Economics

Stocks and Bonds

SecuritiesSecurities refers to bonds, stocks and other documents that are sold by

corporations and governments to raise large sums of $$$$.

These investments are commonly divided into 2 major categories:

1 2

Debt Securities: when companies borrow $

Equity Securities: (stock) shows ownership

Debt Securities• When a company borrows money. Examples of

debt securities are

– US Savings Bonds– Municipal Bonds (from town/city)– Government Bonds (from federal government)– Corporate Bonds (sold by companies)– Mutual Funds (both debt and equity because

they are a combination of stocks and bonds)– Treasury Bills (from government)

• Bondholders are creditors of an organization that he/she bought the bond from.

Equity Securities: Investing in Stocks

• You become part owner of a business

• Stock certificate represents ownership in a company.• Dividends = profit. It’s the money paid to investors from a

portion of the company’s profits.

• Equity Securities have High risk …High return potential.

• Bond holders are paid first in good times or bad times.• Stockholders may not get paid at all in bad

times/bankruptcy

Investing in Stocks (cont).

• Publicly held Corporation – anyone in public can purchase stock of the corporation.

• Privately Held Corporation – only a select group of people can buy stock of the corporation.

• IPO – Initial Public Offering – formal name for going public. Company puts up it’s stock for sale.

Stocks (cont)

• Market value – price that is bought and sold on the market at one particular time – this is determined by how well the business is doing.

• Investor- someone who makes an investment (buys stocks, bonds, puts $ in savings accounts, etc)

• Portfolio- a collection of stocks owned by an investor.

Preferred stock vs. Common stock

• PS owners get paid dividends first.

• Less risk than common stock

• No voting rights in a corporation.

• CS owners are invited to shareholder meetings.

• Are paid dividends after preferred stock holders.

• CS holders have more potential to make money – higher risk … higher earnings.

• Stockbroker – licensed specialist in the buying and selling of stocks and bonds

• Commission- fee for selling stocks and bonds.

– Full service broker – provides you with information about securities you may want to buy.

– Discount broker – places orders only. Charges lower commission.

– Full service broker charges higher commission than a discount broker but provides more services to investor.

Stockbrokers

Stock Exchange

• Brokers work through stock exchanges – business organizations that accommodate the buying an selling of securities.

– NYSE – New York Stock Exchange• Mainly large companies

– AMEX – American Stock Exchange• Medium size companies

– NASDAQ – National Association of Securities Dealers Automated Quotation

• smaller companies

• Dow Jones Industrial Average - average value of 30 large, industrial stocks. Big companies like General Motors, Goodyear, IBM and Exxon are the kinds of companies that make up this index.

• Today, the 30 Dow Jones Industrial Average stocks are all top companies in their industries.

• The average is calculated second-by-second

throughout the U.S. trading day, giving investors an idea of how the market is trading at any point in time.

Averages used to Measure Stocks

• S & P 500- is the average value of 500 different large companies including industrial, transportation, utility, and financial sectors.

• The S&P 500 is a market value weighted index - each stock's weight in the index is proportionate to its market value.

Averages to Measure Stocks (con’t)

• Russel 2000 -tracks the average of 2,000 smaller companies.

• The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equities.

Averages to Measure Stocks (con’t)

• Bull Market- a period when overall prices of stock are rising-optimism is occurring-economy is up

• Bear Market – a period when overall prices of stock are declining-pessimism is occurring-economy down

• SEC- Securities and Exchange Commission –agency that regulates companies and stocks to protect investors.

Bull vs. Bear Market

What do you look for in choosing a stock?

• Company’s net worth

• Amount of debt

• Sales revenue (how much $ they bring in)

• Profits

• Dividend history

• Current outlook for the company’s product and service.

SEC requires companies to file detailed reports electronically.

If you are considering investing in a company, you should ask the following

questions …1. Has the company been profitable over a period

of years?2. Have the company’s managers made good

business decisions?3. Does the company have growth potential in

coming years?4. Does the company have an unusually large

amount of debt?5. How does the company compare with others in

its industry.

