Transcript GITMAN/ JOEHNK/ BILLINGSLEY PFIN Investing in Stocks and Bonds Copyright ©2016 Cengage Learning. All Rights Reserved.

GITMAN/ JOEHNK/ BILLINGSLEY
PFIN
4
12
Investing in
Stocks and
Bonds
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
LEARNING OUTCOMES
1
Describe various types of risk to which
investors are exposed, as well as the sources
of return
2
Know how to search for an acceptable
investment on the basis of risk, total return,
and yield
3
Discuss the merits of investing in common
stock and be able to distinguish among the
different types of stocks
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
PFIN4 | CH12
2
LEARNING OUTCOMES (continued)
4
Become familiar with the various measures of
performance and how to use them in placing
a value on stocks
5
Describe the basic issue characteristics of
bonds as well as how these securities are
used as investment vehicles
6
Distinguish between the different types of
bonds, gain an understanding of how bond
prices behave, and know how to compute
different measures of yield
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly acce ssible website, in whole or in part.
PFIN4 | CH12
3
Risks of Investing
Business
• Variability associated with a firm’s cash flows and with its
ability to meet its operating expenses
Financial
• Associated with mix of debt and equity financing used by
the issuing firm and ability to meet its financial obligations
Market
• Associated with the price volatility of a security
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
PFIN4 | CH12
4
Risks of Investing
Purchasing power
• Results from possible changes in price levels
Interest rate
• Results from changing market interest rates
Liquidity
• Risk associated with the inability to liquidate an investment at a
reasonably price
Event
• Unexpected event leading to a sudden and sizeable change in the
value of an investment
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly acce ssible website, in whole or in part.
PFIN4 | CH12
5
Returns from Investing
• Current income - Received with some
degree of regularity over a year
• Capital gains - Reflected as an increase in
the market value of an investment vehicle
• Earning interest on interest
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
PFIN4 | CH12
6
Exhibit 12.2 The Risk-Return Relationship
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
MKTG4 | CH1
7
Components of a Good Investment
• Future return
• Approximate yield
• Provides a measure of the fully compounded
rate of return from an investment
• Desired rate of return: Minimum rate of
return earned in compensation for the
amount of risk assumed
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
PFIN4 | CH12
8
Exhibit 12.3
Performance of Dow Jones Industrial Average
and NASDAQ Composite, 2004 through 2014
Source: Morningstar 2013.
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly acce ssible website, in whole or in part.
MKTG4 | CH12
9
Investing in Common Stock
• Issuers of common stock
• Issued by any corporation in any line of
business
• Voting rights - For each share of stock held
holders receive one vote
• Proxy: Written statement used to assign a
stockholder’s voting rights to another person
• Basic tax considerations
• Common stocks provide income in the form of
dividends and/or capital gains
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
PFIN4 | CH12
10
Dividends
• Paid by firms to their common stock
holders in cash and/or additional stock
• Dividend yield: Percentage return
provided by the dividends
• Stock dividends
• New shares of stock distributed to existing
stock holders as a supplement for cash
dividends
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
PFIN4 | CH12
11
Key Measures of Performance
• Book value: Amount of stockholder’s
equity in a firm
• Net profit margin: Relates a firm’s net
profits to its sales
• Return on equity (ROE): Captures the
firm’s overall profitability
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly acce ssible website, in whole or in part.
PFIN4 | CH12
12
Key Measures of Performance
• Earnings per share (EPS): Return earned by
each share of common stock
• Price/earnings (P/E) ratio: Measure of
investors’ confidence in a given security
• Beta: Index of the price volatility for a
share of common stock
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly acce ssible website, in whole or in part.
PFIN4 | CH12
13
Types of Common Stock
Blue-chip
• Provides an continuous stream of dividends and long-term
growth prospects
Growth
• Earnings and/or market price have increased over time at a
above average rate
Tech
• Represents the technology sector of the market
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly acce ssible website, in whole or in part.
PFIN4 | CH12
14
Types of Common Stock
Income
• Offers dividend payments that can be expected to increase over
time
Speculative
• Purchased with a hope that its price per share will increase
Cyclical
• Price movements tend to parallel the various stages in the
business cycle
Defensive
• Price movements are contrary to movements in the business
cycle
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly acce ssible website, in whole or in part.
PFIN4 | CH12
15
Reasons for Investing in Common Stock
• Using the stock as a warehouse of value
• Accumulating capital
• Providing source of income
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly acce ssible website, in whole or in part.
PFIN4 | CH12
16
Stock Ownership
• Advantages
• Potential returns
• Actively traded and are highly liquid form of
investment
• Available market and company information
• Disadvantages
• Risk
• Problem of timing purchases and sales
• Uncertainty of dividends
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
PFIN4 | CH12
17
Making the Investment Decision
• Putting a value on stock
• Timing the investments
• Being sure to gain earnings
• Dividend Reinvestment Plan (DRP): Allowing
stockholders to take their cash dividends in
the form of more shares of the firm's stock
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
PFIN4 | CH12
18
Types of Bonds
• Coupon: Defines the annual interest
income paid to bondholder by the issuer
• Types of issues
• Mortgage bond: Secured by a claim on real
assets
• Equipment trust certificates: Secured by
certain types of equipment
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
PFIN4 | CH12
19
Basic Issue Characteristics of Bonds
• Debentures: Unsecured bond issued on the
general credit of the firm
• Sinking fund: Specifies the annual repayment
schedule to be used in paying off the issue
• Call feature: Allows the issuer to retire the
security prior to maturity
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly acce ssible website, in whole or in part.
