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.

Common stock

Preferred stock

Bonds

Stocks and Bonds and How They are Used

Why do corporations issue common stock?To raise money to start or expand a

businessTo help pay for ongoing business

expensesThey don’t have to repay the money Dividends are not mandatoryStockholders have voting rights

Investing in Stocks

Why Do Investors Purchase Stock?

Income from dividends

Dollar appreciationof stock value

Increased value from stock splits

Common vs. Preferred Stock

Common stockget dividends depending on profit the

company makes

Preferred stock receive cash dividends before common

stock holderspre-determined dividend ratemost 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 $8,900Commissions +55 Commissions - 70Total investment $7,155 Total Return $8,830

Transaction Summary:Total Return $8,830Minus Total Investment 7,155Profit from Stock Sale $1,675Plus Dividends +260Total 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

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

Language of Stock Investing

Classifications of Common Stock

Income stocks

Growth stocks

Speculative stocks

Other characterizations

Types of Stock Investments

Blue chip stock low riskconsistent dividendsex. AT&T, Kellogg's, General Electric

Income stockhigher than average dividendsex. utility stock

Types of Stock Investments

Growth stock -earns above average profits low or no dividendsProfits reinvested in

company, so...Stock price

should go upex. Microsoft or Intel

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Types of Stock Investments

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

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Numeric Measures to Consider When Evaluating a Stock

Look at book value of one sharenet 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 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

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Long-Term and Short Term Investment Strategies

Buy-and Hold TechniqueDollar Cost Averaging

Direct Investment and Dividend Reinvestment Plan (DRIP)

Long-Term and Short Term Investment Strategies

Day TradingBuying Stocks on MarginSelling Short

Trading in options

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

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

Language of Bond Investing

Corporate bonds

U.S. government securities

Treasury bills, notes, and bonds Federal agency issues

Municipal Bonds

Types of 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%

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

Considerations Before Investing in Bonds

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 TransactionAssume 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

Pay higher interest rates than savings

Offer safe return of principle

Have less volatility than stocks

Offer regular income

Require smaller initial investment

Advantages of Investing in Bonds

No hedge against inflation

Can be quite volatile

Compounding is almost impossible

Subject to investors tax rate

Poor marketability

Disadvantages of Investing in Bonds