chapter twenty - csivc.csi.cuny.edu · 2 chapter 20 outline – preparing for an investment program...

1

Chapter Twenty

Understanding Personal Finances and Investments

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 decisions.

3. Understand how securities are bought and sold.4. Identify the advantages and disadvantages of savings

accounts, bonds, stocks, mutual funds, and real estate.5. Describe high‐risk investment techniques.6. Use financial information to evaluate investment

alternatives.

Copyright © Cengage Learning. All rights reserved. 20 | 2

2

Chapter 20 Outline

– Preparing for an Investment Program• Managing Your Personal FinancesManaging Your Personal Finances• Investment Goals• A Personal Investment Program• Important Factors in Personal Investment

– How Securities Are Bought and Sold• The Primary Market• The Secondary Market• The Role of an Account Executive• Regulation of Securities Trading


Chapter 20 Outline (cont’d)

– Traditional Investment AlternativesP tf li M t• Portfolio Management

• Asset Allocation, the Time Factor, and Your Age

• Bank Accounts

• Corporate and Government Bonds

• Common Stock

• Preferred StockPreferred Stock

• Mutual Funds

• Real Estate


3

Chapter 20 Outline (cont’d)

– High‐Risk Investment TechniquesS lli Sh t• Selling Short

• Buying Stock on Margin

• Other High‐Risk Investments

– Sources of Financial Information• The Internet

• Financial Coverage of Securities Transactions• Financial Coverage of Securities Transactions

• Other Sources of Financial Information

• Security Averages


Preparing for an Investment Program• Managing Your Personal Finances

– The use of your personal funds to earn a financial treturn

– Personal budget is a specific plan for spending income

• Investment goals– Personal investment goals must be

S ifi d bl• Specific and measurable• Tailored to individual needs• Focused on the future• Realistic in terms of economic conditions and

opportunitiesCopyright © Cengage Learning. All rights

reserved. 20 | 6

4

Preparing for an Investment Program (cont’d)

• Questions to consider when establishing goals– What financial goals do you want to achieve?

– How much money will you need and when?– 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?– What economic conditions could alter your investment goals?

– Are you willing to make the necessary sacrifices to ensure that your investment goals are met?

– What are the consequences of not obtaining your investment goals?



• A personal investment program– Involves a careful evaluation of different

investment opportunities

– Financial planner

– Begin by accumulating an emergency fund

– Invest funds according to your plang y p

– Monitor the plan


5


• Suggestions to help you accumulate the money needed to fund an investment plan– Learn to balance your budget

– Make savings a higher priority

– Take advantage of employer‐sponsored retirement programs

– Participate in an elective savings programp g p g

– Make a special savings effort one or two months each year

– Take advantage of gifts, inheritances, and windfalls

Copyright © Cengage Learning. All rights reserved. 20 | 9Source: Jack R. Kapoor, Les R. Dlabay, and Robert J. Hughes, Personal Finance, 9th ed. Copyright © 2009 by The McGraw Hill Companies, Inc.

.

Important Factors in Personal Investment

• Match potential investments with your goals in terms of several factors

– Safety and risk

– Investment income

– Investment growth

– Investment liquidity


6

Surviving a Financial Crisis

• To survive a financial crisis, many experts recommend that you take action before the crisis to make sure your financial affairs are in order

• Seven 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– 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


How Securities Are Bought and Sold• Securities are usually exchanged with the help of an

account executive or stockbroker• The primary marketThe primary market

– A market in which an investor purchases financial securities (via an investment bank) directly from the issuer of those securities

• Investment banking firm

• High‐risk investment


7

How Securities Are Bought and Sold (cont’d)

• The secondary market– A market for existing financial securities that are

traded between investors

– Securities exchange

– Over‐the‐counter (OTC) market( )

