Exam 3 Investments Basic Financial Rules 04 28 2014 Everything is a trade off opportunity cost o There is good and bad in everything When you invest it is all about the future o Nobody knows the future with certainty As the risk of something happening becomes more uncertain a Liquidity when you want to get your money back you can get it o Forfeit some of the return for the ability to get your money higher return is demanded back at a reasonable price when you need it Default Risk firm goes bankrupt and you have stock or equity in the company the value becomes worthless Interest rate risk cost of money if the interest rate in the economy goes up down fixed rate loans mortgages can t charge your interest rate o Can be good or bad o Risk probability that you won t get what you expect to get Time o some investments have a fixed maturity ex 30 year mortgage house is paid off and debt goes away o Stock has no maturity date considered to be perpetual o Investment horizon plans of the investor When do you need your money by Types of Investments Equity securities o Based on the ownership of something Ex stock Returns from stock come from 2 sources 1 Capital gains What you sell something for minus what you paid for it 2 Dividends Transaction costs You incur these whenever you buy sell Usually pay a commission to the stock anything broker Transaction costs reduces the return on an investment ex Buy a stock for 10 and sell for 25 Commission costs get in the way of your gain When comparing two different stocks look at the percentage change not the dollar amount change Debt securities o Lending money CD s certificate of deposit bonds U S treasuries Returns come from 2 sources 1 Capital gains 2 Interest o Interest rates depend on Cost of money at the time of investment market rate Size amount of investment Maturity length of investment Default risk of investment o Certificate of Deposit CD specific amt for specified time Fixed rate CDs constant rate over security s life Variable rate CDs change with interest rate in economy Early withdrawal penalty Tips 1 Don t allow automatic roll overs 2 Compare rates APYs this is the yield you want the larger number because the interest is being paid to YOU Corporate Bonds lending money to a corporation for a o Bond Types period of time Face price amount the firm issuer borrows Amount to be repaid at maturity o Recap Tradable can be publicly traded btwn investors Issuer pays a higher percentage for risker bonds because it s not backed by FDIC firm can default on the bond and go bankrupt Ex giving 5 interest in a 2 world CD invest locking it up higher amt or longer left in greater return early withdrawal penalty less liquidity Corporate Bond high quality higher return may have less liquidity tend to offer higher rate of return than other debt investments long terms to maturity U S Savings Bond Treasury Bond IS NOT the same as U S o m at Money Market Deposit Acc ts MMDA Money Markets trade in short term securities o High liquidity lower risk lower return o Pay variable interest rates o Minimum balance usually required o Opportunity cost o Penalty if balance falls below minimum amt o May have limited check writing Depository accounts usually FDIC insured MMMF money market mutual funds companies pool money together from various stocks bonds and MMDA depository acc ts are different Indexes Index a group of specified securities group of stocks o Typically diversified around some characteristic Ex DOW 30 diverse companies representing the general condition of the market o More data points make measures more meaningful Indexes help investors o Gauge general market conditions o Compare their returns to an index benchmark o Performance is NOT only about returns also about risk o Higher risk higher returns but greater uncertainty Possible question According to class discussion this class has given you enough information for investments false on the test Common Stocks Outstanding Debt holders vs 04 28 2014 Shareholders Debt holder Depositors bondholders Get paid interest Less risk than SH s fixed amount of return Shareholder Equity Stockholders Return is based on co s performance Debt holder is the one who holds the debt of somebody else when it comes to investing o That person will return the money plus interest Debt holders are entitled to o A return for lending their money o A return of the money they lent Borrower is legally required to pay back principal interest If not then bondholders can push the company into bankruptcy o If company goes bankrupt debt holders are paid first stockholders generally get nothing Shareholders have residual ownership after all liabilities debt obligations are paid Investment Returns I Capital Gain Selling Price Purchase Price o Stocks realize the cap gain is when you sell o Bonds if held to maturity no cap gains If you sell it cap gain loss II Current Income o Dividends stock A share of a firm s profits paid to its owners Firm s Board of Directors group of people that the shareholders vote for They represent the shareholders and hire fire the CEO o Interest Debt General Market Conditions Bull Market Bear Market o Investor optimism occur during economic expansions o Investor pessimism occur during economic slowdowns Market Value Stock Prices Market value based on what the market thinks o Who what is the market o Firm s market value o Determined by supply demand Stock prices are based on our expectations of future earnings of the firm o Change with 1 New information 2 Investor psychology Inherently risky investment No one knows the future with absolute certainty Common Stocks Listed firms trade on exchanges o Such as NYSE NASDAQ Even more firms are unlisted typically penny stocks o These are typically very small firms Limited number of shares illiquid Low trading volume illiquid Low share price often less than 5 Stockbrokers Salespeople who work for brokerage firms o Find counter party to trade Profit from commissions fees whenever stocks trade o Doesn t matter if you make money or not Be wary of recommendations Online brokers are usually cheapest Stock information is plentiful If it looks to good to be true it is Financial Similarities Get information Know why what you re buying o Your goals determine when money s needed what you can invest in risk you can take o Opportunity costs versus potential losses Decide when to sell o Monitor situation for firm economy changes Stay in market position or increase Exit market position or reduce