Introduction to Investments Spring 2012, BUS-123 Introduction to Investments Frank Paiano – “Paco” Professor, Business, Professional & Technical Studies Welcome, Everyone!
Download ReportTranscript Introduction to Investments Spring 2012, BUS-123 Introduction to Investments Frank Paiano – “Paco” Professor, Business, Professional & Technical Studies Welcome, Everyone!
Introduction to Investments Spring 2012, BUS-123 Introduction to Investments Frank Paiano – “Paco” Professor, Business, Professional & Technical Studies Welcome, Everyone! 1 First – A Perspective “It is a gloomy moment in history. Never has the future seemed so dark and incalculable. The United States is beset with racial, industrial and commercial chaos, drifting we know not where. Of our troubles, no one can see the end.” Harper’s Magazine, 1847 2 CHAPTERS 1, 3, Lecture Notes 3 A Brief History of Risk and Return (Chapter 1) Security Types (Chapter 3) Time Horizon & Short-term Investments (Lecture) What I have tried to do here is create what I believe should be the contents of the first chapter of an Introduction to Investments & Securities textbook. “In investing money, the amount of interest you want should depend upon on whether you want to eat well or sleep well” -- J. Kenfield Morley 4 What is an Investment? An investment is any vehicle into which resources can be placed with the expectation that it will generate positive income, or that its value will be preserved or increased, or both Investment returns (a.k.a. investment rewards) Income – interest, dividends, rent a.k.a. cash flows Increased value / Decreased value a.k.a. capital gains, capital appreciation (Yippee!) a.k.a. capital losses (Boo! Hiss!) Investments come in all shapes, flavors and sizes 5 Types of Investments Securities Investments that represent debt or ownership or the legal right to acquire or sell an ownership interest (a.k.a. financial investments) Property Real property (land, buildings) and personal property (precious metals, autos, art, collectibles, etc.) (a.k.a. real estate, hard assets, tangible assets, commodities) Personal Examples: Education and Training, Travel College is often the best investment a person will ever make – Why? This class concentrates on securities 6 Types of Investments (continued) Primary Assets Debt Funds lent in exchange for interest income and the promised repayment of the loan at a given future date Examples: Bonds, Short-term investments (savings accts, etc.) Equity Ownership in a business or a property Examples: Stocks (corporations), Partnerships, Sole Proprietorships, Real Estate, Real Estate Investment Trusts Derivative Assets Securities that derive their value from an underlying security or asset – normally highly speculative Examples: Options, Futures Some in the industry do not classify derivatives as investments 7 Types of Investments (continued) Direct Investments Your name is on the investment and you control the investment – can buy or sell as you wish Examples: Real Estate, Stocks, Bonds Indirect Investments Someone else is in control of the investment You have limited control, or more likely, no control over the underlying investment Examples: Mutual Funds, REIT, Limited Partnership* *You can buy or sell your shares in the mutual fund, REIT, or limited partnership, but you do not control the underlying investments 8 Types of Investments (continued) Domestic Investments Based inside the United States Global = Domestic and (a.k.a. Foreign) International International Investments Based outside the United States Be careful of this subtle distinction International (a.k.a. Foreign) ≠ Global “The world is a very small place these days economically.” Sixty-five percent (by value) of the parts in the Ford Mustang come from the U.S. and Canada. Ninety percent of the parts in the Toyota Sienna – which is built in Indiana – come from the U.S. and Canada. Which is the more American car? (Forbes) Types of Investments Domestic or Foreign? (continued) Budweiser Foreign Fox Network Foreign Shell Oil Foreign Seagram’s Foreign Bayer Aspirin Foreign Vaseline Foreign Arco Foreign Foreign Friskies Foreign Gerber Foreign Motel 6 Foreign Carnation Foreign Union Bank Cup-a-Soup Foreign Volvo & Saab Foreign Domestic Foreign Ben & Jerry’s Foreign Farmers Ins Domestic or Foreign? 