CHAPTER 11: INVESTMENT PLANNING

1. CHAPTER 11:INVESTMENT PLANNING

2. The Objectives & Rewards Of Investing • Investing—usually considered a long-term activity. Future values and returns expected to increase through time. • Speculating—usually considered a short-term activity. Future values and returns highly uncertain. • Adequate insurance coverage and emergency funds should be in place before starting to invest.

3. How Can You Get Started Investing? • Accumulate money by regularly allocating a portion of your earnings for investing—PAY YOURSELF FIRST! • Take advantage of automatic investment & dividend reinvestment programs. • While saving, learn as much as possible about investments and "play" trade. • Determine your financial objective: • How much money do you want to accumulate? • How long do you have to accumulate it? • What is the rate of return you can earn? (look at what market has done over past 10-15 years)

4. What Are Your Investment Objectives? • Supplement current income— appropriate for retired persons. • Save for major expenditures— such as college education, down payment on a home, or starting a business. • Save for retirement—to live comfortably in your "golden years.“ • Shelter income from taxes—to preserve more of your earnings.

5. What is an Investment Plan? It is a simple (preferably written) statement that explains how the accumulated investment capital will be invested for the purpose of reaching the targeted goal.

6. Coming Up With the Capital • How much money will it take? • Do you have a lump sum to invest now, or will you systematically save toward your goal? • Your investment plan provides direction in helping you attain your goal!

7. Average Annual Returns On Stocks, Bonds, And U.S. T-bills Over Various Holding Periods From 5 - 15 Years

8. Different Ways to Invest 1. Common Stock 2. Bonds 3. Preferreds and Convertibles 4. Mutual Funds 5. Real Estate

9. Common Stock • A form of equity (represents an ownership interest in a corporation) • Greater potential returns, but at a higher level of risk • Entitles holder to • Equal participation in earnings/dividends • Equal vote • Equal voice in management • No maturity date—outstanding indefinitely

10. Bonds • Liabilities (they’re IOUs of issuer) • Bondholder loans money to issuer • Pay a stated rate of interest—provides current income • Have a maturity date • Bondholder recovers face vale of bond at maturity • Lower level of risk than stocks, but with lower expected returns as well. • Bond valuations inversely related to changes in prevailing interest rates

11. Preferred Stock • Issued as stock; represent an equity position in corporation • Behaves like debt—provides current income and possible price appreciation • Has a stated (fixed) dividend rate • Payment of dividends is given preference over common stock • Company has no legal obligation to declare dividends.

12. Convertible Bonds • Provide fixed-income benefits of bonds • Usually offer lower interest rates than regular bonds, but-- • Carries a conversion feature (permits investor to convert it to common stock) • Offers price appreciation (capital gains) potential of common stock • Risk that common stock will not do well and investor simply gets lower return provided by bond.

13. Mutual Funds • Organization that invests and manages a diverse portfolio of securities • Returns and level of risk depend on characteristics of underlying portfolio • Sell shares to investors • Investors become part owners of fund’s portfolio

14. Real Estate • Can range from raw land speculation to limited-partnership shares in commercial property • Can invest directly or through buying shares of a REIT. • Estimating risk and expected return can be difficult. Investors must be aware of economic cycles.

15. Securities Markets • Place (not always physical) where financial instruments are traded. • Capital market—where long-term securities (those with maturities greater than 1 year) are traded. • Money market—where low-risk, short-term securities (those with maturities less than 1 year) are traded.

16. Primary market—for new issues which are available for the very first time. • The issuing company gets the proceeds also provides prospectus which describes firm and the issue. • Investment bank underwrites • Secondary market—for trading previously issued securities. • Trading is done between investors; issuing company gets nothing. • Organized securities exchanges • NASDAQ • OTC Market

17. Organized securities exchanges • Secondary markets for trading listed securities. • Physical marketplaces, such as the NYSE, AMEX, and regional exchanges. • Utilize brokers to facilitate trading between buyers and sellers. • Handle transactions of larger, well-known companies' securities.

18. Over-the-counter market • Secondary market where securities are traded via a telecommunications network. • Investors trade directly with securities dealers. • Larger, actively traded issues make up NASDAQ, while smaller, thinly traded issues are listed on "pink sheets."

19. Broker and Dealer Markets

20. Dealer Markets • Bid price— the price at which a security can be sold • Ask price — the price at which a security can be bought

21. Foreign Securities Markets • Organized securities exchanges exist in more than 100 countries worldwide. • Found in major industrialized nations such as Japan, Great Britain, Germany and Canada. • Also found in developing markets around the globe.

22. Regulating the Securities Markets • Federal and state laws regulate the sale of securities. • Purpose is to provide for adequate and accurate disclosure of financial information. • Securities and Exchange Commission (SEC) is the agency in charge of administering federal securities laws.

23. Market Trends: • Bull market—generally rising securities prices for an extended period of time. • Reflects investor optimism. • Associated with favorable economy. • Bear market—generally falling securities prices for an extended period of time. • Reflects investor pessimism. • Associated with economic downturn.

24. Making TransactionsIn the Securities Markets • Stockbrokers (account executives & financial consultants) purchase and sell securities for investors. • Select from • Full-service – broker who offers full array of services in addition to executing client’s transactions • Discount – broker with low overhead, charges low commission, offers little or no services • Online – discount broker through which investors can execute trades electronically • Consider brokerage fees when making securities transactions.

