Investing in Stocks and Bonds

Objectives Describe stocks and bonds and how they are used by corporations and investors. Define everyday terms in the language of stock investing. Classify stock according to their basic descriptive categories.

Objectives Describe the major characteristics of bonds. Differentiate among the four general types of bonds.

Objectives Describe what the investor should consider before investing in bonds, particularly the current yield and yield to maturity. List the advantages and disadvantages of investing in bonds.

Common stock Preferred stock Bonds Stocks and Bonds and How They are Used

Why do corporations issue common stock?  To raise money to start or expand a business  To help pay for ongoing business expenses  They don’t have to repay the money  Dividends are not mandatory  Stockholders have voting rights Investing in Stocks

Why Do Investors Purchase Stock? Income from dividends Dollar appreciation of stock value Increased value from stock splits

Common vs. Preferred Stock Common stock  get dividends depending on profit the company makes Preferred stock  receive cash dividends before common stock holders  pre-determined dividend rate  most preferred stock is callable

Calculating Total Return 100 shares of common stock purchased December 21, 2008, sold December 21, 2009; total dividedts of $2.60 per share for the investment period. Cost when purchased: Return when sold: 100 $71 $7, $89 $8,900 Commissions +55 Commissions - 70 Total investment $7,155 Total Return $8,830 Transaction Summary: Total Return $8,830 Minus Total Investment 7,155 Profit from Stock Sale $1,675 Plus Dividends +260 Total Return for the transaction $1,935

Features of Preferred Stock Cumulative preferred stock  unpaid cash dividends accumulate and are paid before cash dividends to common stock holders Participation feature  rare form of investment  can share in earnings beyond stated dividend amount Conversion feature  can be traded for shares of common stock

How to Evaluate a Stock Read stock quotes in a newspaper, such as the Wall Street Journal  52 week high and low  stock abbreviation and symbol  dividends per share in the last 12 months  percent yield  price earnings ratio  volume  high and low for the day  closing price and net change

Earnings per share (EPS) Price/earnings ratio (P/E ratio) Dividend payout ratio Market price Book value Language of Stock Investing

Market-to-book ratio Par value Total return Language of Stock Investing

Preemptive rights Stock dividends Stock splits Voting rights Language of Stock Investing

Classifications of Common Stock Income stocks Growth stocks Speculative stocks Other characterizations

Types of Stock Investments Blue chip stock  low risk  consistent dividends  ex. AT&T, Kellogg's, General Electric Income stock  higher than average dividends  ex. utility stock

Types of Stock Investments Growth stock -  earns above average profits  low or no dividends  Profits reinvested in company, so...  Stock price should go up  ex. Microsoft or Intel (continued)

Types of Stock Investments Cyclical stock  follows business cycles of advance and declines in the economy  ex. new construction, cars, timber Defensive stock  remains stable even if the economy is declining  ex. food and utility stocks (continued)

Numeric Measures to Consider When Evaluating a Stock Look at book value of one share  net worth of company divided by the number of outstanding shares  if a share costs more than the book value the company may be overextended or it may have a lot of money in research and development

Numeric Measures to Consider When Evaluating a Stock Look at the price earnings ratio  also called the P-E  price of one share of stock divided by the earnings per share of stock over the last 12 months  a low number means could be a good time to buy it, however many technology stocks have high P-Es Look at the beta for the stock  stock with a beta >1.0 means more volatility (continued)

Long-Term and Short Term Investment Strategies Buy-and Hold Technique Dollar Cost Averaging Direct Investment and Dividend Reinvestment Plan (DRIP)

Long-Term and Short Term Investment Strategies Day Trading Buying Stocks on Margin Selling Short Trading in options

Make a Decision to Sell Stocks 1. Stock reaches target price. 2. Favorable development temporarily push up price. 3. Good profits unlikely to continue. 4. Stock lags behind others in industry group. 5. Company profits begin to fall short of projections. 6. Industry/company prospects are deteriorating. 7. Losses are moderate. 8. Stock’s price/earnings ratio appears too high.

Corporate bond Face value Maturity date Bond indenture Debenture Mortgage bond Trustee Secured and unsecured Senior and subordinated Language of Bond Investing

Registered and bearer Callable Convertibility Bond Ladder Language of Bond Investing

Corporate bonds U.S. government securities  Treasury bills, notes, and bonds  Federal agency issues Municipal Bonds Types of Bonds

Tax Equivalent Yield Taxable equivalent yield = Tax exempt yield 1.0 – tax rate The taxable equivalent yield on a 5% tax- exempt municipal bond for a person in the 28% tax bracket is 6.94% =.0694 = 6.94%

Susceptibility to certain risks  Credit  Callability  Inflation  Interest rate Considerations Before Investing in Bonds

Premiums and discounts Current yield Yield to maturity Tax-equivalent yields When to sell Considerations Before Investing in Bonds

Approximate Market Value of a Bond Example: Shawn purchased a corporate bond that pays 4.5% interest based on a face value of $1,000. Comparable new corporate bond issues are paying 7%. How much is Shawn’s bond worth? Formula:Dollar Amount of Annual Interest = Approximate Market Interest Rate of Comparable Bonds Value A. Find the dollar amount of annual interest. Face Value of Bond x Annual Interest Rate = Dollar Amount of Annual Interest $1,000 x 4.5% = $45 B. Solve for approximate market value. Dollar Amount of Annual Interest = Approximate Market Interest Rate of Comparable Bonds Value $45 = $ %

Current Yield Assume you own a $1,000 corporate bond that pays 7% interest annually and matures on July 15, This means you will receive $70.00 annually. Also assume the market price is $940. The current yield is calculated:

Yield to Maturity

Corporate Bond Transaction Assume that on March 15, 1998, you purchased a 9.2% corporate bond. Your cost for the bond was $920 plus a $10 commission charge. Also assume that you held the bonds until March 15, 2008, when you sold them for the current value of $1,040.

Bond Ratings

Pay higher interest rates than savings Offer safe return of principle Have less volatility than stocks Offer regular income Require smaller initial investment Advantages of Investing in Bonds

No hedge against inflation Can be quite volatile Compounding is almost impossible Subject to investors tax rate Poor marketability Disadvantages of Investing in Bonds