9 Types of Investments Australia Top 18 Austria countries Belgium Canada according Denmark to per France capita Germany Hong Kong income Italy (alphabetical Japan order) Netherlands Norway Singapore Spain Sweden Switzerland UK USA Which country had the best average annual return over the past quarter century? Sweden Netherlands Denmark Switzerland France Australia UK Belgium Germany Norway Canada USA Spain Hong Kong Austria Italy Singapore Japan Global Investing 10 (continued) 14.0% 24.9% 12.8% Average 19.5% 11.7% annual 19.6% 11.5% 18.8% return 10.5% 23.1% 1973 10.5% from24.7% 10.5% to 2009 22.9% 10.4% 21.3% 10.3% 22.3% 10.2% 27.9% 9.6% 20.4% 9.5% 15.8% 9.2% 23.4% 9.0% 33.1% 8.4% 23.7% 7.5% 26.0% 7.3% 29.0% 7.0% 22.1% The return of the stock markets in the developed world has been 9.2%. 11 Types of Investments Short-term Investments Up to a 1 year Intermediate-term Investments 2 to 5 years Long-term Investments 5 or more years (continued) These are general guidelines used throughout the industry I disagree with the general guidelines. Here are mine: Short-term – 1 to 2 years Intermediate – 3 to 5, maybe even 6 or even 7 years Long-term – 7 years or longer (10 to 30 years) Before you make an investment, you must know your time horizon! 12 Types of Investments (continued) Liquid Investments Easily and quickly converted into cash There is a ready market to purchase the investment and change of ownership happens quickly Examples: Stocks, Bonds, Mutual Funds, REITs Illiquid Investments May be difficult to convert into cash Market for investment is small or change of ownership happens slowly or both Examples: Real Estate, Partnerships, Collectibles 13 Risk & the Risk/Return Spectrum Risk is the chance that actual investment returns will differ from the expected returns What is the typical definition of risk? “The possibility of suffering harm or loss; danger” In general, the higher the expectation of investment returns, the higher the risk level The Risk / Return Spectrum Low-risk – 3% to 5% Moderate-risk – 5% to 8% High-risk – 8% to 12% Speculative-risk – Greater than 12% These are my guidelines Speculation is often not considered investing (I certainly do not consider it investing…) 14 Let’s Try Some Examples… What type of investment is… Bank of America passbook savings account Nestle’s Foods, Inc. Southwestern College Propositions AA & R Bonds Duplex in Spring Valley (rent one, live in other) Qualcomm Corporation Loan to Uncle Harry Security or Property? Debt or Equity? Direct Domestic or or Indirect? Foreign? Short, Inter, or Long Term? Low, Moderate, or High Risk? Liquid or Illiquid? Measuring Investment Return 15 Return is straight-forward to measure Total Dollar Return The return on an investment measured in dollars that accounts for all cash flows and capital gains or losses Total Percent Return The return on an investment measured as a percentage that accounts for all cash flows and capital gains or losses Measures of return allow us to compare investment alternatives Measuring Investment Risk 16 Risk is difficult to measure There are many ways, all of them are imperfect One popular measure is standard deviation Standard Deviation Measures the volatility of an investment In any given year, there is about a ⅔ chance that the return of an investment will be within one standard deviation of the historical average return (average return plus or minus one standard deviation) The higher the standard deviation, the more volatile the investment The greater the variance from the norm We will investigate standard deviation in detail later in this chapter Investments Overview Equity Securities – a.k.a. Common Stocks Fixed-Income Securities – a.k.a. Bonds Short-term Investments – a.k.a. “Cash” Mutual Funds – a.k.a. Investment Companies Hybrid Securities – Preferred Stocks, Convertible Securities Others – Real Estate, Physical Assets Derivatives – Options, Futures Let us look at each in more detail 17 Investments Overview Chapters 5 through 8, 17 (continued) Equity Securities – a.k.a. Common Stocks Represents ownership in a corporation Investors receive… Dividends – optional payments to shareholders Capital Gains – shares increase in value Limited Liability Moderate-risk to high-risk to speculative-risk “Volatility” – euphemism for “I lost a whole lotta’ money!” Historically best returns over time 8% to 12% (I normally tell people 8% to 10%) Should be considered a long-term investment 2008 Definition: “Stocks are equity investment instruments designed to lose value.” 