• Nasdaq



• The role of an account executive– An individual, sometimes called a stockbroker orAn individual, sometimes called a stockbroker or

registered representative, who buys and sells securities for clients

• Full‐service broker

• Discount broker


8


• The mechanics of a transaction

– Market order

– Limit order

– Discretionary order



• Online security transactions– Software can help investors evaluate potential

investments, manage investments, monitor value, and place buy and sell orders online

– Investors must still analyze the information and make decisions

– Online trading generally has lower costsProgram trading a computer driven program that– Program trading—a computer‐driven program that monitors the market value of particular stocks and enters buy or sell orders when those stocks reach specified prices


9


• Commissionsb k f h– 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 a percentage of the g g p gtransaction amount (as much as 1.5 to 2.0%)

– Commissions for bonds, commodities, and options are lower than for stocks


Regulation of Securities Trading

• A regulatory pyramid of four different levels i t t k i t t t dexists to make sure investors are protected

– 1st level: Federal regulation by the U.S. Congress

– 2nd level: Securities and Exchange Commission (SEC)

– 3rd level: State regulation

– 4th level: Self‐regulation by securities exchanges and brokerage firms


10

Traditional Investment Alternatives• Portfolio management• Asset allocation, the time factor, and your age

– Asset allocation

– The time factor

– Age


Traditional Investment Alternatives (cont’d)

• Bank accounts– Advantagesg

– Disadvantage

• Corporate bonds

• Convertible bondsCopyright © Cengage Learning. All rights

reserved. 20 | 20

11


• Government bonds– Considered risk free; pay low interestConsidered risk free; pay low interest– Treasury bills

– Treasury notes

– Treasury bonds

– Savings bonds

– Municipal bonds



• Common stock– Dividend income

• Stock dividendStock dividend

• Dividend payments

– Increase in dollar value• Capital gain

• Market value

– Stock splits


12


• Preferred stock– Stock in a corporation that has a claim on the p

dividends that supersedes common stock

– Cumulative preferred stock

Convertible preferred stock– Convertible preferred stock



• Mutual funds– A professionally managed investment vehicle that combines and

invests the funds of many individual investors

– Closed‐end funds

– Open‐end funds

– Net asset value (NAV)

Net asset value Value of the fund’s portfolio – Liabilities


Net asset value Value of the fund s portfolio LiabilitiesNumber of shares outstanding

=

• Current market value of a mutual fund’s portfolio minus the mutual fund’s liabilities and divided by the number of outstanding shares

13


• Mutual funds (cont.)– Load funds

– No‐load funds

– Yearly management fee

– Managed funds

– Index funds

– Family of funds



• 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– Long‐term U.S. bond funds– Sector stock funds– Small‐cap stock funds


14


• Real estate– AdvantagesAdvantages

– Disadvantages


High‐Risk Investment Techniques

• Buying longBuying stocks expected to increase in value which can then can– 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

• Buying stock on margin• Buying stock on margin– Buying stock by borrowing part of the purchase price, usually

from a stock brokerage firm• Margin requirement


15

High‐Risk Investment Techniques (cont’d)

• Other high‐risk i t tinvestments– Stock options

– Commodities

– Precious metals

– GemstonesGemstones

– Coins

– Antiques and collectibles


Sources of Financial Information

• The Internet– www bloomberg comwww.bloomberg.com

– http://money.cnn.com

– www.fool.com

– www.quicken.com

– www.sec.gov

– http://finance.yahoo.com

• Newspaper coverage of securities transactions– Common and preferred stocks

– Bonds

– Mutual funds


16

Sources of Financial Information• Other sources of financial information

– Investors’ services• Moody’s, Standard & Poor’s, Mergent, Value Line, Morningstar, Lipper y , , g , , g , pp

Analytical Services, Wiesenberger Investment Companies

– Brokerage firm analysts’ reports• UBS PaineWebber, Smith Barney, Merrill Lynch

– Business periodicals• Business Week, Fortune, Forbes• Advertising Age, Business Insurance• U.S. News & World Report, Time, Newsweek• Money, Kiplinger’s Personal Finance Magazine, Consumer Reports

