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Financial Markets and Investment Strategies

Chapter 19

Chapter 19 Objectives

After studying this chapter, you will be able to:• Distinguish between common and preferred

stock and explain the difference between market value and intrinsic value.

• Explain the three key variables that distinguish bonds, compare the advantages and disadvantages of owing bonds, and list the major types of bonds.

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Chapter 19 Objectives Cont.

• Define mutual fund and explain the advantages and disadvantages of this popular investment vehicle.

• Define derivative and identify the major types of derivatives.

• Describe the four major types of financial markets.

• Describe the major steps required to become an investor.

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Stocks

Securities: Investments such as stocks, bonds, options, futures, and commodities.

Stock refers to ownership of or equity in a company.

A share of stock represents a specific portion of ownership.

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Stocks

• Common stock: Shares of ownership that include voting rights.

• Preferred stock: Shares of ownership without voting rights but with defined dividends.

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Common StocksCommon stock is the type people are usually referring to when they talk about stocks.

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Potential benefits

•Realize capital gains

•Regular income

•Right to vote on certain corporate decisions

Disadvantages

•Risk

•Volatility

Preferred StocksPreferred stock, which can be thought of as a hybrid that combines attributes of common stock and corporate bonds.

Represents equity in the company.

Resemble bonds in the sense that they pay fixed dividends

Have a greater claim to assets than common shareholders, meaning they get paid first in the event of cash flow problems or bankruptcy.

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Stock Valuation

• Par value

• Book value

• Market value

• Intrinsic value

• Price-earnings ratio

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Stock ValuationPar Value; the value assigned when the stock is first issued.

Book value per share is the difference between the assets and liabilities as listed on the balance sheet, divided by the number of shares in circulation.

Market value (market price) is the price at which the stock is actually selling in the stock market.

Intrinsic value; an estimate of what a company is actually worth, independent of book and market values

Price-earnings ratio (p/e ratio) defined as the market value per share divided by the earnings per share.

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Face ValueFace Value

Maturity DateMaturity Date

YieldYield

CorporateBonds

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Corporate Bonds

Face Value: The amount of money, or principal , a bond buyer lends to a bond issuer; also known as par value or denomination.

Maturity Date: The date on which the principal of a bond will be repaid in full.

Yield: Interest income a purchaser receives from the bond.

BondsAdvantages :

•Most bonds are less risky than stocks and many other investments

•Bonds offer lower volatility than stocks

•Corporate bonds with twice-yearly interest payments can provide a regular source of income

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Types of Bonds

• Treasury Bills

• Treasury Notes

• Treasury Bonds

• U.S. Savings Bonds

• Municipal bonds

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Types of Bonds

Treasury bills (T-bills) are short-term government bonds that are repaid in less than one year. Treasury bills are sold at a discount and redeemed at face value.

Treasury notes are intermediate-term government bonds that are repaid from 1 to 10 years after they were initially issued.

Treasury bonds are long-term government bonds with maturities of more than 10 years.

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Types of Bonds

Treasury Inflation-Protected Securities (TIPS): Treasury issues in which the principal amount is tied to the Consumer Price Index to protect the buyer against the effects of inflation

Savings bonds are issued by the U.S. government in amounts ranging from $50 to $10,000.

Municipal bonds (munis) are issued by states, cities, and various government agencies to raise money for public projects such as building schools, highways, and airports.

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Mutual Funds

Portfolio Diversification: Spreading investments across enough different vehicles to protect against significant declines in any one vehicle

Mutual funds are financial instruments that pool money from many investors to buy a diversified mix of stocks, bonds, or other securities.

Thousands of funds are now available on the market, so choosing the right fund takes some research.

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Mutual Fund Categories

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Derivatives

• Options

• Financial futures

• Commodities futures

• Currency futures

• Credit futures

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Securities Markets

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• Stock exchanges

• Bond market

• Money market

• Derivatives market

Investment Strategies and Techniques

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• Why do you want to get more money?

• How much will you need—and when?

• How much can you invest?

• How much liquidity do you need?

• What are the tax consequences?

Analyzing Financial News

• Bull Market

• Bear Market

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Creating an Investment Portfolio

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Buying and Selling Securities

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