18 Investments Overview Chapters 9 & 10, 18 through 20 (continued) Fixed-Income Securities – a.k.a. Bonds Long-term loans to Corporations (Corporate bonds) State and local governments (Municipal bonds) Federal government (Treasury bonds) Bond investors lend their money to the bond issuers (corporation, state or local municipality, Treasury) The bond investors then receive interest and a promise that the loan will be repaid when due Historically much less riskier than stocks but… Also less reward – 4-6% (govt/mun) to 6-8% (corp) Good intermediate-term / long-term investment 2008 Definition: “Bonds are fixed-rate investment instruments designed to lose value.” 19 Investments Overview Lecture Notes, Chapters 3, 19 (continued) Short-term Investments a.k.a. “Cash” “Short-term vehicles” Normally up to 1 year (1 to 3 years) Usually guaranteed (or pretty darned close) Liquid (many let you simply write a check!) Very low risk of losing principal Hence, very low reward 2% to 5% over time (currently less than 1%) “A place to park your money” Also used for holding an “emergency fund” 2008 Definition: “Short-term investments are instruments designed to accept what remains of investors’ money after they have given up on stocks and bonds.” 20 Lecture Notes, Chapters 3, 19 Investments Overview (continued) Short-term Investments – Examples Deposit accounts at financial institutions Passbook savings accounts at banks, share accounts at credit unions More about short Series EE or I savings bonds term investments U.S. Treasury bills (T-bills) later in this Certificates of Deposit (CDs) presentation… Money market accounts Money market mutual funds Commercial paper (Corporate IOUs) Banker’s acceptance notes (Bank IOUs) 21 22 Investments Overview Chapter 4 (continued) Mutual Funds a.k.a. Investment companies A company that pools investors’ money and invests in a diversified portfolio of securities Investors get… Diversification Mutual fund can purchase hundreds of securities Professional money management Very popular form of investment Range from low-risk to speculative-risk 2008 Definition: “Yeah, them too.” 23 Investments Overview (continued) STOCKS Stock mutual funds BONDS Balanced mutual funds Bond mutual funds “CASH” Money market mutual funds a “mutual” fund a.k.a. investment company Professional Money Management Diversification Approximately 50% of American households own mutual funds. Or used to … Investments Overview Chapters 3 and 18 (continued) Hybrid Investments Preferred Stock Represents ownership in corporation, but… Dividends are not considered optional Convertible Securities A bond or preferred stock that can be converted into common stock Hybrid investments are designed to offer the stability of fixed-income investments (bonds) with the opportunity for capital growth of equity investments (stocks) Some in the industry categorize these with stocks, some categorize them with bonds 24 25 Investments Overview Lecture Notes (continued) Other Popular Investment Vehicles Real estate Examples: residential, commercial, raw land, Real Estate Investment Trusts (REITs) Tangible assets Examples: precious metals, jewels, art, collectibles Tax-advantaged investments Examples: oil and gas limited partnerships, lowincome housing projects If there is sufficient time and interest, we will look at some or all of these, especially real estate and tangible assets. By the way, none of these were spared in 2008, either. Investments (???) Overview 26 Chapters 14 and 15 (continued) Derivative Assets Speculative securities that derive their value from an underlying security or asset Options – a.k.a. Options Contracts Calls and puts Futures – a.k.a. Futures Contracts Commodities Stock indexes Many in the financial world (myself included) do not categorize these as investments The derivative speculators did not feel so all alone in 2008. Usually, they are the only ones who are proud to have only lost 30%. 