Investing in Stocks and Bonds

Objectives

 Describe stocks and bonds and how they are used by corporations and investors.

 Define everyday terms in the language of stock investing.

 Classify stock according to their basic descriptive categories.

Objectives

 Describe the major characteristics of bonds.

 Differentiate among the four general types of bonds.

Objectives

 Describe what the investor should consider before investing in bonds, particularly the current yield and yield to maturity.

 List the advantages and disadvantages of investing in bonds.

Stocks and Bonds and How They are Used  Common stock  Preferred stock  Bonds

Investing in Stocks

 Why do corporations issue common stock?

 To raise money to start or expand a business  To help pay for ongoing business expenses  They don’t have to repay the money  Dividends are not mandatory  Stockholders have voting rights

Why Do Investors Purchase Stock?

 Income from dividends  Dollar appreciation of stock value  Increased value from stock splits

Common vs. Preferred Stock  Common stock  get dividends depending on profit the company makes  Preferred stock  receive cash dividends before common stock holders  pre-determined dividend rate  most preferred stock is callable

Calculating Total Return

100 shares of common stock purchased December 21, 2008, sold December 21, 2009; total dividedts of $2.60 per share for the investment period.

Cost when purchased: Return when sold: 100 Shares @ $71 $7,100 100 shares @ $89 $8,900 Commissions +55 Commissions - 70 Total investment $7,155 Total Return $8,830 Transaction Summary: Total Return $8,830 Minus Total Investment 7,155 Profit from Stock Sale $1,675 Plus Dividends +260 Total Return for the transaction $1,935

Features of Preferred Stock

 Cumulative preferred stock  unpaid cash dividends accumulate and are paid before cash dividends to common stock holders  Participation feature  rare form of investment  can share in earnings beyond stated dividend amount  Conversion feature  can be traded for shares of common stock

How to Evaluate a Stock

 Read stock quotes in a newspaper, such as the

Wall Street Journal

 52 week high and low  stock abbreviation and symbol  dividends per share in the last 12 months  percent yield  price earnings ratio  volume  high and low for the day  closing price and net change

Language of Stock Investing

 Earnings per share (EPS)  Price/earnings ratio (P/E ratio)  Dividend payout ratio  Market price  Book value

Language of Stock Investing

 Market-to-book ratio  Par value  Total return

Language of Stock Investing

 Preemptive rights  Stock dividends  Stock splits  Voting rights

Classifications of Common Stock

 Income stocks  Growth stocks  Speculative stocks  Other characterizations

Types of Stock Investments  Blue chip stock  low risk  consistent dividends  ex. AT&T, Kellogg's, General Electric  Income stock  higher than average dividends  ex. utility stock

Types of Stock Investments

(continued)  Growth stock  earns above average profits  low or no dividends  Profits reinvested in company, so...

 Stock price should go up  ex. Microsoft or Intel

Types of Stock Investments

(continued)  Cyclical stock  follows business cycles of advance and declines in the economy  ex. new construction, cars, timber  Defensive stock  remains stable even if the economy is declining  ex. food and utility stocks

Numeric Measures to Consider When Evaluating a Stock  Look at book value of one share  net worth of company divided by the number of outstanding shares  if a share costs more than the book value the company may be overextended or it may have a lot of money in research and development

Numeric Measures to Consider When Evaluating a Stock (continued)  Look at the price earnings ratio  also called the P-E  price of one share of stock divided by the earnings per share of stock over the last 12 months  a low number means could be a good time to buy it, however many technology stocks have high P-Es  Look at the beta for the stock  stock with a beta >1.0 means more volatility

Long-Term and Short Term Investment Strategies

Buy-and Hold Technique Dollar Cost Averaging Direct Investment and Dividend Reinvestment Plan (DRIP)

Long-Term and Short Term Investment Strategies

Day Trading Buying Stocks on Margin Selling Short Trading in options

Make a Decision to Sell Stocks

  1. Stock reaches target price.

2. Favorable development temporarily push up price.

      3. Good profits unlikely to continue.

4. Stock lags behind others in industry group.

5. Company profits begin to fall short of projections.

6. Industry/company prospects are deteriorating.

7. Losses are moderate.

8. Stock’s price/earnings ratio appears too high.

Language of Bond Investing

 Corporate bond  Face value  Maturity date  Bond indenture  Debenture  Mortgage bond  Trustee  Secured and unsecured  Senior and subordinated

Language of Bond Investing

 Registered and bearer  Callable  Convertibility  Bond Ladder

Types of Bonds

 Corporate bonds  U.S. government securities  Treasury bills, notes, and bonds  Federal agency issues  Municipal Bonds

Tax Equivalent Yield

Taxable equivalent yield = Tax exempt yield 1.0 – tax rate The taxable equivalent yield on a 5% tax exempt municipal bond for a person in the 28% tax bracket is 6.94% .05

1.0-.28 = .0694 = 6.94%

Considerations Before Investing in Bonds  Susceptibility to certain risks  Credit  Callability  Inflation  Interest rate

Considerations Before Investing in Bonds  Premiums and discounts  Current yield  Yield to maturity  Tax-equivalent yields  When to sell

Approximate Market Value of a Bond

Example: Shawn purchased a corporate bond that pays 4.5% interest based on a face value of $1,000. Comparable new corporate bond issues are paying 7%. How much is Shawn’s bond worth?

Formula:Dollar Amount of Annual Interest = Approximate Market Interest Rate of Comparable Bonds Value A. Find the dollar amount of annual interest.

Face Value of Bond x Annual Interest Rate = Dollar Amount of Annual Interest $1,000 x 4.5% = $45 B. Solve for approximate market value.

Dollar Amount of Annual Interest = Approximate Market Interest Rate of Comparable Bonds Value $45 = $642.86

7%

Current Yield

Assume you own a $1,000 corporate bond that pays 7% interest annually and matures on July 15, 2013. This means you will receive $70.00 annually. Also assume the market price is $940. The current yield is calculated:

Yield to Maturity

Corporate Bond Transaction

Assume that on March 15, 1998, you purchased a 9.2% corporate bond. Your cost for the bond was $920 plus a $10 commission charge. Also assume that you held the bonds until March 15, 2008, when you sold them for the current value of $1,040.

Bond Ratings

Advantages of Investing in Bonds

 Pay higher interest rates than savings  Offer safe return of principle  Have less volatility than stocks  Offer regular income  Require smaller initial investment

Disadvantages of Investing in Bonds  No hedge against inflation  Can be quite volatile  Compounding is almost impossible  Subject to investors tax rate  Poor marketability