Transcript INVESTMENT PLANNING CHAPTER 11:

CHAPTER 11:
INVESTMENT PLANNING
11-2
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 shortterm activity. Future values and returns
highly uncertain.
 Adequate insurance coverage and
emergency funds should be in place
before starting to invest.
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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
and dividend reinvestment programs.
 While saving, learn as much as possible
about investments and "play" trade.
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Coming Up With the Capital
 Determine your financial objective.
 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!
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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.
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Save for retirement—to live
comfortably in your "golden
years."
Shelter income from taxes—to
preserve more of your earnings.
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Different Ways to Invest
1. Common Stock
2. Bonds
3. Preferreds and Convertibles
4. Mutual Funds
5. Real Estate
6. Commodities, Financial Futures,
and Options
1. Common Stock
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– Represents a share of ownership in a
company.
– Greater potential returns, but at a higher
level of risk.
2. Bonds
– Represent the debt of a company.
– Provide current income.
– Lower level of risk than stocks, but with
lower expected returns as well.
– Bond valuations inversely related to
changes in prevailing interest rates.
3. Preferred Stock
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– An equity security that behaves like
debt—provides current income and
possible price appreciation.
– However, company has no legal
obligation to declare dividends.
Convertible Bonds
– Usually offer lower interest rates than
regular bonds, but —
– Can be converted into common stock.
– Risk that common stock will not do well
and investor simply gets lower return.
4. Mutual Funds
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– Collection of professionally managed
securities offered by an investment
company.
– Returns and level of risk depend on
characteristics of underlying portfolio.
5. Real Estate
– 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.
6. Commodities and Futures
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– Originally designed for agricultural
producers to manage price risks;
participants are now mostly speculators.
– Traders enter contracts to buy or sell a
certain physical or financial item at a
future date.
Options
– Contract which conveys the right, but not
the obligation, to buy (call) or sell (put)
the underlying asset at a specific price on
or before the expiration date.
– Learn more at www.cme.com.
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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, shortterm securities (those with maturities
less than 1 year) are traded.
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 Primary market—for new issues which
are available for the very first time.
The issuing company gets the
proceeds.
 Secondary market—for trading
previously issued securities. Trading
is done between investors; issuing
company gets nothing.
Organized securities exchanges
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– 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, wellknown companies' securities.
Over-the-counter market
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– 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."
Foreign securities markets
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– 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.
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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.
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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.
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Making Transactions
In the Securities Markets
 Stockbrokers purchase and sell
securities for investors.
 Select from full-service, discount, or
online broker, depending on your
needs.
 Consider brokerage fees when
making securities transactions.
Investor Protection:
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 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!).
Executing Trades:
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 Investor must first establish account
with broker.
 Trades can be executed by phone, at
the brokerage firm, or online.
 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!
Investor places
the order with
the broker.
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Investor places
the order with
the broker.
Broker transmits
order to the
market via telecommunications
equipment.
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Investor places
the order with
the broker.
Broker transmits
order to the
market via telecommunications
equipment.
Order is
filled at the
market by
other buyers
and sellers.
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Investor places
the order with
the broker.
Broker transmits
order to the
market via telecommunications
equipment.
Execution of
the order is
confirmed
to the broker.
Order is
filled at the
market by
other buyers
and sellers.
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Investor places
the order with
the broker.
Broker confirms order
fulfillment. Investor has
3 days to settle account.
Execution of
the order is
confirmed
to the broker.
Broker transmits
order to the
market via telecommunications
equipment.
Order is
filled at the
market by
other buyers
and sellers.
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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.
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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.
Example of Margin Trade with Profit:
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(See Exhibit 11.3 in text)
Transaction
w/out w/margin
 Initial investment (100 shares @ $50)
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
Example of Margin Trade with Loss:
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Transaction
w/out w/margin
 Initial investment (100 shares @ $50)
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)
Margin Trade Returns:
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Return = Profit (loss)  Amount Invested
 Price Increase
Return
 Price Decrease
Return
w/out w/margin
$2,000 $1,775
$5,000 $2,500
40%
71%
($2,000) ($2,225)
$5,000 $2,500
(40%)
(89%)
Short Selling:
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 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.
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Example of Short Sale:
(See p. 459 in text)
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
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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!!
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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!!
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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!
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Becoming an Informed Investor
Types of Information to Follow:
– Economic developments and
current events
– Alternative investment vehicles
– Current interest rates and price
quotations
– Personal investment strategies
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Available Investment Information :
 Annual Reports
 Financial Press
(WSJ and financial magazines)
 Brokerage Reports
 Advisory Services
 Investment Advisors
 On-Line Sources
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Online Investing
 Online services
 Educational
material
 Investment
tools
 Investment
planning
 Research and
screening
 Portfolio
tracking
 Day trading
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Using the Internet Wisely:
Do your own research.
Realize that frequent trades
mean higher transaction costs.
Don’t believe everything you
read.
Avoid online scams!
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Questions to Ask:
Is the stock registered?
Who is making the sales pitch?
Is it too good to be true?
Refer to SEC Web site:
www.sec.gov
(Search on “investment scams.”)
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Managing Your
Investment Holdings
 Build a diversified portfolio of
securities based upon your goals
and personal situation.
 Allocate your assets according to
your objectives.
 Track your investments and
rebalance your portfolio as your
needs change.
THE END!