Chapter 14: Investing in Stocks and Bonds

Objectives

Describe stocks and bonds and how they are used by corporations and investors.

Define everyday terms in the language of stock investing.

Classify stock according to their basic descriptive categories.

Objectives

Describe the major characteristics of bonds.

Differentiate among the four general types of bonds.

Objectives

Describe what the investor should consider before investing in bonds, particularly the current yield and yield to maturity.

List the advantages and disadvantages of investing in bonds.

Common stock

Preferred stock

Bonds

Stocks and Bonds and How They are Used

Why do corporations issue common stock?Equity financing

To raise money to start, expand or help pay for ongoing business expenses

They don’t have to repay the money Dividends are not mandatoryStockholders have voting rights-proxy

Investing in Stocks

Why Do Investors Purchase Stock?

Income from dividends

Dollar appreciationof stock value (averaged 10% since 1926).

Increased value from stock splits

Percentage of People in Different Age Groups That Own Stocks

Income from Dividends

Dividends can be paid in: Cash Additional stock Company products

Who is entitled to the dividends? Record Date Ex-dividend Date

Dollar Appreciation of Stock Value

100 shares of common stock purchases January 5, 2007 and were sold January 5,2010; total dividends of $4.97 per share for the four years.

Transaction summaryTotal return $7,065Minus total investment - 5,735Profit from stock sale $1,330Plus dividends +497Total return from the transaction $1,827

Stock Split

• 2:1• 3:1• 3:2

• Firm’s management usually has a theoretical stock price range for the firm’s stock.

Common vs. Preferred Stock

Common stockget dividends depending on profit the

company makes

Preferred stock receive cash dividends before common

stock holderspre-determined dividend ratemost preferred stock is callable

Features of Preferred Stock

Cumulative preferred stock unpaid cash dividends accumulate and are

paid before cash dividends to common stock holders

Conversion feature can be traded for shares of common stock

Characteristics of Common Stock

Earnings per share (EPS) After tax earnings divided by the number of

outstanding shares of common stock.

Price/earnings ratio (P/E ratio) Price of a share of stock divided by the

corporation’s EPS.

Dividend payout ratio Annual dividend amount divided by EPS

Language of Stock Investing

Historical information

Price/Earnings to Growth Ratio: A Look to the Future

Step 1: Determine the projected change Step 2: Use the PEG formula

PEG = Price earnings ratio divided by annual EPS growth.

Language of Stock Investing

Language of Stock Investing

Look at book value of one sharenet worth of company divided by the

number of outstanding shares

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

Buying and Selling Stocks

Primary market Initial Public Offering (IPO)

Secondary market Security Exchange

New York Stock ExchangeRegional Exchange

Over the Counter MarketNasdaq

Brokerage Firms

Full Service

Discount

Online

Completing Stock Transactions

Market Order

Limit Order

Stop Order

Day Order, Week Order, Month Order or Good Until Canceled (GTC) Order

Long-Term Investment Strategies

But-and-Hold

Dollar Cost Averaging

Direct Investment

Dividend Reinvestment Plan (DRIP)

Short-Term Techniques

Day Trading

Buying on Margin

Selling Short

Trading in Options

Make a Decision toSell Stocks

1. Stock reaches target price. 2. Favorable development temporarily push up

price. 3. Good profits unlikely to continue. 4. Stock lags behind others in industry group. 5. Company profits begin to fall short of

projections. 6. Industry/company prospects are deteriorating. 7. Losses are moderate. 8. Stock’s price/earnings ratio appears too high.

Registered and bearer

Callable

Warrants

Convertibility

Language of Bond Investing

Indenture

Face value, coupon rate, maturity date

Secured and unsecured

Senior and subordinated

Language of Bond Investing

Corporate bonds

U.S. government securities

Treasury bills, notes, and bonds Federal agency issues

Municipal Bonds

Types of Bonds

Susceptibility to certain risks

Credit

Callability

Inflation

Interest rate

Considerations Before Investing in Bonds

Premiums and discounts

Current yield

Yield to maturity

Tax-equivalent yields

When to sell

Considerations Before Investing in Bonds

Formula 14.2

Formula 14.3

Pay higher interest rates than savings

Offer safe return of principle

Have less volatility than stocks

Offer regular income

Require smaller initial investment

Advantages of Investing in Bonds

No hedge against inflation

Can be quite volatile

Compounding is almost impossible

Subject to investors tax rate

Poor marketability

Disadvantages of Investing in Bonds