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b) How to Use the Rule of 72:1) Rates of Return Time to Double: a) Compound interest is an amazing thing, and the Rule of 72 is a simple way to quickly estimate how long it will take your investment to double. The only piece of information you need for this calculation is the annual rate of return. While most investments don’t have a fixed rate of return over a long period of time, you can use an average estimate to get a pretty good idea.b) How to Use the Rule of 72:c) To estimate how long it takes for your money to double, simply divide 72 by the interestrate. The result is how many years it will take for your money to double at that rate. For example, let’s assume you can earn a 6% rate of return. How long will it take $1,000 to grow into $2,000?d) 72 / 6 percent = 12 years e) In this example, if you invested $1,000 into an account that earned a flat 6% annual rate of return, after 12 years, your investment would be worth around $2,000.f) From 1950-2000 the average total return on the S&P500 was 13.7% per year. i) At that rate investors could double their money in 5-6 years.2) Dividend Yield Compared to Other Investments: a) Dividends are periodic payments to shareholdersi) By paying out dividends, typically on a quarterly basis, companies share with their stock holders some of the profits they’ve earnedb) Capital gains Provide more a much bigger source of return than dividends – at least overthe long haulc) Cash flow from dividends are far more certain than profits from capital gainsd) Dividends provide a nice cushion when the market stumblese) Recent changes in federal tax laws put dividends on the same plane as capital gainsi) Both now are taxed at the same minimum 15% tax rate, although this is sure to change soonf) Usually firms pay dividends in the form of cash. Occasionally they pay dividends by issuing additional shares of stock called a stock dividendg) More firms pay cash dividends than any other type of dividendsh) A nice by product of cash dividends is that they tend to increase over time, as companies earnings growi) Average annual increase in dividends is around 3% - 5%ii) Steadily increasing stream of dividends tend to shore up stock returns in soft marketsi) Method to assets the amount of dividends received is the Dividend Yield:i) Dividend Yield= Annual Dividends Received per share/Current Market price of the stockii) EX: company that annually pays $2 per share in dividends to its stockholders, and whose stock is trading at $40, has a dividends yield of 5%j) The Dividend Yield for stocks is significantly lower than the payout of a coupon from a bond. k) Coupon yield 2% higher than the Dividend yield.3) Common – Place Aspects to Stocks: a) Advantages to owning stock:i) Stocks generally provide attractive, highly competitive returns over the long haulii) Stocks typically outperform bondsiii) Stocks also provide investors protection from inflation because over time their returns exceed the inflation rate(1) By purchasing stocks investors gradually increase their purchasing power of moneyiv) Easy to buy and sell and the transaction costs are modestv) Price and market information is widely disseminated in the news of financial mediavi) Unit cost of a share of stock is usually within reach of most investorsb) Disadvantages:i) Risk is most significantii) All stocks possess elements of riskiii) Earnings and general performance of stocks are subject to wide swings, so it is difficult to value commons stocks and consistently select top performersiv) Sacrifice current incomec) A market where listed securities are traded regularly. These securities may be issued by corporations, governments, and other entities.d) Includes both a primary and a secondary market for securities.e) The securities trading is regulated, and the exchange does not trade in the securities butonly regulates and facilitates this trading.f) The stock exchange has a specific location, whether this is a physical location or an online marketplace.g) Government recognition is needed for a stock exchange to operate, because this type ofmarket is organized and plays a role in the economy of a country.h) A stock exchange is an indicator of economic development for a country, and this market acts as a financial barometer4) Rights Offering: a) A way for companies to issue new shares of stockb) Rights Offering - Existing stockholders are given the first opportunity to buy the new issuec) In essence, a stock right gives a share holder the right (but not the obligation) to purchase new shares of the company’s stock in proportion to his or her current ownership positiond) EX: If a stockholder currently owns 1% of a firm’s stock and the firm issues 10,000 additional shares, the rights offering will give that shareholder the opportunity to purchase 1% (100 shares) of the new issuee) If the investor does not want to use the rights, he or she can sell them to someone who doesf) The net result of a rights offering is the same as that of a public offering: The firm ends up with more equity in its capital structure, and the number of shares outstanding increases5) Round Lot (Retail): a) Round Lot -100 shares of stock or multiples thereofb) EX: the sale of 400 shares of stock would be a round-lot transactionc) Odd Lot – transaction involving fewer than 100 sharesd) EX: trading of 250 shares would involve a combination of two round lots and one odd lote) An investor incurs certain transaction costs when buying or selling stockf) Higher fees are connected with the purchase or sale of odd lots, which requires a specialist known as an odd lot dealerg) This usually results in an odd lot differential of 10 to 25 cents per share, which is tacked on to the normal commission charge, driving up the costs of these small tradesh) The relatively high cost of an odd lot trade makes it better to deal in ROUND lots whenever possible6) Par, Book and Market Values/ Type of Accounting Values for Firms : a) *Par value – refers to the stated, or face, value of a stocki) Except for accounting purposes, it is relatively uselessii) Par value is a throwback to the early days of corporate law, when it was used as a basis for assessing the extent of a stockholders legal abilityiii) Because the term has little or no significance for investors, many stockholders are issued as no par or low par stocks. That is they may only have a value of a penny or twob) *Book value – another accounting measure, represents the


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FSU FIN 3244 - Rates of Return Time to Double

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