– Corporate reports

• A security average (security index) is an average of the current market prices of selected securities


Sources of Financial Information (cont’d)

• Security averages– An average of the current market prices of

selected securities

– Dow Jones Industrial Average

– Standard & Poor’s 500 Stock Index

– New York Stock Exchange Composite Indexg p

– American Stock Exchange Index

– Nasdaq Composite Index


278

© 2010 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.1 Steps in a Typical Stock Transaction on the New York

Stock ExchangeS

tep

s in

a T

yp

ical S

toc

k T

ran

sactio

n

on

the N

ew

Yo

rk S

tock

Exch

an

ge

Account executive receives your order tosell stock and relays order electronically tobrokerage firm

’s representative on floor of NYS

E.1

Firm’s clerk signals transaction from

booth to broker on stock-exchange floor.

2

Broker goes to trading post w

here stock istraded w

ith a stock-exchange mem

ber who

has an order to buy.3

After the trade is executed, a notice is sentto the brokerage firm

and the consolidatedticker tape.

4

Sale appears on the ticker tape, and

confirmation is relayed to account executive,

who notifies you of com

pleted transaction.5

3768X_20_ch20_p278-291.indd 2783768X_20_ch20_p278-291.indd 278 3/6/09 9:32:16 PM3/6/09 9:32:16 PM

279


Pride/Hughes/Kapoor, BUSINESS, 10th editionTable 20.2 Typical Commission Costs Charged by Online Brokerage

Firms for a Transaction in Which 1,000 Shares Are Bought or Sold

Source: TD Ameritrade website, www.tdameritrade.com, accessed October 23, 2008.

Typ

ical C

om

mis

sio

n C

osts

Ch

arg

ed

by O

nlin

e B

rokera

ge F

irms fo

r a

Tra

nsactio

n in

wh

ich

1,0

00 S

hare

s

Are

Bo

ug

ht o

r So

ld

Inte

rnet

Inte

ractiv

eV

oic

e-R

esponse

Tele

phone S

yste

mB

roker-A

ssis

ted

TD Am

eritrade$ 9.9

9$

34

.99

$ 4

4.9

9

E*Trade

$12.9

9$

12

.99

$ 5

7.9

9

Fidelity$19.9

5$

67

.50

$18

1.0

0

Schw

ab$12.9

5$

17

.95

$ 3

7.9

5


280


Pride/Hughes/Kapoor, BUSINESS, 10th editionTable 20.3 Investment Alternatives

Investm

en

t Alte

rna

tives

ksi

R h

giH

la

noi

tid

arT

snoit

casn

art

troh

Sst

nuoc

ca k

naBC

orporate and government bonds

Margin transactions

snoit

po k

cot

Skc

ots

nom

moC

seiti

dom

moC

kcot

s de

rref

erP

slat

em

suoi

cerP

sdnu

f lau

tuM

seno

tsme

G e

tats

e lae

R

Coins/antiques/collectibles


281


Pride/Hughes/Kapoor, BUSINESS, 10th editionTable 20.5 Sample Common-Stock Transaction for General Mills

Sample Common-Stock

Transaction for General Mills

Source: Price data and dividend amounts were taken from the Yahoo Finance website, http://fi nance.yahoo.com, accessed October 26, 2008.

dloS nehW nruteRdesahcruP nehW tsoC

100 shares @ $48 $4,800 100 shares @ $64 $6,400

Plus commission + 55 Minus commission – 70

Total investment $4,855 Total return $6,330

Transaction Summary

033,6$nruter latoT

Minus total investment –4,855

574,1$elas kcots morf tiforP

Plus total dividends (3 years) + 455

039,1$noitcasnart siht rof nruter latoT


282


Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.2 Reading Stock Quotations

Reading Stock Quotations

Source: Wall Street Journal, October 28, 2008, p. C9.