27 Our Emphases in this Course Equities – a.k.a. Stocks You are an owner Fixed-Income Securities – a.k.a. Bonds You are a loaner Short-term Securities – a.k.a. “Cash” Your principal is safe (often guaranteed) Mutual Funds – a.k.a. Investment Companies Your investments are managed on your behalf For the vast majority of investors, these are the most popular and most important financial investment options 28 Investments: What are ___? Investment companies that pool investors' money and invest in a diversified portfolio of securities. Investors get diversification and professional money management. A. short-term securities B. common stocks C. bonds D. mutual funds The correct answer is (D). Investment company is the legal term; mutual fund is the popular term. 29 Investments: What are ___? Represent ownership in a corporation. Investors receive dividends and capital gains (or capital losses). hybrid securities B. common stocks C. bonds D. short-term securities A. The correct answer is (B). When people use the term “stocks,” they are talking about common stocks. 30 Investments: What are ___? Investments with very little risk, and correspondingly, very little return. Often used as a place to "park your money" or for an emergency fund of 3 to 6 months income. A. hybrid securities B. common stocks C. bonds D. short-term securities The correct answer is (D). Low risk, low return. 31 Investments: What are ___? Fixed-income securities that represent loans to corporations, municipalities (state & local governments & agencies), and the Federal government. Investors receive interest and a promise to repay the loan. A. B. C. D. hybrid securities common stocks bonds short-term securities The correct answer is (C). Bonds are “fixed-income” investments. 32 Investments: What are ___? Securities designed to offer the stability of fixed-income investments with the opportunity for capital growth of equity investments. Examples include preferred stock and convertible bonds. A. B. C. D. derivatives common stocks bonds hybrid securities The correct answer is (D). The best (?) of both worlds. 33 Investments: What are ___? Speculative securities that derive their value from an underlying security or asset. Examples include options contracts and futures contracts. A. B. C. D. derivatives hybrid securities bonds short-term securities The correct answer is (A). You can make a lot of money; you can lose a lot of money. 34 What are Reasonable Expectations? What are reasonable long-term expectations of returns from the following investments? A. B. C. D. E. F. stocks bonds short-term securities mutual funds hybrid securities derivatives 8% - 12% 4% - 8% 2% - 5% ? ? ? Now, let us look at investment returns and risks in detail… 35 Investment Return – Revisited Over the long term, equities (stocks) have produced the best returns Equities – Stocks 8% to 12% (I usually tell people 8% to 10%) Fixed-income Securities – Bonds Treasury & Municipal Bonds – 4% to 6% Corporate Bonds – 6% to 8% Short-term Investments – “Cash” 2% to 5% Mutual funds will more or less (often less) reflect the underlying assets that they invest in Growth of $1 Investment 36 1925 – 2009 Growth of $1 Investment 37 1801 – 2009 38 Investment Risk – Revisited It is no accident that stocks and bonds have produced better returns than short-term investments (a.k.a. “cash”) Otherwise, why would investors assume the higher risks of stocks and bonds? Why wouldn’t they just assume the… Risk-free Rate of Return The return on guaranteed short-term investments Specifically, the return on U. S. Treasury Bills Risk Premium The reward for bearing risk; the extra return on a risky asset over the risk-free rate of return 39 Investment Risk Premiums 40 Investment Risk – Revisited (continued) Risk versus Reward; Risk versus Return Investment return is very straight-forward How much did you start with and how much did you end with? That is your return! But measuring how much risk you took to receive that return is much more difficult Each year, the investment community measures the average annual return and the amount of variance from the average return Using statistics, the resulting measures of risk are called variance and standard deviation 41 Investment Risk – Revisited (continued) Variance and Standard Deviation We will leave the calculations for your statistics class Suffice to say the higher the variance and standard deviation, the riskier the investment i.e. The higher the variance and standard deviation, the more the investment return will deviate from the average annual return ? ? var(R) σ 2 ? R n ? ? i 1 R 2 i n 1 ? ? ? ? ? stddev(R) σ var(R) ? ? These are just fancy, schmancy terms for, “You Can Lose Yer Money!” Distribution of Annual Returns on Common Stocks: 1926 to 2011 Does this distribution resemble anything you are familiar with? 42 