chapter 12 investing in stocks and bonds

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CHAPTER 12 INVESTING IN STOCKS AND BONDS. The Risks Of Investing. Business Financial Market Purchasing Power Interest Rate Liquidity Event. Returns from Investing. Current income Capital gains Interest-on-interest. Interest-on-Interest. - PowerPoint PPT Presentation

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CHAPTER 11: INVESTING IN STOCKS AND BONDS

CHAPTER 12

INVESTING IN STOCKS AND BONDS 2008 Thomson South-Western12-#The Risks Of Investing

BusinessFinancialMarketPurchasing PowerInterest RateLiquidityEvent12-#Returns from InvestingCurrent incomeCapital gainsInterest-on-interest

12-#Interest-on-InterestInvestment returns must be reinvested in order for compounding to take place

Utilizes the time value of money concepts presented earlier12-#Chapter 12Interest-on-Interest

12-#The Risk-Return Trade-Off

If you want GREATER RETURN, you will most likely have to accept GREATER RISK12-#Chapter 12The Risk-Return Trade-Off

If you want GREATER RETURN, you will most likely have to accept GREATER RISK12-#Chapter 12The Risk-Return Relationship

12-#What Makes A Good Investment?Future return

Approximate yieldDesired rate of return

12-#Chapter 12Investing in Common StockEach share represents equity or part ownership in the company.

Stock ownership allows the investor to participate in the profits of the firm.

Stock ownership is a residual; other obligations of company must be paid first.12-#Chapter 12The Dow and the NASDAQ, 1996-2006

12-#Usually one share = one vote

Most small shareholders assign their votes to a proxy, another party who will vote for them

Voting rights are not particularly important to small shareholders

Voting Rights12-#Short-term capital gains (sale of securities held less than one year) are taxed at regular income tax rates, which go up to over 30%.

Cash dividends and long-term capital gains (sale of securities held longer than one year) are taxed at a maximum rate of 15%.

Gains are not taxed until realized.Basic Tax Considerations 12-#Usually paid quarterly.

Can be paid even when company shows a loss.

Paid either in cash or in additional shares of stock.Dividends12-#Stock dividends are paid in new shares given to current shareholders. Cash dividends are most common and most desirable.Dividends12-#EPS =(Net profits after taxes Preferred stock dividends paid)Number of shares outstandingEarnings per Share (EPS) amount of net income earned by one share of common stockKey Measures of Performance12-#The market is used as a benchmark of performance and is assigned a beta of 1. Stocks with betas < 1 are relatively less volatile in price swings.Stocks with betas > 1 are relatively more volatile in price swings.Beta indicator of a stocks price volatility relative to the market. Key Measures of Performance12-#Types of Common StockBlue-Chip issued by large, well established companies.Usually pay dividends, which lends price stability.Returns are considered more dependable and less risky.

12-#Usually pay low or no dividends.Typically experience more price volatility.

Tech issued by companies in the technology sector.

Most are either growth or speculative stocks.Some are blue-chip stocks.Growth issued by companies expected to have above average rates of growth in operations and earnings.Types of Common Stock12-#Pay relatively high dividends.Attractive to people who seek current income.

Speculative issued by companies which are considered to have higher risk.

The company, its products, or the industry may be new or unproven.Stock prices may be highly volatile.Income issued by companies which have a fairly stable stream of earnings.Types of Common Stock12-#Most are found in basic industries.Always have a positive beta.

Defensive issued by companies whose stock prices usually remain stable during economic downturns.

Companies usually provide basic needs, such as consumer goods.Betas are usually low or even negative.Cyclical issued by companies whose stock prices move in same direction as the business cycle.Types of Common Stock12-#Usually offer greater returns than larger companies.Stock prices tend to be less volatile than small caps.

Small Cap issued by companies with market capitalization of $1 billion or less. Offer possibility of high returns.Prices can be very volatile due to high risk exposure.Mid-Cap issued by companies with market capitalization of $15 billion.Types of Common Stock12-#Offer investors greater portfolio diversity.International mutual funds and American Depositary Receipts (ADRs) provide convenient ways to invest in foreign securities.Currency exchange rates can impact returns on investments.Foreign stock issued by companies from other countriesMarket Globalization and Foreign Stock12-#Investing in Common StockAdvantagesPotential returnsActively traded and highly liquidInvolve no direct managementDisadvantagesRiskTiming of purchases and salesUncertainty of dividends

12-#Investing in Common Stock

12-#Making the Investment DecisionPutting a value on stockThe investment club approachTiming your investmentsPlow back your earningsDividend reinvestment plan (DRP)12-#Dividend Reinvestment Plan

12-#Investing in BondsFixed income securityInterest rates and bond prices move in opposite directionsVersatilePreservation and long-term accumulation of capital

12-#Bonds v. StocksRelative to stock, bonds have a lower returnBut, lower risk

12-#Bonds v. Stocks

12-#Bond Issue CharacteristicsA bond is loanthe bondholder is lending money to the bond issuer.Generally, interest is paid to the bondholder every 6 months.The coupon rate is the annual interest rate paid by the bond issuer.The maturity date is when the loan ends and the bond issuer repays the principal to the bondholder. 12-#Regardless of the market price paid for the bond, the bondholder will receive the par value at maturity.

Bonds offer current income during the time the bonds are held.

If sold before maturity, bonds can also generate capital gains (losses). The par value is the amount of principal that must be repaid to the bondholderusually $1000 on a corporate bond.Bond Issue Characteristics12-#The Bond MarketTreasury BondsMunicipal BondsCorporate Bonds12-#The Bond MarketTreasury Bonds U.S. Treasury obligation with maturity of more than 10 years that pays interest semiannually12-#The Bond MarketMunicipal bondsIssues of states, counties, cities, and other governmental subdivisionsInterest income is usually free from federal income tax (tax-free bonds)

12-#The Bond Market

Municipal bonds:12-#The Bond MarketCorporate bondsIndustrialsPublic utilitiesRail and transportation bondsFinancial issuesFirst mortgage bonds, convertible bonds, debentures, subordinated debentures, income bonds12-#Bond RatingsA letter grade is assigned to new bond issues to designate investment quality.

The lower the rating, the greater the risk of default and the higher the coupon rate which must be offered.

Outstanding bonds are also reviewed regularly to ensure that their ratings are still valid.12-#Chapter 12Bond Ratings

12-#Chapter 12Bond Ratings

12-#Chapter 12Bond Prices and YieldsThe price of a bond is a function of its coupon, length of maturity, and the movement of market interest rates.Premium bondDiscount bond

12-#Bond Prices

12-#Bond YieldsThe yield on a bond is the rate of return you would earn if you held the bond for a stated period of time.

12-#