You should also consider …

• The yield of a stock Dividend = Dividend per share

Market Price p/share

The higher the better

And …

• Price Earnings Ratio – The ratio of a stock’s selling price to its

earnings per share.– It gives you an indication of whether the stock

is priced too high or low in relation to its earnings per/share.

The lower ratio the better

Price-Earnings Ratio (P/E Ratio)• Price-earnings ratio is the relationship between the market

value per share and earnings per share of stock.

• It’s calculated as market price per share divided by earnings per share.

• Investors use this ratio to determine the price of stock relative to the earnings.

• Low P/E ratios typically mean a company has slow growth.

• High P/E ratios typically mean that a company will have high growth in future earnings.

Example• Company ABC reported earnings of $10 per share,

while company XYZ has reported earnings of $20 per share.

• Each is selling on the stock market for $50. What does this mean?

• Company ABC has a P/E ratio of 5 (50/10), while Company XYZ has a P/E ratio of 2 ½ (50/20). This means that company XYZ is much cheaper on a relative basis.

• For every share purchased, the investor is getting $20 of earnings as opposed to $10 in earnings from ABC.

• All else being equal, an intelligent investor should opt to purchase shares of XYZ; for the exact same price ($50), he is getting twice the earning power.

PE RatioPE Ratio

• ExampleExample: A stock is currently trading at $43 and the earnings over the last 12 months $1.95 per share

• PE Ratio=43/1.95=$22.05

Price EarningsRatio

=Earnings

perShare

÷Market Price

per Share

Earningsper Share

=Number of

SharesOutstanding

÷Net Incomeafter FederalIncome Tax

FINANCIAL RATIOSpage 459

Earnings per Share

Price-Earnings Ratio

$32.13=2,500÷$80,313.95

10.7=$32.13÷$345.00

What do you look for in choosing a stock?

• Company’s net worth

• Amount of debt

• Sales revenue (how much $ they bring in)

• Profits

• Dividend history

• Current outlook for the company’s product and service.

SEC requires companies to file detailed reports electronically.

What is a bond?

• A bond is a certificate representing a promise to pay a definite amount of $ at a state interest rate on a specified maturity date.

• By buying a bond, you become a creditor of the organization and in return your $ is used to help build the company.

More about Bonds

• Corporate bonds – bonds issued by a corp.• Government bonds - bonds issued by the

government.• Face value – AKA maturity value – the amount

you buy the bond for.• Bonds are sold in Bond Markets• Some risk (more in corporate bonds)• Bond prices are determined by buyers and sellers

in the bond market.

Government BondsMunicipal Bonds US Savings Bonds

Exempt from Federal and most state income taxes.

Low/no risk

Interest usually not as high as corp. bonds.

Can invest small amounts

Usually sold in amounts of $1,000 or more.

Series EE savings bonds

Very low risk $50 – 10,000

Payroll deductions

Tax deferred

Bonds cont.• Interest earned = purchase price – redemption

(payoff value)• The time it takes for a bond to mature will be

determined by the economy and current interest rates.

• Purchase limit $20,000 (face value) as of January, 2008

•Pays interest when bond is cashed•Can be purchased at any financial institution.

Bonds (cont)

• Bonds pay interest when the bond is cashed in or periodically depending on the type of bond purchased.

• (Ex. Series EE pays interest when the bond is cashed in)

• Bonds can be purchased at any financial institution.

• Bonds continue to earn interest after the maturity date.

Mutual Funds

• Consist of buying and selling a variety of stocks and bonds in one family.

• Less risk because where one stock goes down another may go up and it offsets the loss.

Investment Tradeoffs

Investment Safety Liquidity Rate of return

Savings acct

$ market

CD

Gvt bonds

Corp bonds

Pf stock

Cm stock

Mutual funds

Online Investing

• Becoming a standard practice for many individual investors

• Get quotes for companies• Buy and sell stocks• Maintain a portfolio of your investments• Learning tips for new investors• Research company news, income statements,

annual reports, and stock performance histories.