INVESTING & THE STOCK MARKETS

1. INVESTING & THE STOCK MARKETS Chapter 11

2. Investing & Free Enterprise • Investing is essential to the free enterprise system. • It promotes economic growth and contributes to a nation’s wealth. – HOW? • People deposit money into a savings account and the bank lends this money to businesses. • Businesses can then increase production, which leads to expansion and growth.

3. Financial Intermediaries • Financial intermediaries, including banks and other financial institutions, accept funds from savers to make loans to investors.

4. Sharing RISKS • Dealing with financial intermediaries offers three advantages: • Sharing risk • Providing information • Providing liquidity • Sharing risk • Don’t put all your eggs in one basket! • Diversification allows you to spread out your investments so that you don’t put all of your money into one single investment. • Sharing risk helps ward against losing everything on a bad investment.

5. TYPES OF RISK • Investors must weigh the risks of investment against the potential rate of return on their investment. • How does diversification lessen the risks described in the chart?

6. Return and riskThe higher the risk, the higher the potential return! • The safer the investment, the lower the return. • Whenever people evaluate their potential investments, they must balance the risks involved with the rewards they expect to gain. • Some investments, like CDs, are very safe since they are gov’t- insured • Investing in a new business is far riskier, but … if it’s a success, the return could be very big.

7. INVESTMENT ALTERNATIVES BONDS = a way to save $ and earn interest Businesses and governments borrow $ through issuing of bonds A bond is an IOU Investor “loans” $ to corporation/government, holds bond until maturitydate, then gets paid back at par value Just like any loan, the borrower pays interest – the coupon rate - to the lender – usually via a coupon every 6 months U.S. savings bonds paid differently – all at end. Bond ratings: Standard & Poor’s, Moody’s Higher the bond rating, the lower the interest rate it will pay Risk? Liquidity? Return? Corporate Bonds U.S. Savings Bonds Municipal Bonds

8. Certificates of Deposit (CDs) Loans from investors to banks Investors can choose maturity date Usually 6 months, two years, three years, etc. Can deposit as little as $100 Severe $ penalties for early withdrawal Risk? Liquidity? Return? IRAs – Individual Retirement Accounts Way to save for retirement Set aside $3000/year – no taxes on this income so puts off paying taxes until worker is retired (& then in a lower tax bracket) High $ penalties if cashed in early Risk? Liquidity? Return? INVESTMENT ALTERNATIVES

9. A professionally managed type of collective investment scheme that pools money from many investors to buy securities(stocks, bonds, etc.) Have a staff of analysts Investors like them because: Gives them a diversified portfolio Experts are keeping up with the investments They pay dividends Slow to change in value Risk? Liquidity? Return? INVESTMENT ALTERNATIVES

11. WHAT ARE YOU REALLY GETTING WHEN YOU BUY A STOCK? • Part ownership… but no real control • A certain amount of risk • Faith in the financial reporting • Fairly liquid investment • Only a paper value until sold

12. What to look for when picking stocks… • Company information • News articles • Numbers: dividends; charts – price/volume trends • Analyst reports • Annual/quarterly reports • Insider buying/selling

13. PREFERRED STOCK Bought like any stock Dividends, if any, go to preferred shareholders first and are “guaranteed” Generally has no voting rights Ahead of common stock for liquidated assets in bankruptcy COMMON STOCK Most widely held type of stock Confers voting rights: 1 share = 1 vote May attend company annual meeting May raise concerns to Board of Directors May receive dividends Last in line for assets in a bankruptcy TYPES OF STOCK

14. “WALL STREET” ... • Refers in general to the markets in the U.S. for stock trading • It is where financial trading began in colonial America. • It is home to our oldest stock exchange, the New York Stock Exchange

15. WHAT IS AN EXCHANGE? • It simply refers to the meeting place - physical or virtual - for buyers and sellers of stocks & bonds (a/k/a “securities”) • In a stock exchange, representatives of buyers & sellers meet to trade on behalf of their customers. • These exchanges function as auction markets.

16. MAJOR U.S. STOCK EXCHANGES: • New York Stock Exchange - NYSE • is the oldest & largest in U.S. • is located at 11 Wall Street, NY, NY • “Blue Chip” stocks listed here • American Stock Exchange - AMEX • younger companies are listed here • lots of energy companies listed • located in NY also -- just a few blocks from NYSE

17. The Trading Floor of the New York Stock Exchange

18. How is this exchange different?

19. NASDAQ - National Association of Securities Dealers Automated Quotations • is an electronic market -- no floor trading / phone & computer only • is our second largest market • is based in Washington, D.C. • Primary focus -technology stocks

20. Securities & Exchange Commission • The SEC • Government agency responsible for overseeing the stock market • Established after the 1929 Crash • Function is to make sure investors are informed & to help prevent cheating in stock transactions • Prospectus required before stock purchases

21. THE “DOW” • Is the Dow Jones Industrial Average • Takes the average of 30 stocks to determine whether the market traded up or down for the day (compared to a previous average) • Serves as a “thermometer” & gives a quick reading of the market’s temperature

