Financial Assets and Investments

1. Financial Assets and Investments An Introduction

2. Terms • Investments-The act of redirecting resources from being consumed today so they may create benefits in the future; the use of assets to earn income or profit • Financial Assets (securities)-The claim on the property or income of a borrower • Bond-a note stating that you have loaned money to a company or government institution & will be paid interest on the loan. • Intermediaries-institutions that help channel funds from savers to borrowers: banks, savings and loans, credit unions, finance companies, life insurance co., pension funds, mutual funds • Dividends-portion of a corporations profit paid to stockholders • Capital gain-profit you make when you sell your stock for more than you paid for it. • Pension-income a retiree receives after working a certain number of years or reaching a certain age.

3. Municipal Bonds (“muni” bond) • The purchaser of a municipal bond is effectively loaning money to a government entity, which will make a predetermined number of interest and principal payments to the purchaser (it’s like an I.O.U. issued as a way to borrow) • Issuers typically use municipal bond proceeds to finance day-to-day operating activities or capital expenditures for the public good such as road, hospital, school, or infrastructure projects. • When the bond matures, the issuer repays the principal to the investor. In most cases, the investor will receive regular interest payments from the issuer until the bond matures. • One of the biggest advantages of investing in municipal bonds is their tax-advantaged status. Majority of municipal bonds are exempt from federal, state, and local taxes. • That means many investors in high tax brackets particularly benefit from investing in municipal bonds. • Secure-Municipal bonds are more likely to repay the debt since it is issued by government entities because government is unlikely to declare bankruptcy. • Disadvantage is that it yields a lower return.

4. Junk Bond • A junk bond works the same as most other bonds -- an investor purchases a bond from a bond issuer with the assumption that the money will be paid back when the bond reaches its maturity date. • Junk bonds are usually purchased as speculative investments. • Although investors rake in higher yields (sometimes over 12%), they risk the chance that they never get their money back. • The junk bond issuer may not be able to repay the original principal or interest.

5. Corporate Bond • When a person loans money to a corporation with a set coupon and/or interest rate-usually used to expand business, cover expenses, and finance other activities • The par value may go as low as $1000, $5000, $10,000-$10,000 being the more common • There is a moderate risk involved depending on the financial health of the company-if the company goes bankrupt-it won’t be able to pay what it owes. • Usually purchased as a long-term investment but the bond can be liquidated quickly • Disadvantage is that is it taxable income and the interest rate can change • Pays a higher rate of interest than government bonds • Supply & Demand determine the price of the bond • Monitored by the SEC

6. Mutual Funds Open-ended investment companies that pool investors' money into a fund operated by a portfolio manager (sells stock in itself-reinvests the money and pays dividends to its shareholders) This manager then turns around and invests this large pool of shareholder money in a portfolio of various assets, or combinations of assets., such as stocks, bonds, currencies, money market securities Advantages of investing in mutual funds include: • Professional management • Investment diversification (instant portfolio and invested money is spread out among many companies which the mutual fund is investing in) • Liquidity • Potential for growth • Lower risks Disadvantages: • Many funds charge hefty fees, leading to lower overall returns. • Over time, statistics have shown that most actively managed funds tend to underperform their benchmark averages. • Mutual funds cannot be bought or sold during regular trading hours, but instead are priced just once per day.

7. Money Market Mutual Funds • Special type of Mutual Fund • Purchased by intermediaries as short-term financial assets • Money invested will make short-term loans to businesses or the government • Low risk • Pays higher interests to investors • Not covered by the FDIC

8. U.S. Treasury Notes & Bonds • Are debt instruments of the U.S. Government, used to pay for government activities and to pay off government debt-buy directly from the U.S. Treasury • Considered to be long-term investments • Safest form of investment (almost no risk) • Very easy to obtain-minimum purchase is $1000 • Non-transferable • Long term-Treasury bonds have maturities of 10 years or longer (30 years) • Notes have maturity time of 2-10 years • Penalty for early redemption • Low return due to trade-off between risk and return • Carry lowest degree of risks • Are a benchmark against which all other types of bonds are measured • Market value can fluctuate but considered to be the safest of bonds due to the fact that they are secured by the full faith and credit of the U.S. government

9. Preferred Stock • Your buying the right to receive a fraction of the corporation’s profit • Non-voting share of ownership in a corporation • Pays dividends-fixed at an annual rate • Lower to moderate risk level • Good growth potential • Lower returns • Preferred shareholders have priority over common stockholders on earnings and assets in the event of liquidation and they have a fixed dividend (paid before common stockholders), but investors must weigh these positives against the negatives, including giving up their voting rights and less potential for appreciation. 

