© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Chapter Twenty Understanding Personal Finances and Investments 20 | 1 PRIDE HUGHES KAPOOR INTRODUCTION TO BUSINESS ELEVENTH EDITION

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Learning Objectives 1. Explain why you should manage your personal finances and develop a personal investment program. 2. Describe how the factors of safety, risk, income, growth, and liquidity affect your investment program. 3. Understand how securities are bought and sold. 4. Recognize how you can reduce investment risk and increase investment returns. 5. Identify the advantages and disadvantages of savings accounts, bonds, stocks, mutual funds, and real estate investments. 6. Describe high-risk investment techniques. 7. Use financial information to evaluate investment alternatives. 20 | 2

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Managing Your Personal Finances  Step 1: Tracking your income, expenses, assets, and liabilities Determine your current financial condition -Construct an income statement -Construct a balance sheet -Net worth–the difference between the value of your total assets and your total liabilities  Step 2: Developing a budget that works Personal budget–a specific plan for spending your income -Compare to actual income and expenses -Review periodically 20 | 3

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Managing Your Personal Finances (cont’d)  Step 3: Managing credit card debt Reduce or eliminate credit card debt before starting an investment program Warning signs that credit card spending is excessive -Inability to pay entire balance due each month -Use for many small purchases that surprisingly add up -Taking cash advances -Limit the number of cards held, use for emergencies -Get help if necessary. Compare to actual income and expenses -Review periodically 20 | 4

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Managing Your Personal Finances (cont’d)  Investment Goals Personal investment–the use of your personal funds to earn a financial return  Goals must be Specific and measurable Tailored to your particular financial needs Oriented toward the future Realistic in terms of economic conditions and opportunities  Advantages of long-term investing Accumulate money over twenty-to forty years for emergencies and retirement Value of investments grows 20 | 5

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Managing Your Personal Finances (cont’d)  Investment goals (cont’d)  Questions to consider when establishing goals What financial goals do you want to achieve? How much money will you need, and when? What will you use the money for? Is it reasonable to assume that you can obtain the amount of money you will need to meet your investment goals? Do you expect your personal situation to change in a way that will affect your investment goals? What economic conditions could alter your investment goals? Are you willing to make the necessary sacrifices to ensure that your investment goals are met? 20 | 6

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Managing Your Personal Finances (cont’d)  A personal investment program Involves a careful evaluation of different investment opportunities Financial planner -An individual who has had at least two years of training in investments, insurance, taxation, retirement planning, and estate planning and has passed a rigorous examination Begin by accumulating an emergency fund Invest funds according to your plan Monitor the plan 20 | 7

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Managing Your Personal Finances (cont’d)  Suggestions to help you accumulate the money needed to fund an investment plan Pay yourself first Take advantage of employer-sponsored retirement programs Participate in an elective savings program Make a special savings effort one or two months each year Take advantage of gifts, inheritances, and windfalls Source: Jack R. Kapoor, Les R. Dlabay, and Robert J. Hughes, Focus on Personal Finance, 3 rd ed. Copyright © 2010 by The McGraw Hill Companies, Inc. Reprinted with permission of The McGraw Hill Companies Inc., p | 8

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Important Factors in Personal Investment  Match potential investments with your goals in terms of several factors Safety and risk -Minimizing the risk of loss (e.g., investing in blue-chip stocks) -Maximizing potential returns by assuming some risk Investment income -Predictable income, interest, and dividends from stable investments (e.g., certificates of deposit, corporate and government bonds, and certain stocks) Investment growth -An increase in the value of an investment, such as mutual funds and real estate that appreciate in value Investment liquidity -The ease with which an investment can be converted into cash 20 | 9

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Managing Your Investments in an Economic Crisis  If you think the economy is about to take a nosedive, make sure your financial affairs are in order  Eight steps you can take Establish a larger than usual emergency fund Know what you owe Reduce spending Pay off credit cards Apply for a line of credit at your bank, credit union, or financial institution Notify credit card companies and lenders if you are unable to make payments Monitor the value of your investment accounts Consider converting investments to cash to preserve value  Don’t panic 20 | 10

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. How Securities Are Bought and Sold  Securities are usually exchanged with the help of an account executive or stockbroker  The primary market A market in which an investor purchases financial securities (via an investment bank) directly from the issuer of those securities  The secondary market A market for existing financial securities that are traded between investors 20 | 11

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. How Securities Are Bought and Sold (cont’d)  Brokerage firms and account executives Account executive–an individual, sometimes called a stockbroker or registered representative, who buys and sells securities for clients -Full-service broker—provides personal investment advice and other market and investing information -Discount broker—simply executes buy and sell orders for lower commissions than a full-service broker; does not offer advice 20 | 12

