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Slide 1: Personal & Family Finance Section 8 Investing 9-1
Slide 2: Why would you want to invest your money? What are some ways you can invest your money? 9-2
Slide 3: Goals and Investment Alternatives  Reasons for investing:     Enjoyment such as your home or antiques Current income such as interest or dividends Providing for future needs such as retirement To reduce your current tax liability Tangible assets: Assets you can touch such as a house Intangible investments: Assets such as stocks and bonds that are paper assets 9-3  Types of investments  
Slide 4: Tangible Investments  Advantages:    Disadvantages:    Can enjoy or use May provide a good hedge against inflation May have greater control over return May offer significant tax advantages   Can involve work and inconveniences Not liquid so not easily bought and sold Usually have high carrying costs, such as insurance or taxes 9-4
Slide 5: Factors to Consider Before Investing  Do you want current or future return?  Investing versus speculating   What is your income tax situation? What is your attitude towards risk?     Risk averse investors have a low tolerance for risk. Risk seeking investors have a high tolerance for risk. Investors need to understand their risk profile before investing. If an investor wants a higher rate of return, they must accept higher risk to earn a higher rate of return. 9-5
Slide 6: Basic Investment Alternatives      Investments Held for Liquidity Securities with Long or No Maturities Pooling Arrangements Contractual Claims Tangible Assets 9-6
Slide 7: Investments Held for Liquidity  Bank accounts    Savings Certificates of deposit Money market deposit accounts   Money market mutual funds Series EE and Series HH bonds 9-7
Slide 8: Securities with Long or No Maturities  Bonds and notes issued by:    The U.S. Treasury and other federal agencies State and local governments Corporations     Preferred stock issued by corporations Common stock issued by corporations Bonds and notes mature from one to thirty years Stock never matures because it is ownership in a business 9-8
Slide 9: Pooling Arrangements  Mutual funds     Income funds Growth funds Balance funds Index funds   Investment trusts Limited partnerships 9-9
Slide 10: Contractual Claims   These are very high risk investments because their value is dependent upon the value of other assets Some of these assets are:     Warrants and rights Call and put options Commodity futures Financial futures 9-10
Slide 11: Tangible Assets  Real estate   Personal residence Rental properties   Gold and other metals/minerals Jewelry and collectibles 9-11
Slide 12: Organized Exchanges   A physical place where buyers and sellers meet to trade securities. Examples are the New York and American Stock Exchanges New York Stock Exchange (NYSE):   It is the largest exchange in the world. It is known as the “Big Board”. It is much smaller than the NYSE. It is now affiliated with NASDAQ. 9-12  American Stock Exchange (AMEX):  
Slide 13: How the NYSE Works     Securities are traded at designated sites on the floor, which are called “posts”. You must have a “seat” to trade on the floor. Seat owners are commission brokers, floor brokers, floor traders, and specialists. Specialists play a key role in maintaining an orderly market.  A specialist stands ready to take the opposite side of a trade. If an investor wants to buy a stock and there is not another investor who wants to sell, the specialist will sell. 9-13
Slide 14: The Over-the-Counter Market    Largest exchange, in terms of number of issues traded Securities are traded through a communication system called National Association of Securities Dealers Automated Quotations System (NASDAQ). Mostly small companies and high-tech companies are traded in this market.  High-tech companies: Intel, Microsoft, etc. 9-14
Slide 15: How SIPC Insurance Works    Suppose you own 100 shares of GM when your broker closes down. GM’s price on that day is $50 a share. Your account is worth $5,000 that day. Two weeks later, your account is taken over by a new broker who confirms your ownership of 100 shares. GM’s price has fallen to $30 a share. SIPC only guarantees delivery of the shares; but, you lose $2,000.  GM’s share price decline is unrelated to the failure of your broker. 9-15