1. Name (often abbreviated) of the corporation: Heinz2. Ticker symbol or letters that identify a stock for trading: HNZ3. Close is the price paid in the last transaction of the day: $39.454. Difference between the price paid for the last share sold today and the price paid for the last share sold on the previous day: –0.04 (in Wall Street terms, Heinz “closed down $0.04” on this day).

STOCK

HeinzHellenicHelmPayne

(SYM)

HNZOTEHP

39.455.65

25.14

–0.04–0.34–2.28

CLOSENETCHG

STOCK (SYM) CLOSENETCHG

Heinz

Hellenic

HelmPayne

HNZ

OTE

HP

39.45

5.65

25.14

–0.04

–0.34

–2.28

1 2 3 4


283


Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.3 Reading Bond Quotations

Reading Bond Quotations

Source: The Yahoo! Finance bond website: at http://bonds.yahoo.com, accessed October 28, 2008.

OVERVIEW

1. Price

2. Coupon (%)

3. Maturity Date

4. Yield to Maturity (%)

5. Current Yield (%)

6. Fitch Ratings

7. Coupon Payment Frequency

8. First Coupon Date

9. Type

10. Callable

86.57

5.600

15-Mar-2018

7.605

6.468

A

Semi-Annual

15-Nov-2008

Corporate

No

Price quoted as a percentage of the face value: $1,000 × 86.57% = $865.70

Coupon (%) is the rate of interest: 5.600 percent

Maturity Date is the date when bondholders will receive repayment: March 15, 2018

Yield to Maturity (%) takes into account the relationship among a bond’s maturityvalue, the time to maturity, the current price, and the amount of interest: 7.605 percent

Current Yield (%) is determined by dividing the dollar amount of annual interest bythe current price of the bond: ($56 ÷ $865.70 = 0.06468 = 6.468 percent)

Fitch Ratings is used to assess risk associated with this bond: A

Coupon Payment Frequency tells bondholders how often they will receive interestpayments: Semi-Annual

First Coupon Date: November 15, 2008

Type: Corporate

Callable: No

AT&T INC

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.


284


Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.4 Reading Mutual Fund Quotations

Reading Mutual Fund

Quotations

Source: Wall Street Journal, October 28, 2008, p. C11.

FUND

US SmCpValDodge & CoxBalancedIncomeIntl StkStock

13.81

48.1611.2220.9769.65

–0.57

–1.11–0.02–1.27–2.36

–41.6

–38.1–6.5

–54.4–47.1

NAVNETCHG

YTD%RET

US Sm CpVal

Dodge & Cox

Balanced

Income

Intl Stk

Stock

13.81

48.16

11.22

20.97

69.65

–0.57

–1.11

–0.02

–1.27

–2.36

–41.6

–38.1

–6.5

–54.4

–47.1

1. The name of the mutual fund: Dodge & Cox Income2. The net asset value (NAV) is the value of one share of the Dodge & Cox Income Fund: $11.223. The difference between the net asset value today and the net asset value on the previous trading day: –0.02 (in Wall Street terms, the “Dodge & Cox Income fund closed down $0.02” on this day)4. The YTD% RET gives the total return for the Dodge and Cox Income fund for the year to date: –6.5%

1

FUND NAVNETCHG

YTD%RET

2 3 4


285


Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.A Chapter Outline

Chapter 20 Outline

Understanding Personal Finances and Investments

Preparing for an Investment Program

– Managing Your Personal Finances

– Investment Goals

– A Personal Investment Program

– Important Factors in Personal Investment

How Securities Are Bought and Sold

– The Primary Market

– The Secondary Market

– The Role of an Account Executive

– Regulation of Securities Trading

Traditional Investment Alternatives

– Portfolio Management

– Asset Allocation, the Time Factor, and Your Age

– Bank Accounts

– Corporate and Government Bonds

– Common Stock

– Preferred Stock

– Mutual Funds

– Real Estate

High-Risk Investment Techniques

– Selling Short

– Buying Stock on Margin

– Other High-Risk Investments

Sources of Financial Information

– The Internet

– Financial Coverage of Securities Transactions

– Other Sources of Financial Information

– Security Averages


286


Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.B Class Exercise

Class Exercise

Rank the following investments on the

factors of safety, income, growth, and

liquidity. (7 = highest; 1 = lowest)