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. How Securities Are Bought and Sold (cont’d)  Brokerage firms and account executives (cont’d) Difficulties choosing an account executive -Trust that investment recommendations are made to enhance your wealth rather than earn commissions -Account executives are not generally liable for losses -Deciding to use a full-service or discount broker 20 | 13

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Steps in a Typical Stock Transaction on the NYSE 20 | 14 Figure 20.1

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. How Securities Are Bought and Sold (cont’d)  The mechanics of a transaction Market order -A request that a security be purchased or sold at the current market price Limit order -A request that a security be bought or sold at a price that is equal to or better than some specified price 20 | 15

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. How Securities Are Bought and Sold (cont’d)  Commissions Most brokerage firms have a minimum commission Additional commission charges are based on the number of shares and the value of stock bought and sold Generally, online transactions are less expensive when compared to trading through a full-service brokerage firm Full-service brokerages charge as much as 1 to 2 percent of the transaction amount Commissions for bonds, commodities, and options are lower than for stocks 20 | 16

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Typical Commission Costs Charged by Online Brokerage Firms Source: The BestCashCow.com Web site at accessed July 13, | 17 Table 20.2

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Regulation of Securities Trading  A regulatory pyramid of four different levels exists to make sure investors are protected 1st level: Federal regulation by the U.S. Congress -Securities Act of 1933 (Truth in Securities Act) -Provides for full disclosure -Requires registration statement about the corporation and a prospectus describing the new security -Additional legislation to curb insider trading -Sarbanes-Oxley Act 2nd level: Securities and Exchange Commission (SEC) -The agency that enforces federal securities regulations 3rd level: State regulation -States require registration of stock issues and licensing of brokers and securities dealers 20 | 18

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Regulation of Securities Trading (cont’d)  A regulatory pyramid of four different levels exists to make sure investors are protected (cont’d) 4th level: Self-regulation by securities exchanges and brokerage firms -NYSE has published rules, policies, and standards of conduct -Standards apply to every member -Each member firm the NYSE conducts business with is examined yearly -Individual brokerage firms are responsible to ensure their employees are highly trained and meet rigorous ethical standards 20 | 19

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Factors That Can Improve Your Investment Decisions  Portfolio management Depends on your investment goals, age, tolerance for risk, financial resources available for investment  Asset allocation, the time factor, and your age Asset allocation—the process of spreading your money among several different types of investments to lessen risk The time factor—investing for the long term or the short term based on when the money will be needed Age—growth-oriented investments for younger investors versus conservative investments for older investors 20 | 20

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. The More You Make, the More You Can Invest! Source: The U.S. Bureau of the Census, Statistical Abstract of the United States 2010 (Washington, DC: U.S. Government Printing Office), Table 676 ( 20 | 21

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Investment Alternatives 20 | 22 Table 20.3

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Factors That Can Improve Your Investment Decisions (cont’d)  Your role in the investment process Evaluate potential investments Monitor the value of your investments Keep accurate and current records 20 | 23

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Traditional Investment Alternatives  Bank accounts Advantages—bank accounts are safe (low risk) and have definite rates of return Disadvantage—low risk means low investment returns  Corporate bonds Primarily a long-term, income-producing investment with a value that fluctuates with market interest rates and the financial condition of the issuer  Convertible bonds Interest-bearing corporate bonds that can also be exchanged for a specific number of shares of common stock Bond market value is equal to the underlying value of the stock 20 | 24

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Traditional Investment Alternatives (cont’d)  Government bonds Considered risk free; pay low interest Treasury bills—sold in minimum units of $100; short maturities Treasury notes—issued in $100 units with maturity of one to ten years Treasury inflation-protected securities (TIPS)—issued in $100 units with maturity of five to thirty years, adjusted based on the consumer price index; upon maturity payment is the greater of the original principal or adjusted principal 20 | 25

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Traditional Investment Alternatives (cont’d)  Government bonds (cont’d) Treasury bonds—issued in minimum units of $100 with a thirty year maturity Savings bonds—(EE bonds) purchased for ½ their maturity value Municipal bonds—issued by a state or local government; may be exempt from federal taxes 20 | 26

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Traditional Investment Alternatives (cont’d)  Common stock Dividend payments -Stock dividend—a dividend in the form of additional stock -Dividend payments—cash payments as the result of a distribution of the company’s profits Increase in dollar value -Capital gain—the difference between a security’s purchase price and its selling price -Market value—the price of one share of a stock at a particular time Stock splits -The division of each outstanding share of a corporation’s stock into a greater number of shares -Reduces the stock price to a price range that management feels is attractive to investors 20 | 27

