Personal Finance Final Exam I Investments 1 This class is NOT enough for you to begin investing on your own 1 but it is useful because going over pension plans or mutual funds that you will be presented by your employer 2 Investing is all about FUTURE EXPECTATIONS Remember NO ONE KNOWS THE FUTURE WITH CERTAINTY 3 Liquidity the ability to convert an asset to cash quickly how easy is it to get your money now think that commercial its my money and I want it now 4 Default risk probability that the firm will be unable to meet is contractual 5 obligations basically the odds that they cannot pay their bills Interest Rate risk the the probability that interest rates move against you upward if you are borrowing see laddering strategy later in guide to help avoid this 6 Time a As investment characteristic maturity example bonds you know the exact interest and when the bond is mature b As length of time to invest How long until you need your money Retirement coming up Etc Investment horizon 7 Equity ownership stocks of earnings a Get returns from capital gains difference between selling and purchasing price or dividends explained later in guide Interest is the cost of money 8 9 Debt lending money a fixed amount gets paid FIRST before equity cds bonds treasuries get returns from capital gains selling bonds for example for more than you paid for them interest a For example if company goes bankrupt they pay those they are indebted to first and those with equity stocks last and there usually is never enough for stock holders to get paid 10 ALL TRANSACTION COTS REDUCE RETURN 11 Bond Types a Corporate bonds b Treasury Securities 1 Face price dollar amount firm borrows amount to be paid maturity tradable and can be publicly traded 1 Bonds notes or bills issued by the government safer than corporate bonds very liquid unlike corporate bonds c US Savings Bond cannot be traded d A bonds face price goes up and down not always its purchase price this has to do with interest rates expected in future etc 12 Bullets from this section to remember 13 Money Market Deposit accounts MMDA are like bank accounts they are very liquid but low return depository account 14 Money Market Mutual Funds MMMF mutual funds MUCH MORE RISKY THAN MMDA 15 See DEPOSITORY MEANS BACKED BY GOVT 16 Stock has no maturity date because you can keep it as long as you want 17 If you want to sell your bond to someone when market interest rates are lower you have to decrease the price you have to increase the price 18 If you want to sell your bond to someone when market interest rates are higher 19 When buying a corporate bond check the solvency rate of company you re buying from Since some companies go bankrupt that s why government bonds are less risky than corporate bonds II Common Stocks 1 Debt holders entitled to a Pay for lending the money interest b Returns of the money lent principal c Returns are NOT related to how well firm does d Can force a firm or person in bankruptcy if payments are not made 2 Shareholders stock is residual ownership it can can be a profit or a loss a No entitlement can loose entire sum of investment b Debts must be paid before stock holders get any when company goes into bankruptcy this is especially important c Share in firms profits 2 ways 1 Capital gains buying and selling stocks for less than what you paid for them what something sells for what you paid for it 2 Dividends if it is a relatively mature company they will give out a portion of their profits determined per share and how ever many shares you have you get shares X dividend per share the dividends you receive actual check determined amount per share is determined by BOARD OF DIRECTORS 3 With dividends if they think they can reinvest rather than make more they wont pay dividends ex early microsoft vs microsoft today if they think are relatively mature and not expanding to much they will pay dividends to keep share holders happy and to keep a hold of their money 4 3 Current income dividends and or interest if dealing with debt securities 4 Bull Market optimisitc rising asset prices economic expansions just remember that bulls gore UPWARDS 5 Bear Market pessismitc falling asset prices economic slowdown just remember that bears slash DOWNWARDS 6 Stock Market Prices are a Based on firms anticipated FUTURE EARNINGS b Determined by a large of trades c Expectations of future changes with supply and demand and 2 important factors 1 New Info 2 Investor Psychology 7 Info that you hear on public circuit already is already OLD INFO It has be included in the current price of the stock Think back to the super computer traders they are faster than you can possibly be 8 The Market Value is based on a Supply and demand b Firm market value stocks X share price 9 Listed firms trade on exchanges a Example NYSE NASDAQ etc 10 Even more firms are unlisted thousands of risky usually very small firms with limited number of shares illiquid a Have a small share price usually under 5 b And a low trading volume which makes prices move easily making it risky 11 Penny stocks are very risky you can make a lot or loose it all as simple as that 12 In order to be an Exchange it needs to be reasonably large firm and have lots of trading to be considered an exchange NYSE is most famous 13 Stockbrokers a Simply a salesperson who work for brokerage houses and they find those that can either buy or sell depending on which point you are at either buying a stock or selling it so you need to find someone doing the opposite someone can simply go on CNBC and brag about a certain stock people go buy it makes price go up because demand went up and now he can sell his stock for more does not make him an expert remember no one knows future b They make a profit from sales commissions you pay for every transaction doesn t matter if you make or loose money you still pay c Online brokers usually cheaper because they have a flat rate about 7 per transaction Information on stocks in plentiful so brokers are somewhat becoming obsolete If it looks to good to be true it probably is d e 14 Stock Performance a No investment type beats stock returns for the long run that means that stocks have the highest return but recall they are also the riskiest b Diversification buying a wide variety not putting all eggs in one basket or just buying one company and by liquidity lowers risk c Long time horizons It is the time until you need your money in your hand lowers risk without lowering return some up and some