Slide 16: The Sarbanes-Oxley Act of 2002   This law was passed in response to some of the financial scandals of 1990 such as the failure of Enron, WorldCom, etc. The act institutes reforms to improve corporate responsibility and financial disclosures.  Stock analysts are also required to disclose potential conflicts of interest that might influence their stock ratings.  It also was created to combat corporate and accounting fraud.  It created the Public Company Accounting Oversight Board (PCAOB). 9-16
Slide 17: Other Regulation  States have what are called “Blue Sky” laws.   These are similar to federal laws. The laws apply to intrastate Security Sales.  Self-regulation is also provided by the National Association of Securities Dealers (NASD) through:    Dealers Rules of Fair Practice Code of Procedure Uniform Practice Code  Binding arbitration is an important component of self-regulation. 9-17
Slide 18: Using the Services of a Stockbroker    Most financial investments are bought and sold with the help of a securities dealer (stockbroker). Stockbrokers are distinguished in terms of the level of service provided as well as the fees. Investors can choose among the following:    Full-service firms Discount brokers Internet trading 9-18
Slide 19: Selecting a Stockbroker  Full-service firms feature:      Research that identifies investment opportunities Representatives to help with portfolio planning Access to new stock offerings Dedicated advisor who works directly with customer High commissions 9-19
Slide 20: Selecting a Stockbroker (Con’t)  Discount brokers feature:    Possibly no personal contact; you trade over an 800 number or over the Internet Therefore, discount brokers are most appropriate for customers who have some trading experience and are comfortable placing orders Lower commissions-savings can be as high as 90% versus a full-service firm  Internet trading: both full-service and discount brokers offer this service due to its low cost. 9-20
Slide 21: Kinds of Accounts  Cash account is similar to a charge account except the purchase must be paid for within three working days.  The broker will hold the securities or you can ask to have them sent to you.  Margin accounts allow you to borrow money to purchase securities.     Currently, you can borrow 50% of the cost of securities. You are only required to deposit 50% of the amount. Since you are borrowing money, you are charged interest. Borrowing money increases your risk! 9-21
Slide 22: How Margin Works   You must deposit funds equal to 50% of the value of the securities purchased. This is your initial margin requirement. There is also a maintenance margin requirement (MMR) of 25%. Your equity in the account cannot be less than 25%.  If the stock prices fall, you may get a margin call from the broker. You will be required to deposit additional funds. 9-22
Slide 23: Margin Example  You buy 100 shares of GM stock @ $50 per share    Total purchase = $5,000 You must deposit $2,500 to meet your initial margin. You borrow the balance ($2,500) from the broker’s firm.  You will get a margin call if the total value of the securities falls below $3,333. Solve this equation:  Minimum value of securities = broker’s loan/(1 – MMR) = $2,500/(1 – 0.25) = $3,333  With 100 shares, GM would have to fall to $33.33 per share for you to get a margin call. You would have lost $1,667 ($5,000 – $3,333) 9-23
Slide 24: Finding Investment Information  Company sources  The Annual and Quarterly Reports; also company Web site Examples: Value Line, Moody’s, Standard and Poor’s Examples: Wall Street Journal, Investor’s Business Daily, Barron’s Internet as well as companies such as Bloomberg 9-24  Investment advisory services   Newspapers and magazines   Computer data sources 
Slide 25: What Is a Bond?   A bond is simply a loan. It is a marketable IOU. Bond parties   The issuer who is borrowing money The investor who lends the money Specifies interest payments Has a maturity, such as 20 years Is a small part of the overall loan Is easily traded in the bond market 9-25  The loan    The bond certificate  
Slide 26: Bond Certificate 9-26
Slide 27: Your Rights as a Bondholder   Bondholders are creditors. They have rights comparable to the rights of other creditors. A bond indenture is the contract between the issuer and the bondholders that spells out the rights of the bondholders.  It is similar to a loan agreement that you sign when you borrow money.  Protective covenants are restrictions on the issuer. These are included in the indenture and they are intended to strengthen the bondholders’ position. 9-27