25. Types of Brokers

26. Online Brokers • E-trade • Setting up an online account

27. Brokerage Fees

28. Investor Protection: • Securities Investor Protection Corp. protects customer accounts against financial failure of brokerage firm. • SIPC insures accounts up to $500,000 (brokerage firms often purchase even greater amounts of coverage). • Guarantees securities or cash held by broker will be replaced (does not guarantee dollar value of securities!). • Arbitration used to settle disputes between brokerage firm and clients.

29. Executing Trades: • Investor must first establish account with broker. • Trades can be executed by phone, at the brokerage firm, or online. Example: E-Trade • Odd lots (less than 100 shares) may incur extra fee. Round lots (multiples of 100) do not. • Market orders generally take less than a minute!

30. Investor places the order with the broker.

31. Investor places the order with the broker. Broker transmits order to the market via tele- communications equipment.

32. Investor places the order with the broker. Broker transmits order to the market via tele- communications equipment. Order is filled at the market by other buyers and sellers.

33. Investor places the order with the broker. Broker transmits order to the market via tele- communications equipment. Order is filled at the market by other buyers and sellers. Execution of the order is confirmed to the broker.

34. Investor places the order with the broker. Broker transmits order to the market via tele- communications equipment. Broker confirms order fulfillment. Investor has 3 days to settle account. Order is filled at the market by other buyers and sellers. Execution of the order is confirmed to the broker.

35. Types of Orders: • Market order—trade now at best available price. • Limit order—trade when a specified price or better is reached; investor is seeking opportunity. • Stop-loss order—sell if price drops to certain price; investor is seeking to limit losses. • e-trade stop loss

36. Margin Trading: • Allows investor to purchase securities on credit by borrowing part of purchase price from broker. Increases gains when returns are positive. Increases losses when returns are negative.

37. Example of Margin Trade with Profit: Initial investment (100 shares @ $50) Transaction w/out w/margin Amount invested $5,000 $2,500 Amount borrowed 0$2,500 Total purchase $5,000 $5,000 Price INCREASES(100 shares @ $70) Gross proceeds $7,000 $7,000 Less interest (9%) 0$ 225 Net proceeds $7,000 $6,775 Net profit $2,000$1,775

38. Example of Margin Trade with Loss: Initial investment (100 shares @ $50) Transaction w/out w/margin Amount invested $5,000 $2,500 Amount borrowed $ 0$2,500 Total purchase $5,000 $5,000 Price DECREASES(100 shares @ $30) Gross proceeds $3,000 $3,000 Less interest (9%) $ 0$ 225 Net proceeds $3,000 $2,775 Net loss ($2,000)($2,225)

39. Margin Trade Returns: Return = Profit (loss)  Amount Invested w/outw/margin • Price Increase $2,000 $1,775 $5,000 $2,500 Return 40% 71% • Price Decrease ($2,000) ($2,225) $5,000 $2,500 Return (40%) (89%)

40. Short Selling: • Allows investor to sell securities borrowed from the broker or broker's accounts. • Before period is over, investor must replace the borrowed securities. Investor profits if security’s price has declined. Investor loses if security’s price has increased.

41. Example of Short Sale: • Investor wishes to short 100 shares of ABW now selling at $52.50/share. • Broker sells borrowed shares for investor: 100 x $52.50 = $5,250 proceeds

42. Scenario A: Price of security drops to $40/share & investor repurchases: • Costs 100 x $40 = $4000 to replace shares. • Investor receives: $5250 – $4000 = $1250 profit!!

43. Scenario B: Price of security rises to $60/share & investor repurchases: • Costs 100 x $60 = $6000 to replace shares. • Investor receives: $5250 – $6000 = ($750) loss!!

44. To profit from short selling: Not only must the price of the security fall, but it must do so within the given time period. Double jeopardy!

45. Becoming an Informed Investor • One of key elements in successful investing is knowing how to achieve decent rates of return without taking unnecessary risks • First Rule of Investing: Never start an investment program, or buy an investment vehicle, unless you’re thoroughly familiar with what you’re getting into! • Types of Investment Information to Follow: • Economic developments and current events • Alternative investment vehicles • Current interest rates and price quotations • Personal investment strategies

46. Available Investment Information : • Annual Reports • Financial Press • Brokerage Reports • Subscription Advisory Services • Investment Advisors • On-Line Sources

47. Annual Stockholders’ Reports • Describes the firm’s business activities, recent developments and future plans and outlook • Read the Highlights or Selected Financial Data sections • CEO’s letter to stockholders • Discussion of operations in management’s discussion and analysis section • Review financial statements and notes • Read the auditor’s report

48. Financial Press - Publications • Newspapers – local, big city • Financial papers – The Wall Street Journal, Barron’s Investor’s Business Daily, and the “Money” section of USA Today • Magazine-type publications – Money, Forbes, Fortune, Business Week, Smart Money, and Kiplinger’s Personal Finance

49. Financial Press - Economic Data • News items related to government actions and their effects on the economy • Political and international events as they pertain to the economy • Statistics related to price levels, interest rates, the federal budget, and taxes

50. Financial Press - Market Data • Dow Jones Industrial Average – most widely followed measure of stock market performance; consists of 30 blue-chip stocks listed mostly on the NYSE • Standard & Poor’s (S&P) Index – index that uses more stocks (500 in its composite index) from greater breadth (NYSE, AMEX, and OTC) • NYSE Index – index of the performance of all stocks listed on New York Stock Exchange • AMEX Index – index of the performance of all stocks listed on the American Stock Exchange • Nasdaq Index – Index that tracks the performance of stocks traded in the OTC market • Wilshire 5000 – Index of the total market value of 6,000 to 7,000 or so most actively traded stocks in this country