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Investing in Stocks and Bonds Investing in Stocks and Bonds

Objectives n Describe stocks and bonds and how they are used by corporations and 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 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 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 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 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 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 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 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 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 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) 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 Market-to-book ratio n Par value n Total return

Language of Stock Investing n Preemptive rights n Stock dividends n Stock splits n 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 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 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 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 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 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 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 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 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. 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 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 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, 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 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 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 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 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 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 Yield to Maturity

Corporate Bond Transaction Assume that on March 15, 1998, you purchased a 9. 2% 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.

Bond Ratings Bond Ratings

Advantages of Investing in Bonds n Pay higher interest rates than savings n Offer 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 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