Slide 28: Zero Coupon Bonds   Zero coupon bonds do not pay interest during the life of the bond. Interest is earned by paying less than the face value of $1,000 to buy the bond.  Example: you pay $500 today to buy a bond that will be redeemed in eights years for $1,000  A savings bond is an example of a zero coupon bond. You buy it for $50 and it is redeemed for $100 in the future. 9-28
Slide 29: Convertible Bonds  These bonds can be converted into common stock.  The conversion rate is the number of shares of stock acquired by converting 1 bond; e.g., 40 shares per bond. This is the bond value if it was converted into common stock. It is determined by multiplying the stock price by the conversion rate. For example: Stock price = $30; the conversion rate is 40 shares per bond; conversion value = $30 × 40 = $1,200 9-29  Conversion value of the bond   
Slide 30: Investing in Corporate Bonds  Trading costs can be high   Commission cost The bid-ask spread  Callable bonds are bonds that can be called prior to maturity.  No interest is paid after the call date  Mutual funds may be the best way for individual investors to invest in bonds. 9-30
Slide 31: Government-Issued Bonds   U.S. Treasury Securities U.S. Agency Bonds   Conventional Mortgage-backed General obligation (GO) bonds Revenue bonds  Municipal Bonds   9-31
Slide 32: U.S. Treasury Bonds  The characteristics are the same as corporate bonds:    Face value of $1,000 A maturity date such as 10 years Semiannual coupon payments    Investors can buy these directly from the Federal Reserve Bank Free of default risk May be subject to price risk but the degree depends on the time to maturity 9-32
Slide 33: U.S. Agency Bonds   Conventional bonds have the same characteristics as U.S. Treasury Bonds Mortgage-Backed Bonds:     Issued by agencies such as Fannie Mae Agency buys mortgages from local lenders Creates a pool of similar mortgages and issued bonds backed by these pools of mortgages Mortgage payments are “passed through” to the bond buyers  Due to the complexities of these bonds, it is best to invest through a mutual fund. 9-33
Slide 34: Municipal Bonds (Munis)   Issued by cities, counties, or states to fund projects General obligation (GO) bonds  These are backed by the full taxing authority of the issuer. Backed only by the revenues of the project that the bonds are financing These bonds are considered more risky since they are dependent upon the revenues from a project.  Revenue bonds    Most municipal bonds are free of federal income tax and may be free of state income tax. 9-34
Slide 35: Mutual Funds     A mutual fund is an investment company that pools the funds of many individuals to invest in stocks, bonds, and other investment securities. Investors buy shares in the mutual fund. The mutual fund buys: Shares in companies and/or, bonds of companies, municipalities, governments and/or, other investment securities A fund’s net asset value (NAV) is the total value of all the assets the fund owns (minus any liabilities) divided by the number of shares issued by the fund. 9-35
Slide 36: Selecting a Mutual Fund      Evaluate performance. Review the fund’s current portfolio. Examine expenses and turnover. Review evaluations in popular magazines and newspapers. Consult a professional evaluation service such as Morningstar or Lipper Analytical Services. 9-36
Slide 37: Other Evaluation Items  Review the fund’s current portfolio  Is there adequate diversification? Usually expressed as a percent of net assets Low expense ratios are desirable Compare to other funds with similar investment objectives Turnover percent measures the trading frequency High numbers = high trading 9-37  Review the fund’s operating expenses     Examine the portfolio turnover percent  
Slide 38: Portfolio Diversification  Reduces risk  Minimizes return 9-38
Slide 39: Investment Selection  Aggressive investor:  100% stocks: 1/3 large company, 1/3 small company, 1/3 international 30% large company growth stocks, the balance in bonds, including zero coupon 50% high-quality corporate bonds, 25% medium-quality corporate bonds, and 25% income stocks  Cautious investor:   Investor who needs current income:  9-39