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Investing in Stocks and Bonds

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Investing in Stocks and Bonds Bond Ratings Pay higher interest rates than savings Offer safe return of principle Have less volatility than stocks Offer regular income ... – PowerPoint PPT presentation

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Title: Investing in Stocks and Bonds


1
Investing in Stocks and Bonds
2
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.

3
Objectives
  • Describe the major characteristics of bonds.
  • Differentiate among the four general types of
    bonds.

4
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.

5
Stocks and Bonds and How They are Used
  • Common stock
  • Preferred stock
  • Bonds

6
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 dont have to repay the money
  • Dividends are not mandatory
  • Stockholders have voting rights

7
Why Do Investors Purchase Stock?
  • Income from dividends
  • Dollar appreciationof stock value
  • Increased value from stock splits

8
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

9
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 _at_ 71 7,100
100 shares _at_ 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
10
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

11
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

12
Language of Stock Investing
  • Earnings per share (EPS)
  • Price/earnings ratio (P/E ratio)
  • Dividend payout ratio
  • Market price
  • Book value

13
Language of Stock Investing
  • Market-to-book ratio
  • Par value
  • Total return

14
Language of Stock Investing
  • Preemptive rights
  • Stock dividends
  • Stock splits
  • Voting rights

15
Classifications of Common Stock
  • Income stocks
  • Growth stocks
  • Speculative stocks
  • Other characterizations

16
Types of Stock Investments
  • Blue chip stock
  • low risk
  • consistent dividends
  • ex. ATT, Kellogg's, General Electric
  • Income stock
  • higher than average dividends
  • ex. utility stock

17
Types of Stock Investments
(continued)
  • Growth stock -
  • earns above average profits
  • low or no dividends
  • Profits reinvested incompany, so...
  • Stock priceshould go up
  • ex. Microsoft or Intel

18
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

19
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

20
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 gt1.0 means more volatility

21
Long-Term and Short Term Investment Strategies
Buy-and Hold Technique Dollar Cost
Averaging Direct Investment and
Dividend Reinvestment Plan (DRIP)
22
Long-Term and Short Term Investment Strategies
Day Trading Buying Stocks on Margin Selling Short
Trading in options

23
Make a Decision toSell 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. Stocks price/earnings ratio appears too high.

24
Language of Bond Investing
  • Corporate bond
  • Face value
  • Maturity date
  • Bond indenture
  • Debenture
  • Mortgage bond
  • Trustee
  • Secured and unsecured
  • Senior and subordinated

25
Language of Bond Investing
  • Registered and bearer
  • Callable
  • Convertibility
  • Bond Ladder

26
Types of Bonds
  • Corporate bonds
  • U.S. government securities
  • Treasury bills, notes, and bonds
  • Federal agency issues
  • Municipal Bonds

27
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
28
Considerations Before Investing in Bonds
  • Susceptibility to certain risks
  • Credit
  • Callability
  • Inflation
  • Interest rate

29
Considerations Before Investing in Bonds
  • Premiums and discounts
  • Current yield
  • Yield to maturity
  • Tax-equivalent yields
  • When to sell

30
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 Shawns bond worth?
FormulaDollar 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
31
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
32
Yield to Maturity
33
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.
34
Bond Ratings
35
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

36
Disadvantages of Investing in Bonds
  • No hedge against inflation
  • Can be quite volatile
  • Compounding is almost impossible
  • Subject to investors tax rate
  • Poor marketability
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