Principles of Finance Part 5

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Investors individuals who purchase investments with current savings in anticipation of relatively stable growth on average, or in the long term

Investment Concepts Speculators individuals who search for mispriced securities in an effort to earn abnormal returns

Investment Concepts Speculators gamble on whether the prices of financial assets believed to be mispriced will adjust accordingly in the market

Investment objectives 1.Retirement planning The Investment Process

Investment objectives 2.Supplement current income The Investment Process

Investment objectives 3.Shelter current income from taxes

The Investment Process Investment objectives 4.Achieve future goals

The Investment Process Income securities preferred stock corporate bonds steady dividend or interest payments

The Investment Process Investor’s attitude toward risk risk tolerance level an investor’s ability and willingness to tolerate, or accept, risk

Implementation to Achieve Investment Objectives Transaction costs the costs associated with trading securities, which include the costs of time, effort, and phone calls, as well as brokerage commissions that are incurred

Investment portfolio a combination of investment instruments Stock Bond Real Estate Implementation to Achieve Investment Objectives

Asset allocation the proportion of funds invested in various categories of assets, such as money market instruments, long-term debt, stocks, and real estate Implementation to Achieve Investment Objectives

Monitoring the investment positions 1.to make sure goals are met 2.to adjust to changing economic and legal conditions 3.to include new investment instruments

Securities Transactions Brokerage firms versus financial intermediaries broker agent (middleman) who helps investors trade financial instruments such as stocks, bonds, and derivatives investors directly provide funds to users of those funds

Securities Transactions Brokerage firms versus financial intermediaries financial intermediaries banks, credit unions, and S&Ls manufacture financial products such as mortgages, automobile loans, NOW accounts, or pension funds allow savers to indirectly provide funds to borrowers

Securities Transactions Brokerage firms full-service brokerage firm offers a variety of services to its clients, including research information, monthly publications that contain investment recommendations, advisory services, etc...

Securities Transactions Brokerage firms discount brokerage firm offers clients only the basic services associated with trading securities provides trade execution and related reporting requirements

Securities Transactions Trading securities trading quantities round lots -multiples of 100 shares odd lots - trades with shares that are not in multiples of 100

Securities Transactions Trading securities types of orders market order an order to execute a transaction at the best price available when the transaction reaches the market stop order an order that specifies the price at which an order to buy or sell at the market price (a market order) is initiated

Securities Transactions Trading securities types of orders limit order an order to buy or sell a stock at no worse than a specified price day order (DO) instruction to cancel an order if the price conditions are not met by the end of the trading day

Securities Transactions Trading securities types of orders good ‘til cancelled (GTC) indicates an order is active until the price limitations are met or until the investor cancels it fill or kill order instructs the broker to cancel the order if it cannot be executed immediately

Securities Transactions Trading securities evidence of ownership physical possession of shares registered in your name brokerage firm holds shares in street name (registered to the brokerage firm)

Securities Transactions Trading securities security insurance provided by most brokerage firms SIPC limit of $500,000 additional limits from private organizations

Investment Information Value Line Investment Survey Moody’s Investment Services Standard and Poor’s

Investment Information Newspapers New York Times The Wall Street Journal Barron’s Investor’s Business Daily Magazines Business Week Forbes Fortune Money

Investment Information Stock Quotes

Investment Information Bond Quotes

Investment Information Treasury Quotes

Individual security Computing Investment Returns

Holding period return (HPR) the return earned over the period of time an investment is held

Dividend yield the part of the total return associated with the dividends paid by the firm computed by dividing the amount of dividends paid by the stock price Capital gain (loss) change in the market value of a security Computing Investment Returns

Annualized rate of return Computing Investment Returns

Simple arithmetic average return computed by summing each return and then dividing by the number of returns does not consider compounding Computing Investment Returns

Simple arithmetic average return Computing Investment Returns

Geometric average return computed by taking the nth root of the growth multiple and subtracting 1.0 takes into account compounding

Geometric average return Computing Investment Returns

Computing the return on a portfolio

Indexes Measuring Market Returns Dow Jones Industrial Average (DJIA) 30 largest industrial firms in U. S. Standard & Poor’s family of indexes S&P 500, S&P 400, S&P Industrials Exchange indexes NYSE, AMEX, NASDAQ Russell 3,000 Wilshire 5,000

Indexes Measuring Market Returns Market capitalization the total market value of a firm’s stock computed by multiplying the number of shares outstanding by the market price per share

Indexes Measuring Market Returns Bull market rising stock market Bear market falling stock market

Alternative Investment Strategies Buy-and-hold strategy Strategy where investors purchase securities with the intent of holding them for a long period, perhaps a number of years

Alternative Investment Strategies Margin trading type of trade that allows an investor to borrow from his or her broker some portion of the funds needed to purchase an investment

Alternative Investment Strategies Margin requirement the minimum percent of the total purchase price an investor must have to buy stock (or other investments) on margin

Alternative Investment Strategies Hypothecation agreement assigns securities as collateral for a margin loan

Alternative Investment Strategies Broker loan rate the rate charged by brokers to borrow funds for margin trading

Alternative Investment Strategies Actual margin the percentage of investor’s equity must meet the margin requirement when the stock is purchased

Alternative Investment Strategies Actual margin

Alternative Investment Strategies Margin call a call from the broker to add more funds to a margined account Maintenance margin the lowest actual margin the broker will permit margined investors to have at any time

Alternative Investment Strategies Short selling type of trade that allows an investor to borrow the stock of another investor and then sell it, but with a promise to replace the stock at a later date cannot sell short on a downtick

Alternative Investment Strategies Downtick a decrease in price from one trade to another

Alternative Investment Strategies Uptick occurs when the price of the most recent trade is higher than the previous trade

Alternative Investment Strategies Zero-plus tick occurs when the price of the latest trade equals the price of the previous trade, but exceeds the price from one trade earlier Shorting against the box occurs when an investor short sells a stock he or she also owns refers to having the securities in a strong, or safe deposit, box

End of Chapter 16 Investment Concepts