Download - Investing in Stocks and Bonds. Introduction When you invest in stocks and bonds, you can increase returns significantly while increasing risk only slightly

Investing in Stocks and Bonds

Introduction

When you invest in stocks and bonds, you can increase returns significantly while increasing risk only slightly. These investments belong in everyone’s investment portfolio because they provide opportunities for conservative, moderate, and aggressive investors alike

Your Next Five Years

In the next five years:

1. Include stocks and bond or mutual funds that own stocks and bonds in your investment portfolio.


2. Use fundamental analysis to determine a company’s basic value before investing in any individual stock.

3. Resist putting money into so-called hot stocks.


4. Invest part of the conservative portion of your portfolio in TIPS (Treasure Inflation-Protected Securities) to beat inflation.

5. When you have children use zero-coupon bonds to help save for their education.

Copyright ©Cengage Learning. All rights reserved. 14 - 6

Learning Objective #1

Explain how stocks and bonds are used as investments.

The Role of Stocks and Bonds in Investments

Corporation

Public Corporation

Startup Capital

Common Stock

Stocks are shares of ownership in a corporation.

Cash Dividends

Market Price

Shareholder (or Stockholder)

Common Stock

Residual Claim

Limited Liability

Board of Directors

Management

Preferred Stock

Cumulative Preferred Stock

Noncumulative Preferred Stock

Convertible Preferred Stock

Bonds

Bonds are interest-bearing, negotiable instruments certificates of long-term debt.

Principal

Maturity Date

Concept Check 14.1

Distinguish between common stocks and bonds.

How do public corporations use stocks and bonds?

Why do individuals invest in stocks and bonds?



Classify common stocks according to their major characteristics.

The Major Characteristics of Common Stocks

Match your investment choices using P/E ratio and Beta.

Price/Earnings (or P/E) Ratio Trailing P/E Ratio Projected P/E (or Forward P/E) Ratio Earnings Yield


Use Beta to Compare a Stock to Similar Investments Beta (or Beta Value or Beta Coefficient):

Measure of stock volatility.


Most stocks are cyclical and some are countercyclical.

Cyclical stock

Countercyclical (or defensive) stock


Income Stocks

Growth Stocks Well-known growth stocks Lesser-known growth stocks

Value Stocks


Speculative Stocks

Tech Stocks

Blue-Chip Stocks

Large-cap, Mid-cap, Small-cap, and Microcap Stocks

Concept Check 14.2

Distinguish between income stocks and growth stocks.

Explain how a value stock might or might not differ from a blue-chip stock or a tech stock.



Describe fundamental and numerical ways to evaluate stock values.

How to Evaluate Stock Values

Use fundamental analysis to evaluate the financial strength of the company.

Use technical analysis to predict the success of a stock based on indicators of the workings of the market as a whole.

How to Evaluate Stock Values

Corporate earnings are most important.

Earnings per share

Price/Sales ratio

Numerical Measures to Evaluate Stock Prices

Cash Dividends

Dividends Per Share

Dividend Payout Ratio

Dividend Yield


Numerical Measures to Evaluate Stock Prices

Book Value

Book Value Per Share

Price-to-Book Ratio

Concept Check 14.3

What is the focus of fundamental analysis?

Distinguish between EPS and the P/E ratio.

Summarize the differences among dividend payout ratio, dividends per share, and dividend yield.



Determine whether an investment’s potential rate of return is sufficient.

Calculating a Stock’s Potential Rate of Return

Use beta to estimate the risk of the investment.

Estimate the market risk (or systematic risk).

Calculate your required rate of return.

Calculate the Stock’s Potential Rate of Return

Add up projected income and price appreciation. Potential Rate of Return Approximate Compound Yield (or

ACY) Compare the required rate of return with

the potential rate of return on the investment.

Concept Check 14.4

Explain why individuals considering investing in stocks begin by thinking about the return on U.S. Treasury bills.

Explain how a stock with a beta of 1.0 differs form ones with a beta of 1.2 and 2.5.

Summarize the steps in calculating the potential rate of return on a stock investment.


Use the Internet to evaluate common stocks in which to invest.

Use the Internet to Evaluate and Select Stocks

Begin by setting criteria for your stock investments.