22. It is compiled daily by Dow Jones & Company (owner of the Wall Street Journal) • Investors use the Dow to compare the performance of their stocks • Dow was originally 12 stocks. The only stock in the original 12 Dow stocks that is in the 30 Dow stocks today is GE

23. The 30 Stocks of the Dow Jones Industrial Average

24. THE IMPACT OF 9-11 ON THE DOW

25. What’s the difference between a Bull and a Bear Market? Bull market – prices climbing over an extended period of time Bear market – prices falling over an extended period of time

27. Other Ways of Making Money in the Market Margin buying – you believe a stock will rise Buying with borrowed money

28. Buying on margin works like this: • You could buy stock with only a 10% down payment (1,000 shares, $10/share = total cost of $10,000 but you just put 10%/$1,000 down) • You borrow the remaining 90% ($9,000) from the stockbroker • Then, when the price goes up ($20/share for ex., you sell it ($20,000) & pay off broker ($9,000) and keep the remaining profit ($11,000) • BUT, when stock values start going down, everybody tries to sell & prices keep plummeting • Broker then sells off your stock (for ex., at $5 per share- $5,000) & gets less than what you owe him • Now you have no stock, and still owe $4,000 on your loan to the broker • So … what type of market do you need if you want to use margin buying?

29. Other Ways of Making Money in the Market: Short selling – you believe a stock price will fall Selling with borrowed stock – Borrow stock, not $, then sell to “cover” the stock you borrowed.

30. Short selling works like this: • You borrow stock from the broker (1000 shares) – this is what you have to return to him…1000 shares • You sell the borrowed stock – for ex., at $10 per share – and you are expecting the stock value to continue to go down (you now have $10,000) • When the prices do go down (let’s say to $5 per share), you now “cover” your stock loan and buy 1000 shares to repay the stock to the broker • You made a $5,000 profit off stock you never owned! • BUT, when stock prices start going up, you have a problem • If you had to buy back the stock at $12 for example, your cost would be $12,000 and you would be $2,000 down on this transaction

31. Should you diversify your stocks? How lucky do you feel? Had been dubbed “America’s Most Innovative Company” but in 2001 it died out in a bankruptcy wrapped up in accounting fraud, criminal charges, and the destruction of employee investments and retirement savings. TIP: Do diversify your portfolio! Buy different stocks so that losses in one can be balanced by gains elsewhere.

32. SAVING & COMPOUND INTEREST • THE TIME VALUE OF MONEY HAS A SIGNIFICANT IMPACT ON SAVINGS & INVESTMENT GROWTH: • The more time you have to invest, • The more money you have to invest, • & the higher the rate of interest you can earn • EQUALS A GREATER RETURN ON YOUR $

33. REMEMBER: THE RETURNIS THE AMOUNT EARNED ON ONE’S SAVINGS/INVESTMENTS COMPOUNDINGprovides even more incentive to invest early. COMPOUND INTEREST = the $ earned on your original deposit AND the interest payments you have received on that deposit in the past

34. The Rule of 72 • An easy rule to determine how much your savings or investments can grow with compound interest. • Just divide the interest rate into 72. The result tells you how long it will take for your money to double without further savings. • For example, you have $10,000, which is earning 6% interest (after tax). 72 divided by 6 = 12. • Every 12 years your $10,000 will double, so: • After 12 years you have $20,000 • After 24 years you have $40,000 • After 36 years you have $80,000

35. You go in for a summer job interview. The boss offers to pay you $50 a day for a 5-day, 10-week position • OR • You can earn only one cent on the first day but have your daily wage doubled every additional day you work. • Which option would you take? • Option A – you would earn $2,500 if you work all 50 days • Option B – if you took this offer and worked only HALF the summer, you would earn $167,772.16……by the 30th day you would have over $5,000,000!!! Do I Have A Deal for You!

36. The The Time Value of $ • DOES IT REALLY MATTER WHEN YOU START SAVING? • Jim and Mary are both 22. They both want to save $1000 a year for retirement. • Mary starts saving at age 22 and saves for 20 years, until she is 42. Mary then quits and leaves her savings to compound. • Jim starts 10 years later at 32 and saves for 33 years until age 65. • Both earn 4% on their savings every year. • Who do you think has more money at age 65?

37. Mary has built a fund of $76,327 at age 65. • At age 65, Jim’s fund is $68,855, • Jim put more money into his savings but because Mary started early and gave her savings more time to compound, Jim was not able to catch up.

38. More on the time value ….The sooner you start to save, the greater the benefit of compound interest! • In this example, two different individuals--Darryl and Cheryl, each 22 years old--have an extra $2,000 a year to invest or spend as they choose. Darryl opens an Individual Retirement Account (IRA) to start saving. Cheryl chooses to spend her $2,000. • In this example, Darryl's IRA earns 12% per year. Darryl saves $2,000 per year for 6 years, then never puts another cent into his IRA. Darryl's total investment is $12,000. • Cheryl spends her $2,000 per year for six years. At age 28, she starts investing $2,000 per year until she is 65 years old (37 years). Cheryl's total investment is $74,000 . Cheryl earns the same 12% interest per year that Darryl does. • Because she lost some of the time value of money, Cheryl had to invest an extra 31 years & an extra $62,000 to get to the same stage by retirement age.