© 2008 Thomson South-Western CHAPTER 11 INVESTMENT PLANNING

11-2 The Objectives & Rewards Of Investing  Investing—usually considered a long-term activity. Future values and returns expected to increase through time.  Speculating—usually considered a short- term activity. Future values and returns highly uncertain.  Adequate insurance coverage and cash/savings are investment prerequisites

11-3 How Do I Get Started?  Accumulate money by regularly allocating a portion of your earnings for investing—PAY YOURSELF FIRST!  Take advantage of automatic investment and dividend reinvestment programs.  While saving, learn as much as possible about investments and "play" trading.  Determine your financial objectives.

11-4 What Are Your Investment Objectives?  Supplement current income— appropriate for retired persons  Save for major expenditures— such as college education, down payment on a home, or starting a business

11-5  Shelter income from taxes—to preserve more of your earnings.  Save for retirement—to live comfortably in your "golden years." What Are Your Investment Objectives?

11-6 Coming Up With the Capital  How much money will it take?  Do you have a lump sum to invest now, or will you systematically save toward your goal?  Your investment plan provides direction in helping you attain your goal

11-7 Average Annual Returns On Stocks, Bonds, And U.S. T-bills Over Various Holding Periods From Years

11-8

11-9 Different Ways to Invest 1. Common Stock 2. Bonds 3. Preferreds and Convertibles 4. Mutual Funds 5. Real Estate

Common Stock –Represents a share of ownership in a company. –Greater potential returns, but at a higher level of risk. 2. Bonds –Represent the debt of a company. –Provide current income. –Lower level of risk than stocks, but with lower expected returns as well. –Bond valuations inversely related to changes in prevailing interest rates. Different Ways to Invest

Preferred Stock –An equity security that behaves like debt—provides current income and possible price appreciation. –However, company has no legal obligation to declare dividends. Convertible Bonds –Usually offer lower interest rates than regular bonds, but — –Can be converted into common stock. –Risk that common stock will not do well and investor simply gets lower return. Different Ways to Invest

11-12 –Collection of professionally managed securities offered by an investment company. –Returns and level of risk depend on characteristics of underlying portfolio. 5. Real Estate –Can invest directly or through buying shares of a REIT. –Estimating risk and expected return can be difficult. Investors must be aware of economic cycles. 4. Mutual Funds Different Ways to Invest

11-13 Securities Markets  Securities market: place (not always physical) where financial instruments are traded. –Capital market—where long-term securities (with maturities greater than 1 year) are traded. –Money market—where low-risk, short- term securities (with maturities less than 1 year) are traded.

11-14  Secondary market—for trading previously issued securities. –Securities exchanges –NASDAQ –OTC Market  Primary market—for new issues which are available for the very first time. –Investment bank underwrites –Issuing company gets proceeds –Prospectus Securities Markets

11-15  Dealer market— the buyer and seller are never brought together directly; their buy/sell orders are executed separately through securities dealers, who act as market makers  Broker market— the two sides to the transaction, the buyer and the seller, are brought together and the trade takes place at that point: the seller, Party A, sells securities directly to the buyer, Party B. Broker and Dealer Markets

11-16 Broker and Dealer Markets

11-17  Bid price— the price at which a security can be sold  Ask price — the price at which a security can be bought Dealer Markets

11-18 –Organized securities exchanges exist in more than 100 countries worldwide. –Found in major industrialized nations such as Japan, Great Britain, Germany and Canada. –Also found in emerging economies around the globe. Foreign Securities Markets

11-19  Federal and state laws regulate the sale of securities.  Purpose is to provide for adequate and accurate disclosure of financial information.  Securities and Exchange Commission (SEC) is the agency in charge of administering federal securities laws. Regulating the Securities Markets

11-20  Securities Act of 1933  Securities Exchange Act of 1934  Investment Company Act of 1940  The Sarbanes-Oxley Act of 2002  Others: –Maloney Act of 1938 Created the NASD –The Securities Investor Protection Act of 1970 Created the SIPC Regulating the Securities Markets

11-21  Bull market—generally rising securities prices for an extended period of time. –Reflects investor optimism. –Associated with favorable economy.  Bear market—generally falling securities prices for an extended period of time. –Reflects investor pessimism. –Associated with economic downturn. Market Trends

11-22 Making Transactions In the Securities Markets - Stockbrokers  Stockbrokers (account executives, financial consultants) buy and sell securities for investors.  Investor can select from full-service, discount, or online broker  Brokerage services  Consider brokerage fees when making securities transactions.

