HACE 3200 1nd Edition Lecture 22Outline of Last Lecture I. Property insuranceII. Liability InsuranceOutline of Current Lecture- Prospectus: a document (booklet) tells you all the information about what makes up the funds. A portfolio about what goes into a particular investment.- Chapter 11: Investment Basicso Investing Versus Speculating Investing: putting your money into an asset that generates a return- Examples: stocks, bonds, mutual funds Speculating: putting your money into an asset that the future value, or return, relies on supply and demand- Examples: collectors items, gold, baseball cards, or derivative securities o Lending Investments Savings account: loan institutions money Bonds: loans where your rate of return is predetermined- Par value: the amount you receive when bond matures- Coupon interest rate: the interest paid annually on a bond as a percentage of par valueo Ownership Investments Stocks: you become part owner in the corporation and receive a portion of the profits as dividends Real estate: you generate a return through rent or capital appreciation o Returns From Investing Investors expect a return for delayed consumption- 1. Capital gains/losses: your investment goes up or down- 2. Incomeo 1. From bonds you receive interesto 2. From stocks you receive dividendso Returns from Investing( cont’d) Rate of return=- (Ending value- beginning value) + income/ beginning valueThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute. rate of return=- ($55 - $55) + $3/ $45= $13/$45= 28.89%o Returns from Investing( cont’d) Annualized rate of return=- (ending value- beginning value) +income/ beginning value X 1/No N= number of years you have held onto investmento Nominal and Real Rates of Return Nominal( quoted) rate- the rate of return without adjusting for inflation Real rate- the inflation adjusted rate of return Premiums—additional returns demanded by investors for taking on additional risko Types of risk Premiums Inflation risk premium( IRP)- compensation for the anticipated inflation over the life of the investment Default risk premium( DRP) – compensation for the possibility that the issuer may not pay the interest or repay the principal.o Types of risk Premiums (cont’d) Maturity risk premium( MRP)- compensation on longer- term bonds for value fluctuations in response to interest rate changes Liquidity risk premium( LRP)—compensation for a bond that can not be quickly converted into cash at a fair market valueo Sources of Risk in the Risk- return Trade-Of Interest rate risk- Risk associated with fluctuations in security prices due to changesin the market interest rate.- A rise in the market interest rate reduces the value of your lower rate security- Impossible to eliminate Inflation Risk- Risk that rising prices will erode purchasing power- Closely linked to interest rate risk because of the efect of inflation on interest rates- Almost impossible to eliminate Business Risk- Is the risk associated with poor company management or productacceptance in the marketplace- Varies by company Financial Risk- Risk associated with the company’s use of debto If they default: Bond holders paid 1st Preferred stock Common stock Liquidity Risk- Risk associated with not being able to liquidates a security quicklyand cost efectively- Collectibles and real estate have high liquidity risk Market Risk- Risk associated with the swings in the overall market- Can be caused by the economy, supply and demand, and interest rates- Impossible to eliminate Political and regulatory risk- Risk that results from unanticipated changes in the tax or legal environment- Can be very difficult to predict Call risk- Risk that a callable security may be taken back before maturity- If a bond is called, the investor normally receives the face value plus one year of interest payments- Only applies to callable bonds Systematic and Unsystematic Risk- Systematic risk: the risk associated with all securities and cant be reduced through diversification( interest rate risk)- Unsystematic risk: risks associated with one particular investmentand can be reduced through diversification ( financial risk) Risk and Diversification- Diversification refers to the number of diferent types of securities owned- Diversification reduces risk- Investors demand a return for taking on additional systematic riskChapter 12: Security Markets- A place where you buy or sell securitieso The primary marketso Secondary markets- The Primary Marketo The market for new security issues. In the primary market the security is purchased directly from the issuer( corporation)- The Primary Market: Two forms of Issueso 1. Initial public ofering—the first time the company’s stock is traded publiclyo 2. Seasoned new issues—new shares being issued buy a company that is already publicly traded- How to setup an IPOo A corporation will hire an investment bank to facilitate the sale of its shares to the public. This process is commonly called underwriting.- Underwritingo In such a case, the underwriter will guarantee a certain price for a certain number of securities to the corporation( in exchange for a fee). Thus the issuer is secure that they will raise a certain minimum from the issue, while the underwriter bears the risk that the security does not do well.- Secondary Marketso Trade previously owned shares of stocko Consist of organized exchanges and an over-the-counter market.- Secondary Market: The Organized Exchangeso Facilitate trading between investorso Occupy a physical locationo New York Stock Exchange Nationalo American Stock Exchange Nationalo Regional Stock Exchanges Does futures(looking at things that are going to be available in the future- Cows,wheat, corn- Make-up of the Stock Exchangeso Limited # of seats (membership)o Only members can buy and sell on trading flooro Brokerage firms may have 20 seatso Over 3,000 listed companies traded on NYSEo 780 companies on the AMEX- New York Stock Exchangeo Called “the Big Board:o Over 200 years old(1792)o Limited to 1,366 seats since 1953o Highest price of a seat was $2.6 million- Secondary Markets: Over- The-Counter Marketo Computer network of dealers used to execute tradeso