes, and bonds w Federal agency issues n Municipal Bonds
Tax Equivalent Yield Taxable equivalent yield = Tax exempt yield 1. 0 – tax rate The taxable equivalent yield on a 5% taxexempt municipal bond for a person in the 28% tax bracket is 6. 94%. 05 1. 0 -. 28 =. 0694 = 6. 94%
Considerations Before Investing in Bonds n Susceptibility to certain risks w Credit w Callability w Inflation w Interest rate
Considerations Before Investing in Bonds n Premiums and discounts n Current yield n Yield to maturity n Tax-equivalent yields n When to sell
Approximate Market Value of a Bond Example: Shawn purchased a corporate bond that pays 4. 5% interest based on a face value of $1, 000. Comparable new corporate bond issues are paying 7%. How much is Shawn’s bond worth? Formula: Dollar Amount of Annual Interest = Approximate Market Interest Rate of Comparable Bonds Value A. Find the dollar amount of annual interest. Face Value of Bond x Annual Interest Rate = Dollar Amount of Annual Interest $1, 000 x 4. 5% = $45 B. Solve for approximate market value. Dollar Amount of Annual Interest = Approximate Market Interest Rate of Comparable Bonds Value $45 = $642. 86 7%
Current Yield Assume you own a $1, 000 corporate bond that pays 7% interest annually and matures on July 15, 2013. This means you will receive $70. 00 annually. Also assume the market price is $940. The current yield is calculated:
Yield to Maturity
Corporate Bond Transaction Assume that on March 15, 1998, you purchased a 9. 2% corporate bond. Your cost for the bond was $920 plus a $10 commission charge. Also assume that you held the bonds until March 15, 2008, when you sold them for the current value of $1, 040.
Advantages of Investing in Bonds n Pay higher interest rates than savings n Offer safe return of principle n Have less volatility than stocks n Offer regular income n Require smaller initial investment
Disadvantages of Investing in Bonds n No hedge against inflation n Can be quite volatile n Compounding is almost impossible n Subject to investors tax rate n Poor marketability