10. Common Stock • One share of common stock represents ownership of a small percentage of the respective company. • Each share of common stock owned entitles the purchaser to one vote on certain issues within the company (issues such as instituting new corporate policy, electing or re-electing the board of directors and stock splits are voted on, usually annually, by the investors). • Greatest potential for growth • Higher return than many assets-The price of a common stock depends on the perceived health of a company and fluctuations in the overall stock market • Last claim on assets-Common stockholders are last in line for dividends behind all debtors and preferred stockholders; meaning that they will get what money is left over after all others have been paid. • May not get a dividend • Risky • Common stock can be easily bought through many channels, such as banks, stockbrokers or even online trading companies

11. 401K • A 401(k) plan is a tax-deferred salary savings plan that companies can offer their employees as a retirement account. • The plan invests contributed funds in a securities portfolio. The composition of the portfolio may vary depending on how plans are managed by the company and on the risk preferences of the employee. In most cases, employees may choose from a variety of portfolio allocations.  • Contributions are deducted on a pre-tax basis from payroll. Employees choose how much they want deducted from their salary, up to the maximum allowed by the plan. In many cases, employers will match employee contributions up to a specified percentage and, in some cases, employers may offer additional contributions as part of an incentive package. • The 401(k) plan contains constraints regarding when funds accruing in the account may be withdrawn. Each plan specifies a retirement age when funds may be freely withdrawn. Should the employee choose or need to withdraw funds prior to retirement age, he will incur certain penalties specified in the plan. • The plan's withdrawal restrictions serve as an incentive for employees not to use the funds and allow them to grow as much as possible.

12. Certificate of Deposit (CD) • A certificate of deposit is a promissory note issued by a commercial banks but you may purchase them through stockbrokers also (they are still bank CD’s).   • A CD bears a maturity date, a specified fixed interest rate (even if interest rates increase) and can be issued in any denomination-will vary among banks • The term of a CD generally ranges from one month to five years • Lower returns but higher than traditional money market accounts • Penalty for early redemption-set by each bank and different nationwide • Non-transferrable • Low risks- beneficial for a risk-averse investor who is looking to save and will not need funds until the instrument reaches maturity. • CDs are not publicly traded securities. As such, you will not find them traded on any exchange. • The FDIC insures CDs for up to $100,000. FDIC Insurance covers both principal and accrued interest. • Unlike Treasury notes, CDs are fully taxable at the state, local and federal levels.

13. IRA • A government sponsored, tax-deferred personal retirement plan.  • Once the account has been established, the individual can contribute a maximum of several thousand dollars per year into an IRA. The IRA plan, which was established in 1974 by Congress, has been an extremely popular retirement savings plan for workers for over thirty years. • Taxes on Traditional IRA contributions and earnings are deferred until the account owner takes a distribution from the IRA. When money is withdrawn from a Traditional IRA it is taxed as regular income. Withdrawals are typically made when or after the plan owner has reached the age of 59 1/2. If the plan owner withdraws money from the account prior to retirement age, then he/she will incur a 10% penalty payable to the IRS (unless specific circumstances apply). • Eventual withdrawal from an IRA is taxed as income; including the capital gains. Because income is likely to be lower after retirement, the tax rate may be lower. Combined with potential tax savings at the time of contribution, IRAs can prove to be very valuable tax management tools for individuals. Also, depending on income, an individual may be able to fit into a lower tax bracket with tax-deductible contributions during his or her working years while still enjoying a low tax bracket during retirement. • Non-transferrable • Long-term