PFIN4 | CH12
20
Bond Market
• Treasury bond
• Issued and backed by the full faith and credit
of the U.S. government
• Treasury inflation-indexed bond (TIPS):
Principal payments adjusted to provide
protection against inflation
• Agency bond
• Obligation of a political subdivision of the U.S.
government
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
PFIN4 | CH12
21
Bond Market
• Mortgage-backed securities
• Claim on the cash flows generated by
mortgage loans
• Municipal bonds: Issued by state or local
governments
• Serial obligations: Issue broken down into a
series of smaller bonds with own maturity
date and coupon rate
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly acce ssible website, in whole or in part.
PFIN4 | CH12
22
Bond Market
• Revenue bonds: Serviced from the income
generated by a specific project
• General obligation bonds: Backed by the full
faith and credit of the issuing municipality
• Corporate bonds: Issued by a corporation
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly acce ssible website, in whole or in part.
PFIN4 | CH12
23
Bond Market
• Convertible bonds
• Conversion privilege: Stipulates the conditions
of the conversion feature
• Conversion ratio: Specifies the number of
shares of common stock into which a
convertible bond can be converted
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly acce ssible website, in whole or in part.
PFIN4 | CH12
24
Bond Market
• Conversion value: Measure of what a
convertible issue would trade for if it were
priced to sell based on its stock value
• Conversion premiums: Difference between a
convertible security’s market price and its
conversion value
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
PFIN4 | CH12
25
Exhibit 12.2 Moody’s and Standard & Poor’s
Bond Ratings
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
MKTG4 | CH12
26
Pricing a Bond
• All bonds are priced as a percentage of par
• Priced in decimals in the corporate and
municipal market
• Accrued interest: Amount of interest
earned since the last coupon payment date
by the bond holder/seller
• Clean Price: Quoted price of a bond minus
accrued interest
• Dirty Price: Quoted price of a bond plus
accrued interest
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
PFIN4 | CH12
27
Bond Prices and Yields
• Bond price depends on its:
• Coupon
• Maturity
• Movement of market interest rates
• Premium bond: Market value is higher
than par
• Discount bond: Market value is lower than
par
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly acce ssible website, in whole or in part.
PFIN4 | CH12
28
Bond Prices and Yields
• Current yield
• Amount of current income a bond provides
relative to its market price
• Yield to maturity
• Fully compounded rate of return that bond
would yield if held to maturity
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
PFIN4 | CH12
29
KEY TERMS
•
•
•
•
•
•
•
•
•
•
•
Business risk
Financial risk
Market risk
Purchasing power risk
Fixed income securities
Interest rate risk
Liquidity risk
Event risk
Risk-free rate of return
Desired rate of return
Residual owners
•
•
•
•
•
•
•
Proxy
Dividend yield
Stock dividends
Book value
Net profit margin
Return on equity (ROE)
Earnings per share
(EPS)
• Price/earnings (P/E)
ratio
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
PFIN4 | CH12
30
KEY TERMS
•
•
•
•
•
•
•
•
•
•
•
Beta
Blue-chip stock
Growth stock
Tech stock
Income stock
Speculative stock
Cyclical stock
Defensive stock
Large-cap stock
Mid-cap stock
Small-cap stock
• Dividend reinvestment
plan (DRP)
• Coupon
• Mortgage bond
• Equipment trust
certificate
• Debenture
• Sinking fund
• Call feature
• Treasury bond
• Treasury inflationindexed bond (TIPS)
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly acce ssible website, in whole or in part.
PFIN4 | CH12
31
KEY TERMS
• Agency bond
• Mortgage-backed
securities
• Municipal bond
• Serial obligation
• Revenue bond
• General obligation
bond
• Corporate bond
• Conversion privilege
• Conversion ratio
•
•
•
•
•
•
•
•
•
•
Conversion value
Conversion premium
Junk bond
Accrued interest
Clean price
Dirty (full) price
Premium bond
Discount bond
Current yield
Yield to maturity
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
PFIN4 | CH12
32
SUMMARY
• Investors are exposed to business, financial,
market, purchasing power, interest rate,
liquidity, and event risks
• Sources of return - Current income, capital
gains, and interest
• An investment is acceptable only if it is
expected to generate a rate of return meets
one’s desired rate of return
• Types of stock
• Blue-chip, growth, tech, income, speculative,
cyclical, defensive, and market-cap
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
PFIN4 | CH12
33
SUMMARY
• Measures of performance
• Book-value, net-profit margin, ROE, EPS, P/E
ratio, and beta
• Bonds are referred to as fixed-income
securities as the debt service obligations of
the issuer are fixed
• Types of bonds
• Treasury, agency, mortgage-backed, municipal,
corporate, and convertible
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly acce ssible website, in whole or in part.
PFIN4 | CH12
34