Basic investment information: Fool.com kiplinger.com/personalfinance/ money.cnn.com/pf/indes.html finance.yahoo.com/marketupdate?u

How To Use the Internet to Evaluate and Select Stocks

Stock-Screening Tools: Screen.yahoo.com/stocks.html screen.morningstar.com

Security analysts’ research reports

Corporate news Annual reports, 10-K reports, prospectus


The two most popular firms that offer stock advisory research services: Morningstar Value Line


Economic data Stage in the business cycle Inflation rates Interest rates Expected changes in these



Securities market indexes Dow Jones Industrial Average Standard & Poor’s 500 Index NASDAQ Composite Index Russell 3000 Index Wilshire 5000 Index


Securities exchanges (stock markets)

Over-The-Counter (or OTC) Marketplace

NASDAQ

Figure 14.2: How Stocks Are Quoted


Use portfolio tracking to monitor your investments: E*Trade: us.etrade.com/e/t/home MSN Money: moneycentral.msn.com Morningstar: morningstar.com InvestorGuide.com

Concept Check 14.5

Give three examples of the types of website resources available to investors on the Internet.

List five places where you can obtain investment information on a specific stock.

Concept Check 14.5

Distinguish between the Dow Jones Industrial Average and the S&P 500.

Where can you go to look up stock symbols and prices



Summarize how stocks are bought and sold.

Buying and Selling Stocks

Stockbroker (or Account Executive)

Security’s street name


Discount, online, and full-service (or general) brokers


Broker commissions and fees Round Lots Odd Lot Differential: The odd-lot portion of the

transaction.

Figure 14.3: Securities Transactions


How to order stock transactions: The process of trading stocks involves a

floor broker and a specialist.

Securities prices are either matched or negotiated.


Types of stock orders (executing an order): Market order Limit order Stop order (or stop-loss order) Time limits: fill-or-kill order, day order,

open order


Margin buying and selling short are risky trading techniques.

Margin trading is buying stocks on credit (using a margin account).


Buying on margin can increase returns.

Buying on margin can also increase losses.

A margin call makes matters even worse.


Selling short is selling stock borrowed from your broker. Buying long Selling short

Concept Check 14.6

Summarize the differences among discount, online, and full-service brokers.

Distinguish between round lot and odd lot broker’s commissions.

Summarize the differences among types of stock orders: market, limit, and stop order.

Concept Check 14.6

Explain what buying on margin is an how it can go wrong for an investor.

Explain what selling short is and how it can go wrong for an investor.



Describe how to invest in bonds.

Investing In Bonds

Investment-Grade Bonds

Speculative Grade (or Junk) Bonds

Default Rate

Investing In Bonds

Corporate, U.S. government, and municipal bonds Bond rating Default (or Credit) risk

Table 14.3: Summary of Bond Ratings

Moody’s S&P Description

Aa–A AAA-A High Quality

Baa-Ba BBB-B Medium Quality

B-Ca CCC-C P and I at Risk

C DDD-D In Default

Investing In Bonds

Treasury bills (t-bills), notes, and bonds Discount yield, I-bonds TIPS (or Treasury Inflation-Protected

Securities) Series EE savings bonds Federal agency debt issues

Investing In Bonds

Municipal Bonds (or Munis)

Tax-Free (or Tax-Exempt) Bonds

Investing In Bonds

Unique characteristics of bond investing: Coupon rate (or coupon, coupon yield,

or stated interest rate)

Secured bond or unsecured bond (debenture)

Callable bonds

Evaluating Bond Prices and Returns

Interest rate risk results in variable value. Market interest rates

Interest rate risk

Fixed yield versus variable value

Premiums and discounts

Evaluating Bond Prices and Returns

Present Value

Current yield

Yield to maturity

Concept Check 14.7

Distinguish between investment- and speculative-grade bonds.

Give some reasons why individuals often invest in corporate bonds rather than Treasuries.

Concept Check 14.7

Summarize the differences among treasury bonds, I bonds, and TIPS bonds.

Explain what interest rate risk is and tell what calculation individuals considering bond investments should use to avoid that problem when buying an existing bond.

The Top 3 Financial Missteps of Investing in Stocks and Bonds

People slip up in investing in stocks and bonds when they do the following:1. Buy and sell more often than they should.

2. Diversify less than they should.

3. Hold on to a poor performing investment too long.

Do It NOW!

The smart investor in stocks and bonds studies particular securities thoroughly before investing. Start today by:

1. Identifying three individual stocks (see pages 421-423) that are appropriate for your investment goals.

Do It NOW!

2. Assessing after one or two months whether the changes in price you saw were due primarily to movements in the stock market as a whole (market risk) or aspect s of the companies’ own success (random risk).

3. Following the price fluctuations of those stocks for one or two months.

Download - Investing in Stocks and Bonds. Introduction When you invest in stocks and bonds, you can increase returns significantly while increasing risk only slightly

Top Related