investing in stocks and bonds. objectives describe stocks and bonds and how they are used by...
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Investing in Stocks and Bonds
ObjectivesDescribe 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.
ObjectivesDescribe the major characteristics of bonds. Differentiate among the four general types of bonds.
ObjectivesDescribe 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?To raise money to start or expand a businessTo help pay for ongoing business expensesThey dont have to repay the money Dividends are not mandatoryStockholders have voting rightsInvesting in Stocks
Why Do Investors Purchase Stock?Income from dividends Dollar appreciation of stock value Increased value from stock splits
Common vs. Preferred StockCommon stockget dividends depending on profit the company makes Preferred stockreceive cash dividends before common stock holderspre-determined dividend ratemost preferred stock is callable
Calculating Total Return100 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: Return when sold:100 Shares @ $71 $7,100 100 shares @ $89 $8,900Commissions +55 Commissions - 70Total investment $7,155 Total Return $8,830Transaction Summary:Total Return $8,830Minus Total Investment 7,155Profit from Stock Sale $1,675Plus Dividends +260Total Return for the transaction $1,935
Features of Preferred StockCumulative preferred stockunpaid cash dividends accumulate and are paid before cash dividends to common stock holdersParticipation featurerare form of investmentcan share in earnings beyond stated dividend amountConversion featurecan be traded for shares of common stock
How to Evaluate a StockRead stock quotes in a newspaper, such as the Wall Street Journal52 week high and lowstock abbreviation and symboldividends per share in the last 12 monthspercent yieldprice earnings ratiovolumehigh and low for the dayclosing price and net change
Earnings per share (EPS) Price/earnings ratio (P/E ratio) Dividend payout ratio Market price
Book valueLanguage of Stock Investing
Market-to-book ratio Par value Total returnLanguage of Stock Investing
Preemptive rights Stock dividends Stock splits Voting rightsLanguage of Stock Investing
Classifications of Common Stock
Income stocks Growth stocks Speculative stocks Other characterizations
Types of Stock InvestmentsBlue chip stocklow riskconsistent dividendsex. AT&T, Kellogg's, General ElectricIncome stockhigher than average dividendsex. utility stock
Types of Stock InvestmentsGrowth stock -earns above average profitslow or no dividendsProfits reinvested in company, so...Stock price should go upex. Microsoft or Intel(continued)
Types of Stock InvestmentsCyclical stockfollows business cycles of advance and declines in the economyex. new construction, cars, timberDefensive stockremains stable even if the economy is decliningex. food and utility stocks(continued)
Numeric Measures to Consider When Evaluating a StockLook 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
Numeric Measures to Consider When Evaluating a Stock Look at the price earnings ratioalso called the P-Eprice of one share of stock divided by the earnings per share of stock over the last 12 monthsa low number means could be a good time to buy it, however many technology stocks have high P-EsLook at the beta for the stockstock with a beta >1.0 means more volatility(continued)
Long-Term and Short Term Investment StrategiesBuy-and Hold TechniqueDollar Cost Averaging
Direct Investment and Dividend Reinvestment Plan (DRIP)
Long-Term and Short Term Investment StrategiesDay TradingBuying Stocks on MarginSelling 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. Stocks price/earnings ratio appears too high.
Corporate bondFace valueMaturity dateBond indentureDebentureMortgage bondTrusteeSecured and unsecuredSenior and subordinated
Language of Bond Investing
Registered and bearer Callable Convertibility
Language of Bond Investing
Corporate bonds U.S. government securitiesTreasury bills, notes, and bondsFederal agency issues Municipal BondsTypes of Bonds
Tax Equivalent YieldTaxable equivalent yield = Tax exempt yield 1.0 tax rateThe taxable equivalent yield on a 5% tax-exempt municipal bond for a person in the 28% tax bracket is 6.94%
.05 1.0-.28 = .0694 = 6.94%
Susceptibility to certain risks CreditCallabilityInflationInterest rateConsiderations Before Investing in Bonds
Premiums and discounts Current yield Yield to maturity Tax-equivalent yields When to sellConsiderations Before Investing in Bonds
Approximate Market Value of a BondExample: 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 Shawns bond worth?Formula:Dollar Amount of Annual Interest = Approximate Market Interest Rate of Comparable Bonds ValueA. 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% = $45B. Solve for approximate market value.Dollar Amount of Annual Interest = Approximate Market Interest Rate of Comparable Bonds Value
$45 = $642.86 7%
Current YieldAssume 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
Corporate Bond TransactionAssume 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.
Pay higher interest rates than savings Offer safe return of principle Have less volatility than stocks Offer regular income Require smaller initial investmentAdvantages 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