43 The Normal Distribution – The “Bell curve” Investment returns over time tend to mirror a normal distribution Historical Returns, Standard Deviations, and Frequency Distributions: 1926-2009 The greater the standard deviation, the wider the distribution of returns and the riskier the investment 44 45 Another View of Risk versus Return Average Annual Return versus Annual Return Standard Deviation 46 A Global View of Risk versus Return Now we can complete the global picture regarding risk versus return. Who had the best riskadjusted return? Sweden Netherlands Denmark Switzerland France Australia UK Belgium Germany Norway Canada USA Spain Hong Kong Austria Italy Singapore Japan Return 14.0% 12.8% 11.7% 11.5% 10.5% 10.5% 10.5% 10.4% 10.3% 10.2% 9.6% 9.5% 9.2% 9.0% 8.4% 7.5% 7.3% 7.0% Standard Deviation 24.9% 19.5% 19.6% 18.8% 23.1% 24.7% 22.9% 21.3% 22.3% 27.9% 20.4% 15.8% 23.4% 33.1% 23.7% 26.0% 29.0% 22.1% Sweden may 57. 59% have had the 23. 42% best average 24. 05% 18.annual 99% return, 46. 20% but you had to 56. 33% 44.accept 94% almost 34. 81% 60% more risk 41. 14% 76. 58% to get that 29. 11% return. 0.00% 48. 10% 109.49% 50. 00% 64. 56% 83. 54% 39. 87% The standard deviation of the developing world was 15.2% with a 9.2% average annual return. 47 So, Does You’se Got’s It Yet? You’se Wants High Returns? You’se Gonna’ Gets High Risk! You’se Gonna’ Lose Some Money, Maybe All’s Yer Money! If’n Anybodies Tells You’se Different, De’re Lying! So when (not if) you see an advertisement for a “12% Safe Rate of Return,” you will know that the chances of losing your money are pretty high. When you see claims such as 300% or even 3000% (and you will if you are involved in investing for any length of time), sit on your hands and grab your wallet! P.S. By the way, they are also breaking the law. Examples: Wade Cook, WizeTrade, Day Trading Coach, Optionetics, etc. 48 But Isn’t Somebody Doing It? Yes, it is true Some people make tremendous rates of return But those people are not Investors They are Traders (a.k.a. Speculators) Being a Trader can be very profitable But it is also very stressful and very perilous And you are up against the best in the world Story: John Gutfreund versus John Meriweather John Bogle: http://www.forbes.com/2009/01/09/intelligentinvestingbogle.html So What is a Realistic Rate of Return For Me? 49 After you have taken this course, you will have a strong knowledge of the most popular types of investments Stocks, Bonds, “Cash,” Mutual Funds, etc. You will also know what levels of returns and what levels of risks you should reasonably expect to receive And if you are a patient, long-term investor, I believe it is realistic to expect 8% to 10% I am certainly working on it myself! Of course, as we will reiterate time and time again, there are no guarantees! 50 But Is 9% or 10% Good Enough? It turns out the answer to this question is, “YES!” If you start early … If you are patient and consistent … If you do not get cocky or greedy … If you do not chase after every “Next Big Thing” that comes along … And most importantly, you don’t PANIC when the market swoons! As it inevitably will do from time to time The trick is to take advantage of the Time Value of Money a.k.a. Compound Annual Return The Time Value of Money 51 The amount to which a sum you invest now will increase based on a specified rate of return and time period Calculating amounts into the future is called compounding – a.k.a. the future value of money Future value can be computed for a single amount – a.k.a. a lump sum or principal Future value can also be determined for a series of deposits – a.k.a. stream of investments, “annuity” We will also learn how to move from the future back to the present (a.k.a. discounting, the present value of money) when we learn how to assign valuations to stocks and bonds The Time Value of Money 52 (continued) Let us do some future value exercises… One last comment on risk versus return Psst! Here is One of Paiano’s Secret Tips… 53 Avoid Large Losses! Where would you put $100? Investment A Investment B Year 1 Year 2 85% -50% $185 $92.50 10% 9% $110 $120 Now, before we embark on the process of identifying and familiarizing ourselves with the longer-term, higher-yielding investments, let us learn how and where to “park our money” using short-term investments. 