INVESTMENT SAFETY INCOME GROWTH LIQUIDITY

1. Bank

accounts

2. Selling

short

3. Commod-

ities

4. Govern-

ment

bonds

5. Buying

stock on

margin

6. Common

stock

7. Real estate


287


Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.C Debate Issue

Debate Issue

Should you use a full-service broker

or a discount broker?

FULL-SERVICE

BROKER

• Since small investors

need all the help they

can get, they should

use a full-service

broker.

• Full-service brokers

can provide detailed

research information

that can provide the

edge that small

investors need.

• The added services

provided by full-service

brokers are worth the

commissions they

charge.

DISCOUNT

BROKER

• Since small investors

invest their own money,

they should make their

own decisions.

• Some brokerage fi rm

reports are biased.

Also, reliable

information is available

on the Internet, at the

public library, or from

discount brokers.

• Small investors can

save money by using

discount brokers. Also,

most small investors do

not need all the services

that full-service brokers

offer.


288


Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.D Chapter Quiz

Chapter Quiz

1. A fi nancial statement that lists your personal assets, liabilities, and net worth is the a. retained earnings statement. b. personal income statement. c. personal balance sheet. d. personal asset sheet. e. risk-return statement.

2. __________ and risk are two sides of the same coin. a. Income b. Safety c. Liquidity d. Growth e. Investment

3. A(n) __________ market is a market in which an investor purchases fi nancial securities (via an investment bank) directly from the issuer of those securities. a. institutional b. third c. exchange d. primary e. secondary

4. A(n) __________ order to buy or sell a security lets the broker decide when to execute the transaction and at what price. a. market b. limit c. exchange d. discretionary e. monitored

5. When investors pay no sales charges to buy or sell a mutual fund, they have invested in a a. contingent deferred fund. b. no-load fund. c. load fund. d. restricted fund. e. managed index.


289


Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.E Suggestions to Help You Accumulate the Money Needed to

Fund an Investment

Suggestions to Help You Accumulate

the Money You Need to Fund an

Investment Program

1. Pay yourself fi rst. (Pay your monthly

bills, save a reasonable amount of

money, and use whatever money is left

over for personal expenses.)

2. Take advantage of employer-sponsored

retirement programs.

3. Participate in an elective savings

program and have money deposited in a

savings account or an investment

account.

4. Make a special savings effort one or two

months each year.

5. Take advantage of gifts, inheritances,

and windfalls.


290


Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.F Four Important Factors in Personal Investment

Four Important Factors in

Personal Investment

SAFETY

This factor in an investment means

minimal risk of loss

INCOME

This factor in an investment means

a predictable source of income

each year

GROWTH

This factor means that an investment will increase or

appreciate in value

LIQUIDITY

This factor means the ease with

which an investment can be

converted to cash


291


Pride/Hughes/Kapoor, BUSINESS, 10th editionFigure 20.G Mutual Fund Terminology

Mutual Fund Terminology

CLOSED-END FUNDS sell shares to investors only when the fund is originally organized.

OPEN-END FUNDS issue and sell new shares to any investor who requests them.

EXCHANGE-TRADED FUND is a fun that invests in the stocks contained in a specifi c stock index and whose shares are traded on a stock exchange.

NET ASSET VALUE (NAV) per share is equal to the current market value of their mutual fund’s portfolio minus the mutual fund’s liabilities, divided by the number of outstanding shares.


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