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Sample Common Stock Transaction Source: Price data and dividend amounts were taken from the Yahoo Finance website, accessed July 14, | 28 Table 20.4

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Traditional Investment Alternatives (cont’d)  Preferred stock Stock in a corporation that has a claim on the dividends that supersedes common stock Cumulative preferred stock -Stockholders have priority claim to full payment of all omitted dividends and corporate assets Convertible preferred stock -Stock that pays dividends and can also be exchanged for a fixed number of shares of common stock 20 | 29

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Traditional Investment Alternatives (cont’d)  Mutual funds and exchange traded funds A professionally managed investment vehicle that combines and invests the funds of many individual investors Closed-end funds -Funds with a fixed number of shares Open-end funds -Funds with an unlimited number of shares Exchange-traded fund -generally invest in the stocks or other securities contained in a specific stock or securities index 20 | 30

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Traditional Investment Alternatives (cont’d)  Mutual funds and exchange traded funds (cont’d) Net asset value (NAV) Current market value of a mutual fund’s portfolio minus the mutual fund’s liabilities and divided by the number of outstanding shares Net asset value Value of the fund’s portfolio – Liabilities Number of shares outstanding = 20 | 31

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Traditional Investment Alternatives (cont’d)  Mutual funds and exchange traded funds (cont’d) Load funds -Investors pay sales and purchase fees every time they purchase shares No-load funds -No sales or purchase fees are charged Yearly management fee Managed funds -Professional fund manager chooses securities in the fund Index funds -Managers buy stocks or bonds contained in an index (such as Standard & Poor’s 500) Family of funds -A group of mutual funds managed by one investment company 20 | 32

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Traditional Investment Alternatives (cont’d)  Mutual funds and exchange traded funds (cont’d) Types of mutual fund investments -Aggressive growth stock funds -Global stock funds -Growth stock funds -High-yield (junk) bond funds -Income stock funds -Index funds -Lifecycle funds -Long-term U.S. bond funds -Regional funds -Sector stock funds -Small-cap stock funds 20 | 33

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Traditional Investment Alternatives (cont’d)  Real estate Advantage -One of the best hedges against inflation Disadvantages -Risk of the property losing of value due to poor location -Buyers may be difficult to locate -Real estate market may be in decline at time of sale -Taxes, mortgage interest, and Installment payments can be a heavy burden 20 | 34

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Real Estate Checklist 20 | 35 Table 20.2

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. High-Risk Investment Techniques  Buying long Buying stocks expected to increase in value, which can then can be sold at a profit  Selling short The process of selling stock that an investor does not actually own but has borrowed from a brokerage firm and will repay at a later date Assuming that the stock is overvalued and will soon decrease in price, the investor intends to repay the brokerage later with less costly stock, resulting in a profit for the investor  Buying stock on margin Buying stock by borrowing part of the purchase price, usually from a stock brokerage firm -Margin requirement—the portion of the price of a stock that cannot be borrowed; set by the Federal Reserve Board 20 | 36

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. High-Risk Investment Techniques (cont’d)  Other high-risk investments Stock options Derivatives Commodities Precious metals Gemstones Coins Antiques and collectibles 20 | 37

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Reading Stock Quotations Source: Wall Street Journal, July 14, 2010, p. C4. 20 | 38 Figure 20.2

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Reading Bond Quotations Source: The Yahoo! Finance bond website at accessed July 18, | 39 Figure 20.3

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Reading Mutual Fund Quotations Source: Wall Street Journal, July 14, 2010, p. C | 40 Figure 20.4

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Sources of Financial Information  The Internet  Financial Coverage of Securities Transactions Newspaper coverage of securities transactions -Common and preferred stocks -Bonds -Mutual funds 20 | 41

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Sources of Financial Information (cont’d)  Other sources of financial information Professional advisory services -Moody’s, Standard & Poor’s, Fitch Ratings, Mergent, Value Line, Morningstar, Lipper Analytical Services Brokerage firm analysts’ reports Business periodicals -Business Week, Fortune, Forbes -Advertising Age -U.S. News & World Report, Time, Newsweek -Money, Kiplinger’s Personal Finance Magazine, Smart Money Corporate reports 20 | 42

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Mergent’s Research Report for The Coca-Cola Company Source: From Mergent’s Handbook of Common Stocks, Spring 2010 (New York: Mergent, Inc., copyright © 2010). Reprinted by permission of Mergent, Inc. 20 | 43 Figure 20.5

© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Sources of Financial Information (cont’d)  Security averages an average of the current market prices of selected securities -Stocks -Mutual funds -Bonds -Mortgage rates -Real estate -Most other investments 20 | 44