Personal Finance Final Exam Review Investments This class is not enough for you to being investing on your own but its useful b c going over pension plans or mutual funds that you will be presented by your employer Basic Financial Rules Risk and return Investing is about future expectations o No one knows the future with certainty As the risk increases you demand a higher return for it Liquidity any time you want your money you can get it The ability to convert an asset to cash quickly o How easy is it to get your money now think that commercial its my money and I want it now Example checking accounts Default risk the chance a firm won t be able to meet its legal financial obligations The probability that the firm will be unable to meet its contractual obligations o The odds that they cannot pay their bill Interest rate risk the chance that interest rates will move against you The probability that interest rates move against you o Upward if you are borrowing see laddering strategy to avoid this Time As a characteristic of the investment vehicle maturity goes away o Bonds you know the exact percentage of interest and when the bond is mature Length of time before investment money is needed by the investor investment horizon Investing Equity Securities Ownership Returns from Capital gains Dividends of earnings stocks Stock Debt Securities Lending money a fixed amount Gets paid FIRST before equity Get returns from capital gains interest CDs Bonds Treasuries o Dividends a partial return of the earnings of a company to its shareholders o Capital Gains difference between selling price purchase price o If a company goes bankrupt they pay those they are indebted to first and those with equity stocks last There is usually never enough for stockholders to get paid Interest def the cost of money rates you receive depend on Cost of money at the time of investment market rate Size amount of investment Maturity length of investment Default risk of investment Certificate of Deposit CD specific dollar amount for specified time You re putting money into a bank locking it up for a period of time The higher the amount the greater the return The longer you leave it in the more risk you re taking and less liquidity you have Fixed rate CDs constant rate over security s life Variable rate CDs change with interest rate in economy o Early withdrawal penalty If you take out your money early and break the contract there will be a penalty Returns Capital gains Interest Tips 1 Don t allow automatic roll overs because the economy is changing and life changes You can adjust when you need to but don t let it be automatic 2 Compare rates APYs they can vary a lot Equity Debt Securities INVESTING Capital Gains difference between selling price purchase price Transaction costs costs incurred in buying or selling anything o All costs reduce returns Generally Speaking Stock prices Debt security Bond prices bond yields Specifically Investments move in the same direction either up together or down together prices move in the same direction always move in opposite directions o Move in whatever direction they do o Move up down in various amounts Bond Types A bond is a contract where you are lending money to a corporation for a period of time 5s Make sure they are high quality They pay a higher rate of return than other debt instruments which means they are high risk May have less liquidity Long terms to maturity which means you need to make sure the company will still be alive Face price the dollar amount the firm issuer borrows o Amount to be repaid at maturity o Tradable can be publicly traded between investors U S Treasury Securities U S gov t issued bonds notes bills longest to shortest maturity Issued by the government safer than corporate bonds and very liquid unlike corporate bonds U S Treasury bond notes bills are the largest market that there is they are very tradable and extremely liquid U S Savings Bonds cannot be traded and illiquid A bond s face price goes up and down and is not always its purchase price this has to do with interest rates expected in the future etc Not the same as a U S Treasury Bond It is not tradable and you have to keep it for a certain period of time Money Market Deposit Accounts MMDA Money Markets trade in short term mature in less than one year securities Short term debt instruments By putting your money in a bank you re actually losing money due to inflation Its safer but you will lose purchasing power Example of sweater price rising from year to year Although you lose purchasing power it can save you from having to take money out of another investment at a very high cost so you should have some money saved in the bank High liquidity Lower risk Lower return because they mature for a short term and that s it Its unlikely for someone to default immediately Pay variable interest rates Minimum balance usually required Opportunity cost May have limited check writing From study guide notes Penalty if balance falls below minimum amount o Are like bank accounts very liquid but low return depository account MMMF mutual funds MMDA depository accounts are different Depository accounts usually FDIC insured MMMF mutual funds are much more risky than MMDA MMMF pays a slightly higher rate than MMDA they can lose your principle because they are not FDIC insured It is still short term security when these things go away they buy new ones that come out It s a continuing cycle MMMF is an investment company product which can lose money because it s a private enterprise and not backed by anything Indexes An index is a group of specified securities give you the general trend Indexes help investors Typically diversified around some characteristics based on what you want it to be More data points make measures more meaningful a single day point in the stock market doesn t Gauge general market conditions Attempt to forecast future behavior Compare their returns to an index benchmark Compare stock s in a specific sector I want to know if I m doing better than the average Index Examples CPI consumer price index measures inflation Bond Indexes Well known stock indexes o DOW 30 huge US firms all sectors o S P 500 500 largest US firms leading firms in leading industries NYSE AMEX o NASDAQ Composite 3 000 firms on NASDAQ exchange Components tend to be weighted toward tech new firms Comparing numeric levels is meaningless must compare percentage returns MSCI Morgan Stanley Country Indexes Often used to benchmark an