1. Personal Finance Investing Basics
Bill Klinger

2. Personal Finance
Review
Exam

3. Investing First things first Securities
Pay off debts before investing. Why?
Example
Securities
Stocks, bonds, or money market instruments that represent an obligation on the part of the issuer.

4. Securities Three major asset classes There are others Asset allocation
Cash
Bonds (fixed income)
Stocks (equities)
There are others
Real estate
Commodities
Collectables
Asset allocation
The percent of your assets in each category
Very important concept in investing

5. Securities Markets
Primary Market—market where new security issues are first sold to investors; the issuer receives the proceeds from the sale.
Initial Public Offering (IPO)
Secondary Market—financial markets where previously issued securities are traded among investors.
Examples: NY Stock Exchange and the NASDAQ
Firm makes no money on price changes

6. Returns and Rates Nominal Real Quoted rate or amount The printed value
Subtracts inflation
Real rate = nominal rate – inflation rate

7. Cash Money Market Instruments—short-term debt securities
Mature within one year
Examples:
U.S. Treasury Bills,
Commercial paper,
Repurchase agreements
Certificates of Deposit (CDs)
Treasury Bills are special
The “risk-free asset”
Returns come from interest
Generally low-risk securities that are purchased by investors when they have surplus cash.

8. Stocks (Equities) Represent ownership in a firm Types Markets
Common
Preferred
Markets
Primary
IPO
Secondary
Investors
Institutional
Individual
Market cap
Value of company = (price of a share of stock) x (# of shares)

9. Equity Returns Dividends Change in price
Profits returned to the owners
Optional for common stock
Required for preferred stock
Usually quarterly
Sometimes one-time event
Change in price
Based on investors’ view of a firm’s future
Will cause a capital gain or loss

10. Bonds (Fixed Income) Long-term debt Corporate Municipal Federal
State and local government
Federal
Treasure Bonds (>2 year maturity)
Returns
Interest
Capital gain / loss if sold before maturity

11. Investment Return Holding period return (total return) Stocks
return = (priceend – pricebeginning + dividend) / pricebeginning
Bonds
return = (priceend – pricebeginning + interest) / pricebeginning

12. Taxes on Returns Ordinary income tax Capital gains tax
Taxed at marginal rate
Interest
Dividends
Capital gains for securities held less than 1 year
Capital gains tax
Currently 15%
On sale of securities held more than 1 year
Do example exhibit 14.1

13. Investment Risks Systemic risks Idiosyncratic risk Inflation
Risks that all investments share
Economy
Terrorism
Government laws and actions (e.g. the Fed)
Idiosyncratic risk
Risk unique to a firm
E.g. Exploding smart phone, E.coli in food, sticking gas pedals
Inflation

14. Measuring Risk Range of returns Standard deviation
Subjective evaluation

15. Exercise Deal or No Deal What affects your decision?
You have a 50/50 chance of getting either $500,000 or $1. I offer you either those odds or $200,000 guaranteed. What do you take?
You have a 50/50 chance of either losing $100 or losing $1. I offer you either those odds or a guaranteed loss of $45. What do you take?
What affects your decision?
Expected value
Expected utility

16. Investment Risks
Cash
Stocks (equities)
Bonds (fixed-income)

17. Average Annual Return Since 1925
Risk – By Asset Class
Worst Annual Return
Since 1925
Average Annual Return Since 1925
Stocks
-43.4%
(-67.6% worst 12 mo.)
9.6% (162.9% best 12 mo.)
Bonds
-7.8%
5.5%
Cash
.1%
3.7%
Sources: personal.fidelity.com, Morgan Stanley, Federal Reserve – St. Louis

18. In Class
In groups of two
Chapter 14 Financial Planning Problems