11-23 Types of Brokers

11-24 Brokerage Fees

11-25 Odd or Round Lots  ODD LOT: A quantity of fewer than 100 shares of a stock. –Odd-lot dealer –Odd-lot differential  ROUND LOT: A quantity of 100 shares of stock, or multiples thereof.

11-26  Securities Investor Protection Corp. (SIPC) protects customer accounts against financial failure of brokerage firm  SIPC insures accounts up to $500,000  Guarantees securities or cash held by broker will be replaced (does not guarantee dollar value of securities)  Arbitration used to settle disputes between brokerage firm and clients Investor Protection

11-27 Executing Trades  Investor must first establish account with broker.  Trades can be executed by phone, at the brokerage firm, or online.  Market orders generally take less than two minutes!

11-28 Investor places the order with the broker.

11-29 Investor places the order with the broker. Broker transmits order to the market via tele- communications equipment.

11-30 Investor places the order with the broker. Broker transmits order to the market via tele- communications equipment. Order is filled at the market by other buyers and sellers.

11-31 Investor places the order with the broker. Broker transmits order to the market via tele- communications equipment. Order is filled at the market by other buyers and sellers. Execution of the order is confirmed to the broker.

11-32 Investor places the order with the broker. Broker transmits order to the market via tele- communications equipment. Order is filled at the market by other buyers and sellers. Execution of the order is confirmed to the broker. Broker confirms order fulfillment. Investor has 3 days to settle account.

11-33 Types of Orders  Market order—trade now at best available price.  Limit order—trade when a specified price or better is reached; investor is seeking opportunity.  Stop-loss order—sell if price drops to certain price; investor is seeking to limit losses.

11-34 Margin Trading and Short Sales  Buying on Margin: allows investor to purchase securities on credit by borrowing part of purchase price from broker. Increases gains when returns are positive. Increases losses when returns are negative.

11-35 Short Sale Transactions  Allows investor to sell securities borrowed from the broker or broker's accounts.  Before period is over, investor must replace the borrowed securities. Investor loses if security’s price has increased. Investor profits if security’s price has declined.

11-36 To profit from short selling: Not only must the price of the security fall, but it must do so within the given time period. Short Sale Transactions

11-37 Becoming an Informed Investor  Types of information to follow: –Economic developments and current events –Alternative investment vehicles –Current interest rates and price quotations –Personal investment strategies

11-38 Available Investment Information  Annual Reports  Financial Press (WSJ and financial magazines)  Brokerage Reports  Advisory Services  Investment Advisors  On-Line Resources

11-39 Annual Stockholder Reports  Read the Highlights or Selected Financial Data sections  CEO’s letter to stockholders  Discussion of operations in management’s discussion and analysis section  Review financial statements and notes  Read the auditor’s report

11-40 Financial Press  Economic data  Market data –DJIA –S&P indexes –NYSE, NASDAQ, and other market indexes

11-41 Financial Press  Industry data  Company data  Stock quotes

11-42 Other Sources  Brokerage reports  Subscription advisory services  Investment advisors

11-43 Analyst Reports

11-44 Online Investing  Online services  Educational material  Investment tools –Investment planning –Research and screening –Portfolio tracking  Day trading

11-45 Tips for Successful Online Trades

11-46 Managing Your Investment Holdings  Build a diversified portfolio of securities based upon your goals and personal situation.  Allocate your assets according to your objectives.  Track your investments and rebalance your portfolio as your needs change.

11-47 Types of Investments Held by Average Individual Investors

11-48 Investor Characteristics  Level and stability of income  Family factors  Investment horizon  Net worth  Investment experience and age  Disposition toward risk

11-49 Investor Objectives  Trade-off between earning a high current income from an investment and  Obtaining significant capital appreciation from it.

11-50 Asset Allocation and Portfolio Management  How to divide portfolio among different types of securities  Total return on a portfolio is influenced far more by its asset allocation plan than by specific security selections.

11-51 Asset Allocation and Portfolio Management  Asset mix:

11-52 Asset Allocation and Portfolio Management  Reevaluate asset allocations regularly, especially when: –A major change in personal circumstances –Proportion of an asset rises or fall considerably –You’re close to reaching a particular goal

11-53 Keeping Track of Investments