Ch 4 Return and Risk Investors are motivated to invest in a given vehicle by its expected return We can look at past performance charting however past performance is not indicator of future performance Expected Return is key what does the investor expect to happen to the value of the investment Key factors are Internal and External forces Internal forces are the types of investment ex A stock bond or derivative are all very different vehicles with different risks External Forces are the political environment business environment and economic environment The economic cycle and inflation and deflation Historically Small company stocks have higher returns than large company stocks Long term corporate bonds have slightly higher returns than long term government bonds US Treasury bills have the lowest return Measuring Return Risk Free Rate Real Rate of Return Expected Inflation Real rate of return Risk free rate expected inflation Expected inflation Risk free rate Real Rate of return Risk Premium Very dependent on particular asset Holding Period The period of time over which an investor wishes to measure the return on an investment vehicle Realized Return Current return actually received by an investor during the given return period IRR is annualized as compared to a holding period which is any amount of time Chapter 6 Common Stocks participate in firm profits The basic investment attribute of common stocks is that they enable investors to Every shareholder is a part owner Common stockholders are residual owners They are entitled to dividend income and a share of the company s earnings only after all other corporate obligations have been met As residual owners there is no guarantee of any return Common stock returns come in the form of dividends and capital gains few securities can match the returns of capital gains Investors can expect a steady price appreciation bad days are the exception Stock returns are different from stock price They take into account both the stock price and stock returns Stocks are subject to various types of risk including business and financial risk Stock splits are when a company increases shares outstanding by exchanging a specified number of shares of new stock for each outstanding share An investor with 200 shares in a 2 for 1 stock split would have 400 after This lowers the price and increases liquidity Small cap stocks are most risky followed by mid cap and large cap stock Friday Alternative investment strategies 1 Storehouse of value safety of investment is primary goal Have to beat inflation use high quality stocks and non speculative stocks 2 To accumulate capital growth of investment is primary goal investors use stocks to 3 source of income current income is primary goal investors use stocks with generate capital gains dependable flow of dividends Buy and hold strategies investors buy high quality stocks and hold them for extended periods of time Regardless of the market Current income investors buy stocks with high dividend yields Quality long term growth investors buy high quality growth stocks mid cap stocks and tech stocks capital gains are primary goal Aggressive stock management investors buy high quality growth stocks mid cap stocks tech stocks and cyclical stocks capital gains are primary goal high level of risk timing of market is key Speculation and short term trading day trading investors aggressively trade in and out of stocks capital gains are primary goal Chapter 10 Fixed income securities Bonds provide current income and can still provide capital gains or losses for aggressive investors bonds can provide tax free income The behavior of interest rates is the single most important force in the bond market Current income from bonds combined with a possible capital gain if interest rates fall Interest rates and bond prices move in opposite directions lead to attractive returns from bonds Bonds are significantly more stable than stocks Bonds are exposed to 5 types of risk Purchasing power risk if inflation takes off bond yields aren t greater than inflation Interest rate risk interest rates cause the price volatility in the bond market rates and purchasing power risk rises Business financial risk This is basically the risk that the issuer will default on interest and or principal payments Credit risk Liquidity risk is the risk that a bond will be difficult to unload at a reasonable price Call risk is the risk that a bond will be called by calling them in for prepayment Zero coupon bonds have no coupons they are sold at deep discounts from par and their values increase over time Mortgage backed securities debt issues that are backed by a pool of residential mortgages Sold in denominations of 25 000 Collateralized mortgage obligations bondholders are split into classes of short to long term investments that are paid off from short to long Asset backed securities the process of securitization various lending vehicles are turned into marketable securities Ex Loans for cars credit card companies receivables can be sold off as bonds convertibles are issued only by corporations they start out as bonds but can be converted to common stocks Chapter 12 Mutual Funds rate A mutual fund is a type of financial services organization that receives money from its shareholders and then invests those funds in a diversified portfolio Dividends and interest are paid back to the investors in the mutual fund at a prorated Growth funds goal is to achieve capital appreciation long term growth and capital gains are the primary goals of such funds They invest primarily in well established large and mid companies Aggressive growth Are highly speculative investment vehicles that seek large profits from capital gains Most are fairly small may use leverage Value funds confine their investing to stocks that are under valued buy and hold
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