investment concepts chapter 16. investment concepts uinvestors f individuals who purchase...

Investment ConceptsInvestment Concepts

Chapter 16


Investors individuals who purchase investments with

current savings in anticipation of relatively stable growth on average, or in the long term


Speculators individuals who search for mispriced

securities in an effort to earn abnormal returns


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 ProcessThe Investment Process

Investment objectives 2. Supplement current income



Investment objectives 3. Shelter current income from taxes


Investment objectives 4. Achieve future goals


Income securities preferred stock corporate bonds steady dividend or interest payments


Investor’s attitude toward risk risk tolerance level

an investor’s ability and willingness to tolerate, or accept, risk

Implementation to Achieve Implementation to Achieve Investment ObjectivesInvestment 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



Asset allocation the proportion of funds invested in various

categories of assets, such as money market instruments, long-term debt, stocks, and real estate


Monitoring the investment positions to make sure goals are met to adjust to changing economic and legal

conditions to include new investment instruments

Risk tolerance Time frame

Investment AlternativesInvestment Alternatives

Securities TransactionsSecurities 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


Brokerage firms versus financial intermediaries financial intermediaries

banks and S&Ls manufacture financial products such as

mortgages, automobile loans, NOW accounts, or pension funds

allow savers to indirectly provide funds to borrowers


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...


Brokerage firms discount brokerage firm

offers clients only the basic services associated with trading securities

trade execution and related reporting requirements


Trading securities trading quantities

round lots

– multiples of 100 shares odd lots

– trades with shares that are not in multiples of 100

Securities TransactionsSecurities 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 TransactionsSecurities 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


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


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)


Trading securities security insurance

provided by most brokerage firms SIPC limit of $500,000 additional limits from private

organizations

Investment InformationInvestment Information

Value Line Investment Survey Moody’s Investment Services Standard and Poor’s New York Times The Wall Street Journal


Barron’s Investor’s Business Daily Business Week Forbes Fortune Money


Stock Quotes


Bond Quotes


Treasuries Quotes

Individual security

01 P - P INC

investment of investment of received return

value Beginning - value Ending Income Dollar

+=

+=

Computing Investment Computing Investment ReturnsReturns


Holding period return (HPR) the return earned over the period of time

an investment is held

( )(HPR)

return

period Holding

P

P - P INC

return

investment of value Beginning

investment of investment of

value Beginning - value Ending Income

k of Rate

0

01 =+

=

⎟⎟⎠

⎞⎜⎜⎝

⎛+

==

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


Annualized rate of return

( )⎟⎠

⎞⎜⎝

⎛×+

=TP

P - P INC k

0

01 360


Simple arithmetic average return computed by summing each return and

then dividing by the number of returns does not consider compounding


Simple arithmetic average return

N

k

N

kkk K

N

1tt

N21A

∑==

+++=

L



Geometric average return computed by taking the nth root of the

growth multiple and subtracting 1.0 takes into account compounding

Geometric average return

( ) ( ) ( )[ ]

( ) 01

01111

1

.k1

.kkk1 K

NN

1tt

NN21G

−⎥⎦

⎤⎢⎣

⎡+=

−+××+×+=

∏=

L



Computing the return on a portfolio

∑=

=

+++=

⎟⎟⎟⎟

⎠

⎞

⎜⎜⎜⎜

⎝

⎛

++⎟⎟⎟⎟

⎠

⎞

⎜⎜⎜⎜

⎝

⎛

+⎟⎟⎟⎟

⎠

⎞

⎜⎜⎜⎜

⎝

⎛

=

n

1jjj

nn1111

N21p

kw

kw k w k w

k

valuePortfolio

NSecurity of Value

k

valuePortfolio

2Security of Value

k

valuePortfolio

1Security of Value

k

L

L

IndexesIndexesMeasuring Market ReturnsMeasuring 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


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


Bull market a rising stock market

Bear market a falling stock market

Alternative Investment Alternative Investment StrategiesStrategies

Buy-and-hold strategy strategy allowing investors to purchase

securities with the intent to hold them for a long period, perhaps a number of years


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


Margin requirement the minimum percent of the total purchase

price an investor must have to buy stock (or other investments) on margin


Hypothecation agreement assigns securities as collateral for a margin

loan


Broker loan rate the rate charged by brokers to borrow

funds for margin trading


Actual margin the percentage of investor’s equity must meet the margin requirement when

the stock is purchased


Actual margin

investment of valueMarket

equity sInvestor'

⎟⎟⎠

⎞⎜⎜⎝

⎛×

⎟⎟⎠

⎞⎜⎜⎝

⎛−⎟⎟

⎠

⎞⎜⎜⎝

⎛×

=

share

per Price shares #

borowed

Amount

share

per Price shares #


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


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


Downtick a decrease in price from one trade to

another


Uptick occurs when the price of the most recent

trade is higher than the previous trade


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 16End of Chapter 16

Investment Concepts

investment concepts chapter 16. investment concepts uinvestors f individuals who purchase...

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