54 Uh, Wait a Sec. One More Time… The greater the variance and standard deviation of the average annual returns of an investment, ______________. the greater the risk (a.k.a. the more volatile) B. the lesser the risk (a.k.a. the less volatile) C. there is no correlation (a.k.a. no relationship) D. standard what? (I always hated statistics…) A. The correct answer is (A). Don’t you dare get this one wrong on the exam! 55 Short-term Investments Review a.k.a. “Cash” “Short-term vehicles” Normally up to 1 year (1 to 3 years) Usually guaranteed (or pretty darn close) Liquid Very low risk of losing principal… Hence, very low reward 2% to 5% over time “A place to park your money” Also used for holding an “emergency fund” 56 Interest on Short-term Investments Stated rate of interest Most common form of interest Example: Nominal rate on a savings account Discount basis Method of earning interest on a security by purchasing it at a price below its redemption value; the difference is the interest earned The interest “accrues” on the investment Treasury bills, corporate paper Example: Purchase a security now for $4,800 that will be redeemed for $5,000 in nine months. Interest would be $200. 57 Risks of Short-term Investments Risk of default (a.k.a. capital losses) None or almost none Your principal is safe, often guaranteed Risk of losing purchasing power High! Short-term investments barely keep up with inflation Risk of lost opportunity cost High! Unless your time horizon is very short, there are several investment alternatives, almost all of which will give you a better rate of return Repeat after me: “There is no such thing as a risk-free investment.” 58 Types of Short-term Investments Deposit accounts Passbook savings account Share account at credit unions Negotiable Order of Withdrawal (NOW) account Checking accounts that pay interest Money Market Deposit Account (MMDA) Limited check writing privileges Deposit accounts are offered by banks and credit unions. They are often called demand accounts since the funds are available upon demand. They provide the highest level of liquidity and are usually guaranteed up to $100,000 (currently $250,000) by the government or a government agency. 59 Types of Short-term Investments (continued) Series EE Savings Bonds Discount method of payment a.k.a. Accrual-type security Example: $100 bond cost $50 Do not pay income tax on interest until redeemed Free from state and local income taxes Free from federal income taxes if used for higher education Popular gift for newborns 60 Types of Short-term Investments (continued) Series HH Savings Bonds Issued at face value and pay interest twice a year Being phased out – can no longer purchase Series I Savings Bonds Also issued at face value Inflation indexed! Guaranteed to outpace inflation (but not by much) Pay accrued interest at bond’s maturity of 30 years Again, free from taxes if used for higher education Maximum purchase of $30,000 per year The Series I bonds are becoming more popular with those concerned about inflation 61 Types of Short-term Investments (continued) Treasury Bills Obligations of the United States Treasury Sold at a discount, redeemed at face value Varying short-term maturities Typically one-, three- and six-month maturities Generally regarded as the safest of all investments – a.k.a. “risk-free return” Used as the benchmark for all other investments Free from state and local income tax Can be purchased directly from the Treasury www.treasurydirect.gov 62 Types of Short-term Investments (continued) Certificates of Deposit (a.k.a. CDs) Savings instruments in which funds must remain on deposit for a specified period Periods range from 7 days to several years Penalty for early withdrawal Insured to same $100,000 per investor (Again, currently $250,000) Brokered CDs Sold by brokerage firms; normally offer higher yields Can be sold prior to maturity without incurring a penalty Careful! CDs will usually rollover automatically if you do not redeem them. You can specify that your CD proceeds be automatically rolled into your checking or savings account. 