Post on 30-Dec-2015
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.
Your Next Five Years
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.
Your Next Five Years
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.
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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?
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Learning Objective #2
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
The Major Characteristics of Common Stocks
Use Beta to Compare a Stock to Similar Investments Beta (or Beta Value or Beta Coefficient):
Measure of stock volatility.
The Major Characteristics of Common Stocks
Most stocks are cyclical and some are countercyclical.
Cyclical stock
Countercyclical (or defensive) stock
The Major Characteristics of Common Stocks
Income Stocks
Growth Stocks Well-known growth stocks Lesser-known growth stocks
Value Stocks
The Major Characteristics of Common 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.
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Learning Objective #3
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
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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.
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Learning Objective #4
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.
Learning Objective #5
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
How To Use the Internet to Evaluate and Select Stocks
The two most popular firms that offer stock advisory research services: Morningstar Value Line
How To Use the Internet to Evaluate and Select Stocks
Economic data Stage in the business cycle Inflation rates Interest rates Expected changes in these
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How To Use the Internet to Evaluate and Select Stocks
Securities market indexes Dow Jones Industrial Average Standard & Poor’s 500 Index NASDAQ Composite Index Russell 3000 Index Wilshire 5000 Index
How To Use the Internet to Evaluate and Select Stocks
Securities exchanges (stock markets)
Over-The-Counter (or OTC) Marketplace
NASDAQ
Figure 14.2: How Stocks Are Quoted
How To Use the Internet to Evaluate and Select Stocks
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
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Learning Objective #6
Summarize how stocks are bought and sold.
Buying and Selling Stocks
Stockbroker (or Account Executive)
Security’s street name
Buying and Selling Stocks
Discount, online, and full-service (or general) brokers
Buying and Selling Stocks
Broker commissions and fees Round Lots Odd Lot Differential: The odd-lot portion of the
transaction.
Figure 14.3: Securities Transactions
Buying and Selling Stocks
How to order stock transactions: The process of trading stocks involves a
floor broker and a specialist.
Securities prices are either matched or negotiated.
Buying and Selling Stocks
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
Buying and Selling Stocks
Margin buying and selling short are risky trading techniques.
Margin trading is buying stocks on credit (using a margin account).
Buying and Selling Stocks
Buying on margin can increase returns.
Buying on margin can also increase losses.
A margin call makes matters even worse.
Buying and Selling Stocks
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.
Copyright ©Cengage Learning. All rights reserved. 14 - 53
Learning Objective #7
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.