INVESTMENTS 1 Basic Financial Rules a Risk and Return i Investing is all about Future Expectations 1 No one knows the future with certainty 2 Liquidity The degree to which an asset or security can be bought or sold in the market without affecting the asset s price Liquidity is characterized by a high level of trading activity Assets that can be easily bought or sold are known as liquid assets Ability to convert an asset into cash quickly Also known as marketability 3 Default Risk Probability firm will be unable to meet contractual obligations 4 Interest Rate Risk Probability interest rates will move against you i As an investment characteristic Fixed Maturity Bonds CDs ii Length of time to invest How long When Investment Horizon Retirement 40 50 b Time year 2 Investing a Equity Securities Stock Ownership i Returns Capital Gains Dividends Treasuries i Returns Capital Gains Interest b Debt Securities Lending money Certificate of Deposits Highly Liquid Bonds and c Capital Gains Difference between selling price and what it cost you d Transaction Costs Costs incurred in Buying Selling i All Costs reduce returns capital gains 3 Investments a Generally Speaking i Stock prices move in the Same Direction Up together or down together ii Debt security prices move in the same direction iii Stocks and Bonds move in opposite direction 1 Stock price Bonds b In the Specifics look at General i Investments 1 Move in Whatever Directions they do 2 Move up or down In various amounts a 100 000 today other amount tomorrow 4 Debt Securities a Interest rate you receive depends on i Market interest rates when purchased ii Size amount invested iii Maturity length of investment iv Default Risk Credit v Certificate of Deposit Specific Dollar Amount deposited for a specific time Choose how long 6months 12 months etc 1 Longer Less liquidity higher interest Further the riskier more return 2 Fixed Rate interest rate is constant for Security s life until maturity Know exactly how much 3 Variable Rate changes with interest rate in the economy a Varies with an index at a preset time b Must know what is happening in the economy 4 Early withdrawal Penalty 5 Trade off liquidity vs Risk of return 6 Tips 1 Don t allow Automatic roll overs 2 Compare offer Rates APYS Can vary considerably 3 Give instructions Be aware Maybe you need money now Tuition accident etc Maybe change length of time 4 Laddering 5 Bond Types long term debt a Corporate Bonds i Face Price amount the firm borrows ii IBM issues bond Face Value 1000 7 APY 30 yr bond 1000 40 1040 80 yr in int 2x per year iii Retirement Enough Bonds will add up every 6 months iv Liquidity Relative 1 You can trade in between a Hold until maturity know exactly what you will get v Amount to be repaid At Maturity vi Tradable Can be publicly traded between investors b Treasury Securities Bonds notes bills issued by US gov t Longest shortest maturities c US Savings Bond CAN T TRADE i Savings bonds not the same as treasuries d A bond s face price NOT always its purchase price e Treasury bonds are very liquid corp bonds not so much i 100 000 CDs not FDIC insured Make sure bank is solvent 6 Money Market Deposit Accounts MMDA a Money Mkts Trading in short term securities Low Risk Mature in 1year i High liquidity Lower Risk Lower Return ii Pays a Variable Interest Rate iii Minimum balance usually required 1 Opportunity Cost 2 Penalty If Balance falls below minimum iv May have limited check writing b Depository Accounts usually FDIC insured c MMMF Mutual funds MMDA Depository Accounts Different i MMDA FDIC insured up to 100 000 ii MMMF Reasonably safe but not backed by gov t 1 Can lose money subject to loss 7 Indexes a An Index A group of specified securities Stocks bonds i Typically diversified around some characteristic ii More Data points make measures More meaningful b Indexes help investors i Gauge general market conditions ii Compare their returns to an index Benchmark to measure performance iii Look at past behavior Of represented securities iv Attempt to Forecast stock market behavior 8 Index Examples a CPI Consumer Price Index A measure that examines the weighted average of prices of a basket of consumer goods and services such as transportation food and medical care The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them the goods are weighted according to their importance Changes in CPI are used to assess price changes associated with the cost of living inflation deflation b Bond Indexes method of measuring the value of a section of the bond market It is computed from the prices of selected bonds typically a weighted average It is a tool used by investors and financial managers to describe the market and to compare the return on specific investments ii S P 500 500 largest US firms leading firms in leading industries NYSE AMEX c Well Known Stock Indexes i DOW DJIA 30 Huge US firms all industries 1 High of mkt value industry breath quality 1 Broader measure than the DJIA iii NASDAQ 100 100 firms on NASDAQ exchange 1 Leans toward technical high growth firms d MSCI Morgan Stanley Country Indexes e Comparing numeric levels of two indexes is MEANINGLESS i Often used as benchmarks to measure an individual s performance against market ii Can you beat the appropriate index Must be measured over same time period iii Performance is NOT just about returns also about risks 1 Higher Risk Higher returns but risk of not getting them b Assuming no default the exact return is known on fixed interest security if held to 9 Returns and Debt Securities a Interest Payments maturity c U S treasuries i Very low default Risk low return ii Very High Liquidity Safer d Corporate Bonds Risk level is rated higher interest i Higher Risk bond must offer Higher returns ii Corporate bonds are RISKIER than U S bonds e If sold before maturity i Bond selling price impacted by maturity and interest rates f U S savings bonds Fixed Rate of int Over fixed period Non negotiable Can t Trade i Safe Risk free 10 Common Stocks Outstanding a General Market Conditions i Bull Market 1 Investor Optimism 2 Rising Asset Prices 3 Occurs during economic expansions VS b Bear Market i Investor pessimism ii Falling Asset Prices iii Occurs during economic slowdowns 11 Stock Market and Stock Market Prices a Stocks represent ownership Equity b Based on firm s anticipation c Determined by a large number of trades d Stock prices move with supply and demand changes i Supply