63 Types of Short-term Investments (continued) Commercial Paper Short-term, unsecured promissory notes (IOUs) issued by corporations with very high credit standings 90-day, 180-day and 270-day maturities Maximum maturity is 270 days By keeping the maturity less than one year, commercial paper does not need to be registered with the Securities and Exchange Commission Usually sold in multiples of $100,000 Hence, commercial paper is usually purchased by institutional investors (exp: money market mutual funds) 64 Types of Short-term Investments (continued) Banker’s Acceptance Notes Short-term, low-risk investment vehicles arising from bank guarantees of business transactions Sold at a discount from their face value and generally provide yields slightly below those of CDs and commercial paper Typically 30-day to 90-day maturities As with commercial paper, usually the minimum denomination is $100,000 65 Types of Short-term Investments (continued) Money Market Mutual Funds A mutual fund that pools the capital of a large number of investors and uses it to invest exclusively in short-term securities Virtually all brokerage firms and mutual fund companies offer them Money Market Mutual Funds are not guaranteed Unlike Money Market Deposit Accounts from a bank or credit union Still considered virtually risk-free If there is ever a default, other companies step in and bail out the investors (with blessing from govt) Virtually all offer check-writing privileges and direct transfer to and from checking accounts 66 Choice of Short-term Investments So, which short-term investment is for me? Commercial paper and banker’s acceptance notes are usually only suitable for institutional investors Savings bonds make cute gifts for newborns Many investors purchase Treasury bills directly from the Treasury (www.treasurydirect.gov) Certificates of Deposit are okay for those that are sure that they will not need the money until maturity Money Market Mutual Funds and Deposit Accounts are the preferred choice by most investors Especially since every bank, credit union, brokerage firm and mutual fund company offers them But most non-investors still use a passbook savings account from a bank (they have not taken this course yet) 67 The Emergency Fund Debate Should you have an Emergency Fund? Many financial experts recommend that households create an emergency fund of three, six or even nine months of income I simply do not agree with the concept of an emergency fund of three to nine months of living expenses. As long as you have access to cash (via a line of credit, for example) there is no good reason to keep $10,000 to $25,000 or more in a savings account earning 2%. Instead, use the money to pay down high interest debt, especially credit card debt. Exceptions: salespeople, the self-employed, and those P.S. You are adequately insured, right? who get laid off often 68 Short-term Investments: What are _? A mutual fund that pools the capital of a large number of investors and uses it to invest exclusively in short-term securities. A. commercial paper B. money market mutual funds C. passbook savings accounts D. Certificates of Deposit (CDs) The correct answer is (B). Money market mutual funds and their counterparts at banks and credit unions have rates close to CDs without the early withdrawal penalty. 69 Short-term Investments: What are _? Savings instruments in which funds must remain on deposit for a specified period. There is normally a penalty for early withdrawal. A. commercial paper B. money market mutual funds C. passbook savings accounts D. Certificates of Deposit (CDs) The correct answer is (D). If interest rates are going down, you can lock in a good rate. But you better hope you do not need the money until the CD matures! 70 Short-term Investments: What are _? Short-term, unsecured promissory notes (IOUs) issued by corporations with very high credit standing, normally sold in $100,000 denominations. A. commercial paper B. money market mutual funds C. passbook savings accounts D. Certificates of Deposit (CDs) The correct answer is (A). Commercial paper and their cousins, banker’s acceptance notes, are normally only purchased by institutional investors such as money market mutual funds. 71 Short-term Investments: What are _? A guaranteed demand account at a bank or credit union that normally pays little interest but will often be offered with a toaster or waffle iron which makes it all worthwhile. A. commercial paper B. money market mutual funds C. passbook savings accounts D. Certificates of Deposit (CDs) The correct answer is (C). No comment. CHAPTERS 1, 3, Lecture Notes 72 A Brief History of Risk and Return (Chapter 1) Security Types (Chapter 3) Time Horizon & Short-term Investments (Lecture) Coming Up Next: Chapter 4, Mutual Funds