Savings and Investment

Should you Invest? Why do you come to school today? Besides having a burning desire to learn economics, you expect to get some benefit (or return) for your investment of time and energy. Return is the money an investor receives above and beyond the sum of money initially invested. You came to school because you know that graduating significantly increased the chances of getting a well-paying job . People invest there money for similar reasons Example: If you invest $10 a week at 15% rate of return, you would have $100,000 by the time you are 40

Why are some investments more profitable? Return and Liquidity Savings accounts have greater liquidity, but in general have a lower rate of return. Certificates of deposit usually have a greater return but liquidity is reduced. Return and Risk Investing in a friend’s Internet company could double your money, but there is the risk of the company failing. There is a clear relationship between risk and return…

Risks vs. Rate of Return Nearly all investments share one characteristic… …the less risk, the less return. …the greater the risk, the greater the return.

Types of Investments

Types of Investments Let’s use an example to demonstrate three types of investments. Pretend you are going to start a lemonade stand. You need some money to get your stand started. What do you do? You ask your grandmother to lend you $100 and write this down on a piece of paper: "I owe you (IOU) $100, and I will pay you back in a year plus 5% interest." Your grandmother just bought a bond (IOU) by lending money to your "company" named Lemo. Now you need more money… To get more money, you sell half of your company for $50 to your brother Tom. You put this transaction in writing: "Lemo will issue 100 shares of stock. Tom will buy 50 shares for $50." Tom has just bought 50% of the shares of stock from Lemo.

Revenue – Costs = Profit You sell $500 worth of lemonade. Business is good. Your costs for setting up the stand are $150, plus you pay yourself $100 for the hours you work. The company makes a profit of… Revenue – Costs = Profit $500 - $250 = $250 After one year, from the $250 profits, you pay back your grandmother $100 plus $5 interest. You pay $20 to Tom and yourself, shareholders. This $20 paid to the owners is called a dividend. You decide to put the dividend money in the bank. Banking the money is a short-term investment. We just covered three types of investments: Bonds, Stocks, and Short-term Investments.

Most bonds are low risk, which means… …low returns (4-5% Returns) What are Bonds? Bonds are basically loans, or IOUs, that represent debt that the government or a corporation must repay to an investor. Ex: War Bonds During World War II The person who writes the IOU is the issuer The person who gets the IOU is the holder Most bonds are low risk, which means… …low returns (4-5% Returns)

How do bonds work? Bonds have three basic components: Example: 1. The coupon rate is the interest rate that the bond issuer will pay to the bondholder. 2. A bond’s maturity is the time at which payment to the bondholder is due. 3. A bond’s par value is the amount that an investor pays to purchase the bond and that will be repaid to the investor at maturity. Example: A company called Callahan Auto wants to create a new break pads division so they sell bonds to get money. You buy a bond for $500

Example The Par Value= $500 Coupon Rate= 10% annually Maturity= 5 Years How much would you earn from the bond in 10 Years? 10% of $500 = ____ is paid each year $50 x 5 = ____ $250 (a 50 % return) What happens when the bond reaches maturity? The firm pays you back the par value.

Advantages and Disadvantages to Bond Issuers Bonds are desirable from the issuer’s point of view for two main reasons: 1. Once the bond is sold, the coupon rate for that bond will not go up or down. 2. Unlike stock, bonds are not shares of ownership in a company. Bonds also have two main disadvantages to the issuer: 1. The company must make fixed interest payments, even in bad years when it does not make money. 2. If the issuer does not maintain financial health, its bonds may get a lower bond rating. This makes it harder to sell future bonds.

There are several different types of bonds (pg 280) High or Low Risk? High or Low Returns?

There are several different types of bonds (pg 280) High or Low Risk? High or Low Returns?

There are several different types of bonds (pg 280) High or Low Risk? High or Low Returns?

There are several different types of bonds (pg 280) High or Low Risk? High or Low Returns?

There are several different types of bonds (pg 280) High or Low Risk? High or Low Returns?

Short-Term Investments Certificates of Deposit Certificates of deposit (CDs) are funds that are deposited for a fixed amount of time (6 months -3 Years). CDs have low liquidity but various terms of maturity, This allows investors to plan for future financial needs. Ex: If you inherited $3000 that will go toward college. Instead of leaving it in the bank, put it in a CD. Money Market Mutual Funds Money market mutual funds pool the money of many people to buy stocks and bonds. Investors receive higher interest on a money market mutual fund than they would receive from a savings account or a CD. However, assets in money market mutual funds have more risk

The Stock Market

A portion of stock is called a share (aka: equities) Buying Stock Corporations can raise money by issuing stock, which represents ownership in the corporation. A portion of stock is called a share (aka: equities) Stockowners can earn a profit in two ways: 1. Dividends, which are portions of a corporation’s profits, are paid out to stockholders of many corporations. The higher the corporate profit, the higher the dividend. 2. A capital gain is earned when a stockholder sells stock for more than he or she paid for it. A stockholder that sells stock at a lower price than the purchase price suffers a capital loss.

Decision-Making Differences Types of Stock Stocks may be classified by… whether or not they pay dividends whether or not the stockholder has a say in the corporation’s affairs. Dividend Differences Income stock pays dividends at regular times during the year. Growth stock pays few or no dividends. Instead, the issuing company reinvests earnings into its business. Decision-Making Differences Investors who buy common stock are voting owners of the company. Preferred stock owners are nonvoting owners of the company, but receive dividends before the owners of common stock.

Stock Splits and Stock Risks A stock split is the division of a single share of stock into more than one share. Stock splits occur when the price of a stock becomes so high that it discourages potential investors from buying it. Risks of Buying Stock Purchasing stock is risky because the firm selling the stock may encounter economic downturns That force dividends down or reduce the stock’s value. It is considered a riskier investment than bonds.

How are stocks traded? What is a stockbroker? a person who links buyers and sellers of stock. Stockbrokers work for brokerage firms, or businesses that specialize in trading stock. Some stock is bought and sold on stock exchanges, or markets for buying and selling stock.

Stock Exchanges The New York Stock Exchange (NYSE) NASDAQ-AMEX The NYSE is the country’s largest stock exchange. Only stocks for the largest and most established companies are traded on the NYSE. NASDAQ-AMEX NASDAQ-AMEX is an exchange that specializes in high-tech and energy stock. The OTC Market The OTC market (over-the-counter) is an electronic marketplace for stock that is not listed or traded on an organized exchange. Daytrading Daytraders use computer programs to try and predict minute-by-minute price changes in hopes of earning a profit.

The ups and downs of daytrading…

Measuring Stock Performance Bull and Bear Markets When the stock market rises steadily over time, a bull market exists. Conversely, when the stock market falls over a period of time, it’s called a bear market. Stock Performance Indexes The Dow Jones Industrial Average The Dow is an index that shows how stocks of 30 companies in various industries have changed in value. The S & P 500 The S & P 500 is an index that tracks the performance of 500 different stocks.

The collapse of the stock market in 1929 is called the Great Crash. Causes of the Crash Many ordinary Americans were struggling financially: many purchased new consumer goods by borrowing money. Speculation, or the practice of making high-risk investments with borrowed money in hopes of getting a big return, was common. Effects of the Great Crash The Crash contributed to a much wider, long-term crisis (the Great Depression) during which many people lost their jobs, homes, and farms. Depression lead to more government involvement in the economy Now Americans are wary of buying stock.